Trupanion, Inc.

Hello and welcome to the TruePanion third quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. Please note this event is being recorded. I would like now to turn the conference over to Laura Bainbridge, Senior Vice President of Corporate Communications. Please go ahead.

Good afternoon, and welcome to Trupanion's third quarter 2023 financial results conference call. Participating on today's call are Daryl Rawlings, Chief Executive Officer and Chair of the Board, Margie Tooth, President, Wei Li, Corporate Controller and SVP of Finance, and Fawad Khurashi, Trupanion's Chief Financial Officer. For ease of reference, we've included a slide presentation to accompany today's discussion, which is available on today's webcast. 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 provisions 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 expenses. 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 conference call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. With that, I'll hand it over to Daryl.

Thank you, Laura. I'm happy with the sequential progress within our key financial metrics in the third quarter. The recent improvements are direct reflection of the team's execution and Margie's leadership over the past seven months. For the benefit of what appears to me to be an increasing number of new people interested in our story, our goal is to earn a 15% profit margin from our existing clients. With these pre-tax funds, we can choose to reinvest in our growing business in our large and underpenetrated market by adding new pets, or alternatively, pay dividends or repurchase shares after taxes. We refer to this profit margin as our adjusted operating income. The primary drivers of our adjusted operating income are the monthly revenues we collect from our subscription members minus the costs we incur to pay veterinary invoices on their behalf, and to a lesser degree, our variable and fixed expenses we need to operate our business. In our 23-year history, the cost of veterinary invoices, or our measure of veterinary inflation, has grown consistently in the range of 5% to 6% per year. Our historical track record of pricing to these levels of inflation was equally consistent, delivering within a percent or two of our 71% target value proposition year after year. Coming out of COVID in 2022, the cost of veterinary care began to quickly accelerate. Within a period of less than 10 months, veterinary inflation increased an additional 900 basis points over historical norms. While this rapid rise in the cost of veterinary care was unprecedented in 50 plus years, at Trupanion, we were slower to react than I would have liked. The extra 900 basis points of inflation had a material impact. Adding to this challenge, our current policy terms means it takes us 12 to 18 months to reprice our existing members. In 2020 and 2021, our annual adjusted operating margin for our core subscription business was 13.9% and 14.3% respectively. After this rapid change in veterinary inflation, this same margin compressed sequentially four consecutive quarters until we hit a low of 7.6% in Q1 of this year. Compared to 2021, this was a 670 basis point compression to our margin to our core business. and it should go without saying, made operations more challenging. Today's slide presentation includes these details. Over the past seven months, the team has executed well against our mandate of restoring our target margins. We are managing the business on a much more granular basis, empowering our team through a more decentralized operating structure and making tough but necessary decisions to improve our overall operating efficiency. The actions taken were deliberate and meaningful, and in the quarter translated into what I believe is a significant sequential improvement in our adjusted operating margin and free cash flow. We have work still to do in getting back to our long-term margin targets, but I am encouraged by our progress. With that as a backdrop, I'll hit the key financial highlights for Q3. Total revenue was up 22% year over year, marking our 39th consecutive quarter of 20% plus revenue growth since going public in 2014. Adjusted operating income was $24 million in the quarter. This is up over 40% sequentially over Q2. Free cash flow was $7 million, an improvement of approximately $15 million from our Q2 results. $7 million positive free cash flow equates to approximately 2.5% of total revenue. It is our current expectation we will target at or around this baseline of positive free cash flow on an annual basis to avoid dilution or additional debt while we continue our growth in this large and underpenetrated market for the years and decades to come. And with that, I'm going to turn it over to Margie to provide more details about the actions taken and this quarter's accomplishments. Margie?