Trupanion, Inc. Q3 FY2022 Earnings Call

Good afternoon, and welcome to Trupanion’s third quarter 2022 financial results conference call. Participating on today’s call are Margi Tooth, President; Drew Wolff, Chief Financial Officer and joining us remotely from Europe, Darryl Rawlings, Chief Executive Officer. Similar to prior earnings calls, Tricia Plouf, Chief Operating Officer, will be available for the Q&A portion of today’s call. Before we begin, I would like to remind everyone that during today’s conference call we will make certain forward-looking statements regarding the future operations, opportunities, and financial performance of Trupanion within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release, which can be found on our Investor Relations website, as well as the Company’s most recent reports on Forms 10-K and 8-K filed with the Securities and Exchange Commission. Today’s presentation contains references to non-GAAP financial measures that Management uses to evaluate the Company’s performance, including without limitation variable expenses, fixed expenses, adjusted operating income, acquisition costs, internal rate of return, adjusted EBITDA, and free cash flow. When we use the term 'adjusted operating income' or 'margin,' it is intended to refer to our non-GAAP operating income or margin before new pet acquisition and development expense. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with the U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today’s press release or on Trupanion’s Investor Relations website under the Quarterly Earnings tab. Lastly, I would like to remind everyone that today’s call is also available via webcast on Trupanion’s Investor Relations website. A replay will also be available on the site. With that, I will hand the call over to Darryl.

Thanks, Laura, and good afternoon. Total revenue in the quarter grew 29% to approximately $234 million. Adjusted operating income was $22 million, up 6% year-over-year. We invested $20 million of this acquiring pets at a 37% estimated internal rate of return. We continue to invest in areas where we believe we can achieve high internal rates of return. In today’s environment, I’m especially pleased with the discipline the team has shown in managing to our internal rate of return guardrails. In the quarter, this translated to strong growth within our core subscription business. We added over 70,000 new subscription pets driven primarily from the veterinary channel. We achieved this record growth while also sustaining our high levels of retention. As you’ve heard me say before, in times of uncertainty, the need for Trupanion grows. Our monthly recurring business model drives consistency and results. In fact, our total revenue growth has exceeded 20% every year for the last 10-plus years. I’m proud of this growth, but I am most focused on growing adjusted operating income. Adjusted operating income represents the funds we have to grow our business, and I believe it is a proxy for our value creation. The more adjusted operating income we have, the more we’re able to reinvest at our high internal rates of return and increase the intrinsic value of our company. In Q3, subscription adjusted operating margin was 12.8%, below my expectations, and driven by price. This is the one key metric I was disappointed in for the quarter. If the team is focused and continues taking action on price, not only for the accelerated rate of inflation we’re seeing today, but also for that which we expect will come, I am confident that we’ll get back to our targeted adjusted operating margin of 15% by the end of 2023. Margi, as a leader of our 60-month plan, is monitoring these efforts, making sure we have clear ownership focus and resources to quickly and effectively get ahead of the changes we are seeing in veterinary medicine. Now, let’s get back to the fundamentals. We are in a large under-penetrated market. Today, 97% of pet owners do not have pet medical insurance and are therefore choosing to self-insure. With the rising cost of care and the growing human-pet bond, the need for Trupanion is greater than ever. In our monthly subscription business, growth in pet count and ARPU drives higher lifetime value, and higher lifetime value drives higher allowable pet acquisition costs and greater sums of capital we can deploy efficiently. The team has a strong track record of doing so. In the last five years, we’ve grown our adjusted operating income over 300% and deploy this capital consistently within our target internal rate of return of 30% to 40%. With that, I’ll turn it over to Margi.

Thank you, Darryl. I’ll start by reviewing our quarterly growth metrics and how today’s environment presents a unique opportunity for Trupanion. I’ll then discuss the actions we’re taking to ensure we are well-positioned for where the industry is headed. It was a particularly strong growth quarter. We added over 70,000 new pets in our subscription business. A new quarterly record growth was primarily driven by the veterinary channel reflecting ongoing demand for veterinary care. In the quarter, veterinary leads were at an all-time high. Our pet acquisition spend continues to reflect all efforts to generate leads, convert pet owners to members, and welcome members during their first year with us. I’ll echo Darryl’s sentiment that we were very encouraged by the efficiency of all elements of the spend during the quarter. This effective capital deployment ultimately helped drive our estimated return well within our 30% to 40% target range. Year-to-date, we have deployed approximately $60 million to add over 190,000 new subscription pets. At our current ARPU of around $64, and assuming an average life of 78 months, this new cohort of pets would generate almost $1 billion in forward revenue, and this is before inflation. Encouragingly, we continue to see the veterinary industry adjust their pricing models. They absolutely cannot afford not to, and yet at the same time, people’s disposable income is stagnating. The cost of self-insurance is getting more expensive, and it is an increasingly poor solution. As more enrolled pets enter the community, this higher percentage of insured clients can give veterinarians the confidence to continue to raise prices. This, in turn, helps solve the challenges they face, such as staffing. This is positive news to the industry in general and for us specifically to see these prices come through. It makes the conversation around budgeting for unexpected veterinary expenses more relevant than ever. However, it also requires meticulous execution, exceptional analysis, and constant review from within Trupanion to stay true to our value proposition and the pricing promise we commit to our members. In the third quarter, we fell short of our 71% value proposition by 2.5%. Absent the impact of mixed changes, the cost of invoices was up approximately 10% over the prior year period, outpacing our average rate increase of over 7% for the same period. As Darryl alluded, we are taking actions to get ahead of the changes we are seeing in veterinary medicine. Absent the impact of changes in mix, we now have pricing increases of 11% flowing through into early 2023 with another 7% planned going into next year. We will continue to closely monitor the rate of inflation and are poised to roll forward additional pricing adjustments as needed in the coming months. As a reminder, rate changes are immediate for new enrollments but are applied for existing pets once every 12 months. So the impact of these changes will flow through in 2023 with a full benefit showing up in late 2023 when we anticipate being back on track to hit our margin target. At the same time, our member experience teams have been focused on ensuring that our commitment to members regarding our value proposition is well understood and maintained. Our pricing promise is our pledge to pet owners that we price for the life of the pet, never punish unlucky pets, and price accurately to our value proposition across our millions of categories. If in aggregate we overshoot our 15% subscription margin target, we will make it right. This is our pricing promise. In the coming years, the need for Trupanion and to budget and care for the unexpected will only grow. This need is universal, and so too are our aspirations. International expansion is an important building block of our 60-month plan, and I’m very proud of the progress our team has made on this front year-to-date. We’ve started to see some acceleration in Australia, have team members in place in Japan, and just recently announced two strategic acquisitions to officially mark our entrance into continental Europe to take our new geographies to the cusp of revenue generation. There are over 40,000 veterinary hospitals spanning Continental Europe, and our acquisition of Smart Paws and our pending acquisition of PetExpert gives us immediate access to over 12,000 of these, increasing our addressable market. PetExpert provides high-value pet insurance to approximately 25,000 pet owners in the Czech Republic and Slovakia, and works closely with veterinarians to provide high-quality partner support to our hospitals. This same synergy is also evident in Smart Paws, our recently completed acquisition, while smaller in scale than PetExpert, Smart Paws brings with it a team and infrastructure to further enable rapid expansion and parallel to our North American foundation deep relationships across the European veterinary community. We’re excited that these acquisitions and their pet-passionate teams provide a platform for us to bring Trupanion's world-leading member experience to these new and under-penetrated markets. Together we have taken several steps forward in achieving our global mission to help the pets we all love receive the best veterinary care. The opportunity is significant, and we are well poised to build on it. With that, I’ll hand over to Drew to walk through our financial results in more detail.

Thanks, Margi, and good afternoon everyone. Today, I’ll share additional details around our Q3 performance, as well as provide an update on how we’re tracking against our annual goals. Total revenue for the quarter was $233.8 million, up 29% year-over-year and continued to be driven by strong pet additions and sustained high levels of retention in our Subscription Business along with growth in our other business. Within our Subscription Business segment, revenue was $152.4 million, up 20% over last year. As with the last quarter, the ongoing strength of the U.S. dollar had a meaningful impact on our results. On a constant currency basis, subscription revenue would’ve been $153.7 million or up 21% year-over-year. Total enrolled subscription pets increased 19% year-over-year to over 808,000 pets. Average monthly retention, which is calculated on a trailing 12-month basis, was 98.71%, equivalent to an average life of 78 months. Monthly average revenue per pet was $63.80, up 1.1% year-over-year on a constant currency basis. ARPU growth continues to be impacted by the mix of business. For context, we continue to see accelerated growth in new pet enrollments in lower-income areas that combine with business and product mix, masking the price increases rolling through our book of business. After adjusting for this mix impact, the average pricing change across our book goes from 1.1% to the 7% that Margi referenced earlier. This is behind the cost of veterinary invoices, which increased approximately 10% over the same time period. As a result, our loss ratio in the quarter expanded 70 basis points from the prior quarter to 73.5%. As a percentage of subscription revenue, variable expenses were 9.7%, down from 9.9% in the prior year period. Fixed expenses at 4% of revenue were also down from 4.3% sequentially and 4.8% year-over-year, reflecting additional cost actions in the quarter to drive operating leverage and partially offset the increase in our loss ratio. After the cost of paying veterinary invoices, variable expenses and fixed expenses, we calculate our adjusted operating income. In dollars, our subscription business delivered adjusted operating income of $19.5 million, an increase of 5% over the prior year period. On a constant currency basis, subscription adjusted operating income would’ve been $19.7 million, up 6% year-over-year. As a percent of subscription revenue, our adjusted operating margin was 12.8%. Now I’ll turn briefly to our other business segment, which is comprised of revenue from other products and services that generally have a B2B component and a different margin profile than our subscription business. Total revenue for the other business segment was $81.4 million compared to the prior year quarter. This is an increase of 49% year-over-year reflecting an increase in the number of pets enrolled. Adjusted operating income for the segment was approximately $2.5 million. As a result, our total adjusted operating income was $22 million. During the quarter, we invested 15% more year-over-year, or $20.1 million to acquire over 70,000 new subscription pets. This resulted in a pet acquisition cost of $268, an estimated 37% internal rate of return for a single average pet. We also invested $2.4 million, or 1% of revenue in the quarter on development expense. This reflects a ramp-up of our international activity as well as ongoing support for new distribution channels, which we expect will run through year-end. This resulted in an adjusted EBITDA loss of $900,000 compared to an adjusted EBITDA gain of $2.2 million in the prior year quarter. Total stock-based compensation expense was $8.3 million, in line with our expectations. Net loss for the quarter was $12.9 million, or a loss of $0.32 per basic and diluted share compared to a net loss of $6.8 million or a loss of $0.17 per basic and diluted share in the prior year period. Turning to our balance sheet. We ended the quarter with approximately $238 million in cash and investments. We held approximately $54 million in debt with $90 million available under our long-term credit facility. As Margi mentioned, we recently completed one acquisition and announced another both in continental Europe. In the fourth quarter, we will add about 25,000 new PET policies to our subscription business. As a result of these acquisitions, we do not expect any material impact to our financials in the fourth quarter. In terms of cash flow, operating cash flow was negative $2.3 million in the quarter compared to positive $6.2 million in the prior year period. Capital expenditures totaled $4.1 million in the quarter, and as a result, free cash flow was a negative $6.4 million. I’ll now briefly discuss how we’re tracking for the remainder of the year. We continue to expect consistent growth and revenue and are reintroducing an estimate range for the year to provide more clarity on our business, given the current macro conditions. For 2022, we expect total revenue in the range of $900 million to $902 million, at the midpoint this will result in a growth rate of 29% over the prior year. Subscription revenue is expected to be in the range of $595 million to $596 million at the midpoint. This would result in a growth rate of 20% over the prior year. Total adjusted operating income or the dollars we have to invest in growth is expected to be in the range of $87 million to $89 million, at the midpoint this is up 12% over last year. Also, please keep in mind that our projections are subject to foreign exchange rate fluctuations. For our full-year guidance, we used a 73% Canadian to U.S. conversion rate in our projections, which was the approximate rate at the end of September. Looking into 2023, we have line of sight to our target 15% adjusted operating margin by year-end, primarily reflecting our pricing actions. We expect to provide formal 2023 guidance on our year-end call in February. Thank you for your time. With that, we’ll open it up for questions.

Thank you. Our first question will be from Shweta Khajuria with Evercore ISI. You may go ahead.

Okay, thank you for taking my questions. How should we think about ARPU growth going forward? You gave great context in terms of pricing changes, but I’m not sure if I fully understood how it impacts the overall business, so could you please help us with that? And then the second question is on your acquisitions. The most recent one you announced today is expected to close in the fourth quarter. How should we think about your goals for synergies coming into 2023 and then expansion going forward? Thank you.

Hi, Shweta. This is Tricia. I’ll kick it off with the first question and then I think Margi will touch on the second question. When it comes to ARPU growth, as I’m sure you noticed in the script, I’m talking at a macro level about absent changes in mix, what we have that is flowing through into next year, 11% with an additional 7% planned to be filed, already filed or to be filed in the next 30 days so that we’re positioned well if current inflationary rates continue into next year. Now obviously when it comes to how this then translates over the course of the year as well as on the financial statements, it does take time to roll on. So, we won’t see kind of the full impact coming until the back half of the year. And we’ll definitely start absent, dramatic changes in the types of enrollments we get now. We do expect on the financials, even when you account for the mix shift that, we’re kind of at a lower rate right now, and that will start to move up over the course of the year. Drew, do you want to, do you have anything to add about more on how to expect this to roll through on the financials?

Yes. Given all this mixed impact and assuming constant currency, which is really important because there are significant FX headwinds that we’re going in the year with. We’re looking at an average for the full year 2023 at about a 5% for ARPU. As Tricia mentioned that builds throughout the year and it’s back half-loaded, but that gets us back to an average price increase that we saw in 2019, in 2020, and half of 2021. I’d start at 5% for 2023.

Thanks, Tricia and Drew. Just a quick follow-up on that before the next question, before you address the next question. How should we think about the exit rate of ARPU growth for 2023? So is it fair to say, well you tell us.

Yes. I mean, I would say, obviously we’re still mapping out next year and we’ll give a lot more visibility on the February call with projecting our current rates of inflation and the rates we have flowing through to average 5% for the full year. It’s above 5% in the back half of the year. And we can give you more visibility as we go into next year, but that’s how to think about it. So, we’ll be exiting at a higher rate than that.

Okay, Thanks Tricia.

Okay. Hi Shweta. I’ll pick up the second one, it’s Margi. Just in terms of the acquisition that you mentioned today, we announced the acquisition of PetExpert. So this will close, as you said, in Q4. In terms of synergies, PetExpert really is a key part of our 60-month plan. It’s going to increase our addressable market in general. They’re very vet-centric, so much like Trupanion and their foundation is in through partnerships with the veterinary community, making sure they can solve the issues of being out of pocket and reimbursement. So they have the ability to continue what we’ve been doing in North America for quicker, faster payment. And for us, it’s really about how do we get to those markets with people that are aligned to our core, which is vet and being able to work with people who are like-minded with products that will be very similar to Trupanion and really kind of help us build that market in time. It is very under-penetrated in continental Europe, so they’re definitely going to help us get a foot in the door very quickly in 2023.

Okay, thank you, Margi.

Hey, thanks for taking my question. So, I want to ask first about retention. So you break out retention into three buckets in your shareholder letters, but can you talk about maybe other factors that impact retention and if there are any other factors besides price behind the step back this quarter? Thanks.

So yes, I’ll kind of take it at my level. So in terms of our retention, it’s strong; it’s near an all-time high. I think we have a good pathway towards that 60-month plan, which is at 99% achievement. You’re right, we do break it out into three buckets and typically the impact to that, aside from pet passing away, we also have the financial implications very occasionally, but typically it comes down to understanding the value proposition. We don’t lose many pets, so we look at our overall retention rate; we’re not talking about a high volume here. So the issues are always very minor. And that’s why we’re kind of at that point now with the team executing; they’re looking at those tiny incremental things they can do to adjust the way that people think about their product. And I think in terms of other issues, we’re not seeing anything different. I think the main thing for us is making sure that we explain why Trupanion, and we explain the value proposition and we help them understand the cost-plus model that we have. And I would say that the way that we’ve been managing it for the last several quarters has been very strong and we’ve seen continuous improvements through that. The biggest kind of the biggest thing that if there is any headwind for us is typically when you see that faster rate of growth, and to reiterate what you heard earlier with 70,000 new ads in the quarter, we do often see how do we make sure we’re focusing on that fast growth and offsetting that first-year retention because that’s the weakest point of the journey if there is a weak point. And that comes back to the point of the value proposition and reiterating that to people. So there isn’t anything further that I would add. Darryl, would you add anything?

No, you pointed out, we’ve been coming off quarters of about 60,000 new pets and we just added 70,000, a new record, and that 10,000 incremental pets have an impact on retention. So yes, retention overall is strong.

Got it. Thanks. And then I also wanted to ask about pet acquisition costs. So you demonstrated some flexibility on PAC this quarter and you still put up very strong gross ads. Can you talk about where the flexibility on acquisition spend is coming from, and then how should we think about gross ads going forward with PAC down in the quarter?

Yes, sure. So, I can start this off and then hand over to Drew for the second part of the question, but in terms of overall pet efficiency, as we went through the quarter, I’m very impressed and proud of the team, because of the way they were able to flex the muscles and pull on the levers that we built over the years. So going through the quarter, they really understood that our margin was down, so we adjusted our PACs to see that. And in doing so, we added 10,000 more PACs for the same amount of money from Q2. So really efficient spend. In terms of the flexibility, we’re always looking at making sure that we’re finding what we can do. And I think that proven time and again, that quarter-over-quarter, we can live with those guardrails that we’ve set ourselves, which is a high bar. It’s good execution that develops those results in Q3. Drew, would you add?

Well, just on the question about forward PAC, I would emphasize that it’s an output of our lifetime value, and so we flex in order to solve for what we can afford to spend in order to drive growth. So it’s an output and we’re not subject to the whims of the market. I would also emphasize that it includes everything. It’s fully loaded as there are all these marketing and sales and marketing people, and IT people are in that, so it’s not as we typically think of a marginal advertising PAC, which is important.

I will just add one other thing to that, and we think about our time moving forwards through the rest of the year. So in Q4 we do have our territory partner conference coming up. So to Drew’s point, and we think about all the people that we include within our podcast, the territory partner conference is our sales conference. So it’s an important factor of our calendar. We haven’t been able to have it for three years for obvious reasons. So bringing our TPs together for the first time in three years is a sales group, will be a really important long-term move for us. It’s not going to have an immediate gain in November or December, but we do see there is a benefit for the subsequent 12 months after the conference. And while we’re excited to have them in Seattle, it does hit our PAC in one quarter. So to Drew’s point, that’s kind of all gets fully loaded in there.

Very helpful, thank you.

Thank you very much for the opportunity. My question is on the acquisitions in Europe, can you maybe talk about how Smart Paws and PetExpert will look different versus what is already in the market? And then how do you think it’ll look different than the U.S. and Canadian Trupanion current operating?

Yes, sure. So Smart Paws and PetExpert, just to touch on what I mentioned earlier, they really are both key acquisitions to help us in our 60-month plan. So, we talk about increasing our adjustable market, and both of those will allow us to do that across continental Europe. In terms of the offering, it’s so early stages. As we mentioned, the PetExpert deal should close this quarter. The key for us is making sure we have brand consistency and as close as possible product consistency across the world globally. We recognize there will likely be localizations for those products depending on what the markets dictate to a certain degree, but we feel very confident that our product is a global leader; our retention rates are global leaders. And in doing so, having that vet-centricity means there are certain parts of our product that are hard to replicate that they really do what they say; they solve the same problem no matter which country you’re in. And so we’ll maintain that as close as we can. But at this stage, in terms of the specific differences between the North American product, which is the same in Canada and the U.S., we wouldn’t be able to share specifics as to what that looks like, but you can expect them to be very similar.

Thank you for the answer, and my follow up as I look at ARPU. How should we think about the size on a per dollar amount, FX is headwinds, and then how should we be thinking about that within that vein of the 5% growth?

Well, we’re currently using a conversion rate of 73%. So if you even just look at what it was last year, that could be 2% to 3% headwinds next year. Obviously, things move, but that’s currently the rate we’re using and the assumption we’re using. That would be on, so the 5% is a constant currency basis, and then reported might be different than that based on FX.

Thank you very much.

Yes, thank you very much for taking my question. Sir, I just want to understand the 11% and 7%. 11% is the rate that's in the pricing of enrolled pets as of September 30, and 7% is the rate approvals that have yet to impact the pricing?

Yes, so good question. Let me map it out because I know it can be a little difficult. So we had going through the third quarter, 7% rate during the third quarter, and into October we did additional filings, which now brings what we were rolling through, which was kind of 7% up to the 11% that I mentioned. And that 11% is fully approved, not waiting for anything. The effective dates are set. Now, a portion of that, so that's kind of the run rate that we should expect; some of the approvals have just been within recent weeks. So those will start ramping up and that's kind of our run rate going into Q4 and then Q1 of next year. So the 11% is known and ready to notice customers and start moving through the book. We desire to and have plans to do an additional 7%; 3% of that 7% we've already filed. We're waiting on approval; 2% of that we believe is imminent. And then the remaining 4% that we plan to have as we want to be aggressive in this going into next year will be filed over the next 30 days. So 11% is fully baked known and then of the 7%, we filed for 3% of it and expect that to be approved very quickly. And then the remaining 4% will be filed in the next 30 days, all to really go into next year more aggressively as we look to keep up, continuing to bridge that gap on inflation. Does that help?

Yes. And how much price is embedded in the $152 million of subscription revenue that you reported in the quarter?

How much price?

Well, that included roughly a 7% rate increase, but after changes in mix and FX, it was right around a 1% increase.

Okay. So 7% price, but ARPU is 1%, that's fine. And then my other question on the 56,000 pets, I think you said that they're going to become subscription pets because of the acquisition, and I might have gotten that number wrong. Is the character of that book similar to the subscription business in general, that when we call them subscription pets, they should be expected to have the same kind of return profile as the current Trupanion subscription book?

Yes, this is Darryl; that is correct. The business in Europe is going to have different ARPUs in different countries, obviously different reflecting the different cost of veterinary care, but all of them will over time be targeting the 15% adjusted operating margin. So they should all be targeting the same as well as the same internal rate of return guardrails. So we'll take a little bit of time over the next year or two for that to show up in our GAAP financials in the same way. And that is because right now these companies are operating as MGAs, so they're only going to see a percentage of the revenue hit our P&L until it becomes our own underwriter.

Okay. Thank you very much.

And then just for one correction, I think you said 56,000; it's actually 25,000.

I'm sorry, I was writing too fast. No problem. Thank you very much.

Thanks. Good afternoon. Just two quick clarification questions. First for Tricia, thinking about the 11% and the 7%, so simplistically, would I just add those or multiply those together to get sort of a compounded inflation rate, say exiting 2023?

I mean, in general, essentially how this is going to roll through the book in terms of ARPU is when something is approved—so we know the 11% is approved and those increases hit members on their annual anniversary date. So one-twelfth roughly rolled through the book at any given time. So, with the 11 and then as the seven comes on board, it will start to build and it really does build sequentially. As we look through, we’re looking at the vet trends in general, anticipating double-digit inflation to continue. We’re making sure we’re being aggressive in anticipation of that and pricing through it. And then the pricing will roll through the book. Obviously how things actually play out on the claims costs remains to be seen, but we want to be very proactive in anticipation that current trends will continue and have been pushing these rates. In anticipation of that, and to your question, it'll build and on kind of what are people, what is our book getting on average when it's all rolling through? That is the 11 plus the seven, that's the 18 by the end of next year, that absent any changes in mix, pets on our current book would be getting next year on average. And then obviously as you can see in our current financials, when new pet mix comes in, which is enrolling currently at a slightly lower amount, that brings the average down as well as any changes in FX as well. So you can kind of use that same relativity that we talked about to map out how that looks when it hits the financials. I don’t know if anyone else has anything to add to that.

Okay. That was helpful. Then I want to ask a follow-up question. With respect to the acquisition Smart Paws and PetExpert as well, was it clear to me exactly when those would start appearing in your financial statements? And is that different from when you would add them to new PET ad and PAC figures? And then with respect to these businesses, could you just give us a sense of where they stand with respect to your current financial guardrails and IRR targets and basically how long you generally expect it to be before these businesses can hit those rates?

Yes. As Darryl said, these are MGAs, so they're not the full stack. So you don't have the full gross written premium hit in revenue; you just have the commission. Smart Paws is closed. PetExpert will close this quarter. They will be in our books starting this year; we'll only have one month of revenue. So it won't be material that way. They have very, they're going into subscription because we're targeting similar margins to our existing Trupanion business. And so going into next year when we give an update on 2023 in January, we're looking to grow these businesses, relative to Trupanion. They're not big, but we're looking to grow. And so they'll be in our guidance when we talk in February.

And I can add to that too, just in terms of the synergies that we touched on earlier with these two companies. We've chosen to partner with them and bring them into our Trupanion family because of their ability to grow in the way they think about their business. They think lean; they think like our operator and they have the same drivers and tenets that we value very much as a business. So in terms of how quickly we can get to those central guardrails, they're set up really well. Initially we’re working with two teams who understand how to run a business as we do, and we're looking forward to seeing that impact in 2023.

Okay. And if I could ask one additional follow-up question for yourself. Margi, can you just maybe provide a little bit more granularity in terms of what drove the strength in new pet ads in the period? I guess with the contraction in vet clinic visits, there’s been some expectation, of course, that it would be more difficult to add new pets, and you guys seem to be proving that theory wrong. Is it just a function of better leads, better conversions, more hospitals being called on, or existing client base being called on more frequently? Just maybe some of the key dynamics that enable you to continue to overperform on that metric. Thanks.

Yes, of course. You've actually kind of touched on many of the reasons why. So when we think about the overall growth of pet ads through the quarter, it was led by the veterinary channel predominantly. I’m really happy to see that continuing to get stronger as record levels, record levels of leads. So to answer that question regarding leads and conversions, both were up. We've talked a lot about conversion and how we're focusing there. The team executed really strongly with some tactics they’ve been planning for several months, and we're starting to see them come through. Coupled with lead volume, you see both of those things are going to start to drive a strong return in the back channel. Our other channels continue to perform strongly. So, one of the things we’ve made very clear in our distribution strategy for our 60-month plan is that we have multiple channels. We have multiple opportunities to continue to grow in an under-penetrated market, and I’m happy to see them continue to go up. So we’re growing faster in areas where we see the vet costs—the areas where we see there is a need for our product. We solve the problem of budgeting for the unexpected, and that helps us. Yes, vet visits are down, but that’s not reflected in our number because at the end of the day, that’s the seeing the value in our product. They're having good conversations. Our territory partners have been back now in the field consistently for six months and more through this quarter. That continued conversation, coupled with the fact that we've had record rates of software installation—the thing that really sets us apart in the industry has gone up as well. So there are a number of really positive factors that set us up well for the future. And I think the biggest thing for us to remember is that we are priced to support the needs of the vets and the needs of the pet owners. We are seeing that value proposition, the relationship and that core channel for us, that channel is performing very well. So it's a positive, really positive story for us.

I'll just add a little on top of it. This company has been around for over 20 years. We've been through multiple recessions, we've been through high-impact times of change, and the veterinarian message becomes stronger and more compelling at times when people have concerns, particularly when they have financial concerns. All the headlines are talking about inflation. People are hearing the word recession, and that increases the likelihood that veterinarians want to communicate to new pet owners about the need for high-quality medical insurance and why that message is going to resonate stronger to people. If you go back a couple years ago, a lot of times when some people think that it's easier for us to grow, it's the opposite. What are messages compelling to veterinarians to help people budget for their pets? We're seeing that across the board with vet leads. One thing that I think I just want to point out is our new pets grew from about 60,000 new pets to about 70,000, of that 10,000 incremental in the quarter. About two-thirds of that came from the veterinary channel, and they were mainly driven in areas of lower-income. So this product is not designed for wealthy people; they can self-insure. For those with tighter budgets, they need a solution. Our solution resonates, and veterinarians can drive that message. That comes across in our lower PAC dollar spend and the efficiencies we're having. There'll be puts and takes if we move into a recession over the year; the inflation of ARPU going up will help us on growing our revenue, making that a little bit easier. Messaging will be stronger to vet hospitals, but we'll have some other areas that'll be a little bit more challenging. So we expect another strong year of growth.

Our next question is from the line of Ryan Tunis with Autonomous Research. Please go ahead.

Hey, thanks. Good evening. Just another follow-up, I guess on the rate discussion. So the 18 points of rate, 7 and 11, to the end of 2023, is that on top of the 7% we're observing now? So we think about the cumulative of 2022 and 2023 as 2025 or as 18%, kind of the number to think of over the two-year period.

Yes, now, we’re looking at 18% at least currently as what, when you added together rolls through. So, we really took the seven and increased it to 11 as some of the seven goals off as it related to things that had already been in place. We’ve re-uped to the seven, but the—and then added to that to 11, and then we’ll add again to get that up to 18%. So that’s the top end. Obviously, we’re looking at this on a weekly basis. We’re leveraging data from many different sources, our TPs that are in the field, the data that we already have, relationships with many of the groups as well as the veterinary CPIs. If we see things change, we will be absolutely poised to do that as well to make sure we’re being aggressive. So, we can—but this is the visibility we have right now that we’re acting on and feel good about it going into next year.

Understood. And then can you maybe give us a little bit of a breakdown from a loss trend perspective, frequency, severity, what you saw year-over-year? What you maybe learned this quarter relative to first half of the year or the second?

Yes, at a high level, and I’ll speak more about when we look at things absent dramatic changes in mix. I mean going into the year as we’ve talked about before, particularly in the first quarter as we were coming out of COVID, we definitely saw more changes in frequency with people going back, catching up on things, small, more normal-ish, call it 2% year-over-year changes in severity, but nothing overly dramatic. We started to see movement and severity in the second quarter increasing. And then we’ve seen more movement in severity year-over-year going into the third quarter. Now, the increase that we talked about of cost of claims going up about 10% absent mixed changes has still some frequency; it’s about half frequency, half severity that we’re seeing. When we see both of those moving, many times historically, we’ve seen severity go up, but frequency doesn’t tend to go up as much. So, we’re more seeing both of those moving. We definitely want to be more aggressive, and we’ve seen severity kind of pick up every quarter so far this year, kind of boosting overall inflation moving in general.

Got it. And so I guess my follow-up then would just be, if the plan is kind of for 18% rate over these two years and we’re running at a 10% loss trend, that’s accelerating. Why wouldn’t the plan be to take a little bit more rate? And then the one I had was, I guess just on deductibles; what impact does inflation have in terms? Is that, could that potentially be a reason why you’re picking up more frequency just more attachment? Thanks.

And as a variety of reasons that we’re seeing more frequency. One is, I think we weren’t surprised to see it coming out of COVID, like I mentioned. Also, as more and more hospitals use our software, we tend to see a little bit of a step up in frequency because it’s just much easier to submit those, and that’s a good thing. That’s more of a small one-time step up. But that tends to be the frequency. Now we have had rates flowing through, so we have a current gap of 3%, and we’re looking at that combined with continued inflation into next year, and that’s where we’re getting to the 18%. Obviously, if we see trends change, we’ll react to that very quickly.

Great, thanks so much for taking my questions. Just following up on retention. So as you started passing along this higher magnitude rate increases onto your member base, are you seeing any signs of elevated churn among those subs that got sort of pricing increases so far? And I guess how are consumers responding to this higher prices, especially given the macro backdrop?

Yes, hi Maria, it’s Margi. So just at a high level, I would say our retention rate itself is really strong. So we’re not seeing any signs of elevated retention across those buckets. So one in the events that, when you look at it a granular level, so we’ve got our three buckets. The first year of retention, those with an under 20% rate increase in those with an over 20% rate increase, that’s where you tend to see some of the differences. The first year bucket has been one that has lightly changed—not because of our rate of increase of pet growth. So, as we talk about that relationship between adding more pets, you’re going to see more people in that first year. But in general, we haven’t seen anything that causes any concern. As we think future state, as we think about this aggressive pricing strategy that Tricia has been outlining, we really are making sure that we’ve got our teams aligned to be ready to support anything that we’re seeing. If we see increased calls, if we have different conversations based on what’s happening in the macro environment, we want to be ready to be able to really reiterate and explain our value proposition and really staying true to that, which is why we alluded to the pricing promise earlier as well, just making sure people understand what’s involved, what goes into budgeting for their pets and helping them really kind of get their arms around that. But so far, so good.

Got it. And Margi, you talked about sort of key drivers for strong additions in the quarter. Did any of your new initiatives contribute to this strong growth additions in Q3?

So when we think about the 70,000 pets. So 70,000 is around 10,000 pets more than we have been running on our runway. So, when we think about that and kind of how it’s broken up, better serve then came from new initiatives, so not significant volume; it’s nice to have better additive. But the bulk of that growth came through the vet channel. It came through our core channel, came through the fact that we’ve got our territory partners out in the field who are really reinforcing the most that we have—the owners strength of connection with vets. At a time when they really need to make sure clients can afford this care. That’s really kind of where that halo effect came from our overall pet growth. So while they’re contributing, they’re not the kind of the driver of that.

Our next question will be our last question today and it’ll be from Greg Gibas with Northland Securities. Please go ahead, sir.

Hey, thanks for taking the questions. Thanks for the insights too on claim activity being higher than normal. Are you seeing that begin to stabilize in Q4? Or is that kind of expected to persist well?

Yes, hi Greg, it’s Tricia. The, we’re one month into Q4. I would say with October behind us, in general, we’re seeing, October’s typically a bigger month for us in any given year given there’s no holidays and it’s a month with 31 days. We’re seeing October kind of in similar run rates to what we’ve seen in Q3. We’re not seeing dramatic step-ups; we’re not seeing dramatic downturns. It’s continuing in terms of what I mentioned—the frequency and severity on a similar pace, which we used to help guide us when we projected out into next year, those numbers that I mentioned that we would need and really have prompted us with the plans that we put in place as well speaking October into account.

Okay. Got it. And if I could follow up on PetExpert, what maybe what rough percentage share of the market do they have? What is kind of the total penetration rate in the Czech Republic in Slovakia? And then what pace would we maybe see them or you guys kind of expand into new European markets going forward?

Well, we’re hoping to close the deal—will be closing the deal this quarter. So super excited about the team. Market penetrations in the country are about 5%, which is pretty consistent with a lot of continental Europe, so well behind the UK and Sweden. So a lot of opportunity for growth. Obviously in countries where the cost of veterinary care is lower than the ARPU is lower, and lifetime value will be lower. So, you have to apply a lower pet acquisition cost to get you the same internal rates of return. But they’ve been able to prove to do that and we think that we can help them grow aggressively for the next four to five years to come, and we’re super excited about it.

Great, Thank you. And that does conclude the conference call for today. We thank you all for your participation and kindly ask that you please disconnect your lines. Have a great day, everyone.