Trupanion, Inc. Q1 FY2021 Earnings Call

Greetings, and welcome to the Trupanion, Inc. First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. It is now my pleasure to introduce Laura Bainbridge of Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to Trupanion's first quarter 2021 financial results conference call. Participating on today's call are Darryl Rawlings, Chief Executive Officer; and Tricia Plouf and Margi Tooth, Co-Presidents. Similar to prior earnings calls, Margi will be joining Darryl and Tricia 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, fixed expenses, variable 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. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are in addition to, and not a substitute, for measures of financial performance prepared in accordance with U.S. GAAP. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release or on Trupanion's Investor Relations website under the Quarterly Earnings tab. Lastly, I would like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. With that, I will hand the call over to Darryl.

Thanks, Laura, and good afternoon, everyone. 2021 is off to a flying start. This is apparent in our Q1 results, which I will share momentarily. But first, I want to point your attention to my Annual Shareholder letter, which was published earlier this week. As usual, it includes the key annual metrics that we believe drive Trupanion's intrinsic value. Some of the annual metrics shared in the letter include the number of territory partners, active hospitals, same-store sales, as well as financial highlights, including our year-over-year increases in revenue and adjusted operating income. They show strong internal rates of return and the strengthening of our balance sheet. What is different about this year's letter compared to most is that it also includes a copy of our 5-year strategic growth plan, or as we at Trupanion call it, our 60-month plan. In the plan, we share the vision of where we are headed and lay out the road map for us to deliver meaningful growth in revenue and intrinsic value. I would encourage you all to read it. In doing so, I hope you'll share in our excitement for the future. Ultimately, our ability to deliver against our plan comes down to execution, and execution comes down to people. Tricia and Margi, our Co-Presidents, are leading the teams responsible for the execution of the plan. Our upcoming shareholder meeting on June 16th will be your opportunity to meet and have direct Q&A with the individuals and teams that are directly responsible for the initiatives outlined in the strategic plan. Our annual shareholder meetings are thoughtfully constructed to be the most valuable source of information for shareholders each year, and we hope you'll be able to attend in person or via Zoom. As I noted earlier, but it's worth repeating, the first three months of our 60-month plan are off to a very strong start. So, let me jump into our first quarter results. Total revenue increased 39% in the quarter. This was driven by a 121% increase in subscription net pet growth, which is exceptionally strong. Adjusted operating income increased 40% to $16.8 million. We were able to deploy 100% of these funds within our subscription business at an estimated internal rate of return of 35%. In total, we added approximately 56,000 new subscription pets in Q1, an increase of 54% year-over-year. Growth benefited from both increased leads and conversions across all channels. We also saw continued strong retention, which is impressive given our accelerated growth. One additional marker of our accelerated growth can be seen in our expanded brand presence. Over the last six months, the number of people searching for Trupanion has grown by 57% in the United States and 78% in Canada, while the search term pet insurance has been flat to slightly down. In 2020, we estimate that we increased intrinsic value by $1.4 billion, and we shared approximately $55 million of this increase in stock grants with the team, including a $4 million one-time bonus to all team members. Additional details can be found in our Annual Shareholder letter. Our financial position is strong with cash and assets of over $513 million, and we are well capitalized to afford these accelerated growth rates. With our strong cash position, we have been making longer-term investments in areas like our member experience with the goal of improving retention, as well as in technology that will help strengthen our position as the low-cost provider. While early on, we've already seen some intended benefits manifest in our key metrics. TruTopia, which we used to refer to as Nirvana, measures the difference between existing pet owners adding pets or referring friends and those that churn, reached a new record in the quarter at a gap of just 0.33%. Broadly, we're seeing more and more opportunities that have come from over 20 years of industry experience, achieving operating scale, defensible moats, and our brand position in a large and underpenetrated market. With that, I'll hand the call over to Tricia to talk about our Q1 results.

Thanks, Darryl, and good afternoon, everyone. Today, I will discuss our first-quarter performance and also provide our outlook for the second quarter and full-year of 2021. I echo Darryl's sentiment that it was an exceptionally strong quarter for Trupanion. Our outperformance was driven by an acceleration in pet growth within our subscription business and continued strong performance within our other business. Total revenue for the quarter was $154.7 million, up 39% year-over-year. Within our subscription business, revenue was $113.3 million in the quarter, up 27% year-over-year. Total enrolled subscription pets increased 20% year-over-year to approximately 610,000 pets as of March 31. Average monthly retention, which is calculated on a trailing 12-month basis, was 98.73%, compared to 98.59% in the prior year period. The improvement in retention extended the average pet's life with Trupanion to 79 months, up from 71 months in the prior 12-month period. As we have discussed in the current and prior shareholder letters, we look at retention in three different buckets, with one being retention in the first year. While we have seen improvement in first-year retention, it still acts as a headwind to overall retention during periods of accelerated growth. Based on our current growth rate, while we do project retention improvements within the various buckets, we don't expect to see the blended trailing 12-month retention rate continue to increase during the remainder of the year. Monthly average revenue per pet for the quarter was $62.97, an increase of 6.8% year-over-year or 5.5% on a constant currency basis. We continue to focus on pricing initiatives to deliver ARPU increases of between 6% to 7% to position ourselves to hit our target payout ratio of 71%. Our subscription cost of revenue includes the cost of paying veterinary invoices and variable expenses. As a percentage of subscription revenue, the cost of paying veterinary invoices for our subscription business was 72%, and variable expenses increased slightly to 10%, both reflecting continued investment in people, systems, and claims automation capabilities to reduce future frictional costs and deliver a more differentiated member experience. We will continue to invest in these areas in the short to mid-term, so long as we continue to see future benefit. Our other business segment is comprised of revenue from other products and services that generally have a B2B component and different margin profiles than that of our subscription business. In total, our other business revenue was $41.4 million for the quarter, an increase of 90% year-over-year, due primarily to an increase in pets enrolled within this segment. Cost of revenue for our other business segment was $38 million, compared to $20 million in the prior year period. The year-over-year increase is consistent with the increase in segment revenue over the same period. Total fixed expenses, which are shared services that support both our subscription and other lines of business, were 5% of revenue in the quarter, an improvement from 6% in the prior year period. Adjusted operating income was $16.8 million in the quarter, an increase of 40% over the prior year period, and our net loss was $12.4 million, which I will discuss in more detail momentarily. The vast majority of our adjusted operating income was generated from our subscription business during the quarter at $15.5 million, which was 14% of subscription revenue. During the quarter, we were able to deploy 100% of our adjusted operating income of $16.8 million to acquire approximately 56,000 new subscription pets. This resulted in a PAC of $279 in the quarter, an estimated 35% internal rate of return for a single average pet. Given our large market opportunity, adding pets at strong internal rates of return is core to our strategy, and we are well capitalized to do so. Development expenses or costs that are related to product exploration and development that are pre-revenue were $0.8 million in the quarter. For more detail on how we calculate internal rate of return and adjusted operating income, please refer to our supplemental financial materials on the Investor Relations portion of our website. As I just discussed, in the first quarter, we were able to deploy all of our adjusted operating income to acquire new pets at our targeted internal rate of return. When combined with our development initiatives, this resulted in an adjusted EBITDA loss of $1.1 million for the quarter compared to adjusted EBITDA of $2 million in the prior year period. Depreciation and amortization was $3.1 million during the quarter, an increase of $1.7 million from the prior year period. This increase was primarily due to the amortization of software and intangible assets from our software acquisition in the fourth quarter. Total stock-based compensation expense was $8.4 million during the quarter, up from $1.7 million in the prior year period. This increase reflects our Q1 grant in February, which related to our 2020 intrinsic value growth that Darryl mentioned earlier. The calculation of the overall company performance pool is consistent with our performance compensation plan, which is detailed in our 2016 annual shareholder letter and was approximately 2% of our total diluted share count at year-end. As Darryl mentioned, included in our 2020 performance grants was a onetime grant to our entire team in the amount of $4.3 million, which was fully recognized in our stock compensation expense and net loss for the quarter. We had very strong performance in 2020, and we're happy to share a portion of this value creation with the team. Absent this onetime impact, we expect stock-based compensation to be around $6 million to $7 million per quarter for the remainder of this year. Net loss was $12.4 million or a loss of $0.31 per basic and diluted share, compared to a net loss of $1.1 million or $0.03 per basic and diluted share in the prior year period. Net loss per basic and diluted share was impacted $0.17 compared to the prior year period due to increased stock-based compensation expense and $0.04 compared to the prior year period due to increased depreciation and amortization. Additionally, our accelerated growth rate and associated acquisition spend impacted EPS by $0.06 compared to the prior year period. As a reminder, we view our revenue growth, profitability, and cash flow measures as strategically linked. Historically, operating at or above cash global breakeven was a guardrail to which we manage the business. As we noted in our prior calls, our financial position is very strong, and we're capitalized in a way that we can afford our accelerated growth and execute on the opportunities in front of us. In addition, we're spending more on capitalized items, mainly in software to support our member experience and new product initiatives. As a result, free cash flow in the quarter was negative $4.6 million, compared to free cash flow of $1.4 million in the prior year period. Operating cash flow in the quarter was negative $1.7 million, compared to $2.9 million in the prior year period. At quarter end, we held cash and investments of over $224 million and no debt. I'll now turn to the outlook for the full-year of 2021, which we are updating to account for our over-performance in Q1. We now expect total revenue in the range of $674 million to $682 million. Subscription revenue for the full-year is expected to be in the range of $491 million to $496 million, representing 27% growth at the midpoint. At these revenue levels, we would expect total adjusted operating income of around $75 million, an increase of 31% over the prior year, with over 90% being generated from our subscription business. Of the $75 million, we would expect to invest approximately $66 million in acquiring pets within our subscription business, which at our targeted internal rate of return results in a PAC of around $280 per pet. We believe the most value is created through the compounding effects of cost-effective pet acquisition while operating within our internal rate of return guardrails of 30% to 40%. For the full-year 2021, we also expect to spend $3 million to $5 million on development initiatives discussed earlier, as well as our other business. For the second quarter, total revenue is expected to be in the range of $164 million to $166 million. Subscription revenue is expected to be in the range of $119 million to $120 million, representing 29% year-over-year growth at the midpoint. Also, please keep in mind that our revenue projections are subject to conversion rate fluctuations, most notably between the U.S. and Canadian currencies. For our second-quarter and full-year guidance, we used a 79% conversion rate in our projections, which was the approximate rate at the end of March. Thank you for your time today, and I will now turn the call back over to Darryl.

Thanks, Trish. Before we open it up for questions, I want to remind you of a few upcoming investor relation events. This weekend, Margi, Trish, and myself will be hosting our annual Q&A to immediately proceed the Berkshire Hathaway Annual Shareholder Meeting. This event was designed for us to connect with long-term like-minded shareholders, and we will once again be hosting the event via Zoom. Those interested in participating can register for the event on our Investor Relations website. And as I mentioned earlier, but worth repeating, our Annual Shareholder Meeting will be held on June 16. With vaccination rates increasing, we're excited to offer limited in-person attendance at our Seattle headquarters. I encourage you to visit in person if you are able to, and to register as soon as possible on our Investor Relations website to ensure we have enough space. For those who are unable to join us in person, we will offer a live broadcast via a Zoom webinar. We hope to see you at both of these upcoming events. With that, we'll open it up for questions.

Thank you. Our first question comes from the line of Maria Ripps with Canaccord Genuity. Please proceed with your questions.

Great. Congrats on strong results, and thank you for the shareholder letter. As always, it's very informative. I just have a couple of questions around your two new subscription products. Can you maybe talk about the level of coverage that you anticipate providing for these two products? And maybe broadly speaking, what are some of the conditions that are currently covered under your core plan that will not be covered under these plans? I guess how are you positioning these newer plans for consumers? And maybe related to that, just in terms of pricing, where do you anticipate the discount range to be for these two plans, compared to your core Trupanion offer for the same pet?

Thanks, Maria. So, we talked about offering kind of a low and a medium ARPU product in my annual shareholder letter that was recently published. And those products are going to be set up in such a way that they are clearly identified to the consumer, the difference between something that has low coverage, medium coverage, and our traditional higher coverage product. So, we want to make sure there's clear distinctions, so that the consumer can understand how and what they should choose. All the products will have a high level of transparency and have the same value proposition. We are planning on launching those products later this year. We believe that it's a good time to do it now because the company is now set up where we can leverage our operating scale, as well as our technology and data to do that and we're excited to see how they perform in the market.

Got it. That's very helpful. And maybe a quick follow-up, can you talk about sort of your marketing strategy, primarily around direct subscriber acquisition efforts for these two plans? And are you planning to invest in brand behind these two new products?

Thanks, Darryl. Hi, Maria. So, in terms of marketing strategy, the difference of these two products will be entirely sold direct-to-consumer, so playing in the online space predominantly. When we think about the investments in the brand, we're going to be continuing to adhere to our guardrails of the internal rates of return between 30% to 40%. So, that won't change and won't shift, and we'll continue to do what we can within those parameters to see what growth we can achieve with those products when they enter the market.

Thank you. Our next question comes from the line of Shweta Khajuria with Evercore ISI. Please proceed with your question.

Okay, thank you. Two questions, please. First one is on growth additions. Could you please talk to what really worked in terms of driving this acceleration that you saw in the quarter in subscription pets? And then the second question is, in your letter, you have a table that talks to the active hospitals and the visits. So, I wonder the clinic visits every 60 days to 90 days that decreased last year, primarily because of the curbside care. Do you think that it can get back to 2019 levels sometime this year or maybe exceed that sometime this year? And also, you shared the 5-year goal for software penetration levels. I wonder if you could give us some sort of range for maybe where you think you will be exiting this year or maybe next year in terms of software penetration, too. Thank you.

Hi Shweta, it's Margi. So, I will take as much as I can of those questions and share with you. So in terms of growth additions, what worked well, overall, we saw a really strong uptick in both leads, so people that are finding insurance for the first time. Conversion rates are very strong, and then retention rates overall. As we've talked about historically, we've really been looking at that member experience, which does help to drive our referral channel. So when we think about referrals, we know if we give people a great member experience, something that we can absolutely directly control, that helps. The Vet Foundation we have has seen good growth. And the more that people are thinking about pets as part of their family and continuing to do the best they can for them, we're seeing that continuing in the quarter as well, which I think all rounds up to having a much stronger brand presence as we start to put all of our channels together and see them stacking up to perform very strongly for us. In terms of active hospitals and visits, you're right. We do see a decrease in hospital visits last year due to COVID. We are seeing still around 20% to 25% of those visits historically, that we're starting to get back a little bit more now. So, where possible the field are going back in and meeting with their hospitals, continuing with those relationships. What I will say is the benefit of having built relationships over the last 10 to 15 years as we have in many of those markets, we've really been able to have them picking up the phone, still communicating with us, and still adding value in ways that we can build on while we can't get in the hospital. Our plan is to go back to face-to-face business as soon as we can, as long as we can do it safely, both for our field team and the hospitals themselves. So, we're pleased with picking up and we'll keep working on that through the rest of the year. In terms of our 5-year goal for software and penetration, it depends a lot on COVID. The teams are continuing to pick up software penetration nicely, and we'll be talking more about that at the shareholder meeting.

Okay. Thank you. Can I please try one more as a follow-up? If you were to include virtual visits, so phone calls and call it video calls, would you say that the 60-day to 90-day would be comparable to 2019 levels, if you add physical and virtual?

Yes, absolutely. And we've got not only territory partners that used to have the account management team. So, you know the breadth of support we give to the hospital. I was saying, is probably increased there over the last 12 months as we look at making sure we can do whatever is possible to support our partners. It's not as good as being in person, but it's definitely good to build that relationship and still be here for them.

Thank you. Our next questions come from the line of David Westenberg with Guggenheim Securities.

Hi, thank you for taking the questions and congrats on the really strong growth. So let's actually start with the growth in ARPU. I know you are targeting above 6% or above historical trend. You did seem to get there with the 6.8% growth in that, but you also combine that with strong new pet adds. Can you tell us about the sustainability of those two metrics combined? I know that you say as the cost of veterinary care goes up, it drives the demand for insurance, but I wouldn't necessarily think that would be the case always short-term. So, if you can maybe run us through kind of the assumptions in the year with those two metrics kind of in a combined – thinking about them combined.

Hi Dave, it's Tricia. I'll start and just sort of talk about the thought process that went into our outlook, and then let Margi or Darryl add more color from their perspective. Yes, as you saw, we did have strong ARPU. It was benefited by a little over 1% in our FX rate for the quarter. But we still feel our progress overall is strong. As you know, our ARPU and our pricing is a factor of what the vet invoice expenses are that we see come in and adding that 30 points on top to hit our pricing, and our target margin for that vet invoice expense is 71%. We did make solid progress year-over-year. A year ago, it was 72.6%, and this quarter at 71.9%. So overall, we're very happy with how ARPU is trending, and we would expect in the guidance what we put in is a similar level to what you saw in Q1, and we feel like that is reasonable. Similarly, in our outlook when it comes to our pet growth, and what we're experiencing. As you mentioned, we're very happy with our results in Q1. The results in Q1 definitely exceeded our expectations, particularly around pet growth and the acceleration. Margi and her team did an amazing job of deploying capital at that 35% internal rate of return. And to the extent we can continue to do that going forward, we'll do so. We have good confidence in sustaining sort of that Q1 level as we go through the year. We're not getting ahead of ourselves there being overly aggressive in the guidance beyond that. One other thing I will mention on ARPU. Overall, as we look to introduce new products, we do have accelerated growth, ARPU can be impacted by the mix of business overall and there can be some variability. We are most focused on hitting that 71% value proposition overall.

Got it. The mix thing is actually good reminder as you maybe go into that – those different product categories, I guess. All right. One other question on the search term up 57%. Can you talk about the correlation from buying? And kind of what I'm getting at right now is, is that your new subscription pets actually increased, I believe it was more than 100%. And I would tend to think the way that you purchase it or you go to the veterinarian, the veterinarian recommends your opinion. You come home, at least I do, I never search or put trupanion.com, I would always just go to Trupanion. So what I'm getting at here is – and maybe you already said this, but did conversions actually go up in the quarter, and how meaningful was that conversion in there? And then I'll take the rest of the questions offline.

Well, we mentioned in the opening remarks that our accelerated growth occurred from increased leads as well as increased conversions, and those were spread across all of our distribution channels. And our year-over-year growth shows total pets, you're also looking at net pets, which is reflected in the improvements in retention and our TruTopia stat, which I mentioned was historically the smallest gap at 0.3%. So, the aggregate of that is what drove the 122% year-over-year net subscription growth. You are right. When we are driving leads from veterinarians or referrals and people say, go, take a look at Trupanion. People type in Trupanion, and that's what we're referencing. Our brand awareness has been increasing at a much higher rate than people searching the term pet insurance.

Sorry, Dave. Hi, it's Margi. I would just add to that as well, just to reinforce the point that Darryl was making. When we think about distribution channels and we think about the way that search traffic has worked and the digital channels as well, we're just reinforcing that brand. So, if you go from a vet to Google, that's always going to be a brand play that we have there, and we're always trying to drive that efficiency. When you think about other distribution channels that we've mentioned, we're really starting to get some strength there. We're opening up to new pet owners when they go to the vet. The vet starts to play a role as a conversion piece as opposed to just a lead generator, which again is really where we're saying that brand presence is being maximized because you're touching a pet owner in different places, which we weren't able to do before.

Thank you. Our next questions come from the line of Jon Block with Stifel. Please proceed with your question.

Hi guys, good afternoon. Maybe the first one, I'll actually start with the shareholder letter, specific to the pet food initiative, which I believe is Landspath. And I think you mentioned in the letter, Darryl, is going to be sold through the veterinary channel. It's early, but any color on that with, call it, pricing and margins? And the fact that you mentioned it's going to be sold through the veterinary channel, how do we think of that? In other words, can it still be bundled with a Trupanion policy holder? And if so, would it be bundled in terms of offering a discount because you have greater conviction on the pet health longer-term? And then I'll pivot more to questions on the quarter.

Sure. Well, the hypothesis we have around food, this is something we've held for well over 10 years, is that if a pet eats high-quality food in the right quantity, it is going to have a better health outcome. Well, at this point, that's a hypothesis. And we've been investing in this area for a while to figure out how we could prove or test this hypothesis. And we do know, and there is significant data saying that if a pet eats the right amount of calories, they're going to have a better health outcome. So, we'll be able to come out of the gate early on by saying, if you're eating the right amount of calories recommended by your veterinarian, we should expect some reduced veterinary invoice expense, and we would pass it on to a consumer. But it is going to take us years of actuarial data to be able to determine if there are big health improvements. The goal is, if there was a 27% increase in health improvements based on pets eating a certain diet that we would offer that discount on the insurance; the two would reinforce each other. They would both be monthly subscriptions, but it would not have to be limited to just a brand of food. This could be anywhere we're able to measure it. Our goal with Landspath is really just to kind of test the hypothesis and get this moving.

Got it. Perfect. And just a bit more in the quarter, some quick math, which is always dangerous, but I think you mentioned you're deploying $66 million in spend at a $280 PAC, implies about $235,000 gross adds for 2021, or call it $58,000 per quarter. You just did $56,000 in the first quarter, right? You got a lot of momentum. You got increased brand identity, search terms are up. So, can you talk about why – to be clear, 1Q was impressive, but why call it a leveling off of gross add expectations, which seems to be implied in the guidance for the balance of the year?

Yes, Jon. Overall, I mentioned briefly while we're really excited about the pet growth in the quarter and we have a lot of good confidence about how that level of sustaining that capital deployment and hitting the internal rates of return at that level can flow through the year, we also don't want to get overly aggressive or too far ahead of ourselves at this point, particularly in our outlook. So, this is an area we're comfortable with at this time.

Okay. And last one for me, again, specific to the quarter. A lot of things to like and some accelerations, notably around the gross adds, but pricing fell below our expectations on the subscription business. And you mentioned, sort of to compare it year-over-year, but to be fair, it worsened versus the last three quarters in 2020. And looking at the shareholder letter, it would also seem to imply that the express deployment might have been curtailed under a COVID environment and sometimes express is responsible for accelerated claims. And so that seems, sort of a little bit counterintuitive. Why weren't you able to price better with 6.8% ARPU deployment on express, not accelerated? And it just seems to matter when, at the end of the day, every 100 basis points is obviously a big swing factor when we think about trying to ramp EBITDA.

Yes. I can start, and Darryl can add as well. The one thing that I didn't mention to your prior question that I'll just throw in here quickly is, you know, to the extent that we can deploy more capital and add more pets than we've put in our current guidance, that's obviously our goal is something that we're working toward. When it comes to ARPU and the 71.9% that you mentioned, which did tick up slightly, you know when we talk about investing in our member experience, and that that can lead to strong referrals, it can lead to strong retention. One of those investments was within the 71.9% and investing more in our claims experience. And the processing and efficiencies there, and that was about a 0.5% increase from the prior quarter. Absent that, we would have continued to see strong progress. We haven't seen anything unusual within the vet invoice expense related to our software specifically. What we are doing is we're deploying a little bit more capital into the claims processing side to elevate that member experience. Darryl, did you want to add anything?

Yes. Go ahead, Jon.

Sorry, and I'm trying to slip one more in there. I just want to understand it. The development costs that you guys alluded to, I think it was $300,000 last quarter. It might have been around $1 million, I think I missed the exact number this quarter. Just so I had this correct. That's excluded from the PAC? Is that correct that it's excluded from the PAC?

Yes, it's excluded from the PAC. These are areas when you read the shareholder letter; it talks about international expansion and some new product initiatives that are pre-revenue. That's where those development costs are associated with. And going back to your ARPU question, I think we've made good improvement to hitting our price target. Year-over-year ARPU is affected by the blend of business. It'll be more affected in these accelerated growth rates and offering new products and different distribution channels. So, I'd be a little less sensitive to looking at the year-over-year changes and more laser-focused on looking at the veterinary invoice expense. And if we're close to the 71% target, we're operating it as a highly efficient business that's good at pricing.

Yes. Jon, I would expand on that a little bit because I think this is a good question to make sure it makes sense. Development costs are far more than sales and marketing initiatives. Frankly, they're not any other than training up a team. A lot of it is, for example, our low and medium ARPU product initiative, the product owner getting all of that up and running, the team is getting it priced and filed and ready for launch. So, it encompasses many parts of our P&L. And as soon as the product launches, all of those expenses will go to the respective lines on the P&L and be measured based on a 35% internal rate of return once we have a pet and revenue to associate it with. Is that helpful?

Hi, thanks. So, Tricia, thinking about the lower products here. And I was talking about your last plan, is there simply a focus on what inscription products, and that product seems as good as it's ever been. So, I guess my question is, when you think out over the next year, I know you're introducing this to lower products, what are you afraid that you would be missing out on if you just continued to push this product? You've always said that educating folks about insurance is kind of the most important thing. How do you think or how those cheaper products could potentially account for higher-value products? So, what's kind of the end line? What are you afraid? You didn't do it?

Ryan, your cellphone connection was choppy, but I think I got the gist of your question. I think your question was related to, yeah, we're launching a low ARPU product, why would you do such a thing? You've had a stance for years that having a high-quality product and educating people is how to build the category. And all of that remains true. We're not scared of anything. We're very confident with the strategy we have had and what we have in our 5-year plan moving forward. I would say there's two things to focus on. One is, if you have lower coverage and you educate the consumer that it has lower coverage and corresponding lower ARPU, that is better off than what is currently happening in the marketplace. We're currently competing against about 20 brands. And people learn about Trupanion, and then we don't convert 100% of the leads. Some of those people convert with low and medium ARPU products, which present themselves as being equivalent to Trupanion. We want to level the playing field, and we can do so by offering a higher underlying value proposition by targeting $0.71 of a dollar in the low and medium products. But being very transparent to the consumer on how it is differentiated, these will be unique brands that will need to stand on their own. Another part that I think everyone needs to understand is these products will not likely have nearly as high lifetime values. And our allowable PAC spend while maintaining our 30% to 40% internal rate of return guardrails will mean that we are only able to deploy much smaller capital to acquire these pets. Ultimately, this is a test for us. We think as the category has been accelerating over the last two or three years, it makes sense. As we talked about our brand presence, we grew our revenues grew about 30%. Our brand value is going up by 55%, 70%. That implies that there is some slippage. We're driving leads; we're not converting all of them. This strategy may allow us to convert some that we are not consumer that would be buying these would be learning about the product in a transparent way, which is better for the category, and it would be a better underlying value proposition, as long as we maintain the guardrails of our internal rates of return. If it's successful, great; if it's not successful, that means that nobody else is able to do it in the market.

Got it. I guess a follow-up to reconcile again the growth moment. You said your asset, I think that makes sense. But, yes, why would the higher inflate rate be 72%? I guess, again, products you're selling as they are. So, could you just try to help understand like that extra point, what does that really give you the power to do and – is there really that much elasticity in the market where that type of expense is going to really improve this brand materially?

Ryan, your cellphone is really choppy. So, I'm going to try to read Braille and do my best. But I think you're saying, kind of consumer easily identify the difference between the 72% and a 71% target? No. But over long periods of time and doing it consistently, yes. We believe every basis point we can give back to the consumer ultimately gets felt. And our job as a company is to lower frictional costs as much as possible while having the best customer experience and to be offered the broadest coverage to be recommended through the veterinarian channel. For some of these other channels, we might have lower price or lower coverage products that are designed for those channels. But all of them will have the highest value proposition. Think of it like going into Costco. They have three bottles of wine, one for $10, one for $30, and one for $100. In each case, the consumer knows that they're getting the best value proposition. That's our point of view as well. I hope I answered your question reasonably well, but it was difficult to hear it.

Understood. Thanks for the answers. Sorry for the connectivity issues.

Thank you. Our next question comes from the line of Elliot Wilbur with Raymond James. Please proceed with your question.

Thanks, good afternoon. Second time listener, first time a questioner. Appreciate you taking the questions. Question is for Darryl, just going to the shareholder letter, how can you think about growth and margin expansion of the other segment within the context of the overall corporate long-term top-line growth target of 25%? Second question, I want to ask about the current cancellation policy. I know during the course of the pandemic, it was extended to 60 days. I don't know if it's reverted to historical levels or not, but just wanted to see if that, in fact, 60-day period is still in place. And then I guess the last question for Tricia. With respect to free cash flow, it sounds like we will continue to see negative free cash flow over the balance of the year, but anything you could say about trends relative to what we saw in the first quarter? Thanks.

Well, your first question is about our other revenue, which is a lower-margin business. Do we expect that to change over the next five years? The answer is no, not really. But I would tell you that most of the initiatives we're driving in our 60-month plan will all be running with the Envy reported in our subscription business. So, it's all going to be targeting a long-term 15% margin, and we'll all be targeting a 35% internal rate of return. The other business segment is really where we're doing B2B. It's not a B2C business. We don't really expect any margin improvements over the next four or five years in that business. The second part of the question had to do with the cancellation period. We historically had 60 days. Just prior to COVID, we moved it to 30. We then moved it back to 60, and we plan on keeping it at 60 in the future.

Yes. And with regards to free cash flow, as we trend through the year, big picture, we would always be striving to deploy as much of our adjusted operating income as possible to add pets. With the guidance that we do have currently, we would see slight improvements of free cash flow as we go through the year. But to the extent that we can redeploy that and accelerate growth, that is what we would desire to do. Additionally, I'll just give more context because free cash flow does include capital expenditures. We have increased our investment there, particularly around technology that was fundamental to our acquisition of acquiring software. That technology is core to building the foundation of our 60-month plan and ensuring we can go to market with product launches as well as improve our member experience in claims automation services as we expand within our 60-month plan. So, that's important to us as well in that run rate on CapEx. We would expect to continue through the quarter of this year.

Thank you. There are no further questions at this time. And with that, this call will come to an end. We do appreciate your participation. You may disconnect your lines at this time. Have a great day.