Trupanion : Q2 2022 Earnings Conference Call Transcript

Trupanion, Inc.

Second Quarter 2022 Earnings Conference Call

August 3, 2022

Trupanion, Inc. - Second Quarter 2022 Earnings Conference Call, August 3, 2022

C O R P O R A T E P A R T I C I P A N T S

Laura Bainbridge, Investor Relations

Darryl Rawlings, Chief Executive Officer

Margi Tooth, President

Drew Wolff, Chief Financial Officer

Tricia Plouf, Chief Operating Officer

C O N F E R E N C E C A L L P A R T I C I P A N T S

John Barnidge, Piper Sandler

Shweta Khajuria, Evercore ISI

Joshua Shanker, Bank of America

Katie Saki, Autonomous Research

Maria Ripps, Canaccord Genuity, Inc.

Jonathan Block, Stifel

Elliot Wilbur, Raymond James

P R E S E N T A T I O N

Operator

Greetings, and welcome to the Trupanion, Inc. Second Quarter 2022 Earnings Conference Call.

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Laura Bainbridge, Investor Relations. Thank you. Please go ahead.

Laura Bainbridge

Good afternoon, and welcome to Trupanion's Second Quarter 2022 Financial Results Conference Call. Participating on today's call are Darryl Rawlings, Chief Executive Officer; Margi Tooth, President; and

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Trupanion, Inc. - Second Quarter 2022 Earnings Conference Call, August 3, 2022

Drew Wolff, Chief Financial Officer. Similar to prior earnings calls, Tricia Plouf, Chief Operating Officer, will be available for the Q&A portion of today's call.

Before we begin, I would like to remind everyone that during today's conference call we will make certain forward-looking statements regarding the future operations, opportunities, and financial performance of Trupanion within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release, which can be found on our Investor Relations website, as well as the Company's most recent reports on Forms 10-K and 8-K filed with the Securities and Exchange Commission.

Today's presentation contains references to non-GAAP financial measures that Management uses to evaluate the Company's performance, including without limitation variable expenses, fixed expenses, adjusted operating income, acquisition costs, internal rate of return, Adjusted EBITDA, and free cash flow. When we use the term "adjusted operating income" or "margin," it is intended to refer to our non-GAAP operating income or margin before new pet acquisition and development expense. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with the U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release or on Trupanion's Investor Relations website under the Quarterly Earnings tab.

Lastly, I would like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site.

With that, I will hand the call over to Darryl.

Darryl Rawlings

Thanks, Laura. Good afternoon.

Q2 revenue was up 30% year-over-year. More importantly, our adjusted operating income, or the profits we earned from our existing pets before we invest in growth, grew approximately 13%, or 16% on a constant currency basis. We invested about $20 million acquiring new pets at an estimated 31% internal rate of return, an additional $2 million in development expenses and nearly $6 million repurchasing shares of our common stock.

With the strength of our balance sheet and available cash, we are well capitalized to invest in areas where we can achieve strong rates of returns. In our large underpenetrated market, investing compounding amounts of adjusted operating income at our high internal rates of return is the key to our value creation.

In the quarter, we added over 61,000 new pets. For context, this is up about 10% year-over-year and up about 14% from year-end. Growth was driven by leads and a modest improvement in conversion. In the quarter, we also soft launched Chewy, rolled out the Aflac offerings to brokers serving larger companies, and made progress internationally. We're humbled by the trust these partners have placed in us and are excited to see how these partnerships play out over time. But what I'm most excited about is that after years of shouting from the rooftops that veterinarians should be raising their prices faster, we're finally starting to see it in our data. This is very good news, most notably for veterinarians and their staff, but also for Trupanion. I'll elaborate.

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Trupanion, Inc. - Second Quarter 2022 Earnings Conference Call, August 3, 2022

Over the course of the past year, we've been monitoring veterinary inflation at an extremely granular level. Earlier in the year, we highlighted a return to pre-pandemic frequency, or the number of veterinary visits per pet for accident and illness. In the past month or so, we've also begun to see an accelerated increase in the size or dollar amount of the average invoices we are receiving. The combination of invoice size, what veterinarians charge, and the frequency of accidents and illness related to veterinary visits makes up our cost of claims. For the last 22 years, this veterinary inflation has increased approximately 5% to 6% per year for Trupanion members.

Today, we're seeing the overall cost of care for many veterinary hospitals increased 8% to 12%, or approximately twice that of the historical rate. We expect and hope this will continue to increase in the range of 10% to 15% for at least the next three to four years so veterinarians and their staff can be paid appropriately and in line with other medical professionals.

Our 20-year track record shows that we're pretty good at pricing in line with our value proposition. More important than that is hitting our target for adjusted operating income. Doing both is not easy, and the team will need to remain focused and deliver. It is important to note our mix of business will continue to influence our reported ARPU, which is a blend of all subscription pets.

We are not saying that people should model or expect blended ARPU to grow 10% a year. For example, a higher mix of new pets (phon) means a lower blended ARPU. More pets enrolling through the worksite will mean a lower blended ARPU. More pets enrolling from parts of the world with lower veterinary costs will mean lower blended ARPU. Our blended ARPU is simply an output. For that reason, we believe our ability to operate the business effectively can and should be measured by our adjusted operating margin.

In the quarter, our adjusted operating margin was approximately 13% compared to our annual target of 15%. As Q2 shows, we don't always time things perfectly, nor would I expect us to. Drew will elaborate on this more momentarily. That said, if I don't see an expansion in our adjusted operating margin in the back half of the year, I would be disappointed.

Short term, margin compression is the evidence of additional inflation. This environment creates a unique opportunity for Trupanion. With our cost-plus model, rising cost of veterinary care drives higher ARPU and pet lifetime value over time, increasing our allowable acquisition spend and supporting continued investment in the category.

With rising cost of care also comes a greater need among pet owners to find a solution to help them budget for the unexpected costs of accidents and illness. That is why we exist, and I believe and expect that we are and will continue to be exponentially better, faster, and more accurate than others. In fact, Trupanion's decades of growth has benefited from the cost of veterinary care outpacing the growth of pet owners' bank balances.

Now let's pull back a little and look at the big picture. Parents universally agree that food, shelter, quality health care, and love are the bare necessities for our human children. For the majority of pet owners, and for Trupanion members in particular, our four-legged children have the same basic needs. We believe the combination of these bare necessities currently make up less than 50% of a pet owner's annual pet spend, with veterinary health care being approximately a quarter of a pet owner's existing share of wallet. If veterinarians were to raise their prices in line with my hopes and expectations, this would not necessitate the need for individual households to increase their monthly pet spend. Said another way, pet owners could reallocate spend from discretionary items like pet clothing and doggy day care if required.

Already, our category is accelerating, and this is before pet owners have started to feel the impact of a step-up from the historical 5% to 6% increase in veterinary cost. Last year, the category added over $650

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Trupanion, Inc. - Second Quarter 2022 Earnings Conference Call, August 3, 2022

million in revenue, up from $450 million in the prior year. We believe Trupanion led the category, adding about 30% of its growth.

I'll now turn the call over to Margi, Trupanion's President, to talk more specifically about the significant opportunity ahead of us.

Margi.

Margi Tooth

Thank you, Darryl, and good afternoon, everyone.

I want to take a moment to elaborate on Darryl's commentary around why our trusted partnership with veterinarians is critical to the opportunity we have in this large underpenetrated market. There are times when something happens in the world that exacerbates the problem we, Trupanion, are trying to solve, when we face an even greater duty to step in and make a difference.

Today's inflationary environment with mounting economic uncertainty and increasing pressure on our veterinary partners is one of those times. We partner with veterinarians to ensure that pet parents are able to provide for their pets unexpected care. Today, those trusted stewards, our veterinary teams, are struggling more than ever before. Burdened with the rising cost of care, overworked, tired and stressed, veterinarians have been pushed to the point of burnout. Couple this with a backdrop of rising inflation and the fact that, today, the majority of pet owners cannot afford more than $1,400 in unexpected veterinary costs. The threshold of economic euthanasia is that low.

The rising cost of care will make it only more difficult for the average pet owner to budget for the unexpected, and veterinarians still need to raise their prices. We're starting to see early signs of this increase come through in our data, but it's not enough, and we need to be prepared for this to be much higher.

As Darryl noted, in the next three to four years, veterinarians are going to need to raise their prices in aggregate by 30% to 50%. Too few pet owners can afford unbudgeted veterinary bills today. Fewer will be able to in the future. With this as the backdrop, let me take a moment to walk you through how our value proposition is more relevant than ever.

To start with, we help pet parents budget for the cost of unexpected veterinary bills for the life of their pet. We make it affordable for our members by breaking the cost of care into small monthly payments they can adapt to. Because of our unique pricing at the age of enrollment, we are the only player to offer lifetime coverage. The monthly cost doesn't increase because the pet had a birthday. This is unique in the industry globally.

As vets raise their prices, which they will do, our vertical integration local support through our territory partners, 20-plus years of veterinary data and unmatched team of actuaries positions us ahead of any other player in the industry. Moreover, we are ending the need for reimbursement. Pet owners must understand how paying the vet directly means an end to reimbursement. Our solution has never been more relevant. High-quality insurance should not leave you waiting for a decision. Trupanion does not.

We are paying more veterinarians directly than ever before, enabling them to operate more sustainable businesses. No more time spent on estimates or fees for credit card payments. Year-to-date, total invoice dollars paid directly to veterinary hospitals were up 20% over last year. The majority of these had payment approval in mere seconds, comparable to, if not quicker than, that of a credit card. We want to

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