Trupanion Inc (TRUP) 2022 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Trupanion, Inc. Third Quarter 2022 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the #1 followed by the #4 on your telephone. If at any time during the conference, you need to reach an operator, please press star and #0. As a reminder, this conference is being recorded. I would now like to turn the conference over to Laura Bainbridge, Investor Relations. Please go ahead.

Good afternoon, and welcome to Trupanion's Third Quarter 2022 Financial Results Conference Call. Participating on today's call are Margie Tooth, President; Andrew 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 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 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 in 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'm 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. We Margie, 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 underpenetrated 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. 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 5 years, we've grown our adjusted operating income over 300% and deployed this capital consistently within our targeted internal rate of return of 30% to 40%. With that, I'll turn it over to Margie.

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're 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 an all-time high. Our pet acquisition spend continues to reflect all efforts to generate leads, convert passengers 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 internal rate of return to 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 to self-insure is getting more expensive. It is an increasingly poor solution. As more enrolled pets enter the community, this higher percentage of insured clients can give veterinarians and 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 so 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 mix changes, cost of invoices was up approximately 10% over the prior year period, outpacing our average rate increase of 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 the full benefit showing up in late 2023, and 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 passes that we price for the life of the pet. -- never punish on lucky 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 6-month plan, and I'm very proud of the progress the 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 2 strategic acquisitions to officially mark our entrance into Continental Europe to take our new geographies to the customer revenue generation. There are over 40,000 veterinary hospitals spanning Continental Europe, and our acquisition of SmartPaws and our pending acquisition of Pet expert gives us immediate access to over 12,000 of these increasing our addressable market. Petexpert provides high-value pet insurance to approximately 25,000 pressures in the Czech Republic and Slovakia and works closely with veterinarians to provide high-quality partner support to hospitals. This same synergy is also evident in SmartPaws, our recently completed acquisition, while smaller in scale and pet expert, SmartPaws 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 team to provide a platform for us to bring Trupanion and a world-leading member experience to these new and underpenetrated 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're well poised to build on it. With that, I'll hand over to Drew to walk through our financial results in more detail. Drew?

Thanks, Margie, 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 have 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% equating 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 mix of business. For context, we continue to see accelerated growth in new pet enrollments in lower income areas that combined with business and product mix, max 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 Margie 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 have 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 Margie 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 -$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 -$6.4 million. I'll now briefly discuss how we're tracking for the remainder of the year. We continue to expect consistent growth in 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. If you would like to register question, please press the #1 followed by the #4 on your telephone. You will hear a three tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw, please press #1 and #3. And our first question will be from the line of 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 '23 and then expansion going forward?

Hi Shweta, this is Tricia. I'll kick it off with the first question, and then I think Margie will touch on the second question. When it comes to ARPU growth, -- as I'm sure you noticed in the script. So 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 plans to be filed -- we 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 (inaudible) 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 and it will 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 mix impact and assuming constant currency, which is really important because there's significant FX headwinds that we're going into the year with -- we're looking at an average for the full year 2023 at 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 and 2020 and half of 2021. So... I'd start at 5% for 23.

Drew, thanks, Tricia, 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 out 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. We'll be exiting at a higher rate than that.

Okay thanks tricia.

I'll pick up the second one. It's Margie. Just in terms of the acquisition that you mentioned. So today, we announced the acquisition of Pet expert. So this will close, as you said in Q4. In terms of synergies, Petexpert really is a key part of our 6-month plan. It's going to increase our addressable market in general. They're very vet-centric very much like Japan and their foundation is in -- through partnerships with the venerary community, making sure they can solve the issues of being out of pocket and reimbursement. So they have the ability to kind of continue what we've been doing in North America for a 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 that and being able to work with people who are like-minded with products that will be very similar to Japan and really kind of help us build that market in time. It is very underpenetrated in continental Europe. So that's in going to help us get us fit in the doll very quickly in 2023.

Okay, thank you Margie

Okay, our next question is from Corey Grady with Jefferies. Please go ahead.

Thank you for taking my question, So I want to ask first about retention. So you break out retention to 3 buckets and shareholder letters. But can you talk about maybe other factors that impact retention? And if there are -- or any other factors besides price behind the step back this quarter.

So yes, I'll kind of take it at a high level. So in terms of our attention, it's strong, it's near an all-time high. I think we have a good pathway towards our 6-month plan, which is on 10% achievement. You're right, we do break it out into 3 buckets. And typically, the impact of that aside from pet passing away, we also have the financial implications very occasionally. But typically, it comes down to understanding the buying proposition. We don't lose many pets. So when we look at our overall retention rate, we're not talking about a high volume here. So the issues are always very, 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, 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 -- so on the top for several quarters, it's been very strong. We've seen continuous improvement through that. And 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, were 17,000 new adds in the quarter, we do often see how do we make sure we're focusing on that fast growth and offsetting our 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 have 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's 10,000 incremental pets have an impact on retention. So but yes, retention overall is strong.

Got it. And then I also wanted to ask about the pet acquisition cost. So you demonstrated some flexibility on pack this quarter and you still put up very strong gross adds. Can you talk about where the flexibility on acquisition spend is coming from? And then how should we think about gross adds 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 pack efficiency, as we went through over the quarter, I'm very impressed and prior of the team for the way they were able to select their muscles and pull on the levers that we've built over the years. So going through the quarter, they really -- they understood that our margin was down, so we adjusted our tax then to see that. And in doing so, created -- we added 10000 more pets for the same amount of money from Q2. So really efficient spent. In terms of the flexibility, we're always looking at making sure that we're refining what we can do, and I think they've proven time and again that quarter-over-quarter, we can live within those (inaudible) that we set ourselves, which is a high (inaudible) and it's good execution of those results in Q3. Drew, would you add?

Well, just on the question about forward pack, I would emphasize that it's an output of our lifetime value. And so we flex in order to resolve 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. There's all the marketing and sales and marketing people, IT people are in that. So it's not as we typically think of a marginal advertising pack, which is important.

I will just add one of the things when we think about our part moving forward through the rest of the year. So in the quarter, we do have our Territory Partner conference coming up. So to Drew's point, when we think about all the people that we include within our fat cost, 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 3 years for obvious reasons. So bringing our TP together for the first time in 3 years as a sales group will be a really important long-term move for us. It's not going to have immediate gain in November, December. But we do see is there a benefit for the subsequent 12 months after the conference. And while we're excited to have them in Seattle, it does hit our pack in one quarter. So Drew's point, that's kind of all gets fully loaded in there.

Very helpful, thank you.

Our next question is from the line of John Barnidge with Piper Sandler. Please go ahead

My question is on the acquisitions in Europe. Can you maybe talk about how SmartPaws and Pet expert will look different versus what is already in the market? And then how do you think it will look different than the U.S. and Canadian for Trupanion current offering?

Yes, sure. So SmartPaws and Pet expert, but just to touch on what I mentioned earlier, it really is -- they're both key acquisitions to help us in our 6-month plan. So we talk about increasing our addressable market and both of those will allow us to do that across Continental Europe. In terms of the offering, it's still early stages. As we mentioned, the pet expert 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 to 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, our global leaders. And in doing so, having that be centricity means there are certain parts of our product that are lined to replicate that they really do what they say. They solve the same problem they assay which country you're in. And so we'll maintain that as posed as the cost 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 kind of share specifics as to what that looks like, but you can expect them to be very similar.

Thank you for answering my follow-up. As I look at ARPU, how should we be thinking about the size on a per dollar amount FX headwinds? And then how should we be thinking about that for -- within that vein of the 5% growth?

Well, we're currently using it in convergence headwinds next year. Obviously, it all depends on things move, but that's currently the rate we're using and the assumption we're using.

And 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

Our next question is from the line of Joshua Shanker with Bank of America. Please go ahead

Yeah, thank you very much for taking my question. So I just want to understand the 11% and 7%, 11% is the rate that's in the pricing of enrolled pets at the -- as of September 30 and 7% is 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. We're not waiting for anything. The effective dates are set now a portion of -- so that's kind of the run rate that we should expect that 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 in to 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 -- 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. We'll be filing over the next 30 days. So 11 is fully (inaudible) 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 aggressive as we look to keep continuing to keep up and bridge that gap on inflation. Does that help?

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

How much price...

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

Okay. So 7% price, but ARPU is -- that's fine. And then my other question on the 56,000 bets, 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 costs of veterinary care. But all of them are, Well, 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. That will take a little bit of time over the next year or 2 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 in our P&L and (inaudible) comes into our own underwriter.

Okay thank you very much

And 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

Our next question is from Elliot Wilbur with Raymond James. Please go ahead

Thanks (inaudible) 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, we're essentially how this is going 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, those increases hit members on their annual anniversary date. So 1/12 roughly rolls through the book at any given time. So with the 11 and then 7 comes on board, it will start to build, and it really does build sequentially as we look through, and 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, the cost 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 will 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 7%. 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 pets 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. And 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, SmartPaws and Pet expert as well. It wasn't 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 pack 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 revenue, you just have the commission. SmartPaws, small pet expert is bigger, but for -- so they will -- the smartPaws is closed, pet expert will close this quarter. They were in our books starting this year, we'll only have 1 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 answer that, too. Just in terms of the synergies that we touched on earlier with these 2 companies, we've chosen to partner with them and bring them into our Trupanion family because of their ability to grow and the way they think about the business. They think lean, they think like cost operator, they have the same drivers and tenants that we value very much as a business. So in terms of how quickly we can get to those funeral guardrail, that's 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 can ask one additional follow-up question for yourself, Margie. Can you just maybe provide a little bit more granularity in terms of what drove the strength in new pet adds in the period? I guess with the contraction in bed 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? And is it just a function of better leads, better conversion, 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, on many of the reasons why actually. So when we think about the overall growth pet adds through the quarter, it was led by the veterinary channel kind of predominantly really happy to see that continuing to get stronger at record levels, record levels of leads. So to answer that question regarding lease and conversion, both were up. We've talked a lot about conversion, how we're focusing there. The team executed really strongly with some tactics been planning for several months, and we're starting to see them come through. Have that coupled with lead volume, you see both of those things are going to start to drive some strong return in the back channel. -- our other channels continue to perform strongly. So one of the things we made very clear in our distribution strategy for our 6-month plan is that we have multiple channels. We have multiple opportunities to continue to grow in an underpenetrated market and happy to see them continue to go up. So we're growing faster in areas where the vet cost -- we see there is a need for our product. We solve the problem of budgeting for the unexpected. And that helps us. Yes, that visits are down, but that doesn't be -- that's not reflected in our numbers because at the end of the day, that's seeing the value in our product, having good conversations. Our territory partners have been back now in the field consistently for 6 months and more through this quarter. And that continued conversation, coupled with the fact that we've had record rates of software installations. So the kind of 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 is really to remember that we are priced to support the needs of the vet and the needs the pet owner. And we're seeing that, that value proposition, the relationship and that core channel for asset that channel is performing very well. So it's a positive -- really positive story for us quarter of (inaudible).

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 and particularly when their 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 of years ago, a lot of times when some people think that it's easier for us to grow at the opposite. What our message is compelling to veterinarians to help people budget for their pet. And we're seeing that across the board with that lead. 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 2/3 of that came from the veterinary channel, and they were mainly driven in areas of lower income. So this product is not designed for rich people. Rich people can self-insure for the people that have tighter budgets. They need a solution and our solution resonates and veterinarians can drive that message, and that comes across in our lower pack dollar spend and the efficiencies we're having. And there'll be puts and takes if we move into recession over the year. The inflation of ARPU going up will help us on growing our revenue and make that a little bit easier. Messaging will be stronger to vet hospitals, but we'll have some other areas that will 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.

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 '23, is that on top of the 7% we're observing now? So should we think about the cumulative of '22 and '23 as 25? Or is '18 kind of the number to think of over the 2-year period?

Yeah. No, we're looking at '18 and at least currently as what when you add it together, roll through. So we really the 7% and increased it to 11 as some of the 7 rolls off as it related to things that had already been in place. We've upped the 7 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 GPs that are in the field, the data that we already have relationships with many of the groups as well as veterinary CPIs. If we see things change and we need more, we are absolutely poised to do that as well and 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 the first half of the year and 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 so small, more normal-ish call it, 2% year-over-year changes in severity, but nothing overly dramatic. We started to see movement in 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 of mix changes, it still has some frequency. It's about half frequency have severity that we're seeing. And when we see both of those moving many times, historically, we've seen severity to go up, but frequency doesn't tend to go up as much. So when we're 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 as we've seen overall inflation move in general.

Got it. And yes, so I guess my follow-up then would just be if the plan is kind of for 18% rate over these 2 years and we're running at 10% loss trend, and that's accelerating, why wouldn't the plan be to take a little bit more rate? And then the one other one was, I guess, just on like deductibles, what impact does inflation have in terms that could that potentially be a reason why you're picking up more frequency, just more attached to it? Thanks

And there's 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 more easy to submit those, and that's a good thing. That's more of a small onetime 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.

Our next question is from Maria Ripps with Canaccord. Please go ahead

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

Yes. Maria, it's Margie.. So just at a high level, I would say our retention rate is held really strong. So we're not seeing any signs of elevated retention across those buckets. So one, in the event that when you look at it at the granular level and our 3 buckets, the first year of retention, the those with under 20% rate increase in those is an over 20% rate increase is where you tend to see some of the differences. The first year bucket has been one that has slightly changed, and that's because of our rate of increase of pet growth. So as we talk about that relationship between you as more pets, you're going to obviously see more people in that first year. But in general, we haven't seen anything that causes any concern. And I think as we think future say, 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 able to be ready to support anything that we're seeing. If we see increased pools. 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 pet and helping them to really kind of get their arms around that. But far so good.

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

So when we think about the 70,000 pets, so 70,000 is around 10,000 more than we have been right on our run rate. So when we think about that and kind of how it's broken up a better than came from new initiatives, so not significant volume. It's nice to have that additive. But the bulk of that growth came through the vet channel. So it came through that core channel came through the fact that we've got our territory partners now in the field, really reinforcing the moat that we have there and the strength of connection with vet at a time when they really need to make sure their clients can afford this care. And that's really kind of where that that halos came from our overall pet growth. So while they're contributing, they're not the kind of the driver of that growth there for sure.

Got it that's very helpful, thank you so much

Our next question is from Jon Block with Stifel. Please go ahead

Tom on for John. Thanks for the questions. If I can start with retention. It was down a little bit quarter-over-quarter and kind of piggybacking off the last question, but with pricing growth accelerating substantially in the coming quarters, I mean, do you have confidence retention will either maintain at its current levels? Or do you think it will climb back to kind of the 98%, 7, 4%-ish range. I just love your thoughts on how we should think about price going up so much and kind of the impact on churn?

Sure. Well, to start with, I hope anybody on the call recognizes any time that you're talking about 98-point-something, we've got high retention. And the fact that we're talking about 98.7% and is very high. So we believe that our retention rate compared to the category is significantly higher. If the retention rate goes back to, let's say, 98.6%, which would still be leading the category, that would have a little bit of downside on our total net debt growth, but the offset on having 18% rate increases on what that will do to drive our revenue growth is well offset -- so we've been through this type of cycle before in small regional areas or anywhere else. And it's most important that we price accurately, and we'll take the revenue growth benefits from the ARPU and we might get a small subtraction on retention, but net over, it will help our revenue growth. And it will also, more importantly, help our adjusted operating income and our lifetime value. So we'll be pleased.

Okay. So moving forward, maybe model sequential very small downticks in the retention? Is that fair?

Yes. I mean it depends on if market continues to -- and the team continue to have accelerated growth. Remember, our lowest retention in that first year retention. So if we keep having accelerated growth, that brings down our blended retention more than anything else. If we're putting in more -- if there's more people in the 20%-plus bucket, that will have a smaller impact. But like I say, it will be more than offset by increased revenue growth.

Got it. That's helpful. And then my second question is just on gross adds, really strong in the quarter. Maybe first quickly, did the SmartPaws acquisition contribute to that number at all?

No, I didn't.

Got it. Okay. And so the strength -- it sounded like it came from the vet channel. Margie, you just mentioned this a bit, but can you provide some more color just around leads and conversion sort of outside the vet channel with those new initiatives? I guess, is that 1/3 contribution that you talked about in the 10,000 incremental pets, is that typical relative to history? And then I guess my last one, what is kind of your level of confidence in these gross add levels persistent moving forward? Can we expect to grow sequentially off these 70,000 levels? Thank you

Yes, sure. So I'm going to try and make sure I hit that from the top side, please forgive me if I forget some of those things. So initially, from a -- in terms of the strength, yes, it did come through a majority of growth on the vet channel. But I will say all of our channels for us in terms of lead and conversion, which is great and really plays into a broadened distribution strategy. So always helpful to have growth across the mix of channels we have there. In terms of the 1/3 contribution, it's not typical. We really took a step up in Q3 through that back channel, and that was, like I said, primarily driven through the vet. So the combination of all the things happening in the world of that's kind of being back to full strength that's still under master pressure, but there are for strength, our territory partners being back out there really reiterating seeing the depth of our software penetration really starting to expand. There are always things that combine that are helping to make the conversation about the need to budget for the unexpected care is really helpful. When we think about the growth, we expect year-over-year and quarter-over-quarter to have sustained revenue growth. And I feel confident moving into the quarter based on the way the team has performed and continues to perform. And the announces they're doing that we feel confident in being able to maintain a sustained revenue growth with the combination of the ARPU and the pet growth mix there.

Thanks Margie.

Thank you

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

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

Yeah, Hi Greg, It's Tricia. We're 1 month into Q4, I would say, with October behind us. In general, we're seeing -- cover is 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 rate to what we've seen in Q3. We're not seeing dramatic step up. We're not seeing dramatic step downs. It's kind of continuing in terms of what I mentioned, the frequency and severity on a similar pace, which we use to help guide us when we project it out into next year, those numbers that I mentioned that we would need and really been prompted us with the plans that we put in place as well in October into account.

Okay. Got it. And if I could follow up on pet expert. What -- maybe what rough percentage share of the market do they have? What is kind of the total penetration rate in the Czech Republic and 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 this -- we will be close to 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 U.K. and Sweden. So a lot of opportunity for growth. Obviously, in countries where the cost of veterinary care is lower, then 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 4 to 5 years to come and 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.