Good day, and welcome to the Trupanion First Quarter 2024 Earnings Call. Please note, this event is being recorded. I would now like to turn the conference over to Laura Bainbridge, Senior Vice President of Corporate Communications. Please go ahead.

Good afternoon, and welcome to Trupanion's First Quarter 2024 Financial Results Conference Call. Participating on today's call are Darryl Rawlings, Chief Executive Officer and Chair of the Board; Margi Tooth, President; and Fawwad Qureshi, Chief Financial Officer. For ease of reference, we've included a slide presentation to accompany today's discussion, which will be made available on our Investor Relations website under our quarterly earnings tab. Before we begin, please be advised that remarks today contain forward-looking statements. All statements other than statements of historical facts are forward-looking statements. These include, but are not limited to, statements regarding our future operations, opportunities and financial performance, our ability to remediate our material weaknesses and the company's CEO succession efforts. 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 today's earnings release as well as the company's most recent reports on Forms 10-K and 8-K filed with the Securities and Exchange Commission. Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance, including, without limitation, variable expenses, fixed expenses, adjusted operating income, acquisition costs, internal rate of return, adjusted EBITDA and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to our non-GAAP operating income or margin before new pet acquisition and development expenses. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis, which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are 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 conference call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. With that, I'll hand the call over to Darryl.

Thanks, Laura, and good afternoon. I'm honored to speak to you in my final earnings call as CEO. Today, we announced Margi's appointment as CEO effective August 1. Speaking on behalf of myself and the Board, we could not be more excited about this outcome. Today's announcement is a culmination of an involved multiyear process to identify my successor as CEO. Achieving this milestone ahead of schedule reflects the Board's unanimous support and confidence in Margi's ability to lead Trupanion forward. In the 10 years we've worked together, Margi has shown herself to be a proven leader with an adept ability to manage Trupanion's growth mandate. With her at the helm, I am confident in our continued success in our large underpenetrated market. Margi's track record extends beyond her time at Trupanion. She spent over 7 years with the U.K.'s largest pet insurance provider, during which time the category saw tremendous growth, reaching approximately 25% penetration. She's leveraged that experience here at Trupanion, starting with specific areas of growth and expanding over time. Over the last 18 months, Margi has assumed oversight of every department at Trupanion, including overhaul in key operational areas to drive improved efficiency and performance and promote a culture of accountability, collaboration and action. Since joining Trupanion, the category has grown threefold, with Trupanion being the largest contributor to the category's growth for 3 consecutive years. At over $1 billion in revenue today, Trupanion is the largest player in North America. The veterinary community is the heart of our growth model, and our territory partners are an important link to that community. Margi, having wanted to be a veterinarian herself, holds great admiration for this community, and her understanding of our approach to the market has strengthened our ties. Through our strong growth, Margi has led the team in deploying increasing amounts of capital at consistently strong internal rates of return. When Margi joined Trupanion, the funds we had to invest in new pet acquisition—what we now call our adjusted operating income—was just about $4 million. Since then, we've grown our adjusted operating income to over $80 million last year. Beyond the numbers, however, and most important to me is Margi's character. At Trupanion, we are nimble and courageous, curious and caring. We do what we say, we care for one another, and we simply work harder than most. Margi embodies all of these qualities. In short, she personifies the culture of Trupanion. Over the past several years, Margi has come to lead our over 1,500 global team members. She has done so with compassion, humility, leading with trust and making tough decisions when necessary. There is no one I trust more to lead Trupanion into our next phase of growth. It has been my privilege to serve as a resource to her over the past decade. As we've previously communicated, I am committed to continuing to serve as Chair on the Board for the next 10 years, if agreeable to shareholders. Margi co-authored this year's shareholder letter, which was published just a few weeks ago. For those who have not done so, we encourage you to read it as it provides more insights into how we think and act at Trupanion. This letter can be found on our Investor Relations website. With that, I'll hand it over to Margi to walk through the performance of the business.

Thank you, Darryl. Good afternoon, everyone. Let me begin by saying what an honor it is to be appointed CEO of Trupanion. Trupanion's mission to help pet parents budget and care for their pets is one that resonates with me deeply. Since joining Trupanion over 10 years ago, I've seen our mission brought to life through the dedication of our team. It is truly inspiring to work alongside such passionate people in support of our members every hour of the day and every day of the year. Together, in lockstep with the veterinary industry, we're making a meaningful impact by supporting over 1.7 million pets, paying out over $2 million in veterinary invoices daily and helping tens of thousands of veterinarians practice life-saving veterinary care, and we're just getting started. Despite our long history, we are really just scratching the surface, with less than 5% of pets insured in North America and an equally low number across most of Europe. There is so much more we can do to support pet parents and veterinarians globally to help pets receive the care they need. Today, Trupanion is positioned at the forefront of an exciting growth story. I'm honored and humbled to lead Trupanion on this journey. I'm grateful for the continued support from Darryl and the Board and look forward to our partnership moving forward. With that, I'll now discuss our performance overview for the first quarter of the year. Total revenue grew 19% in the quarter. Our subscription revenue grew even faster at 22% year-over-year, with our core brand, Trupanion, being the primary driver behind this growth. Our total adjusted operating income, or the amount of funds we have available to invest in growth, increased 37% year-over-year. Once again, adjusted operating income for our subscription business outpaced its total, increasing over 55% compared to the prior year period. Our pet acquisition cost was highly efficient in the quarter. We reduced our investment in pet acquisition by 23%, and yet our gross pet adds declined just 9% year-over-year. In total, we acquired over 67,000 pets at an estimated internal rate of return of 44%. As expected, our revenue growth for the quarter was largely driven by a revenue contribution from pricing actions taken over the past 18 months. This translated into total Average Revenue Per Unit growth of 9.8% across our subscription business, the highest level since we became public 10 years ago. Within our core Trupanion brand, the average monthly increase in ARPU was even higher at 11% year-over-year. Against this backdrop of significant pricing increases flowing through to our members, the team has doubled down on communicating Trupanion's value proposition. To date, our efforts have yielded good outcomes. Over the last 12 months, over 40% of our book has received a pricing increase of 20% or more. Average monthly retention within this group was strong in the quarter and up year-over-year. This is a testament to the value our members place in the service Trupanion provides, along with the team's ability to communicate our value proposition and the reasons behind our actions. Moving to the second component of our revenue growth, adding new pets. Our total enrolled subscription pets increased 11% in the quarter. We expect the balance between ARPU increases and growth in subscription pets to be maintained in the near term as we continue down the path of restoring margins before increasing the pace of growth within our subscription business. The team has been consistently making progress against this mandate, as reflected in our year-over-year results. Compared to our 8-year low in Q1 of last year, our subscription adjusted operating margin expanded 210 basis points in the quarter. As expected, this is down from Q4 of last year, mirroring the behavior of veterinarians typically raising their prices early in the year. In aggregate, our operating assumption of 15% veterinary inflation proved sufficient in the first quarter. For veterinarians, charging sustainable rates is necessary to provide our pets with the care they deserve, and we stand behind them, offering a product designed to align the needs of pet parents and veterinarians alike. As the cost of veterinary care continues to rise, outpacing consumer discretionary income, the need for high-quality and dependable pet insurance solutions continues. This dynamic underscores the importance of having a lifetime solution that enables pet parents to budget effectively and offers reliable coverage. Trupanion stands out in the industry, offering the only lifetime product, providing pet parents with complete peace of mind and coverage for life, come what may. With this in mind, it's especially important for us to align our growth strategy with accurate pricing. Although our desire is to assist every pet, we must continue to be highly disciplined in our growth approach. To that end, we will not expedite our efforts to add more pets until we see greater strength in our margin. We know this creates the best, most consistent and positive member experience and avoids abrupt rate increases. We're committed to maintaining this approach and are encouraged by ARPU trends and conversion improvements at this early point in the year and look forward to expanding our pace of growth when margins allow. In terms of pets, our core Trupanion brand represented the bulk of the new pet growth in the quarter as we continue to focus on growth in areas that are most closely aligned with our targeted value proposition. Our newer initiatives, including our powered buy suite of products with Chewy and Aflac, our medium and low ARPU products, Furkin and PHI Direct, and our products in Continental Europe comprised approximately 22% of our gross new pet in the quarter, up from Q4 and over 20% for the first time since we launched these products. We will continue to deploy a conservative amount of capital against these opportunities given that these products are early in their lifecycle and subscale. However, it should be noted that we've made some encouraging progress in Furkin and PHI Direct, with evidence of scale beginning to manifest. As our margins expand significantly into the second half of this year, we will look to adopt a more assertive approach in deploying our capital. In our large underpenetrated market, this remains our overarching mandate; we will do so prudently, however, gradually scaling up our acquisition spend as margins expand. In summary, I'm pleased with our Q1 results, which aligned with our expectations and were delivered through solid execution. This is a testament to the ongoing discipline and focus of the team. We're committed to maintaining this discipline while fulfilling our mission of supporting more pets and veterinarians. I'm excited about the future and the tremendous opportunities that lie ahead. With that, I'll hand it over to Fawwad to provide a detailed overview of our Q1 results.

Thanks, Margi. Today, I will share additional details around our first quarter performance as well as provide our outlook for the second quarter and full year 2024. At a high level, I'll echo Margi's comments that it was a solid start to the year. Total revenue for the quarter was $306.1 million, up 19% year-over-year. Within our subscription business, revenue was $201.1 million, up 22% year-over-year. Total subscription pets increased 11% year-over-year to over 1,006,000 pets as of March 31. This includes approximately 43,000 pets in Europe, which are currently underwritten by third-party underwriters. Total monthly average revenue per pet for the quarter was $69.79, up 9.8% over the prior year period. The subscription business cost of paying veterinary invoices was $151.5 million, resulting in a value proposition of 75.3% and reflecting a 225 basis point improvement over the prior year period. This improvement provides a clear representation of the actions we have taken to repair our margins, and we are pleased with this progress. Due to the seasonality of pricing we highlighted earlier and last quarter, the cost of veterinary invoices as a percentage of revenue increased 260 basis points from Q4. Our target value proposition for our subscription business remains 71%, and we expect to close the gap to our target by year-end. As a percentage of subscription revenue, variable expenses were 9.6%, down from 10.1% a year ago. Fixed expenses as a percentage of revenue were 5.3%, up from 4.7% in the prior year period due to increases in our technology and G&A expenses, including additional expenses incurred related to the remediation of our material weaknesses. After the cost of paying veterinary invoices, variable expenses and fixed expenses, we calculate our adjusted operating income. Our subscription business delivered adjusted operating income of $19.6 million, an increase of 55% from last year. Subscription adjusted operating margin was 9.7% of subscription revenue. This is up from 7.6% in the prior year quarter and represents approximately 210 basis points of year-over-year margin expansion. Now I'll turn to our other business segment, which is comprised of revenue from our other products and services that generally have a B2B component and a different margin profile than our subscription business. Our other business revenue was $105 million for the quarter, an increase of 15% year-over-year. Adjusted operating income for this segment was $1.7 million, a decrease of 41% from last year. The decrease was driven by the previously mentioned increase in fixed expenses and a lower gross margin. In total, adjusted operating income was $21.3 million in Q1, in line with our expectations. This was up 37% from Q1 last year, but down 22% from Q4. In Q1, our higher-value subscription business comprised approximately 92% of our adjusted operating income in the quarter. This is up from 84% for the full year in 2023. We expect this trend to continue as one of our partners in our other business, Pets Best, continues to enroll pets with their new underwriter. During the quarter, we deployed $15 million to acquire approximately 67,200 new subscription pets. Excluding the approximate 3,900 new European pets that are underwritten by a third party, this translated into an average pet acquisition cost of $207 per pet in the quarter, down from $247 in the prior year period and $217 in Q4. We also invested $1.2 million in the quarter in development costs. Stock-based compensation expense was $7.4 million during the quarter. As a result, net loss was $6.9 million or a loss of $0.16 per basic and diluted share compared to a loss of $24.8 million or a loss of $0.60 per basic and diluted share in the prior year period. In terms of cash flow, operating cash flow was $2.4 million in the quarter compared to a negative $6.9 million in the prior year period. Capital expenditures totaled $3.1 million. As a result, free cash flow was negative $0.6 million, an $11.4 million improvement from the prior year's first quarter. Similar to our adjusted operating income, our free cash flow is impacted by the seasonal fluctuations we've discussed. It is for this reason we have set an annual free cash flow target at 2.5% of revenue. We believe this is a prudent amount given the strength of our capital position and our desire to grow in such a large underpenetrated global market. Turning to the balance sheet, we ended the quarter with $275.2 million in cash and short-term investments. Outside of our insurance entities, we held $38.1 million in cash and short-term investments, with an additional $15 million available under our credit facility. At the end of the quarter, we maintained $256.7 million of capital surplus at our insurance subsidiaries, which was $103.4 million more than the estimated risk-based capital requirement of $153.3 million. This is down from our year-end requirements as growth in our other business slows and the capital intensity of our business lowers. Last quarter, we reported two material weaknesses as a result of the 2023 audit. In response to this, we have made investments in internal controls, technology and SOX compliance. We have also hired PwC to assist us in the remediation of these material weaknesses, and we are making progress in addressing these deficiencies. We will look to regain more efficiency in our fixed expenses throughout the year while balancing our continued remediation efforts in earnest. I'll now turn to our outlook. We are updating our full year revenue guidance, which is now expected to be in the range of $1.244 billion to $1.276 billion or 14% growth at the midpoint. This takes into account our slight overperformance in Q1. We continue to expect to grow subscription revenue in the range of $842 million to $862 million, representing 20% year-over-year growth at the midpoint. We also continue to expect total adjusted operating income to be in the range of $100 million to $120 million, or 32% year-over-year growth at the midpoint. As we think about the shape of the year, we expect that the first half of the year will start from a lower margin standpoint within our subscription business and build back to a 15% adjusted operating margin by Q4 of this year. Second, for the second quarter of 2024, total revenues are expected to be in the range of $306 million to $311 million, representing 14% year-over-year growth at the midpoint. Subscription revenue is expected to be in the range of $206 million to $208 million or 20% year-over-year growth at the midpoint. Total adjusted operating income is expected to be in the range of $21 million to $23 million. As a reminder, our revenue projections are subject to conversion rate movements predominantly between the U.S. and Canadian currencies. For the second quarter and full year of 2024, we used a 74% conversion rate in our projections, which was the approximate rate at the end of March. With that, I'll hand it back to Margi.

Thank you, Fawwad. This weekend, Darryl and I will be joined by Fawwad in Omaha for our annual Q&A to follow Berkshire Hathaway's Annual Shareholder Meeting. This is an event I personally look forward to every year and one that presents a unique opportunity to meet with long-term-minded investors. We hope to see many of you there. Now before we open for questions, I'd like to take a moment to pay tribute to Darryl. Since the development of the Trupanion idea nearly 40 years ago, Darryl has been an exceptional visionary, entrepreneur and leader. He has also been a brilliant coach to many, not least to me. I am deeply humbled to be appointed as your successor and to follow in his footsteps. I'm proud to lead the company and a team that has such a profound significance for so many. Looking ahead, as we continue to grow and expand our reach on products in support of pet parents globally, Darryl has agreed to further develop the early work around our food initiative. On behalf of the Trupanion community everywhere, thank you, Darryl, for your mentorship, support, and the impact you've made across the world of animal health. With that, we'll open it up to questions.

The first question comes from Jian Li with Evercore ISI.

Great. Congratulations on your appointment. Darryl, we'll certainly miss you. So Margi, first, maybe just on the high level, you've been with Trupanion for quite a while now. In this new capacity, how does your focus on priorities evolve? Can you talk about the key areas that you'll be focused on in the next 6 to 12 months? It sounds like profitability is a big focus for you, so if you can kind of talk through that a little bit? And then the second question on the macro environment: is there anything you're seeing that is impacting your retention, impacting the pricing flow through? And what kind of assumption is baked into your full year guide and also the trajectory of your margins?

So just to pick up on the focus on priorities, I think during my time at Trupanion, I initially came in very heavily focused on the growth side of things and started very close to both the website and also our territory partners, which are foundationally what makes Trupanion unique. That really has been where I continue to focus. I believe that, in the long haul, that will always be the mainstay for the company in such a highly underpenetrated market. That said, to your point, with the size of the company, it's about ensuring that we are operating within our core guardrails for every element of our P&L, ensuring that we can get scale and maintain that scale for years to come. So I'm very excited by what the team has been able to create so far and look forward to moving the business forward in that direction.

Yes, thank you for the question. The way we think about the annual plan and what's baked into the guidance is really three key components that we're focused on as a leadership team. The first is pricing, as you mentioned. The second is, of course, expense management, as we think about higher costs related to some of the remediation work that we've embedded in, and then retention. So, yes, I would say at a macro level, what we baked into our forecast was 15% inflation. From a Q1 perspective, that assumption was validated. So when we look at our expectations for where we were going to end up on subscription cost of veterinary invoices, we came in pretty much on target. This gives us a data point or a proof point to model out the rest of the year. If I think about the guidance, the endpoint of the guidance is Q4, where the objective, our North Star, is to get to our target margin from a subscription cost revenue at 71%. Our adjusted operating income subscription is expected at 15%. We've assumed a gradual build back to that over the course of the year, similar to what we saw in the first half of last year, where there was modest margin improvement from Q1 to Q2. Typically, in Q1, we implement price increases; those flow through, and we see acceleration of margin expansion in the second half, but that is effectively what we're modeling into our guidance, both for Q2 and the full year. Obviously, we're vigilant when it comes to evaluating the macro situation, and we have a lot of data to help us be as predictive as possible. So when we think about pricing and the efficacy of our pricing efforts, it's very much grounded in the data that we’re seeing. So far, so good; we’re not seeing anything surprising, but obviously, more to come as the year progresses.

The next question comes from Joshua Shanker with Bank of America.

A few items on medical loss ratio. You talked about the seasonality of the medical loss ratio in the first quarter. Can you talk about when you think about the annual seasonality patterns, how much do you think in a normal year, the first quarter loss ratio should be elevated versus the remainder of the year?

Yes, this is Fawwad. I'll take that question. The assumption we've baked in, as you can see from the actuals, is about a 2.6% sequential increase from Q4 to Q1. If you look back historically, that's not dissimilar to what we've seen in terms of patterns. The other thing that I would ground is we have discussed free cash flow. Generally, the second half is higher than the first half. So our expectation is that loss ratio will peak as it typically does in Q1 and then gradually reduce down to the 71% model P&L. Generally, you'll see a flat transition from Q1 to Q2. From a margin perspective, we see modest improvement, and then really the bulk of it happens in the second half.

I can add to that as well. Just as we think about that flow of rate and it comes through, the reason for that slightly delayed margin expansion typically in the year is because the rates—price increases—occur in the first quarter at the veterinary level. Then visit patterns follow, meaning people start to visit vets and realizing those invoices. It takes time to flow through the year. By Q2, you begin to see peak visit patterns, and gradually the loss ratio starts to come in as it aligns with the prices we receive from invoices.

In 1Q '22, the subscription medical loss ratio was 71.1%, and now it's 75.3%. So it has expanded by about 400 basis points over the past 2 years through a lot of inflation and followed by price increases. Can you talk about whether that squares with what you look at as the loss cost trend increases over the past 2 years and how much price action you've taken?

Yes, that's a good reference point to anchor to. If we get to what we might call a normal year, I think calendar year 2022 would be a good benchmark. You're correct to cite that. We are looking at the same data. If we can hit target margins by Q4, this is obviously a different situation as we are coming off of a higher peak and have a more accelerated drop to that level in the second half. I would expect that eventually, our model will reflect an equilibrium, similar to 2022. The thing we don't know is the level of inflation going forward. We are currently targeting 15% as the new standard, which is markedly higher than the historical mid-single digits. Eventually, we expect to reach equilibrium at pricing, assuming success with our price increases indexing to the rate of inflation. But at present, we are playing catch up.

Just a quick note: if we rewind to Q1 of 2022, everything seemed normal. We experienced our usual pricing increase of between 6% and 7% coming from vets. What we did not anticipate was seeing further increases in Q2, Q3, and Q4. By the end of the year, we were in catch-up mode. We encountered a total annual increase of 12% by the time we reached December. Thus, we assumed 12% inflation, which was double the previous norm, and adjusted our expectations to 15%. We began following up with price increases throughout the year to accommodate these conditions. The upside is that consistency in these requests creates less volatility, stabilizing our pricing patterns, and the pricing cadence we ask for is more tempered. If this average holds at 15%, then the overall loss ratio will begin to decrease as we achieve a more measured transition from one year to the next.

The next question comes from Maria Ripps with Canaccord Genuity.

Margi, congrats on your new role, and I wish you all the best as you navigate this next chapter. First, I wanted to follow up on your adjusted operating income in the quarter. It seems like, with a slightly higher subscription revenue, the adjusted operating income was marginally below the midpoint of your guidance. It's not a significant delta, but given that investors are focused on this metric, any color you can share on what drove that delta versus your guidance, especially considering that it seems like inflation met expectations?

Yes, thanks for the question. The principal driver was higher technology costs. When we forecast the quarter from a technology perspective, there was more work required to sustain our digital transformation and vision platform. So technology cost was the main driver—it was higher operating expenses, but lower capital expenditures. As we think about the remainder of the year, the larger factor will be the fixed expense perspective, specifically related to the cost of remediation. In my prepared remarks, I mentioned we engaged PwC for assistance in that effort. This is something we are taking very seriously, and we are putting significant investment behind it, which is driving our fixed expenses higher. It did not have as substantial an effect on Q1, but will become more apparent as we proceed throughout the year. Our objective is to reach target margin levels across all segments of our P&L, inclusive of AUM. We're focusing on driving efficiencies in our fixed spend, and our company has successfully done this many times before.

Got it. That makes sense. Now, for a bigger picture question. In your shareholder letter, you drew parallels with auto insurance. Could you expand a little on the key differences and similarities between pet and auto insurance in relation to the recent inflation dynamics? With companies like Progressive and Allstate seeing share prices at all-time highs, while yours is not reflecting recovery, what do you believe is driving this gap in investor perception or expectations?

From my perspective, auto insurance companies have been around for a long time, and their investors understand that if their costs rise, they will recoup their margins given time. This is a universal scenario across insurance lines and is even regulatory mandated. In contrast, we operate within a newer category, and the investor base has perceived margins may continue to drop. The inflation context for auto insurance stems from a combination of material costs and labor costs emerging from COVID. Conversely, for the veterinary sector, the primary driver is labor costs, leading us to expect 15% inflation levels for several years to come. As mentioned earlier, historically, vet inflation was around 5% to 6%, so the difference between Q1 and Q4 will see a significant jump as we currently deal with a 15% inflation situation. If we look at our subscription margin improvement of 55% year-over-year and ARPU for our Trupanion subscription up by 11%, we can see the initial effects of our implemented pricing changes. It’s only a matter of time until margins fully expand, and investors regain confidence in our outlook.

The next question comes from Jon Block with Stifel.

To start, the Q1 2024 gross adds were down 9% year-over-year. I don't think there's been any growth now on a last twelve months basis. I understand the greater scrutiny on the PAC deployment until the MLR improves. What are the plans for the MLR? I thought I heard we'd close the gap on 71% by year-end, which is a change from before. When do you expect to recapture the main goal of 71%? In the interim, should we be concerned about losing significant market share during this time? I have a follow-up question.

Thanks for the question. I can’t speak about market share, I'll let others chime in on that. Our expectation hasn’t changed; our goal is to hit 71% by Q4. We are not satisfied with this because of everything we've discussed regarding the first half versus the second half of a typical year, but that is still our expectation.

To follow on the market share discussion, as we assess our growth year-over-year, it has indeed dropped by 9%. However, our PAC has decreased by 23%. This reflects significant efficiencies. Regarding the category growth overall, recent reports indicate a total category growth of just under 22%. Meanwhile, Trupanion's growth was 26.5%. There is definitely a massive market available for us, with only about 3% penetration. The category has crossed $4 billion for the first time, illustrating the vast opportunity ahead. As our margins expand, we will increase our pet acquisition efforts and expect to see those numbers improve. So far, everything is following our anticipated trajectory.

Okay. Just to clarify what I heard, when you mentioned closing the gap, you did not indicate a new timeline for reaching the 71% goal, correct? And Margi, regarding the 3% penetration, clearly, there's a TAM and a SAM, and I don't think the SAM is only 3%. Can we shift to the second question? Apologies for asking, but it seems vital. Margi, since taking over as sole President, the stock is down over 70%, while the market is up 12%. To be fair, inflation has been a major headwind. But shareholders have experienced considerable pain during this period. You're losing share, the MLR is stubbornly high, and new product launches have taken longer than anticipated. Can you identify the top 2 or 3 priorities that you are focusing on to turn this situation around over the next 12 months?

Certainly! The first priority is to continue the teams' focus over the past year on margin expansion. We touted a 55% year-over-year subscription AOI growth in Q1, which I am really pleased to see reflected. This highlights our dedication to this objective. We will keep efforts concentrated within our pricing strategies, ensuring that we are effectively communicating our value to our members, enhancing retention. Member experience is always a priority for us, and that dovetails with margin expansion as well. Next, focusing on where to deploy capital is crucial. The pool and distribution channels that were part of our six-month plan will expand, allowing us to tap into more opportunities than ever. We will proceed with caution rather than a knee-jerk reaction to just increase everything at once, making sure to maximize internal rates of return. This may include opportunities in North America, new products, or even prospects in Europe. Ultimately, we must ensure that our margins and operational expenses comply with the guardrails we’ve set, which requires a delicate balance across growth metrics.

The next question comes from John Barnidge with Piper Sandler.

My first question is regarding the opportunity for the food initiatives you will be involved in, Darryl. What do you see as the total addressable market (TAM)? Will you maintain 100% control? Will those expenses flow through to the other business?

We first talked about our food initiative in our 60-month plan. It's still early days. We believe it has a very large TAM. If we get to 25% market penetration on insurance, then 100% of pets are eating food. We think we're in a unique position to understand the health outcomes. That's what we're focused on, but we don't have any promises on how or when it's going to affect the P&L nor where it will be flowing through. So it's early days for that.

Okay. And then as a follow-up, can you explain the growth in capital in excess of the minimum during the quarter? It appears to have increased from 64.1% to 103.4%. With growth slowing, should we anticipate this to continue to build as the year progresses?

Certainly! We look at excess capital or overcapitalization of our insurance entities driven by two main factors. First, as the business continues to grow from a subscription perspective, we contribute to that pool of capital. Second, the dynamic of Pets Best has gradually rolled off, impacting capital intensity. A good portion of the $24 million increase in capital above minimum requirements can be attributed to this dynamic. We view this as a positive indicator for a few reasons. First, it positions us well to continue adding more policies and expands our subscription business where we see appropriate growth opportunities. Second, it enhances our risk-based capital requirements, which we monitor closely. Lastly, as we've observed over the past year, elevated interest rates have also generated unexpected cash influx. As previously noted in Q4, we received an ordinary dividend from interest earned on that cash, providing further utility. I would expect to see this growth continue as we advance, but the overall capital intensity with Pets Best will diminish.

The next question comes from Katie Sakys with Autonomous Research.

Margaret, both congratulations on your respective new roles! I want to clarify some things on the invoice ratio first across both subscription and other pets. A year ago, we discussed an adverse development of about 1 point on the invoice ratio. Can you check if there's any similar degree of revision included in this quarter's invoice ratio? And more broadly, can you provide some context on how you're feeling about the past year's loss picks holding in?

Of course! I just want to confirm we interpreted the question correctly; you're asking about the loss ratio and trend. Notably, the loss ratio was elevated in Q1 regarding the other business related to Pets Best. We are observing the same phenomenon in our subscription business where we are implementing pricing adjustments. In this context, we are less concerned about Pets Best affecting the overall view. Therefore, I'd say that the increase in the loss ratio corresponds closely with the pricing flow discussed earlier.

Just to clarify our reserves and ABR: in Q1, we released a little reserve linked to much older claims that we were holding back reserves for. The advantage of our vet-direct payment model—where we handle invoices directly—is that we see much less development over time, allowing us to release those reserves. I think this is aligned closely with what your question aimed at.

If it’s helpful, a little more context on reserves: if you review reserve as a percentage of revenue across the total book, it was down—from 21.4% to 20.3%. When we look at it year-over-year against last year’s $18.8 million in reserves, elevated claims were observed from Q4 claims paid in Q1, leading us to feel comfortable lowering reserves. If you were to index the current reserves against $18.8 million and consider the 5.6% increase in pet count, we feel assured that reserves and revisions to them remain unchanged.

That’s helpful clarification. Now on the growth metrics: I see the deceleration in the other pets enrolled is expected given the pet business agreement changes. Are there any positive growth trends in that segment that are being masked by the Pets Best shift?

The only element I would refer to is ARPU. Back to my earlier comments, we’re seeing increased ARPU and the ability to pass on price to consumers. So I would say it mirrors closely what's seen in the subscription. If we're discussing overall adjusted operating margin change and why it decreased, there are two reasons—one being the new agreement detailing different revenue tiers. Since our business is declining, we are no longer benefiting from additional tiers. Additionally, the higher fixed expenses due to remediation and technology costs have impacted our rates. Therefore, I'd expect that the adjusted operating margin is anticipated to stay stable at about 1.5% to 1.7% for the remainder of the year.

The next question comes from Wilma Burdis with Raymond James.

Congratulations to Margi and Darryl! A couple of quick questions for you. First, can you discuss the trajectory of adjusted operating income throughout 2024? Trupanion appears on track for about $43 million in the first half of the year, which implies around $70 million of adjusted operating income in the second half. Can you share what components will drive you toward that higher level in the second half?

Certainly! The primary driver will be pricing and the pricing flowing through the book. If you compare adjusted operating margin, it has improved by around 200 to 450 basis points, which is largely due to pricing-driven margin expansion. We anticipate sequential improvement, with Q1 to Q2 stabilizing in margin perspective, then seeing further acceleration in the back half.

Fantastic! Regarding higher ARPU in your other business: Should we expect a similar growth rate in pricing moving forward?

Yes. When you assess the contribution to revenue, the year-over-year increase of 15.2% in the other business was almost solely attributed to ARPU, which rose by about 13.9%. That's largely driven by ARPU. We'll see some trickle-off of that.

This concludes our question-and-answer session for the Trupanion First Quarter 2024 Earnings Conference Call. It is now concluded. Thank you for attending today's presentation. You may now disconnect.