TRUPANION, INC. 2023 Shareholder Letter
Table of Contents | |
To Our Shareholders | 3 |
2023 in Review | 5 |
Trupanion Subscription Business | 9 |
Why We Love Organic Growth | 14 |
Darryl's Case Study: UnitedHealth | 19 |
New Free Cash Flow Target | 21 |
Our Other Business | 22 |
Intrinsic Value per Share | 23 |
Margi's Conclusion | 27 |
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To Our Shareholders
"I basically believe in the soldier on system. Lots of hardship will come and you gotta handle it well by soldiering through."
- Charlie Munger, in his last CNBC interview
Why I Founded Trupanion
Darryl Rawlings
Chief Executive Officer & Chair of the Board
Twenty-six years into this journey, I feel it is appropriate to remind our shareholders of the why behind Trupanion. It is the story of my childhood dog, Mitzy. Many of you have heard this story, but I revisit this story today, because while we are nearly 40 years out from losing Mitzy, and 26 years into building Trupanion, the problem that faced my parents is still one that faces millions of pet-loving families around the world.
The story of Mitzy begins when I was a teenager growing up in Vancouver, Canada. We were your typical middle-class family, and my parents, looking to give my brother and I all the opportunities they could afford, lived paycheck to paycheck.
One weekend, when Mitzy was only 2 years of age, it was clear she was ill and not obvious to us what the issue was. With our local veterinarian closed for the weekend, we headed to a 24/7 emergency clinic on West 4th in downtown Vancouver.
The diagnosis was quick. The veterinarian informed us that Mitzy had a twisted stomach, which fortunately was operable, and the operation would save her life. With the surgery, we would have another decade or so of time with Mitzy. But, then came the discussion of cost. And, because my parents, like so many families, lived month to month with no available credit, they could not afford the surgery.
In the end, we left the veterinarian that day without Mitzy, and in the process, everyone was devastated. The veterinarians and their staff were available to help, had the knowledge and the tools to do so, but also had a business to run. They simply could not operate without being paid. My parents were not only devastated that they could not save our beloved dog but also embarrassed for their son to discover the impact of his parents not having a way to budget for the care that Mitzy needed. I too was devastated, frustrated, and angry. There had to be a better way. This horrible outcome is what set the wheels in motion for me to start Trupanion.
Fourteen years after losing Mitzy, at the age of 28, I sold a cigar business that I had started a few years earlier. I used those proceeds to build a company that could solve the problem and make it easier for families like mine to budget and care for their pets, while empowering veterinarians and their staffs to deliver high quality care effectively. Two years later, I enrolled Trupanion's first pet, my dog, Monty.
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Our goal was--and still is--to eliminate the need for "financial" euthanasia, and our mission is to help loving, responsible pet parents budget and care for their pets.
To be successful, we have to help more than a few Mitzies--we need to help millions! We measure our impact in the billions of dollars we have spent paying veterinary invoices on behalf of our members. It took 20 years for Trupanion to pay out our first billion dollars in member invoices. Three years later, we crossed the $2 billion threshold. Later this year, we expect to cross $3 billion, and if we continue to grow intrinsic value per share at 20% to 25% year after year, within a decade, we will be paying out $5 billion per year in veterinary invoices. This is how we define success. By all the Mitzies and responsible, loving pet parents that we get to help. To make this happen, everyone in the ecosystem needs to win. Everyone! This includes pets, pet parents, veterinarians and their staff, our territory partners, team members, industry partners, regulators, and, of course, our shareholders.
Normally, this is where I would pivot my attention to the results of the business over the past year. But, those of you who are close to the story know that it is Margi who has been leading the execution of the company and of the 60-month plan. For this reason, Margi has been involved in the drafting of this year's letter, and I expect that she will play a bigger role in writing these letters moving forward. I will let her introduce herself.
Margi's Introduction
Margi Tooth
President
I've had the privilege of working closely with Darryl on a number of letters in the past, not least a heavy involvement in the writing of the 60-month plan letter in 2021. This year, however, our approach has been different, giving me time to reflect fully on the progress over the last year, as well as step back and assess the many learnings collected over the last 12 months. I look forward to a more involved role with this unique shareholder letter for many years to come. Before we walk you through our 2023 results, I'd like to share a brief overview of why I am so pleased to be here.
Trupanion is a unique company, and the opportunity in front of us is immense. We are in a large, under-penetrated (and now global) market. We have a dedicated and talented team that genuinely cares about our mission and is focused on the long term. Our value proposition to our members is the best in the industry, and our partnership with veterinarians is deep-rooted, aligned, and unique in helping pet parents when it matters most by improving access to care. We now have multiple products across various geographies and price points, and to support this diverse portfolio, we are developing an organizational and technological infrastructure to be able to service our growing pool of members. Finally, we are now building a stronger financial model by self-funding our capital requirements and strengthening our balance sheet. The future in front of us is brighter than ever.
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2023 in Review
2023 was an interesting year for many reasons. For the first time in company history, we generated over a billion dollars in annual revenue. Total revenue grew 22% to $1.1 billion. Our core Subscription Business contributed $713 million in revenue, and our lower margin "Other Business" contributed $396 million.
On the surface, crossing a billion dollars with a 22% revenue growth rate could be deemed by some as a good year, but these results mask some more distinct challenges.
We have long considered our Adjusted Operating Income (AOI) as the most important metric in our business. This is our own self-defined,non-GAAP term, and it is a critical financial metric that we use to manage the business. It represents the discretionary profit (pre-tax) that we earn from our existing pets before we spend money to acquire new pets or invest in new growth initiatives.
Key Consolidated Financial Metrics
Enrolled | Adjusted | Invested | Net | Net | Fully | Revenue | YoY | Adjusted | YoY | Statutory | Required | ||
Year | Revenue | operating | capital to | income | diluted | operating | capital & | statutory | |||||
pets | acquire | cash* | share | per share | growth | income per | growth | capital & | |||||
income | new pets | (loss) | count** | share | surplus | surplus *** | |||||||
2014 | 232,450 | 115.9 | 0.9 | 11.1 | 61.5 | (21.2) | 33.8 | $3.43 | 2% | $0.03 | -82% | 23.7 | 23.7 |
2015 | 291,818 | 147.0 | 3.6 | 14.8 | 45.6 | (17.2) | 34.1 | $4.30 | 26% | $0.11 | 267% | 28.1 | 27.8 |
2016 | 343,649 | 188.2 | 14.8 | 14.7 | 51.6 | (6.9) | 34.9 | $5.40 | 25% | $0.42 | 282% | 32.9 | 29.5 |
2017 | 423,194 | 242.7 | 23.4 | 18.4 | 57.8 | (1.5) | 35.4 | $6.85 | 27% | $0.66 | 57% | 40.4 | 26.5 |
2018 | 521,350 | 304.0 | 31.9 | 23.7 | 135.2 | (0.9) | 37.9 | $8.03 | 17% | $0.85 | 29% | 60.1 | 60.0 |
2019 | 646,728 | 383.9 | 44.2 | 33.3 | 140.2 | (1.8) | 38.0 | $10.12 | 26% | $1.16 | 36% | 78.3 | 62.6 |
2020 | 862,928 | 502.0 | 57.1 | 45.1 | 302.6 | (5.8) | 42.4 | $11.85 | 17% | $1.35 | 16% | 98.6 | 88.5 |
2021 | 1,176,778 | 699.0 | 78.5 | 69.5 | 294.3 | (35.5) | 42.8 | $16.32 | 38% | $1.83 | 36% | 131.7 | 129.3 |
2022 | 1,537,573 | 905.2 | 89.3 | 80.4 | 239.0 | (44.7) | 42.8 | $21.17 | 30% | $2.09 | 14% | 171.4 | 158.7 |
2023 | 1,714,473 | 1,108.6 | 83.5 | 70.4 | 242.0 | (44.7) | 43.5 | $25.47 | 20% | $1.92 | -8% | 241.3 | 177.2 |
Note: Revenue, Adjusted operating income, Invested capital to acquire new pets, Net cash, Net income, Statutory capital shown in $ millions
* Cash, investments, and our building assets minus debt ** Total share count plus options and warrants granted, which includes outstanding shares plus unexercised/unvested options and RSUs, as well as shares granted in subsequent years pertaining to the year's performance *** Estimate
From 2015 to 2021, we experienced strong double-digit growth in AOI and AOI per share every year. In 2022, adjusted operating income only grew 14%--a disappointing result that we covered in last year's letter. In 2023, our discretionary income went backwards! AOI per share decreased 8%. Entering the year, we had assumed veterinary inflation would jump to 12%, more than double the historical rate of 5-6% per year we have seen (nearly) every year for the past 20+ years. At the time, we believed 12% to be a reasonable, if not an overly conservative, assumption. In actuality, veterinary inflation came in even higher than we anticipated, at 15% year over year. Our conservatism was not sufficient, and we got it wrong.
Undoubtedly, the spike in inflation hurt us in the short term. We also wish we had caught it sooner and had been poised to react quicker. But, the why behind the 15% inflation is important to touch on. For some time, we have been saying that veterinarians need to raise their prices. We are part of the animal health eco-system, and the overwhelming stressors within the veterinary community are clear to us. We see the ongoing challenges of staffing, compassion fatigue, and the hangover of the pandemic directly affecting the once revered relationship between veterinarians and their clients. Veterinary teams across North America have been struggling, and we have been a very vocal advocate for this heroic profession, championing their plight. In fact, in our Q2 2022 conference call, we said it was our expectation that veterinarians would need to raise prices by a total of 30-50% over a 3-4 year period in order to build
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sustainable businesses and continue to treat and care for our pets. It seems that all the talk across the veterinary industry in 2022 finally led veterinarians to increase their prices. Comparing prices at the end of 2021 with those in December 2023, the total increase of almost 30% is well on the way to our ballpark estimate and on track to give the industry the economic relief it so desperately needs.
What is also reflected in this step up is a direct demand among pet parents to access veterinary care for their pets. This is our reason for being. We exist so pet parents and veterinarians can treat pets the way they deem necessary. We are not here to control cost of care, nor do we dictate the type of care provided. We simply ensure pets get the care they need, when they need it. With rising cost of care and more demand amongst pet parents for greater access to care, the need for Trupanion will only continue to grow.
Now, returning to adjusted operating income. Our goal in our 60-month plan (published in 2021) was to grow our intrinsic value per share at 25% a year from 2021 to 2025. Growth in adjusted operating income also can act as a simple proxy for our growth in intrinsic value per share. Last year, we said that growing intrinsic value per share at 20% year over year is a good result and that we are ecstatic when we grow 25%+.
In aggregate, the total AOI that we would have available to invest at a 20% AOI CAGR versus a
25% AOI CAGR is as follows:
(in $ millions) | 2020 AOI | 2021 AOI | 2022 AOI | 2023 AOI | 3yr total | 2024 AOI | 2025 AOI | 5yr total |
20% growth | 57.1 | 68.5 | 82.2 | 98.7 | 249.4 | 118.4 | 142.1 | 509.9 |
25% growth | 57.1 | 71.4 | 89.2 | 111.5 | 272.1 | 139.4 | 174.3 | 585.8 |
Actual & 2024 Guidance | 57.1 | 78.5 | 89.3 | 83.5 | 251.3 | 100-120 |
If veterinary inflation in 2023 had been at the 12% we had predicted and planned for, we would have earned another 3 percentage points on our subscription revenue of $713 million. On that basis, our AOI would have been approximately $105 million, firmly between the 20% and 25% 3-year CAGR growth rates. Instead, at 15% inflation, we earned just $84 million. The negative cash impact of our pricing miss and not reaching our subscription AOI margin target of 15% will likely be $72 million when it is all said and done ($10 million in 2022, $37 million in 2023, and an estimated $25 million in 2024 based on our guidance).
(in $ millions) | 2022 AOI | 2023 AOI | 2024 AOI |
Actual & 2024 Guidance | 89.3 | 83.5 | 100-120 |
Subscription @ 15% AOM + Other | 99.4 | 120.3 | 130-140 |
Deficit | (10.2) | (36.7) | (10)-(40) |
Even with the setback in 2023, in which our AOI declined year over year, we are still working to have our aggregate 5-year adjusted operating income total exceed $510 million. This is above our 20% benchmark but shy of our aspirational goal. If we take into account the guidance range for 2024, announced in our year-end earnings release, we would need $139-159 million of AOI in 2025 in order to reach the $510 million total. Doing so will require that we re-accelerate growth in adjusted operating income in the final 24 months of our 60-month plan. This will require us to continue the ongoing repair of our margins, which will in turn give us license to increase our spending on pet acquisition costs and re-accelerate our growth, while maintaining the realized efficiencies noted across our business during the last year.
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Subscription Adjusted Operating Margin
Now back to that "interesting year" comment. Our margin compression rippled through the company, hurting our year-over-year growth in AOI, year-over-year growth in total pet acquisition spending, and the lifetime value of a pet. With most of these key metrics, taking a step back, one would expect that this would be considered a disappointment--especially when compared to our performance in 2022. Yet, what is reflected in the chart above tells us a different story, one that we collectively should be proud of. Here's why…
We committed to our cost-plus model and went about the 12-18 month journey to restore our adjusted operating margin (AOM). We cut expenses, realizing that this temporary margin compression was going to cost us close to $72 million of cash between 2022, 2023, and 2024. We reduced our overall pet acquisition spend to lean into the lower margin per pet and focused on a return to free cash flow positive. Additionally, we began to monitor and report multiple P&Ls across our various products and across different geographies within our core Trupanion product. This de-centralized approach is critical when managing the unique lifetime values of our pets from different P&Ls, and it resulted in a 21% reduction of our average per pet acquisition cost in the year.
Turning away from margin, the year threw one final challenge in front of of us - this time in the form of our audit and the material weaknesses that arose from it. Efforts to remediate these material weaknesses are underway, and as a business, we have been taught the lesson that rapid growth must come with an equally rapid development of processes and controls. In some instances, this did not happen. Ultimately, these findings have stimulated a deeper level of discipline, rigor, and operational diligence across our technology and infrastructure processes that will undoubtedly make us stronger in the long run.
Despite it all, the team has shown great resilience and fortitude. The passion borne from a company obsessed with its mission and its members is a gift. Motivation to solve the problem of how to budget for the cost of unexpected veterinary care has resulted in important lessons and learnings as we reorganized, tested, and began to build stronger, more resilient foundations.
The team has and will continue to soldier on.
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Inflation Parallels within Auto Insurance
We have not been alone in our dealings with inflation. According to S&P, in 2020, the US automotive insurance sector recorded its lowest claims ratio (loss ratio + LAE ratio) in over 20 years as people stayed at home and drove less. The industry refunded customers due to this significant windfall. When life returned to normal and inflation came through, the cost of new cars and car repairs went up. In 2022, the sector reported its highest claims ratio in over two decades.
US Private Auto Insurance Industry - Total Claims Ratio
While 2022 was a difficult year, the sector is implementing rate increases at levels not seen in decades. Revenues across the sector are now hitting all-time highs. Progressive and Allstate share prices are currently trading at all-time highs as well. This suggests that investors believe that claims ratios will eventually recover and that high inflation is actually healthy for the industry. High inflation increases the need for insurance.
US Private Auto Insurance Industry - Annual Price Changes
When comparing our experience with veterinary inflation to the charts above, the trends look eerily similar. This provides us with further confidence that our margin pressures will be temporary if we take the right pricing actions.
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Trupanion Subscription Business
As we have said before, the vast majority of Trupanion's intrinsic value is derived from our core Subscription Business. Today this includes our core Trupanion product; our 'Powered By' suite of products for Aflac and Chewy; our medium and low average monthly revenue per unit (ARPU) products, Furkin and PHI Direct; and our products in Continental Europe. Of our $83.5 million of adjusted operating income in 2023, $70.2 million, or 84%, was generated from our Subscription Business. We ended the year with over 991,000 total enrolled subscription pets. During the year, we earned subscription revenue of approximately $712.9 million. Of this, we spent approximately $539.7 million paying veterinary invoices on behalf of our members, $69.2 million providing member support (for Trupanion and our 'Powered By' products, this support is 24/7/365), and $33.7 million on fixed expenses.
Trupanion - Subscription (in $ millions) | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
Total Enrolled Pets | 215,491 | 272,636 | 323,233 | 371,683 | 430,770 | 494,026 | 577,957 | 704,333 | 869,862 | 991,426 |
Revenue | $103.5 | $133.4 | $173.4 | $218.4 | $263.7 | $321.2 | $387.7 | $494.9 | $596.6 | $712.9 |
YoY Change | 35% | 29% | 30% | 26% | 21% | 22% | 21% | 28% | 21% | 19% |
Minus paying veterinary invoices | ($74.0) | ($95.2) | ($124.4) | ($155.2) | ($190.5) | ($231.7) | ($277.9) | ($351.9) | ($432.8) | ($539.7) |
Minus paying variable expenes | ($10.9) | ($14.0) | ($16.6) | ($21.1) | ($24.6) | ($29.4) | ($35.4) | ($48.5) | ($58.6) | ($69.2) |
Minus paying fixed expense | ($17.3) | ($19.9) | ($17.3) | ($18.2) | ($17.7) | ($18.2) | ($20.4) | ($23.4) | ($25.9) | ($33.7) |
Discretionary Profit (AOI) | $1.3 | $4.3 | $15.0 | $23.8 | $31.0 | $41.9 | $54.0 | $71.0 | $79.3 | $70.2 |
YoY Change | 231% | 249% | 59% | 30% | 35% | 29% | 31% | 12% | -12% | |
Discretionary Profit Margin (AOM) | 1.3% | 3.2% | 8.7% | 10.9% | 11.7% | 13.0% | 13.9% | 14.3% | 13.3% | 9.8% |
Capital deployed to acquire new pets (PAC) | $10.9 | $14.7 | $14.5 | $18.4 | $23.3 | $32.9 | $44.2 | $69.0 | $79.8 | $70.2 |
YoY Change | 34% | -1% | 25% | 27% | 41% | 34% | 56% | 16% | -12% | |
Estimated IRR of PAC | 33% | 43% | 46% | 40% | 41% | 36% | 30% | 22% | ||
Cash after new pet aquisition | ($9.6) | ($10.4) | $0.5 | $5.4 | $7.7 | $9.0 | $9.8 | $2.0 | ($0.5) | $0.0 |
Capital expenditures | ($5.6) | ($4.9) | ($1.9) | ($3.1) | ($4.4) | ($5.4) | ($7.5) | ($12.4) | ($17.1) | ($18.3) |
Cash generated / (Cash used) | ($15.2) | ($15.3) | ($1.4) | $2.3 | $3.3 | $3.6 | $2.3 | ($10.4) | ($17.6) | ($18.3) |
Below is our monthly per-pet economics, or cash flow prior to new pet acquisition, for our average subscription pet in 2023.
2021 | 2022 | 2023 | ||||
Average monthly cost (ARPU) * | $63.56 | 100.0% | $63.82 | 100.0% | $65.26 | 100.0% |
Less: paying veterinary invoices | ($45.27) | 71.2% | ($46.38) | 72.6% | ($49.50) | 75.9% |
Less: variable expenses | ($6.25) | 9.8% | ($6.27) | 9.8% | ($6.34) | 9.7% |
= contribution profit | $12.04 | 18.9% | $11.17 | 17.5% | $9.42 | 14.4% |
Less: fixed expenses | ($3.01) | 4.7% | ($2.77) | 4.3% | ($3.10) | 4.8% |
= profit per pet per month | $9.03 | 14.2% | $8.40 | 13.2% | $6.32 | 9.7% |
Less: capital charge requirement** | ($0.64) | 1.0% | ($0.64) | 1.0% | ($0.65) | 1.0% |
= cash generated per month for the average pet | $8.39 | 13.2% | $7.76 | 12.2% | $5.67 | 8.7% |
- Analysis excludes MGA products
- Capital charge is an estimate of capital cost, it does not represent the actual net interest expense in the period
The decrease in AOI margins in 2023 resulted in our profit per pet, per month decreasing 25% to $6.32. Our average monthly retention decreased from 98.69% to 98.49%. This combination drove a reduction in the lifetime value of a pet (LVP) from $641 per pet to $419. All else being equal, a contraction in LVP requires us to reduce pet acquisition cost (PAC) in order to stay within our IRR guardrails of 30-40%. In aggregate, we reduced our PAC spending by nearly $10 million, or 12% year over year, and we added 287,000 new pets to Trupanion or 11% more than last year.
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On a per pet basis, our PAC decreased from $289 per pet to $228, a 21% reduction. In short, the team demonstrated an impressive ability to maintain growth discipline, despite lower PAC dollars.
We have been frequently asked how our PAC has become more efficient-this comes down to being more granular in our investments, looking at each P&L (different products and geographies) independent of one another, and reducing some areas of spend that act as a longer-term halo effect. Throttling back spend is not our long-term aspiration, but we know we can do this if we need to.
How We Think About Pet Acquisition Spend
Our pet acquisition cost consists of every dollar we spend to acquire a pet. This includes territory partner commissions, the cost of our contact center sales team, the compensation of team members involved in pet growth and more traditional sales and marketing costs such as paid search, direct mail
and social media spend (to name a few). This all-inclusive approach gives us a clear cost base to understand the cost of acquiring a pet. Once we have this insight, we can make decisions on how best to deploy our capital.
PAC spend across each P&L is built up in layers with each component driving lead volume (market awareness and interest), improving conversion rate, or supporting the first 90-day member experience (the point at which our churn is greatest).
With each layer, the team then considers geography, breed and value proposition (if our pricing is right) before investment is made. Each P&L requires a different focus; some may be early stages of development, some may have higher lead volume with lower conversion and some may have a currently mispriced product, leading us to lower spend. In the quirky world of pets, sometimes we see higher cat enrollment rates versus dogs and this again influences our decisions. The individual P&L growth characteristics can shift quickly depending on key operating metrics. It is the role of each P&L growth owner to understand which levers to pull and push. When spend is higher, we tend to see the sales funnel widen - raising awareness of the need for pet insurance and the rationale behind choosing Trupanion. When spend reduces, we double down our focus on the businesses with the highest returns and painstakingly work to grow from the ground up. In both instances
we grow, yet our learnings are less broad - which is good in the short term but in an underpenetrated market, we don't aspire to grow slowly. In fact, if our AOI continues to grow at the high rates we aspire to, we will soon have hundreds of millions of dollars available each year to grow the business. Over time, I expect we will continue to learn, refine and reapply concepts and tactics to drive efficiency. While more investment helps to drive faster growth, it's critical that any step up in spend is managed thoughtfully.
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Trupanion Inc. published this content on 16 April 2024 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 16 April 2024 19:45:06 UTC.
