WaveDancer Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 4, 2023

There are 13 speakers on the call.

Operator

Welcome to the Trupanion First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Laura Bainbridge, Investor Relations.

Operator

Thank you. You may begin.

Speaker 1

Good afternoon, and welcome to Trupanion's Q1 2023 Financial Results Conference Call. Participating on today's call are Daryl Rawlings, Chief Executive Officer Margie Toues, President Andrew Wolf, Chief Financial Officer. Before we begin, I would like to remind everyone that during today's conference call, We will make certain forward looking statements regarding the future operations, opportunities and financial performance of Trupanion within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release, which can be found on our Investor Relations website as well as the company's most recent reports on Forms 10 ks and 8 ks filed with the Securities and Exchange Commission.

Speaker 1

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.

Speaker 1

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

Speaker 2

Thanks, Laura. 2 years ago, we kicked off our 60 month plan. We are now 28 months in and on track to achieve many of the goals we've set. Since that time, we've grown revenue to above 30% annually, increased our adjusted operating income by nearly 50% And acquired over 500,000 new subscription pets at a strong estimated internal rate of return. The number of active hospitals in North America now approximates 16,000.

Speaker 2

We're paying nearly half of veterinary invoices through our software and retention rates remain strong. We're seeing Consistent levels of conversion and strong growth in pet owners referring friends and adding pets. We've also added new brands and new channels and have laid the foundation to double our addressable market, extending our runway for growth by decades. I provided more detail around these highlights in my annual shareholder letter published in March. The core of our business model is to earn the trust of veterinarians and pet owners.

Speaker 2

We do this by providing a solution to the rising cost of veterinary care, making it easier for pet owners to budget for their pets care over their lifetime. Over the long term, the underlying need and demand for high quality insurance will continue to grow. Last year, the cost of veterinary care increased at an unprecedented rate with veterinarians raising prices multiple times throughout the year. As expected, we saw veterinarians take additional price early this year, and it is our belief that the long term sustainability The veterinary industry will require veterinarians to pass on higher fees in the form of inflation for the years to come. Keep in mind that the cost of veterinary care for Trupanion is a combination of the number of veterinary invoices received and the increase in our average invoice size.

Speaker 2

As one can imagine, these ongoing rapid rate increases will prove more challenging to uninsured pets compared to those with insurance. As a result, veterinarians and their staff will have greater urgency when introducing the concept of high quality insurance or answering questions from inquiring pet owners. Long term, the category and Trupanion are set up very well to meet this demand. Importantly, we do not and will not dictate the cost of veterinary care. We are a cost plus model.

Speaker 2

It is our job to understand the trends in the cost of care and to share the risk appropriately through a granular approach to pricing. Because our product is for the life of the pet, we do not try to predict the cost 5, 10 15 years out. We simply monitor the cost, the year over year inflation and project out the next 12 to 18 months. In my shareholder letter, I detailed some of the temporary and near term challenges we faced and accurately forecasting veterinary costs throughout the course of 2022, namely the ongoing impacts of COVID and the post pandemic In total, we estimated our cost of veterinary care increased by 12% in 2022, twice that of our historical rate of veterinary inflation over our 23 year history. Entering 2023, it was our expectations that the cost of veterinary care for our members would persist at the elevated rate of 12% and that our pricing plans would be sufficient to get us back on track to our adjusted operating margin target by year end.

Speaker 2

In Q1, we saw our actual cost of veterinary invoices increased by 15% year over year, ahead of our previous assumptions. Within our cost plus model, this means we need to add an additional 3% in pricing to get us back on track with our margin targets. At our revenue run rate, this has a $30,000,000 impact on our adjusted operating income for the year. We've updated our adjusted operating income outlook To account for the step up in veterinary inflation to 15% year over year, Drew will provide more details momentarily. Rapid changes in inflation will continue to challenge our ability to price accurately for our members.

Speaker 2

Unlike other direct to consumer subscription models, Within the insurance industry, we are limited in how quickly we can adjust and implement pricing. Typically, in the U. S, it will take us 18 months in order to file or receive approval and implement new pricing across the entirety of our book. Over this time period, our members will, on average, Receive a higher than usual value proposition. In a world where veterinarian and members come first, this is an okay outcome.

Speaker 2

Over the long haul, well managed insurance providers sticking to their values and diligently growing when and where it's prudent Come out stronger in the years following a period of margin compression. Between then and now, the team is energized and working hard to restore our margins as soon as practical. With that, I'm going to hand the call over to Drew to discuss our Q1 results and outlook in greater detail. Margie will then provide more context around our performance and our plans to hit our key financial targets.

Speaker 3

Thanks, Daryl, and good afternoon, everyone. Today, I will share additional details around our Q1 performance as well as provide our outlook for the Q2 and full year of 2023. Total revenue for the quarter was 256,300,000 up 24% year over year and ahead of our expectations. Revenue performance was driven primarily by strong pet additions and sustained high levels of monthly retention in our subscription business and continued growth in our other business. Within our subscription business, Revenue was $165,200,000 in the quarter, up 18% year over year.

Speaker 3

On a constant currency basis, subscription revenue would have been up 20% year over year or 167,200,000. Total subscription pets increased 23% year over year to over 90 1,000 Pets as of March 31. Calculated on a trailing 12 month basis, our average monthly retention across all our North American subscription products was 98.65 percent compared to 98.75 percent in the prior year period, equating to an average life of 74 months. Monthly average revenue per pet for the quarter was $63.58 which was largely flat year over year on a constant currency basis. On that same basis, cost of veterinary invoices per pet increased 9.5% over the same time period.

Speaker 3

This increase per pet is attributable to both an increase in the number of veterinary invoices received as well as a higher average invoice size. Using insights from Q1 data, we also increased the size of our reserve for veterinary invoices by $1,200,000 for prior periods, primarily Q4. As a percentage of subscription revenue, variable expenses were 10.1%, up 10 basis points from the prior year period. This slight year over year increase reflects investments in maintaining our member experience and initiatives shifting out of development. Fixed expenses as a percentage of subscription revenue were 4.7%, down from 4.9% in the prior year period as the team continued to drive efficiencies throughout our business to offset our elevated loss ratio.

Speaker 3

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 $12,600,000 or 7.6 percent of subscription revenue. As Daryl noted, veterinary invoice expense outpaced our expectations in the quarter. Now I'll turn to our other business segment, which is comprised of revenue from other products and services that generally have a B2B component and a different margin profile than our subscription business. In total, our other business revenue was $91,100,000 for the quarter, an increase of 37.7% year over Due to primarily to an increase in pets enrolled.

Speaker 3

As discussed last quarter, we anticipate slowing growth throughout the year in our other business segment as our partner transitions to an additional underwriter for their new pets. Adjusted operating income for the segment was $2,900,000 in the quarter. In total, adjusted operating income was $15,500,000 in Q1, a decrease of 28% over the prior year period. During the quarter, we deployed $19,600,000 to acquire over 74,000 new subscription pets. For North America, this resulted in a pet acquisition cost of $47 for the quarter and an estimated 30% internal rate of return for a single average pet.

Speaker 3

We also invested $900,000 in the quarter on development costs. As a percentage of revenue, development expenses was 35 basis points compared to 61 basis points in the prior year period. This step down reflects the shift of some of our new initiatives to variable, fixed and pet acquisition expenses within our subscription business. Adjusted EBITDA was a loss of $4,900,000 for the quarter as compared to $1,200,000 in the prior year period. Depreciation and amortization was $3,200,000 during the quarter, an increase of $500,000 from the prior year period.

Speaker 3

Total stock based compensation expense was $12,300,000 during the quarter, inclusive of compensatory arrangements for departing officers. We expect stock based compensation to be around $7,000,000 per quarter for the remainder of the year. As a result, net loss was $24,800,000 or a loss of $0.60 per basic and diluted share compared to a net loss of $8,900,000 or a loss of $0.22 per basic and diluted share in the prior year period. Turning to our balance sheet, we ended the quarter with over $253,000,000 in cash investments, which was up from around $230,000,000 at year end last year. We held approximately $104,000,000 in debt with $40,000,000 available under our long term credit facility.

Speaker 3

In terms of cash flow, Operating cash flow was negative $6,900,000 in the quarter compared to negative $3,600,000 in the prior year period. Capital expenditures totaled $5,200,000 in the quarter. As a result, free cash flow was a negative $12,000,000 I will now turn to our outlook. For the full year of 2023, after adjusting for Q1 performance and updating our forecast, we are expecting to grow revenue in the range of 1,047,000,000 to $1,076,000,000 representing 17% growth at the midpoint. This reflects Q1 outperformance in our other business segment.

Speaker 3

We continue to expect to grow subscription revenue in the range of $700,000,000 to $720,000,000 This is 19% year over year growth at the midpoint. We now expect total adjusted operating income to be in the range of $65,000,000 to $80,000,000 This is largely reflective of the cost of veterinary outpacing our earlier expectations as Daryl discussed. At the midpoint of the range, this implies expansion in adjusted operating margin in the second half of the year as our Pricing actions flow more meaningfully through our book of business. For the Q2 of 2023, total revenue is expected to be in the range of $260,000,000 to $264,000,000 representing 19% year over year growth at the midpoint. Subscription revenue is Total adjusted operating income is expected to be in the range of $14,000,000 to $17,000,000 As a reminder, Our revenue projections are subject to conversion rate movements predominantly between the U.

Speaker 3

S. And Canadian currencies. For the Q2 and full year 2023 guidance, We used a 74% conversion rate in our projections, which was the approximate rate at the end of March. Before handing the call over to Margie, This will be my last earnings call at Trupanion. I wanted to take a moment to express what an honor it has been to work together with the team.

Speaker 3

I am grateful to have had the chance to be a part of this incredible mission, and I look forward to continuing to work with the team to help recruit my successor and ensure a seamless transition. Thank you for your time today. I will now hand the call over to Margie.

Speaker 4

Thank you, Drew. Good afternoon, everyone. Following the recap of the quarter, I'll provide more context for our Q1 results and our plans to deliver against our key financial targets. It was another quarter of strong pet growth for Trupanion. We acquired over 74,000 new subscription pets, including 4,000 new pets from Europe.

Speaker 4

While the Trupanion product remains the primary engine behind our reportable performance, we're excited that our new initiatives, including international markets, are starting to positively impact our growth. Excluding European activity, on a per pet basis, we enrolled 18% more subscription pets at an average cost of $2.47 which is $54 less than the prior year period. I'm encouraged by the overall efficiency of our spend, which was especially impressive given the margin headwinds faced throughout Quarter. Growth within our core Trupanion product remained robust, led once again by the vet channel. We also continue to see strong growth members referring their friends and adding pets to their family.

Speaker 4

Member retention for the quarter remained at healthy levels and on a trailing 12 month basis, The average Trupanion pet stayed with us for 75 months. With necessary pricing continuing to roll through our book, we're doubling down on our I remain encouraged by our ability so far to sustain high levels of retention within our Trupanion product, but do expect to see some pressure throughout the year as pricing rolls through our total book. That said, our expected ARPU increases should more than offset any revenue impact from this pressure. After several quarters of foundational work, we're finally seeing price take effect. As a reminder, in January, we had 11.2% pricing improved and flowing through the business.

Speaker 4

In February, it was 13.1%, and in March, it was 14.4%. We expect to exit April at 15.8%, May was 16% and June at 17.4% approved and flowing through. We also have an additional 6% filed for, which, If successful, would equate to 23% pricing action flowing through by the end of 2023. This additional pricing action is As a reminder, pricing changes are applied immediately to new pets, but flow through our existing book over a 12 to 18 month period depending on state approval timing. For this reason and accounting for the ongoing impact of mix of business, we do not expect to get the full benefit of this pricing action in ARPU.

Speaker 4

We will continue to take a proactive stance to get ahead of future increases in the cost of veterinary care to return to our margin targets as soon as feasible. Between then and now, the team will remain disciplined in acquiring pets where we're accurately priced to our value proposition, allocating capital to our most efficient channels and operating well within our variable and fixed cost structure. So far this year, the team has worked well to improve our operational efficiency during the quarter despite the additional The team executed well to hold combined variable and fixed expense margins in line year over year. A few weeks ago, we took important steps to reorganize the way our teams are structured. This decentralized approach, moving from 1 to multiple P and Ls, With a core component of our 60 month plan and is expected to provide us with greater visibility into our data, allowing us to identify emerging trends more quickly and set us up to act We further expect these changes to strengthen our data collection and inspection process, improve our level of forecasting, Build on our regulator relationships and file for and approve our pricing needs much closer to real time.

Speaker 4

Already this approach is providing us with greater insights, reporting and decision making. As Drew noted, with recent in-depth analysis of our data, we increased our reserves for prior and current periods by approximately $4,000,000 We will continue to build on this in the coming months, applying more refined approaches to both pricing and growth. In the year ahead, we expect solid growth in subscription pets and revenue with the bulk of this growth to come from categories we're achieving our target loss ratio of 71%. Conversely, categories where we're yet to achieve the necessary rate adjustments will have pace of growth slowed or paused until we can confidently offer a I'll echo Daryl's earlier remarks that we have no intention of trying to control the cost of veterinary care. We will maintain our cost plus approach that is especially challenging in the current environment where vet inflation has increased at times and in amounts that we haven't seen in the past 20 years.

Speaker 4

We have and always will target the highest sustainable value proposition in the industry, which drives high retention, high lifetime value and greater alignment with veterinarians. We are confident we will come out of this inflationary period stronger than we entered it. Today's operating environment is not without its challenges, but it also greatly reinforces the need that Trupanion serves in the market, Helping pet parents to budget and care for their pet if they become sick or injured. This seed has and will only continue to grow in the years ahead. As I look at our business long term, I couldn't be more excited.

Speaker 4

As further details on our recent shareholder letter, the cost of veterinary care is going to continue to escalate at rates higher than ordinary inflation. Self insurance, our biggest competitor, is under pressure with the cost of caring for unexpected accidents Our international expansion is doubling our addressable market, both in the number of pets and the veterinarians we can help. The moats we have been building for decades, along with the values that we live by, continue to resonate with our constituents. Our target customer, the loving and responsible pet parent, continues to So before I hand it back over to I want to take a moment to recognize Drew and to thank him for his time with Trupanion. Drew is a man of great character and is well respected by the finance team.

Speaker 4

We thank him for his assistance in ensuring a smooth transition in finance leadership, including handing the reins over to Wei Li, who will step into the role of interim CFO on June 1. We are in the process of conducting a comprehensive search for a permanent CFO. However, in the meantime, Daryl and I have the utmost confidence in Wei and his ability to lead the finance team until a permanent replacement is named. Thank you again, Drew. With that, I'll hand the call back over to Daryl.

Speaker 4

Daryl?

Speaker 2

Thanks, Margie. At Trupanion, we value trust and transparency. These values form the basis of our interactions with all stakeholders, including pet owners, veterinarians and their staff, state regulators, team members and you, our shareholders. We value the trust you have placed in us and recognize the importance of delivering on our promises. With this in mind, we invite you to join us for our 2 upcoming investor focused events.

Speaker 2

This weekend, Margie and I will be hosting our annual Q and A following Berkshire Hathaway's Annual Shareholder Meeting in Omaha. This is a great forum to connect with long term like minded investors. On June 7, we will host our Annual Shareholders Meeting at our headquarters in Seattle. This once a year event is your opportunity to hear directly from the team members leading the execution of our 60 month plan in an open Q and A forum. We hope to see you there.

Speaker 2

More details, including registration, are included on our Investor Relations website. With that, we'll open it up for questions.

Operator

Thank you. We will now be conducting a question and answer session. Our first question comes from John Barnidge with Piper Sandler. Please proceed with your question.

Speaker 5

Can you talk about the decline in retention experience in the quarter? Is there any signs that Insurers are shifting to lower priced products in the face of pricing increases not just in Trepania but industry wide.

Speaker 6

Yes, sure. Hi, John. It's Maggie. So in terms of retention overall, we saw some really we saw a strong performance. I mean, if we're thinking, We've now flowed through at the end of Q1 14.4%, close to 15% worth of rate, and we saw very minor adjustment in our core book of business.

Speaker 6

So we saw 4 months average retention for the core companion subscription book. We still feel very encouraged by that. We now got additional rate flowing In April, we haven't seen further signs about lowering. So I think overall, given the rate and we've talked about anticipating a slight adjustment to retention based on this We're not seeing that any degradation to a degree that would offset the ARPU increase that we have there.

Speaker 7

And I don't think we really have any visibility on the category as a whole, but I can't say that the category as a whole is taking large rate increases.

Speaker 5

Thank you. And then as a follow-up, you talked about the Other partner migrating to a new underwriter, do you have any update on timing of that or the capital in that other business? Thank you.

Speaker 8

Sure. This is Drew. And to reiterate, this is something we've been working on For many years transitioning Pets Best, I think our calls go back to 2019. We're really happy with how that came out. What we agreed was that they would transition or they would add a new underwriter.

Speaker 8

They can continue to underwrite business with us. We have more line of sight to that and that's why we're raising revenues. So we continue to think they'll have some business with us and That's kind of updated in our outlook. It does free up significant amount of capital for us and We lock in the book that they have with us for 3 years and the new business that stays with us is at a higher margin. So Overall, really positive and reflecting our guidance is an update on how that transition will look.

Speaker 9

Thanks for the answers.

Operator

Our next question comes from Maria Ripps with Canaccord. Please proceed with your question.

Speaker 10

Great. Thanks so much for taking my questions. I wanted to go back to the reasons you sort of outlined in your shareholder letter in terms of why your loss ratio has been impacted in the near term, including Higher than expected frequency, the ongoing mix shift in the business and sort of more claims being processed through your software. So while changes in Frequency coming out of COVID kind of seemed to be one time in nature. Could you maybe talk about whether you're making any adjustments in terms of pricing strategy and framework sort of to enable you to manage these factors going forward.

Speaker 6

Yes, sure. Hi, Maria. So just So taking that piece by piece to provide more context. In terms of frequency, you're right. Kind of COVID was the one time impact on our business we hadn't seen before.

Speaker 6

Really, pets don't get sick anymore Or less during a period of time. What we noticed with our frequency is that the impact of software really influences the arrival patterns of invoices. But in terms of where we are right now and kind of the mix shift, when we take price, we take price in a period and it takes 12 months for that to roll through. And at the moment, as I walked through in the earlier remarks, by the end of Q1, we're at 14.4% that was rolling through in terms of ARPU. We will be at the end of this year at 23%.

Speaker 6

So that staggered through the year, which is an average of 18%. So when that what happens with the mix of business that we see, if you have an average increase of 18%, there are a couple We see if you have an average increase of 18, there are a couple of things that happen with that. The first being you have So typically what that is, someone will get their increase and they will call us and they will contact us and they'll ask, can I hold what I'm paying on a monthly basis, Which means I may adjust my deductible? So the team will work through that with them. We lose about 2% of that 18%.

Speaker 6

And then beyond that, you have a mix shift, which is about 10%. So that mix shift relates to products for specific distribution strategies, geographies. If you think about international business, that's also going to start to play into that as well. So as we manage that moving forward, what we're doing is we're making sure that we are pricing appropriately by geography, by category to ensure we can hit that 71. And what that means is you're going to see a more frequent number of filings with the regulators to ensure we can stay on top of that and monitor that curve, that pricing increase that we see coming through.

Speaker 6

We have an operating assumption right now that we will see a 15% of that inflation year over year for the coming years. And with that operating assumption, we are required to make sure we are on top of that data, reviewing that data. We're looking at it in different ways and we've looked at it previously, which will allow us to get ahead of those changes and make sure that we are having constant adjustments to stay at the 71% level in terms of our loss ratio. Did that answer some of your questions there? Is there anything I can touch on more?

Speaker 10

That's very helpful. Thank you very much. And then secondly, sort of given your lower OI guidance, where do you expect your sort of margin by the end of this year? And any thoughts on when you think you may return to 15% margin for your core subscription business?

Speaker 7

If so our working assumption is 15% net inflation year over year in 'twenty three, 'twenty four and 'twenty five. If the rate of inflation is flat at that level, it takes us 12 to 18 months to reprice. So with that assumption, we're looking 12 to 18 months to get back to our original to our target.

Speaker 10

Got it. That's very helpful. Thank you both.

Operator

Our next question comes from Josh Shanker with Bank of America. Please proceed with your question.

Speaker 9

Yes. Thank you. If we go back in time about a year ago to June at the Investor Day, That definitely you first acknowledge that you saw inflation above expectations in the numbers. It would have come a bit in the 2Q numbers. And certainly around the country, there was a lot of inflation.

Speaker 9

It would have been really present in the back half of the year. The rate actions you were taking really didn't have any impact in the back half They're really starting to come through now. Why are we seeing the spike in the loss ratio now? In retrospect, it looks like things were really well managed in the back half of the year, given there was a lot of inflation and not a lot of rate. Now you're getting the rate through and the loss ratio is going up.

Speaker 9

Why is it happening in 1Q and then we didn't see it in the back half of 'twenty two?

Speaker 6

Right. Yes. So when we think so the back half of 'twenty two, what happened in 'twenty Just to take a little bit of a step back, because you're right, when we first acknowledged there was some inflationary pressures in the business and started to recognize that in the data, that was the midpoint of 2022. The inflation really kicked off at the back end of Q1. So what we saw in 'twenty two was a series of inflationary periods that we had never seen before.

Speaker 6

So typically on average, you'll see a 6% We saw inflation come through in March. We saw it 3 months later and again and again. So there's 4 stages of high inflation Started to put pressure through the book. And you're right, we reacted quickly. The team increased the number of filings we were putting through.

Speaker 6

We got the rate approval. And to the point, We get 1 month at a time, so it takes a good period to really start to impact. We started to see that rate at a volume in Q1, so coming into this year. In Q1 also, as we were pricing our strategy in 2022, we were anticipating a 12% increase in debt inflation. Now that went up another 300 basis points to 15, and we were still playing catch up from 2022.

Speaker 6

So our rates as we file it, you need to look forward Between 12 to 18 months before that impacts book of business, so you've got the compounding impact to 20222023. So what you see now is the catch up, which we're doing. We're now looking at our rates for 2024 today because we know it's going to take us time to catch up on that. And the biggest shift in Q1 was acknowledging the fact that we saw we were seeing it from a 12% assumed inventory inflation to 15%. And then we the reserves adjusted because we saw the higher rate.

Speaker 6

We saw the actuarial team could see the inflation coming through. And our software and arrival pattern of that claim meant that we our reserve rate reflected that, which is where that loss ratio really came in because we're expecting 12 I think now looking forward, confident that the changes we've seen in both the rates we're taking, the rates that are taking action, How they're affecting our book and the ongoing increases we see that we April is looking strong. We're not seeing anything that is surprising to us in right now with the data analysis we're doing. And we fully expect to maintain that same rhythm with the filings, making sure we're staying on top of those so we can bring it back to margin expansion through the back end of this year and into 2024.

Speaker 9

Earlier, you said that your working assumption, which may prove to be better than Turns out is that inflation of this fall, 15% inflation will continue in 'twenty three, 'twenty four, 'twenty five and you'll price for it. At that level of inflation, the lifetime value of the pets is lower than it was going into this period of time. Yes, you continue to grow at a very, very strong rate. Is there in your assumption of the lifetime value that it improves At some time, you're willing to acquire pets at lower than the 30% IRR because you'll eventually get the pricing right. And I guess, Is 5.41 or 5.47, is that the working assumption you're working with?

Speaker 9

When you decide, yes, let's go ahead and acquire the new patents?

Speaker 7

Yes, it's a great point. The way that we've tried to be transparent about our lifetime value is taking a look At the previous 12 months rolling adjusted operating income, which is based on the margin and multiplying it by the ARPU and the number of months to create the lifetime value. The Margins that we are receiving today, that we expect that we'll see in the next 6 months in the back, the previous 6 months Are much lower than we would anticipate over the entire life of a pet. So we are staying within You know, staying very focused on getting strong internal rates of return, but we've always had very historically our margins have been very consistent Fed inflation has been and that methodology has been very prudent in the past. It is important that we say in the future, what do we think is the best Estimate for a lifetime value of a path and our previous calculation would underestimate it or methodology to estimate it would.

Speaker 9

All right. Thank you for the answers.

Operator

Our next question comes from Katie Behcke with Autonomous Research. Please proceed with your question.

Speaker 11

Hi, thank you. Good afternoon. My first question has to do with ARPU. You talked about having about 15 points of rate flowing through in the first quarter, but average revenue per pet really hasn't moved all that much. So I'm wondering why that is and if there's something that's offsetting that metric?

Speaker 6

Yes, sure. Hi, Katie. So I'll kick this off and hand over to Drew to add further context as well. But just at the highest level, so if we look at this year, and you're We've got by the end of this year, for example, we'll have 23% close to 23% flowing through the book. So that would hit at the end of December.

Speaker 6

You've got full year for 2023, that means an average increase of 18%. 2% would be offset by people that are Changing their deductible to take it a little bit higher to get the monthly cost side to the same or a little bit lower, so it takes it to 16%. Then you have that 10% mix. The mix is a bigger chunk, So takes that age 16 down to 6. And what's included in mix is, not many new geographies, so penetrating new geographies that we have not been in before.

Speaker 6

We're also seeing new distribution products. So the products that we've been working on as part of our 60 month plan are coming into the market. They themselves have a very different ARPU profile. So when you put them all together, you see that downward ARPU Ultimately, that's where the ARPU ends up. So the 2018 transfers is up to 6 by the end of the year.

Speaker 6

So we think about how that It kind of manifests itself. That's why we're trying to work hard to ensure we get our prices through on a consistent basis, on a rolling basis. But there is absolutely a difference between the filed and the realized. Drew, do you want to talk a little bit about more at the end of the year?

Speaker 8

Sure. I mean, adjusting to that rate flow view for that Positive mix just pointed into the financial view, which we've talked about in the past, translating this to what you'll see for the full year, consistent with what we An average of about 3.5% for the full year, constant currency. And obviously, that Build through the year, so starting from where we are today, you can kind of figure out what that would be for Q4, but it builds throughout the year.

Speaker 11

Right. Okay. Thank you. And then my second question is regarding your operating margin outlook. What's driving management's view that that starts to improve in the second half of the year?

Speaker 11

It kind of seems to imply that there's going to be a sub-seventy 3 percent invoice expense ratio, but I was wondering if there's any other color you can provide there.

Speaker 7

The main thing for us, Katie, is that We entered the year assuming a 12% year over year increase in our cost of goods.

Speaker 9

If you go back to Q2

Speaker 7

of 2022, on our earnings call, I said we expect And then hope that the veterinarians would increase their rates 10% to 15% for the next 3 to 4 years. In 2022, we saw a 12% increase And we thought that that was the prudent and appropriate assumption going into 15. What gives us greater confidence today than we even had 45 days ago As we analyze our data, we are seeing a consistency in our data with our new analysis As well as looking at additional third party sources like the AVMA. So, if the assumption hold true that it's 15%, We know the rate that's flowing through our book, we'll start to get margin expansion.

Operator

Our next question comes from Jon Block with Stifel. Please proceed with your question.

Speaker 12

Thanks, guys. Good afternoon. Daryl, the first one is just sort of strategic, Pete. The 60 month plan has A lot of interesting initiatives. You've got internationally, you've got new plans and food and other channels.

Speaker 12

But the core business has a lot going on, Right. I mean, there's inflation. You're trying to move off Pets Best. You've got a lot of management turnover. And it just seems from the outside that It's really a business that's in flux.

Speaker 12

So is this the right time to pursue all these initiatives? Or Do you take a step back, arguably get the house in order and then pursue everything else in 12, 18, 24 months' time?

Speaker 7

John, I think the to put in context, this rapid change in inflation, I've been in the business for 23 years. If you go back to 40 or 50 years, veterinarian inflation has never had Such a rapid change. So that is a single challenge that is primarily focused on a pricing team, But we are now also making sure that the information we're getting from additional data sources include the field help us along with that. That's a core consistent challenge that we have been dealing with for 20 years, how to price more accurately by breed, by neighborhood, The core competency, what's changed right now is just the rate of inflation. And as we've said, if that remains consistent at 15% for the next 3 years, which would be great for the veterinary industry.

Speaker 7

That will be much easier for us to price you. It's just a rapid change. It takes us 12 to 18 months, 18 months in the United States to get pricing right through the book. If you look at our cost of goods, the change of In the last 18 months, it's gone from 6% consistent to 15%. So I think anybody can understand that With our business model that that's going to be a challenge.

Speaker 6

And if I can add to that as well, I think kind of as we think about the 60 month plan in general, our 60 month It's designed to set us up for the long term. This is a business for the long term. We have a hugely underpenetrated market, both here in the United States, in Canada and across globally. We believe that we can take our products globally where no other brands or no other product has been able to take it to help more pets to support more veterinarians. And For us, seeing it today, we have decentralized our business to allow us to do these things without interruption to the core business.

Speaker 6

So To Daryl's point, while we're seeing this as a once in a 20 year move, we remain incredibly confident about the plan for the long term to be able to add this address Market, a double the addressable market that we have globally and be able to have a lot of leverage across the international space. And just kind of on that to touch on that a little bit, we weren't able to talk a lot about it earlier in the opening remarks, but we're making really good progress internationally. We've added around 4,000 new pets, so incredibly good growth in those markets. And in Q1, we were able to add Belgium. This in itself, again, is kind of really taking those baby steps that for us to build for the longer term.

Speaker 12

Okay. Thank you. That was great color. And maybe the next question I might try to slip into. So the first Maybe I'll ask Drew a question on his last call.

Speaker 12

But the balance sheet, I think I heard $40,000,000 to draw with the debt. The free cash flow, I believe, was negative $12,000,000 alone this quarter. So is there an estimate for cash burn for the rest of this year? And how should we think about the balance sheet? Is there a potential raise as we exit 'twenty three into 'twenty four?

Speaker 12

And the Part B of This disjointed question is, last quarter, I asked a question on California and regs there. And you mentioned working with Pets Best. But I guess I'm confused because as of recently Pets Best has not been able to underwrite in California until they get a new underwriter. So it just looks Seems unusual to me that there was a cohesive handoff if they can't underwrite in the biggest state. So were there actually Stipulations from a regulatory standpoint that you had to stop underwriting that as of the end of March of 'twenty three?

Speaker 12

Thanks for your time guys.

Speaker 8

Sure. The draw in the quarter was $35,000,000 That was our long agreed draw plan with our lenders because the Soleil Draw Facility is only open for a certain amount of time. As I said in the remarks, we've got $253,000,000 in cash and investments on the balance sheet. That's up from 230 At your end, we have been pretty clear about the strategic nature of this Pets Best agreement and how much capital that frees up. In fact, in Darryl's 22 shareholder letter, he starts to put some quantum behind that.

Speaker 8

They also wrote it out in 2021. So embedded in our outlook is Operating within our current funding, which we have a strong history of doing for most of our lifespan. On California, we talked about this in the November call that we there is this Prop 103 stipulation that goes applies to every insurance company, not just True Banyan. And, it was holding up our pricing increases that we needed. And We agreed with them and Pets Best that Pets Best would find a new underwriter, in California.

Speaker 8

This is all we've been talking to Pets Best about this Well before this, so this has actually worked out nicely. I can't speak to operationally why that they weren't able to

Operator

We have reached the end of our question and answer session. This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.

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Earnings Conference Call
WaveDancer Q1 2023
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