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spk04: Greetings and welcome to the Trupanion, Inc. Second Quarter 2022 Earnings Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question, you may press star 1 on your telephone keypad. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. 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.
spk02: Good afternoon, and welcome to True Panion's second quarter 2022 financial results conference call. Participating on today's call are Daryl Rawlings, Chief Executive Officer, Margie Tooth, President, and Drew Wolf, Chief Financial Officer. Similar to prior earnings calls, Tricia Plouffe, 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 an 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 Daryl.
spk10: Thanks, Laura. Good afternoon. Q2 revenue was up 30% year over year. More importantly, our adjusted operating income, or the profits we earn 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 are 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. 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 accidents 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 increase 8 to 12 percent or approximately twice that of the historical rate. We expect and hope this will continue to increase in the range of 10 to 15 percent 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 cats 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 cost 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 healthcare 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 daycare 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 costs. Last year, the category added over $650 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 Margie, Trupanion's president, to talk more specifically about the significant opportunity ahead of us. Margie?
spk07: Thank you, Daryl, and good afternoon, everyone. I want to take a moment to elaborate on Daryl'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, Trupanian, 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, the 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 to 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 Daryl 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 a 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 a 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 empower veterinarians to offer and practice best medicine, removing the emotional toll of heart-wrenching decisions forced by financial constraints. And finally, we will continue to be there 24-7, 365 days a year, for both the lucky and the unlucky pets. We remain steadfast in our mission. Through our business model, we are able to reach and educate veterinarians and pet owners alike to offer high-quality medical coverage for the lifetime of a pet and to change the paradigm of pet health forever. Drew?
spk08: Thanks, Margie, and good afternoon, everyone. Today I'll share additional details around our Q2 performance, as well as share some thoughts on how we're tracking against our annual goals. Total revenue for the quarter was $219.4 million, up 30% year-over-year, driven by strong pet additions and sustained high levels of retention in our subscription business along with continued growth within our other business. Within our subscription business segment, revenue was 145.8 million, up 21% over last year. In the quarter, the US to Canadian foreign exchange rate had a larger than typical impact. On a constant currency basis, subscription revenue would have been 147.3 million. Total enrolled subscription pets increased 20% year over year to over 770,000 pets. Average monthly retention, which is calculated on a trailing 12-month basis, was 98.74%, equating to an average life of 79 months. This is compared to 98.72%, or an average life of 78 months, in the prior year period. Monthly average revenue per pet was $64.26, an increase of 0.9% year over year. On a constant currency basis, monthly average revenue per pet increased 1.8% year over year and continues to be impacted by the mix of business dynamics that we've previously discussed. Our loss ratio expanded 170 basis points from the prior quarter to 72.8%. While some level of variability is expected, this move is larger than typical and the result of three factors all occurring in the same quarter. I'll explain. First, frequency was the largest driver of the increase in our loss ratio, as we discussed at the shareholder meeting. Secondly, elaborating on Daryl's point regarding timing, we had higher claims processing costs as we continued to staff up for business expansion that will yield cost efficiencies in the back half of the year as we bring on new business. And finally, at the end of the quarter, we saw an uptick in severity of claims. We will continue to monitor our data at an extremely granular level and adjust pricing as needed in order to hit our target margins. As a percentage of subscription revenue, variable expenses were 9.9% in the quarter, reflecting continued investments in our member experience, including additional staffing in advance of new product launches. We expect to leverage these pre-revenue investments now that we are actively in the market. Fixed expenses were 4.3% of revenue. After the cost of paying veterinary invoices, variable expenses, and fixed expenses, we calculate our adjusted operating income. Relative to Q1, we took actions to drive operating leverage to partially offset the increase in our loss ratio. Nonetheless, our subscription adjusted operating margin was 12.9% in the quarter, down from 13.8% in the prior year period. We continue to monitor veterinary inflation and are working to push pricing through based on current rates of inflation. With additional cost actions, we expect to drive sequential expansion in subscription adjusted operating margin, both in Q3 and Q4, ending Q4 in the range of 14 to 15 percent. In dollars, our subscription business delivered adjusted operating income of $18.8 million, an increase of 13 percent over the prior year period. The aforementioned year-over-year change in foreign currency impacted adjusted operating income by approximately $600,000 in the quarter. Now I'll turn to our other business segment, which is comprised of revenue from other products and services that generally have a B2B component and a different margin profile than our subscription business. Total revenue was $73.6 million. Compared to the prior year quarter, this is an increase of 54% year-over-year, reflecting an increase in pets enrolled within the segment. Adjusted operating income for the segment was approximately $2 million. As a result, our total adjusted operating income was up 13% over the prior year period to $20.8 million. While we do expect some variability quarter to quarter, we are running behind the 25% annual growth target outlined in our 60-month plan. I will discuss this more momentarily. During the quarter, we invested 18% more year over year, or $20.2 million, to acquire 61,000 new subscription pets. This resulted in a pet acquisition cost of $309,000. an estimated 31% internal rate of return for a single average pet. We also invested $2 million in the quarter on development costs. These are pre-revenue, non-capitalized costs related to new products, channels, and international expansion, which we expect will add additional long-term growth levers. As a percent of revenue, development expense was 92 basis points in Q2, a step up from recent quarters, reflecting activity ahead of the Chewy and Aflac product offering launches, as well as some additional international investment. Now that we are in market with these products, we expect to drive development expense back toward 0.5 percent of revenue by year end. This resulted in an adjusted EBITDA loss of 1.7 million, compared to an adjusted EBITDA gain of 0.2 million in the prior year quarter. Interest expense totaled 1.2 million in the quarter. Total stock-based compensation expense was 8.5 million, in line with our expectations. We also repurchased approximately $5.8 million in our common stock in the quarter. As disciplined allocators of capital, we will seek opportunities to invest where we can find attractive returns. This includes repurchasing our own stock during periods where we believe our market valuation reflects a deep discount to estimated intrinsic value. We will do so in a prudent manner, always balancing our capital needs with our growth projections. As a result, net loss was $13.6 million, or a loss of $0.33 per basic and diluted share, compared to a net loss of $9.2 million, or a loss of $0.23 per basic and diluted share in the prior year period. Turning to our balance sheet, we ended the quarter with over $243 million in cash, cash equivalents, and short-term investments, which is up from approximately $213 million at the end of the last year. We held approximately $54 million in debt with $90 million available under our long-term credit facility. With the strength of our balance sheet, we believe we can comfortably fund several years of accelerated growth while also maintaining flexibility to repurchase shares or pursue strategic M&A when we believe the opportunity is compelling. In terms of cash flow, operating cash flow was negative $3.1 million in the quarter compared to negative $2.2 million in the prior year period. Capital expenditures totaled $3.9 million in the quarter, and as a result, free cash flow was a negative $7.1 million. As highlighted in our 60-month plan, it is our goal to deliver 25% year-over-year growth in adjusted operating income. Last year, the first year of our 60-month plan, adjusted operating income grew 37%. Currently, we expect to grow adjusted operating income in the range of 15% to 20% for this year. With the backdrop of rising cost of care, growing need for Trupanion in North America, additional distribution channels, products, and international expansion, we believe 25% growth in adjusted operating income remains the right target. This will continue to be our goal for 2023 through 2025. Now I'll hand it back over to Daryl.
spk10: By the numbers, it was a mixed quarter for execution. As I've said before, execution is tough. But when I look at the thousands of public companies one can invest in during times of uncertainty and inflation and given current market sentiment, I believe our love affair with our four-legged family members, our large and underpenetrated market, high retention, and lifetime value of a pet make us stand out from the crowd. And with that, I'll open it up for questions.
spk04: Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star 1 to register a question at this time. Our first question today is coming from John Barnage of Piper Sandler. Please go ahead.
spk12: Thank you very much. I wanted to talk about the subscription loss ratio that came in. about 170 basis points above the target of 71. And I know you talked about getting down to the 14% to 15% AOI margin for the fourth quarter. But I know, Drew, you had talked about some scale economies would maybe offset some of that elevation in the loss ratio. So I wanted to circle back to that target. Are you expecting to exit 4Q22 close to 71% again?
spk08: Yes, we're expecting to get closer to 71 with additional cost action across fixed variable and loss adjustment expense to produce that 14% to 15% adjusted operating margin.
spk12: Okay. And then what was curbside versus a quarter ago in vet clinics, please?
spk08: Could you repeat that again?
spk12: Yeah, so curbside only at vet clinics. I know that's a dynamic that certain vet practices have decided to keep, even in a post-pandemic world. Can you maybe talk about vet hospitals or clinics that you're in that maybe have your software? What percent of those remain curbside only versus a year ago or a quarter ago? Thank you.
spk07: Hi, John, it's Margie. So Curbside definitely is still, we see it in evidence across hospitals across all of our markets. I will say it's more the exception than a rule, certainly than a year ago. And what hospitals have done is they've adapted their processes, as we've seen, from visit patents to make sure their workflow now can bring in the introduction of the opportunity to talk about high-quality medical insurance. We haven't seen an increase in the number of people leveraging Curbside recently. What I will tell you is our software, our VET portal, as we now have been referring to it, is increasing. So our utilization rate throughout the quarter went up 20% year over year. So we're seeing more vets with not only taking the software, adopting it, but using it more often than they were before. And people are now getting back into the hospital. So curbside is very much less of a, like I said, an exception as opposed to rule at the end of the stage.
spk10: Yeah, just one thing to add on that, John. Curbside is one thing that affected pet owners. And as Margie said, that's largely diminished The biggest part for us is our territory partners were often not able to walk into the hospitals, and they're now able to walk through the doors, and that's been a big benefit to the company.
spk12: Thank you for that, and maybe one last question if I can. Are you seeing any sign in the wake of inflation that insurers are choosing to maybe move from lower deductible higher monthly ARPU to higher deductible lower monthly ARPU?
spk07: I can certainly start that and I don't know if others want to add to it. We've actually been looking at our deductible trend as we always do across the board for everything on a very regular basis. Our deductibles have actually been trending down. We've seen that coming through throughout the quarter, the back end of Q1 into Q2. So that means both on phone and web people are taking a lower deductible. which is obviously contrary to the high deductible that you just questioned about there. So people are seeing the value. We've said before that people are very value-sensitive, and there is no difference across markets or different channels using that deductible point that's coming down.
spk12: Thank you very much.
spk04: Thank you. The next question is coming from Shweta Kajari of Evercore ISI. Please go ahead.
spk01: Okay, thank you. Let me try a couple, please. So what does the adjusted operating income growth rate guidance include in terms of the cost? So could you please break it down in terms of your expectations, whether it is investments, loss ratio, et cetera, just a little bit more. And then the second question is, how should we think about the contribution from the lower-priced products in the back half of this year, as well as contributions from Chewy Partnership and other incremental growth channels. Thank you.
spk10: Sure, I'll start on the first question and then hand off the second one. But that guidance on adjusted operating margin includes action across the board.
spk08: We're going to have to, our loss adjustment expense will have to come down We'll get an additional scale on fixed and some work in variable as well as taking pricing action, you know, on the revenue side to produce, you know, get back towards our target loss ratio. And that's embedded in the 14% to 15%. Okay.
spk07: And then the second question. Hi, Shweta. It's Margie. In terms of contribution from lower-priced products in the second half. PHI and Serkin are the products that we have in market right now that have been, as I think we've expressed before, have been pretty disappointed with the overall progress of those products in general. We have changed our overall positioning in terms of having two general managers that now are responsible for heading that growth. We don't anticipate significant impact from them in the back half of the year. What I will say, Chewy and Aflac, they've launched a market where we're very happy with the The overall, the early stages of that, there are two products that we're very honored and I think Darrell touched on this in his prepared remarks. We're humbled by the fact that we've got the trust of these two brands to be able to partner with Trupanion. We don't anticipate seeing anything more than single-digit growth in the back half of the year with these two products. And as a reminder, as a monthly subscription revenue product, we're not going to see the bulk of that impact coming through as we just start to get those rolled out early stages. But we do anticipate seeing some impact, albeit minimal, in Q3 and Q4.
spk01: Okay, thank you.
spk04: Thank you. The next question is coming from Josh Shanker of Bank of America. Please go ahead.
spk09: Yeah, thank you for taking my question. So during the annual shareholders meeting, you throughout a statistic in about May installation, 352 software installs in May. I don't think you want to go updating that number every month, but maybe we can talk about whether that sort of trend is continuing, whether that was a blip or not, and what's happened. You mentioned briefly in one of the questions, but what's going on in terms of face-to-face interaction? How is that trending with the territory partners in the veterinarian clinics?
spk07: Yeah, so you're right, Josh. We won't go into details about how that number, that 352, is continuing to scale, but I can tell you it continues on that same trajectory. So we've been very happy to have the vet visits back at the levels that we were seeing back in 2019. We have more people in the field than we ever have had before, and they can now walk in the doors of hospitals and rekindle those relationships they had face-to-face. What we're seeing as a result of that not only is more people adopting the use of our software, using it on a regular basis, but we're also seeing an increase in lead volume and paying that veterinarian directly at the time of checkout, which we know solves a lot of problems, as we referred to in our prepared remarks. When we think about that face-to-face interaction, what that does is it just reinforces the need for high-quality medical insurance and just reinforces how we can be there at the time of need, whether it's boots on the ground locally, which just helps to understand that market, That information helps to inform our pricing team. It also helps to drive our higher lead volume, which in turn has a higher conversion rate, which means we have a more efficient pack. So that flywheel starts to really come together nicely. So we're very happy with the fact that we've been able to get back into the hospitals. That trend started at the back end of Q1, has been maintained through Q2, and we continue to see that happening in Q3 as well.
spk10: And I'll just add that with all of the general talk of inflation for non-veterinarian and it being even more acute in the veterinary space and not seeing that in some of the numbers it gives a real strong talking points for our territory partners uh craig's level of urgency um and uh you know having them walk through the door is has been great for the business and uh super happy to have them back in the in the field
spk09: And then if I look at the IRR on customer acquisition costs at 31, getting close to your lower bound of 30%, which suggests maybe the efficacy of customer acquisition spend is weakening. Look, the growth is great in terms of subscription pets, but do we get to a point, are we at that point maybe where some of the ad spend doesn't make as much sense, some of the marketing spend, because you just can't get that 30% return?
spk07: So IRR, our guardrails are between 30% and 40%, and that doesn't change quarter over quarter. So we were at 31% as you commented, and when we think about the impact of that, we saw margin compression through the quarter. So what we were doing is we saw that coming through the teams were reacting, they're communicating with each other and adjusting their spend profile. So it did put pressure on it and bring it closer to the 30% mark. Overall, though, when we look at our channels and the efficacy, it's strong as ever. the volume is strong, conversion rates are high, so we don't have any concerns there.
spk09: Thank you for the answers.
spk04: Thank you. The next question is coming from Katie Sackey of Autonomous Research. Please go ahead.
spk03: Hi. Thank you. Good afternoon. Inflation is rising and your ARPU isn't growing much sequentially, so can you just walk us through why you think you'll get back to a 71% loss ratio?
spk06: Yeah. Hi, Katie. This is Tricia. I can talk about this one. I mean, at a high level, what ARHU shows up on our consolidated financials is an output, and it's an output of pricing to as close as we can to that value proposition, that 71 like you mentioned. Now, day-to-day, and I talked about this at a geography level at the shareholder meetings, We are constantly looking at the data at a granular level geo neighborhood breathe Asia enrollment and updating pricing very frequently You know we have many regions and neighborhoods that were pricing that are receiving increases in the five to ten percent range some higher than that now we have some regions where we actually are running below our loss ratio target and so we've been decreasing those prices. So the output that you see on our financials is the blend of that and where we're really targeting is to hit the target of 71 and then, as Drew mentioned, have that flow through then to getting us closer to our 15. Now, based on the data that we see, we are increasing then prices in more areas than we were six months ago to keep up with these rising costs, not only the frequency of the invoices, but now, as Daryl mentioned, in some areas, not all, but in some areas we are seeing average invoice size start to go up more than we have in the past. So the key for us is You know, we'll never be absolutely perfect, but we are looking at this at a very granular level, multiple times a month. We have pricing action going through at all times, about one twelfth of our book every single month sees price changes at a granular level to get them closer to our value proposition. We have pricing that is going through currently, and then we're looking at, you know, additional filings to reflect the inflationary period that we're seeing as well to get us closer. And we feel, you know, we've been doing this for a long time, and so we feel confident while timing may move around that, you know, we can absolutely get close back on track to our value prop.
spk03: Got it. As a follow-up with, you know, inflation running fast, say, 8% to 12% in the Vet Channel. Can you give us an idea of what Trupanion's rate increases are looking like today on a nationwide headline rate?
spk06: Well, I mean, at a macro level, we're seeing in the first half of the year our ARPU is going up 1.4%, and our claims per pet is going up 1.5%. So we've been doing, while there's some timing variation between quarters, we've been doing a good job of keeping that up, although we need to make up about a 1% delta. Now, in general, when we're filing the rate increases, as I said, the vast majority of our book is seeing rate increases between 5% and 10%. It's just offset on a blended basis. with certain regions and breeds that were decreasing prices. So that's where you get the blend, but when we peel back the onion and look at it, we are putting through larger rate increases that you would expect in many areas. I'll also say that some of the rate action that we've taken over the past two years to decrease prices in certain regions to get closer to our value proposition, we are at the tail end of that. So really think about it a little bit more as a reset to being closer to our target, which is the right thing to do. And as we mentioned, being closer to our target has enabled those regions to grow faster because it's a better value proposition as well. But you'll see now what goes through in the future most likely would not reflect so many rate decreases as opposed to keeping up with inflation more on a blended basis. But I would add, you know, it really is important to look at these various metrics because as we add more products into the mix, as certain geographies go faster or slower, you're going to see more of a blended ARPU. If we start growing faster in products that have a lower ARPU, hypothetically, that would impact our overall blended ARPU as well. So mix of business is key here as well.
spk10: Yeah, and Katie, I mentioned in my opening remarks, I mean, our blended ARPU is an output. It'll be what it will be. We We hope that workplace and a bunch of other places really can start to make an impact in the back half of the year. Some of these we're expecting to have lower RPUs, so on a blended basis, you may see that it's not tracking what you might otherwise expect with these inflationary comments. What matters is to look at our adjusted operating margin, and that's our ability to execute. You know, in our comments on here, we're expecting to see some margin expansion in the back half of the year. And if we execute well, that's what you'll see.
spk14: Got it. Thank you so much for the answers. Thank you.
spk04: Once again, that is star one. If you would like to register a question at this time. Our next question today is coming from Maria Rips of Canaccord. Please go ahead.
spk13: Great. Thanks so much for taking my questions. Daryl, if we are indeed going to see 10% to 15% increase per year in like-for-like cost of vet care over the next three or five years, I think you said, and that obviously compounds over the years, how do you think about your capacity to increase prices for your members without impacting retention?
spk10: Well, we've been doing this for over 20 years, Maria, and we know and we've been tracking in our shareholder letters If we're seeing weight increases in the 10 to 15%, our retention rates and conversion rates remain the same. When we see it over 20% year over year, we see it degrade slightly. When I said it's going to be 10 to 15%, that's what I'm hoping the veterinary community will do so that they can pay their employees and the veterinarians appropriately compared to other medical professionals. I'm not guaranteeing it's going to happen, but we certainly hope that they will. And we know that members can afford to pay for that care when it's budgeted and broken into monthly payments and we have no concerns with it and excited to see if it happens.
spk13: Got it. That's very helpful. And then secondly, on your recently announced partnership with EasyVet, could you maybe provide some additional context on how this offering is different from the core software integration And I guess what overhang is being addressed by this partnership so that thousands of additional hospitals are now able to integrate the software?
spk07: Hi Maria, it's Margie. So the partnership with EasyVet is essentially a full integration within their overall platform within their practice management system. So what that does is many folks migrated to EasyVet a couple of years ago that had been working with TruePlanning historically. And we didn't have that full integration embedded, so now we do have. So we have access to hospitals we've historically worked with who do have quite a lot of members, Japan members, as well as those that have onboarded with the cloud-based software that EasyVet is. So it gives us access to hospitals that have partnered with us for a long time, and some of them are very large and some are new. So we think about our practice management approach and how our penetration rates are increasing across the North American market. EasyVet is one that really gives us access to an awful lot more hospitals. It just enables us to be able to pay the vet directly and really solve that problem. And very much with, you know, the veterinary profession that we can offer them the solution that they didn't otherwise have if they had EasyVet previously. So it just reinvigorates those hospitals that are already supporters of us.
spk04: Got it. That's very helpful. Thank you for the call. Thank you. Our next question is coming from John Block of Stiefel. Please go ahead.
spk11: Thanks, guys. Good afternoon. Maybe just two for me. Just first, I'm sort of starting the gross ads. And just when I look back the past six quarters or so, it looks like the gross ad trend line is somewhat flattened out, 55,000 to 58,000, give or take, for 2021 normalized for a quarter, and then 60,000 to 61,000 in the first half of 2022. So, you know, Darrell, there's sort of that anecdotal chatter that pet adoptions might be starting to subside from call it pandemic highs, I think a good amount, maybe 70% or 80% of your gross ads come from puppies or kittens. Just would love your thoughts on that. And more importantly, that trend line going forward, I think as a growth company, people really have that inflecting in 23, 24. So how do we think about that gross ad trend line going forward while arguably adhering to your 30% to 40% IRR? Yeah.
spk10: John, I think when I look at, you know, we're a monthly recurring revenue business. And if I think about our total subscription pets, which is how we get our revenue, if I look at it over a period of time, you know, 17, 18, and 19, our growth rates were about 15%. In 2020, it grew to 17%. And then 21 and 22, it's going to be between 21 and 22% in total subscription pets. Now, with monthly recurring revenue, sometimes you're accelerating new faster, sometimes retention is faster or slower. But when I look out and go into 23, 24, 25 for the company, we not only have the strong growth that will be driven by the veterinary inflation and our territory partners walking through the door. In our 60-month plan, we talk about these additional channels that are coming online, a couple that launched last quarter and will start to make an impact in Q3 and Q4. I'm really excited about the work we're doing internationally that we expect will start to take hold in 23 and 24 as well. So as a company, when I look at it, I look at the total subscription paths, but really I monitor my year-over-year increase in adjusted operating income and can we compound that. Now, I've said before, Our goal is to grow that 25% a year for each year in our 60-month plan, which started in 21 and will end at the end of 25. In the first year, in 21, we grew that greater than 25%. We were over 30. As Drew mentioned, we think our adjusted operating income, which is the closest proximity to intrinsic value, will probably not hit our growth target. It will be probably 15% to 20%. But we do think that as a goal, internally as a company, 25 will be the goal we'll be setting in 23, 24, and 25. And we'll see how we do. I mean, some years we might grow faster. I've mentioned in my shareholder letters, anytime we're growing 20% to 25%, as a shareholder, I'll be thrilled. I'm happy there. If it's over 25, I'm ecstatic doing backflips. And I think we've got a lot of things in the pipeline and a lot of things that ebb and flow. So I'm super encouraged about the future.
spk07: Can I add as well to that, John, just in terms of the future, just when we think about the vet traffic specifically and what we've been able to do, you know, we're coming off the back of a tough comp year over year with the overall pet count. But to Darrell's point, we're seeing things moving in a very positive direction from an overall trend for both retention and acquisition. Being back in the hospital, being able to offer some very high quality products through the vet channel, having our territory partners back there. This is a market that we trust implicitly. The partnership with the veterinarians, being able to offer them unbridled levels of support and service at a time when they absolutely need it to be pushing at the strength that we've been talking about from an inflationary perspective. I am very confident in the numbers that we're seeing coming through at the early stages of Q3 and the back end of Q2. That means that the VET channel traffic, which is our real driver of the growth that we see both from a retention and acquisition perspective, is looking very strong and thriving more than ever.
spk11: Got it. Thanks for that call. Very helpful. Then just a second question, maybe a little long and it's going to end with more of your opinion on something, Daryl. But ARPU is up 1%-ish year-over-year, so modest, well below the rate of inflation, which I think you said is now 8% to 12% in the veterinary world. You'll try to catch up on that on the pricing. I get it. But you said, hey, look, there's not a direct walk across to ARPU because there's a million moving parts, and part of that is mixed. I just want to be clear because I've been confused in the past. I think what you were saying, Daryl, when you were giving examples is that the newer pets coming on, you know, maybe puppies or kittens or alternative channels, Those are lower ARPU pets, you know, the ones that are coming on are called below corporate ARPU. Let me sort of pause there. Is that correct?
spk10: Well, there's two things I want to just correct, John. So I said there's 8% to 12% increases in some of the veterinarian hospitals, not all. So we are starting to see larger, and that's not on invoices paid, that's on total invoices paid. So the first place we look for inflation is, of all the invoices we're seeing, are veterinarians taking larger price? Historically, for the last 20 years, that's been about 5% to 6% for insured clients with Trupanion. The total invoice dollars are going up 5% to 6%. There was a question earlier today saying, has deductibles gone up? They haven't. They've actually been going down. But if deductibles were going up, that would change your cost of claims and then what we're charging as well. So the blend of business really is an impact. It is often true that we are largely enrolling younger pet. That has been the same for year after year. But if we take a city, for example, and let's say in a city we had two – we cut the city in half. And half the city we were running at an 80% loss ratio, and the other half of the city we were running at a 60% loss ratio. But in general, we had a 70 on average. What would have been happening before is we would have been growing faster where there was an 80 and slower when there was a 60 than if we made them both 71. And so you see an accelerated growth in the lower-priced one, the lower-priced neighborhoods, and you see a slowdown in the higher price neighborhood in comparison to what you were doing beforehand. Now, Progressive is an insurance that was more accurately pricing risk than other insurance companies for many, many years, and their mix of business would be different than a different insurance company. Our goal is to be a disciplined grower, to get strong IRRs, and as we continue to refine our pricing, our blend is changing. Now, in addition to that, you know, with Chewy and Aflac and some of the other things in our 60-month plan, as well as international expansion where we'll have lower veterinary costs on average, that's going to continue to influence blend. So, as I mentioned a couple callers before, our blend is really going to be an output. We were pretty easy to predict. You know, 15% year-over-year growth in 17 in subscription pet, 15 in 18, 15 in 19, and you added about 5% in ARPU, and you got about a 20% increase in revenue. We had adjusted operating margin growing at a greater rate because we had margin expansion. Right now, it's hard for us to predict what our blend will be. But to see if we're good managers of our business, It's really about that adjusted operating margin. So you were right. There are a lot of things at play. And there's going to be more things at play in the future. And monitoring that adjusted operating margin is what I look at. And then I look at the year-over-year growth of the adjusted operating income. And then how many dollars are we able to deploy at outsized internal rates of return, which I define at anything over 30%. Okay.
spk11: Maybe I'll follow up offline, but just more the opinion one was there. At a high level, when you're running that internal rate of return, why is that dictated by the ARPU of the entire subscription base rather than the cohort that you're bringing on in the current quarter? In other words, you're doing the PAC dollars, right? But the internal rates of return are predicated on is that a cohort that has a $50 ARPU bringing on the books or 75? Why does it always run over the entire, you know, 770,000 pets that are already on the books? And hopefully that made sense. If not, we could take it offline, but just wanted to throw that out there from more an opinion standpoint.
spk10: Yeah, well, the IRR is actually not driven by ARPU. It's driven by the adjusted operating income or margin. So you take the adjusted operating income and you multiply it by the number of months. that gives you the stream of cash flow. And then you say, how much are you spending? What we use on calculating it is what is our blended adjusted operating income for all of our pets when we report it. But in aggregate, when we're behind the scenes, we are spending much less for a cat than we are on a dog. And the way that we calculate the internal rates of return does not assume that we're going to have larger adjusted operating income two, three, four, five years in advance. So it's actually conservative and understated, assuming that on average the adjusted operating income is going to go up over time. But that's how we run it. And if you have further questions, we can jump on it offline. When we set that up,
spk08: I mean, it's important that people can replicate our numbers. And so it was set up so you could take our financials and back into that without having to know new outputs. So it's another reason why it was set up that way.
spk11: Yeah, I get the transparency. I just want to know if you're spending, you know, the $300 pet to bring on $50 cohorts or $70 cohorts. I think that's ultimately what matters. But I get it in terms of, I guess, investors being able to run it. All good. Thanks, guys. I'll follow up.
spk04: Thank you. The next question is coming from of Raymond James. Please go ahead.
spk05: Thanks. Good afternoon. This may have been asked earlier. I might have just missed it. But just want to get your general sense of trends in ARPU and what the impact would be on churn. And more specifically, thinking about the two buckets kind of, I guess, at each end. bucket where historically you've not had experienced price increases, which I think about 25% of your book, and then smaller bucket where there's been in excess of 20% price increases. Curious as to whether or not you think that change in either of those buckets could have a more outsized impact given that we're obviously looking at sort of much higher overall rates of inflation.
spk10: Yeah, Elliot, it's a good point for people that haven't read the shareholder letters, but we report year after year about where our churn comes from and how it goes through. I'm not sure that how you articulate it is exactly accurate. So we have largely three buckets that we report on. Those are new pets. And those new pets have not yet ever had a rate change. That's actually our lowest retention. So we have the highest churn there. Those are people picking tires, people that sign on and their dog was currently sick and they were disappointed we didn't cover a preexisting condition. Could be people that were going to get a spay or neuter or regular wellness and were confused on what our coverage was. That's in that first bucket. That is our highest churn level. The second bucket is where the majority of our pets are, and they're seeing rate changes that are less than 20% a year. And it could be the rates are going down to they're going up 19%. That is our highest retention. And then we also have a bucket where people are seeing rate changes greater than 20%. That's the medium bucket of churn for us. And what you'll see over time is that third bucket will become a smaller percentage unless veterinarians start to increase their rates, not what I'm hoping 10 to 15%, but if they were to increase it 25% year over year. But as long as it's under 20%, you can look and historically what our churn rates have been. And I can tell you we are at all-time retentions right now that Drew reported on. 98.74, I believe. And our conversion rates are slightly up. Referral at Adapet is also our record numbers of growth. So once again, we don't see the customers that we attract as being price sensitive, but they are certainly value sensitive. And in times of uncertainty, of high inflation, the need for our product is greater than ever.
spk05: And I wanted to ask a question on the PAC number in the quarter and trends in PAC. Maybe just possible to get a little bit more granularity on what's driving that. And I think you've provided some detail in the past and given us a rough split between allocation between lead generation and conversions and more dollars going to conversions over time. You know, wondering if the relative rate increase in those two categories is essentially equal or you're seeing the cost of conversion go up at a higher rate than lead generation, but maybe just a little bit more insight into the increase in the PAC number this period.
spk07: When we think about PAC in general, if we look at it over the last few quarters, it's been relatively flat. In Q4 of 21, it was 306. Q1 was 301. Q2 was 309. When you think about that overall, there's really very little movement between the quarters. As we mentioned before, the real guiding light for us is those guardrails for internal rates of return, so being between 30% and 40% at any given point in time. Our overall split between lead, convert, and retention, so we do have an element of retention, which is that first year sort of that Darrell alluded to just now, sort of the kind of reinforcement of the value proposition just after purchase. It all goes into PAC. This is a fully loaded cost. So as a reminder, this is everybody that works within our acquisition space. And that lead and convert hasn't really shifted significantly. If it has, it's by a couple of points. We're constantly looking at how do we make sure that we are, just as we do from a pricing perspective, we're focused on the right message at the right time with the right combination of different attribution points. There's a number of different elements to a journey that will pull someone through the funnel. So if you've got a vet lead, for example, we're going to see the overall lead cost is going to be the bulk of that. The conversion is very simple. It's very straightforward. It's a much cleaner lead for us because it's a stronger referral up front. but then you have different regions will have different mixes. So in general, it hasn't changed. They're all being as efficient as we would want them to be in various spaces. And, you know, we'll push hard on certain areas and move on to others. And like we said, when we talked about internal rates of return specifically for this quarter, we really saw that pressure coming through from a margin compression point of view. And we want to make sure that we're always adhering to those guardrails, which is where you see that looking like it's kind of towards the as opposed to midpoint, but PAC in general just really isn't moving a great deal over the last three quarters, as I mentioned. So the teams continue to invest at similar sort of levels between lead and convert, and we haven't seen that shift as well, particularly.
spk05: Okay, and then last question for Drew. Drew, you mentioned the uptick in the severity of claims. Was that just within sort of the realm of the ranges that you see historically, anything specific? in terms of territory or what may have driven this period that sort of led you to call that out?
spk08: Yeah. As I mentioned at the shareholder meeting, I talked about movements we were seeing in the loss ratio with frequency being the big driver coming out of COVID and then the change in loss adjustment expense. So those two were about 130 basis points of our move. So 40 basis points was that, you know, we were pricing for inflation and it was the acceleration that we saw really in the back half of June that was that extra 40 basis points. So that is the other part that we picked up. Now luckily we were able to take action in the quarter and mitigate about 60 basis points of that move. But that's that uptick in severity that I talked about. It's not in any specific region. It's across the board.
spk05: Okay. Thank you.
spk04: Ladies and gentlemen, that's all the time we have today for questions. We would like to thank you for your participation and interest in today's Trupanion event. You may disconnect your lines or log off the webcast and enjoy the rest of your evening.
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