Q2 2022 Trupanion Inc Earnings Call

Greetings and welcome to the true Panyard, Inc. Second quarter 2022 earnings Conference call at this time, all participants on a listen only mode.

Shouldn't answer session will follow the formal presentation. If you would like to ask a question you May press star one on your telephone keypad, if anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. As a reminder, this conference is being recorded it is now my pleasure to introduce introduce your host Ms. Laura.

MS Laura Bainbridge Investor Relations. Thank you. Please go ahead.

Good afternoon, and welcome to true opinions second quarter 2022 financial results conference call participating on today's call are Darryl Rawlings, Chief Executive Officer, Martin <unk>, President, Andrew Wolf, Chief Financial Officer.

Similar to prior earnings calls Tricia, plus 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 your opinion 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 Companys. Most recent reports on forms 10-K, and 8-K filed with the Securities and Exchange Commission todays presentation contains.

Frances 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 cost 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.

In addition to and not a substitute for measures of financial performance prepared in accordance with 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 entre opinions Investor Relations website under the quarterly earnings Tab Lastly, I would like.

To remind everyone that today's call is also available via webcast Hunter opinions Investor Relations website, a replay will also be available on the site.

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

Thanks, Laura and good afternoon.

Q2 revenue was up 30% year over year more importantly, our adjusted operating income or the profits we earn from our existing pads 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.

And our large underpenetrated market investing compounding amount of adjusted operating income at our high internal rates of return is the key to our value creation in the quarter. We added over 61000, new pads for context. This is up about 10% year over year and up about 14% from year end growth what's driven.

By leaves in 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 forced your opinion 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 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.

For the last 22 years. This veterinary inflation has increased approximately 5% to 6% per year for Trapan Ewen members.

They were 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 med.

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 ARPA, which is a blend.

Of all subscription pets, we are not saying that people should model or expect blended ARPA to grow 10% a year for example, a higher mix of new cats means a lower blended ARPA more pets enrolling through the work site will mean, a lower blended <unk> more pets enrolling from parts of the world with lower veterinary call.

Cos will mean lower blended ARPA or blended ARPA 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 Japan yen with our cost plus model rising cost of veterinary care drives higher ARPA and Pat lifetime value over time, increasing our allowable acquisition spend and supporting continued <unk>.

<unk> 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 accident 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 companions 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, our the bare necessities for our human children.

For the majority of pet owners and for Japan, Ian 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 our pet owners annual pet spend with veterinary health care being approximately a quarter of a pet owners existing <unk>.

[noise] of wallet.

Is that an area where 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 set 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 cost.

Last year, the category added over $650 million in revenue up from $450 million in the prior year, We believe Japan led the category, adding about 30% of its growth.

I'll now turn the call over to Marty <unk> President to talk more specifically about the significant opportunity ahead of us Marty.

Darryl and good afternoon, everyone I wanted to take a moment to elaborate on Dallas commentary around why on 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 each opinion I'm trying to solve when we face an even greater juicy just step in and make a difference today's inflationary environment with mounting economic uncertainty and increasing pressure on our battery partners is one of those times we.

We partner with veterinarians to ensure that pet parents are able to provide for that pets unexpected cash today those trusted steward. The veterinary teams are struggling more than ever before burdened with the rising cost of care I ever watch tied in stress veterinarians have been pushed that point of burn out couple this with a backdrop.

A rising inflation and the fact that today the majority of personnel cannot afford more than $1400 and 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 person. It's a budget for the unexpected and veterinarians still need to raise their prices were starting to see early signs of this increase come through and on data, but it's not enough and we need to be prepared for there to be much higher as Daryl noted in the next three to four years veterinarian.

I'm going to need to raise our prices in aggregate by 30% to 50% to few passionate as can afford on budgets had Bethany Bell today few out we'll 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 that.

Cost of unexpected VAT me belt for the life of a pet we make it affordable for our members by breaking the cost of care into small monthly payments. They can adopt 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 of pet had a birthday. This is unique in the.

Three globally.

So that's raised their prices, which they will do a vertical integration lycos 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 personnel must understand how paying the vet direct say it means an end to reinvestment oscillation has never been more relevant high quality insurance should not need he waiting for a decision couponing does not we are paying more veterinarians directly than ever before enabling them to operate more sustainable.

There's no more time spent on estimates so fees for credit card payments year to date total invoice Telus paid directly to veterinary hospitals were up 20% over last year. The majority of these have payment approval in mere seconds comparable to if not quicker than that of a credit card, we want to empower veterinarians to offer.

Unpracticed best Medicine for moving the emotional toll of heart wrenching decisions forced by financial constraints.

And finally, we will continue to be that 24, seven 365 days a year, both the lucky and the unlucky pets.

We remain steadfast in our mission to 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.

True.

Thanks, Marty 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 and the quarter. The U S 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.

The year to over 770000 pets average monthly retention, which is calculated on a trailing 12 month basis was $98 seven 4% equating to an average life of 79 months. This is compared to $98 seven 2% 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 one 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 had discussed at the shareholder meeting.

Lee elaborating on Darryl is point regarding timing, we had higher claims processing costs as we continue 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 a data 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 nine 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 fix.

Fixed expenses were four 3% of revenue after the cost of paying veterinary invoices variable expenses and fixed expenses, we calculate our adjusted operating income realm.

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 and in Q4 in the range of 14% to 15%.

In dollars our subscription business delivered adjusted operating income of $18 8 million, an increase of 13% over the prior year period.

The aforementioned year over year change in foreign currency impacted adjusted operating income by approximately $600000 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 beta be 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 this 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're 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 61000, new subscription pets. This resulted in a pet acquisition cost of $309, 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.

Alex 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 towards 0.5% 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.

<unk> always balancing our capital needs with our growth projections.

As a result, net loss was $13 6 million or a loss of 33 per basic and diluted share compared to a net loss of $9 2 million or a loss of 23 cents 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 rise.

Cost of care growing need for true Pan in 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 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 are large enough.

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.

Thank you the floor is now open for questions. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he 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 Thats Star one to register a question at this time. Our first question today is coming from John Barnidge of Piper Sandler. Please go ahead.

Thank you very much wanted to talk about the subscription loss ratio came in.

170 basis points above the target of 71, and I know you talked about getting down to the 14% to 15% Oi margin for the fourth quarter, but I know drew you talked about some scale economies would maybe offset some of that elevation in the loss ratio. So wanted to circle back to that.

Target are you expecting to exit for Q20 to close to 71% again.

Uh huh.

Yes, we're expecting to get.

Closer to 71 with additional cost actions across fixed variable and loss adjustment expense to produce.

Produce that 14% to 15% adjusted operating margin.

Okay, and what was curbside versus a quarter ago and vet clinics. Please.

Okay.

Could you repeat that again.

Yeah, So curbside only at vet clinics I know, that's a dynamic that certain certain vet practices have decided to keep even in a post pandemic world can you maybe talk about.

<unk> vet hospitals or clinics that you're in that maybe have your software.

Percent of those remain a curbside only versus a year ago.

Were a quarter ago. Thank you.

Hi, Todd it's logging.

So I definitely hear so are we saying and evidenced the car that hospitals across all of our markets.

More of the exception than a rule certainly than a year ago, and hopefully they'll sometimes have adopted that price.

They visit and make sure that was clear now can bring and the introduction of the <unk> the opportunity to talk about the 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 stuff where all of that portal as we now have been referring to it is increasing so our utilization rate throughout the course I went up 20.

Year after year, the same move outs with with not having taken it so far are adopting it they're using it more often than they were before and people are now getting back into the hospital.

It's probably much less than that like I said, an exception at the pace.

Yeah, just one thing to add to that John .

I'm sorry, there's one thing that affected HUD on Earth and that's all you said that.

Largely diminished.

Diminish the biggest part for US is our territory partner.

Often not able to walk into the hospital and they're now able to walk through the doors and that's been a big benefit to the company.

Thank you for that and maybe one last question if I can oh.

Are you seeing any signs in the wake of inflation that a church or choosing to maybe move from.

Lower deductible higher monthly or periods of higher deductible lower monthly our pool.

I can I can suddenly felt that and know that others.

I want to add to it we've actually been looking on deductible trend as we await their across the board for everything on a very regular basis, others aren't supposed to have actually been trending down.

We've seen that coming through throughout the course of the back end of Q1 into Q2, so what that means based on funding and where people are taking a lower deductible.

Let's say, it's the same country to add to that the higher deductibles that these questions about that people are seeing the value. We've said before that people are very value sensitive and some very very different to cross market somewhat different channels or anything like that.

At what point its coming down.

Thank you very much.

Thank you. The next question is coming from Sweden <unk> of Evercore ISI. Please go ahead.

Okay. Thank me. Thank you let me try a couple please so what is the adjusted operating income growth rate guidance.

Include in terms of the costs. So could you. Please break it down in terms of your expectations, whether it is investments our loss ratio et cetera, I, just a little bit more and then the second question is how should we think about the contribution from the lower price products in the back half of this year as well as.

Contribution from them that chewy partnership and other incremental growth channels. Thank you.

Sure I'll start on the first question.

Then hand off the second one but the.

Guidance on adjusted operating margin includes action across the board, we're gonna have to our loss adjustment expense will have to come down we'll.

We will get additional scale on fixed and in some work in variable.

As well as taking pricing action 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 and then the second question, how should I say, it's only a incentive contribution coming out if I'm correct. Then in the second half. They are parents I am thinking of the products that we have in market right now that have been asked I think we've expressed before it being pretty disappointed with the April private exercise that's correct in general we have changed our April because they're saying instead of just having to general managers that know all of it.

Plus the fact that they're.

But having that great. We don't anticipate a significant impact from them in the back half of the year, what I will say, our chewy and outflank them they've launched a market, where we're very happy with the the overall the early stages of that but two products that were very honest and I think that I'll touch on this in his prepared remarks, the humbled by the fire.

We've got the trust with these two brands to be able to partner with your opinion, 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 is a monthly subscription revenue products, we're not going to see the bulk of that impact coming through as we just start to get that rolled out in early stages.

But we do anticipate some impact, albeit mineral and the and keeps shrinking pool.

Okay. Thank you.

Okay.

Thank you. The next question is coming from Josh Shanker of Bank of America. Please go ahead.

Yes.

Yeah. Thank you for taking my question.

So.

During the annual shareholders' meeting you throw out a statistic in about May installations 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 as continuing whether that was a blip or not and what's happened. You. You mentioned briefly in one of the questions about what's.

Going out in terms of face to face interaction how is that trending with the territory partners in the veterinarian clinics.

Yeah. So you're right just we won't go into details about how that number at 352 is continuing to scale, but I can tell you. It continues on that same trajectory that 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 had before and they cannot walk in the door with the hospitals and rekindle those relationships they had face to face.

Well, we're seeing results of that not any more people adopting.

Why are you using on a regular basis or what they're saying and increase their mainframe and paying that veterinarian directly at the time of checkout, which we know yourself with other covenants as we referred to in our prepared remarks.

When we think about that face to face interaction and 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.

It's on the ground locally, which just helps to understand that market that information helps inform our pricing team. It also helped to drive a high lead volume, which in turn has a high conversion rate, which means we have a more efficient tax so that flywheel starts to kind of really really coming together nicely.

Happy with the fact that we've been able to get back into the hospitals that kind of started at the back end of Q1 has been maintained through Q2 and that we continue to see that happen and can create itself.

Yeah, and I'll just add that with.

All of the <unk>.

General talk of inflation for NOG veterinarian and it being even more acute in the veterinary space and not seeing that in some of the numbers. It gives them a real strong talking point for our territory partner quite a level of urgency.

And Oh.

Having him walk through the doors.

It's been great for the business in a.

Super happy to have him back in the field.

And then if I look at the IRR on our customer acquisition cost at 31 didn't close to your lower bound of 30%, which suggests maybe the efficacy of our customer acquisition spend.

Is weakening all of the growth scraped 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 kept at 30% return.

So Ira.

I've got about something between 30, and 40% and that doesn't change course ethical or should I say are we were at 31% is he is he commented on and when we think about the impact of that we still margin compression for the quarter as to what we were doing as we saw that coming and creative teams were out saying that communication with each other around adjusting that spend profile.

You want it and bring it closer to that that's exactly the same.

Ever all that when we look at all channels and they are the efficacy that is strong as ever lead volume and strong conversion rates are high. So we don't have any concerns that.

Thank you for the answers.

Thank you. The next question is coming from Katie sake of Autonomous research. Please go ahead.

Hi, Thank you good afternoon.

You know inflation is rising and your ARP, who isn't growing much sequentially. So can you just walk us through why you think you'll get back to a 71% loss ratio.

Uh huh.

Yeah, Hi, Katy this is tricia I can I can talk about that flying I mean.

At a high level what are the shows up on our consolidated financials as an output and that's an output of pricing to as close as we can to that value proposition that 71, like you mentioned no day today and I talked about this.

Thiago for your level at the shareholder meeting and we are constantly looking at the data at a granular level G. O neighborhood breed age out enrollment and updating our pricing very frequently and we have many region.

Neighborhoods that we're pricing that are receiving increases.

And the 5% to 10% range something higher than that now we have some regions where we.

We actually are running below our loss ratio target and so we've been decreasing Dallas prices. So the output that they argue that you'd see them on our financials is the blend of that and you know where we're really targeting is to to hit the target of 71, and then you know as drew mentioned.

How does that flow through then to getting us closer to our 15 now based on the data that we see them. We are increasing then prices and in more areas than we were six months ago to keep up with rising costs not only in the frequency of the invoices, but now as Darryl mentioned.

In some areas not all but in some areas. We are seeing average invoice size start to go up more than we happened to pass them. So the key for US is you know well, we'll never be absolutely perfect them, but we are looking at this at a very granular level more multiples.

Times, a month, we have pricing action going through at all times about 112th of our book every single month CS price changes are at a granular level to get them close channel will start to our value proposition. So.

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 that as well to get us closer and.

And we feel you know we've been doing this for a long time, and so we feel confident while well timing they move around but that you know if we can absolutely get called back on track to our value prop.

Got it and as a follow up with you know inflation running.

8% to 12% and does that channel can you give us an idea of what your opinions rate increases are looking like today.

Like a nationwide headline rate.

Well I mean at a macro level, we're seeing in the first half of the year, our pillars going up one 4% at our claims per pet is going up one 5%. So we've been doing while theres some.

Timing variation between quarters, we've been doing a good job of.

You know keeping that keeping that up although we need to make up about 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 five and 10%. It's just offset on a blended basis with with a certain range.

And brands that were decreasing prices and so that's that's where you where you get the blend but you know when we when we Peel back the onion and look at it where we are putting through larger rate increases that you would expect and in many areas. I'll also say that some of the rate action.

And 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 thinking 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 what goes through in the future. It doesn't mean it 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 metric because as we add more products into them that.

As far as geographies go faster or slower.

You you're going to see more of a blended RPM, if we start growing faster than products that have lower a lower arco I'm hypothetically that would impact our overall blended arco as well so our mix of business is up.

T here as well there'll be no I'm kidding.

I mentioned in my opening remarks, I mean, our Glenn.

Blended into our pool as it is an output it'll be what it will be we hope that our workplace and a bunch of other places are really can start to make an impact in the back half of the year. Some of these were expecting to have lower ARPA. So on a blended basis you may see that.

You know, 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.

And you know and there are 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.

Got it. Thank you so much for the answers.

Thank you once again that is star one if he would like to register a question at this time.

Our next question today is coming from Maria Rips of Canaccord. Please go ahead.

Great. Thanks, so much for taking my questions. There. If we are indeed going to see 10% to 15% increase per year in like for like cost of with key over the next three or five years, I think you said and that obesity compounds over the years. How do you think about your capacity to increase prices for your members without impacting retention.

Well, we've been doing this for over 20 years Maria and we've we know and we've been tracking in our shareholder letter and of course, they are rate 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 the grade.

Leif.

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 to veterinarians appropriately compared to other medical professional.

I'm not guaranteeing its going to happen, but we certainly hope that they will and we know that members can afford to pay for that fair when its budget isn't broken into monthly payments and we have no concerns with us and I'm excited to see if it happens.

Got it that's very helpful. And then secondly on your recently announced partnership with ease of that could.

Could you maybe provide some additional context on how this this offering is different from the core software integration and I guess, what what overhang is being addressed by the partnerships. So that thousands of additional hospitals are now able to integrate the software.

Yeah, Hi, Mary or Smoggy on let's say the policy with easy that is essentially a full integration within their referral platform within their practice management system. So what that does is many thanks migration to eat we've added a couple of years ago that had been watching that you probably would historically and we didn't have that full integration embedded and now we do have that we have access to hospitals, where you can start.

Do you have quite a lot of members.

Members as well as data does that have on boarded with a car based off whether that's easy to say it gives us access to hospitals that are partnered with us for a long time and some of them are very large and somebody needs. When we think about our practice management approach and how our penetration rates are increasing across the north American market. You said that it's one that really gets the fact that.

So an awful lot more hospital, let's say it just enables us to actually be able to pay the factor xa everybody felt that problem.

And very much with the vitamin profession that we can offer them a solution that they they didn't otherwise have if they had anything about previous things that interest.

Reinvigorate states hospitals that were already supporting.

Yeah.

Got it that's very helpful. Thank you for the color.

Thank you. Our next question is coming from Jon Block of Stifel. Please go ahead.

Thanks, guys. Good afternoon, maybe just two for me just first one so.

So to start on the gross adds and you just want to look back.

Six quarters or so it looks like the gross add tread line has somewhat flattened out.

55 to 58000 give or take for 2020 one are normalized for a quarter and then 60 to 61000 in the first half of 'twenty. Two. So you know there are sort of anecdotal chatter that pet adoptions might be starting to subside from call a pandemic highs I think a good amount, maybe 70 or 80% of your gross adds.

Come from from from Puppies and 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 in flooding in 'twenty three 'twenty four so how do we think about that gross add trend line going forward, while arguably adhering to your 30% to 40% IRR.

John I think when I look at you know, where our monthly recurring revenue business and if I think about our total subscription pets, which is how do we get our revenue if.

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 'twenty, one and 'twenty two it's going to be between 21, and 22% and total subscription pets.

Monthly recurring revenue at sometimes you're accelerating new faster, sometimes retention is faster or slower, but when I look out and go into 'twenty three 'twenty four 'twenty five for the company.

We not only have the strong growth that will be driven by via the veterinary inflation in our territory partners walking through the door.

Six of them are flat and we talk about these different additional channels.

That are coming online a couple that launched last quarter, and we will start to make an impact in Q3 and Q4.

I'm really excited about the work we're doing internationally.

We expect it will start to take hold in 'twenty three 'twenty four as well so as a company when I look at it I look at the total total subscription paths, but really I I monitor my year over year increase in adjusted operating income.

And can we compound that so I've said before our goal is to grow that 25% a year for each year and our 60 month plan, which started in 'twenty, one and will end at the end of 'twenty five.

In the first year and 'twenty, one 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'll be probably 15% to 20%.

But we do think that as a goal internally as a company 25 will be the goal will be setting in 'twenty three 'twenty four and 'twenty five and we'll see how it goes I mean, some years, we might grow faster.

And in my shareholder letters anytime or growing 20% to 25% as a shareholder I'll be thrilled.

I am 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.

Can I add as well so that John just inside of it that I can say just when we think about that topic, specifically in what we've been able to do them.

Coming off the back of a tough comp year over year with they are with April pet count, but it's at that point, we're saying things moving in a very positive direction from an April trends have hypertension and acquisition being back in the hospital being able to offer some very high quality products thinking about channel, having a terex for call it like that.

A market that we trust and presently the partnership with the veterinarian sandwich offer them unbridled levels of support and service at a time when they out so you need it to be pushing out the strength that we've been talking about from an inflationary perspective, I am very confident in the numbers or anything coming through in the early stages of Q3 in the backend of Q2 that means that they have that.

Channel traffic, which is a real driver of the growth that we see by some of our attention on acquisitions with much of it is looking very strong in triangle's than ever.

Got it.

Thanks for that color very helpful. And then just a second question, maybe a little long in.

It's gonna have with more your opinion on something Darryl button or if it was up 1% ish year over years show modest well below the rate of inflation, which I think you said it 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 <unk>, because there's a million moving parts and part of that is mix. So I just want to be clear because I've been confusion in the Pea.

I think what you were saying Daryl when you were giving examples is it the newer pets coming on you know, maybe puppies or kittens or alternative channels. Those are lower ARPA pets, you know the ones that are coming on a I'll call. It below corporate <unk>, let me sort of pause there as it is that correct.

Well there.

Two things I wanted to just correct, Jon So I said, the 8% to 12% increases in some of the veterinarian half of hospitals not all yet. So we are starting to see larger and that's all on our invoices paid that's on total invoices. So that's the first place we look for inflation is of all the invoices that we're seeing.

King.

Our veterinarians, taking larger price historically for the last 20 years, that's been about 5% to 6% for insurance clients. What's your opinion. The total invoice dollars are going up 5% to 6%. There was a question earlier today, saying, whereas deductibles gone up they haven't they've actually been going down but.

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.

It is an impact it is often true that we have largely enrolling younger pet that was had been the same for year after year, but if we take a city for example, and let's say in a city we were had to.

We've cut the city and a 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've been happening before if we would've been growing faster whether it was in the 80 and slower when there was a 61.

If we made them both 71.

And so you're seeing accelerated growth in the lower price the lower price neighborhood and you see a slowdown in the higher price neighborhood in comparison to what you were doing beforehand.

<unk> is a company that and ensure that it was more accurately pricing risk than other insurance companies for many many years and their mix of business would be different in a different insurance company. Our goal is to be a disciplined grower to get strong IRR and as we continue to refine our pricing.

Glenda is changing now in addition to that you know with chewy and Aflac and some of the other things on 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 on a couple of callers.

Colors 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, and subscription part 15, and 18 15, and 19 and you added about 5% and our pool 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 are right. There are a lot of things at play.

And theres going to be more things that play in the future and.

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, we're trying to find it anything over 30%.

Okay.

Maybe I'll follow up offline, but just more of the opinion one was Daryl just.

At a high level when you're running that internal rate of return why is that.

Dictated by the Arps, who of the entire subscription base, rather than the cohort that you're bringing on in the current quarter or in other words youre doing the the packed dollars right, but the internal rates of return are predicated on does that.

Cohort that is a $50 <unk>, bringing on the books or 75 why is it always run over the entire 770000 pets that are already on the books and hopefully that makes sense. If not we can take it offline, but just wanted to throw that out there for more of an opinion standpoint, yeah, where are we I don't know all of it is actually not driven by our Poe it's driven.

Adjusted operating income or margin when 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 were behind the scenes. We're spending much left for a cat and we are in a dog.

And the way that we calculate.

The internal rates of return does not assume that we're gonna have larger adjusted operating income a two or three or four or five years in advance. So it is actually conservative and understated assuming that on average are the adjusted operating income is going to go up over time.

But that's how we that's how we that's how we run it and if you have further questions. If we can if we can jump on it offline.

When we set that up.

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 our pets as another another reason would set up that way yeah I get the transparency I just want to know if you're spending you know the $300 pet to bring on $50 cohorts, a 70 dollar cohorts.

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.

Yep.

Thank you. The next question is coming from Elliot Wilbur of Raymond James. Please go ahead.

Thanks. Good afternoon, just may have been asked earlier I might have just missed it but just.

I wanted to get your general sense.

Trends in <unk>, and what the impact would be on churn and more specifically thinking about.

The two buckets kind of I guess at it 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 you where theres been an excess of.

20% price increases so curious as to whether or not you think that change in either of those buckets.

Could have a more.

Outside impact given that we're obviously looking at sort of much higher overall rates of inflation.

Yeah.

It's a good point for people that haven't Radzik shareholder letters, but we report year after year about where our our churn come from and how it goes through.

I'm not sure how you articulated it is.

Exactly accurate so we have largely pre buckets that we report on those are new Pat and those are 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 kicking tires people that's fine on them.

Their dog was currently sick and they were disappointed we didn't cover a preexisting condition could be people that we're gonna get a spare neuter or regular well does some were confused on what our coverage was that's in that first bucket that is our highest churn level.

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 their growing 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 I love veterinarians start to increase their rates not what I'm, hoping kind of 15%, but if they were to increase of 25% year over year, but as long as it's under 20% you can look in historic.

How we've what our churn rates have been and I can tell you.

We are at all time retention right now that are reported on a 98 seven for I believe and our conversion rates are slightly up referral and add a pet is also a 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.

And I wanted to ask a question on the pack number in the quarter and trends in in Pat maybe just a parcel will get a little bit more granularity on what's driving that.

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 conversion over time, you know wondering if the relative rate increase in those two categories.

Essentially equal or you're seeing them the deposit conversion go up in a higher rate than the lead generation, but maybe just a little bit more insight into the the increase in the pack number just curious.

Oh, yes.

I'm, saying when we think about coffee in general if we look at it the last few quarters. It's been relatively flat. Thank you for F. 'twenty. One it was 300 and say you wanted to say I want to wish. The 309. So when you think about that April was very different movement between the quarters.

As we mentioned before that the real kind of a guiding light for us that they've got enough internal rates of returns they being between 30 and 40% to any given point in time.

Overall split between the convert and retention that we do have an element of retention, which is that first is that the dollars that you're just now it's kind of a reinforcement of the value propositions yourself departure April guys into pack, but this is a fully loaded cost as a reminder, this is everybody that works within our acquisition space.

And not that lead and convert it hasn't really shifted significantly if it has it by a couple of points.

We're constantly looking at how do we make sure that we are just as we think from a pricing perspective, we are focused on the right message at the right time with the right combination of different attribution going there's a number of different elements to a journey that will call someone could be the funnels that you've got to have that lead for example, we're going to see that the overall lead cost is going to be.

The bulk of that the conversion is very simple very straightforward. It's a much cleaner lead for us because the stronger referral upfront similar with refer a friend and honest happen. Then you have different regions will have different mixes. So in general it hasn't changed that all being as efficient as we would want them to be in various places.

We will push hard on a certain area to move on to others and like we said when we towards that internal rates of a sense specifically for this quarter.

We really thought that perhaps are coming through from a margin compression point of view and we want to make sure that we're always adhering to carve outs, which is why you see that looking like it was kind of towards that that he wanted to take the midpoint of hockey in general It just really isn't leaving him a great deal over the last three quarters as I mentioned to say the team is continuing to invest a semester level. It's the same.

They didn't convert them and we haven't seen that shift as well, particularly.

Okay and then last question for drew drew you mentioned the uptick in the severity of claims was that just within the realm of the.

The ranges that you see historically anything specific in terms of a territory or what.

What may have driven this that this period that sort of led you to call that out.

Yeah.

As I mentioned.

At the shareholder meeting I talked about you know movements, we're seeing in the loss ratio with frequency being a big driver coming out of Covid and and.

And then the the change in loss adjustment expense. So those two were about 130 basis points of our move to 40 basis points was that you know we were pricing for inflation and it's big.

Celebration that we saw really in the back half of June .

It was that extra 40 basis points. So that that is the other part that we picked up.

Luckily, we were able to take action in the quarter and mitigate about 60 basis points of of that move but.

That said uptick in severity that I talked about it it's not in any specific region, it's across the board.

Okay.

Okay. Thank you.

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 Chew pinion event. You may disconnect your lines or log off the webcast and enjoy the rest of your evening.

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