Greetings, and welcome to the Trupanion Fourth Quarter and Full Year 2016 Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Tyler Drew, Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to the Trupanion fourth quarter and full year 2016 financial results conference call. Before we begin, I would like to remind everyone that during today's conference call, we will make certain 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-Q 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, fixed expenses, variable expenses, adjusted operating income, acquisition costs, 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 acquisitions. 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 Investors 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. And with that, I would like to turn the call over to Darryl, Trupanion's Founder and CEO.

Thanks, Tyler, and good afternoon everyone. I’m joined today by Tricia Plouf, our Chief Financial Officer. Thank you for joining us today as we review our fourth quarter and full year 2016 financial results and discuss our expectations for 2017. 2016 was a productive year for Trupanion, highlighted by strong revenue growth, continued scale in our adjusted operating margin, and our achievement of positive free cash flow. Total revenue increased 28% from 2015 within our 20% to 30% long term revenue growth target. Our adjusted operating margin improved over 500 basis points to reach 8% of revenue, reflecting continued scale in our fixed expenses. Leveraging our fixed expenses provides for increased adjusted operating profit which can be used to cost effectively acquire new pet. As a reminder, we targeted an LVP to PAC ratio of 5 to 1 to ensure that we balance our acquisition spend against our desired internal rate of return. With 2016 in the rearview mirror, I'd like to take some time to update you on the progress we made in our key areas of focus for the company as I detailed in my 2015 shareholder letter. These included: first, opportunities to optimize our LVP to PAC ratio by subcategory; second, continued scale in our fixed expenses; third, better messaging around our competitive value proposition; and fourth, improved training and development programs for our employees. These will continue to be areas of focus for us in 2017 along with testing ways to improve same store sales and exploring opportunities to grow our other business segment. In 2016 we spent $15 million to acquire new pets at a 5.1 to 1 LVP to PAC ratio which is up from an LVP to PAC ratio of 4.5 to 1 in 2015. While we posted a strong year-over-year improvement on…

Thanks, Darryl and good afternoon everyone. Today I will highlight some of our financial achievements from 2016, discuss our fourth quarter results and provide our outlook for the first quarter and full year of 2017. We are very pleased with our performance in 2016, a year in which we delivered strong revenue growth, scale in our fixed expenses, disciplined new pad acquisition and positive free cash flow. These financial results highlight our recurring and scalable subscription-based revenue model. 2016 revenue was $188.2 million, representing growth of 28% compared to the prior year and slightly above our guidance range. Our fixed expenses continued to scale during the year and represented 10% of revenue in 2016 compared to 15% of revenue in 2015, significant progress towards our long term target of 5% of revenues which we expect to achieve when we have 650,000 to 750,000 total enrolled pets. The decrease in fixed expenses as a percentage of revenue was primarily due to strong revenue growth as well as a reduction in certain direct pay technology expenses compared to the prior year. For the full year, our pet acquisition cost was $123 and our lifetime value of a pet was $631, resulting in an LVP to PAC ratio of 5.1, in line with our target for the year. In 2016 we had positive free cash flow of $3.1 million, a significant improvement from negative free cash flow of $15.3 million in the prior year. This improvement was due primarily to consistent revenue growth, scale in fixed expenses and discipline in new pet acquisition spend. Turning to our fourth quarter results. Total revenue for the quarter was $51.3 million, up 28% year over year. Total enrolled pets increased 18% year over year and totaled approximately 344,000 as of December 31. Subscription revenue was $47.4…

In closing, I'm pleased with our 2016 performance and we expect similar financial results in 2017. While continuing to focus on optimizing our LVP to PAC ratio by subcategory, testing initiatives to bolster same store sales, expanding the footprint of our direct pay initiative, investing in direct to consumer testing and exploring additional revenue opportunities within our other business segment, we believe improving on this foundation will set us up well for 2018 and the years to come. With that, we will open the call up to questions. Operator?

[Operator Instructions] Our first question comes from Andrew Bruckner from RBC Capital Markets.

Thank you. And very nice quarter there. Darryl and Trish, I'm wondering if you could answer two questions; one, provide maybe a little bit more granularity on the experiments you are going to do in terms of acquisition channels, how you're thinking about going direct to consumer at all and what marketing channels you’ll use? And the second one is, just if you can comment at a high level in terms of any mix changes in terms of geographies and types of pets that could impact potential pricing? Thank you.

Thanks, Andrew. But your first question, more detail on some of the testing that we're hoping to do in kind of direct to consumer. We’ll start by saying 2016, because we were focused on cash flow breakeven, hitting our blended 5 to 1 and our LVP was a little lower than we would have anticipated. We were a little bit on our heels and didn't get as much testing in 2016 as I would -- we would have liked. So testing that we’re expecting to do would be direct to consumer TV, direct to consumer radio, some online levers that we would be testing, more likely to be testing them in some small markets, maybe more mature markets where we have a higher percentage of active hospitals, places where we have a better brand recognition which will aid in increasing higher conversion rates. Maybe places where we have higher lifetime values of pets. So that will increase the likelihood that they may become successful but we don't think they're going to have a material impact on the pet growth in 2017. As Trish mentioned in her remarks, we're looking at a modest pet growth with revenue growing about 24% for 2017. So these tests are going to be small and really trying to set us up for 2018 and ’19. As part of your next question about the mix, we will be trying to work on our mix of business primarily on enrolling less of our subcategories that are unprofitable. And to me unprofitable is where our LVP to PAC ratio is at a 1 to 1 or less. I've mentioned before that, that was as high as 20% of our blended business for the last couple of years. We've got that down to about 17% and we want to continue to make big improvements on that, so that’s trying to shut down certain areas and accelerate other areas. We're not planning on publicly disclosing which of our subcategories we're going after, which mix of business, by geography or breed. But it is something that we're focused on in 2017 and something we need to get really good at before we can try to spend more money to acquire pets. Our adjusted operating profit has increased from about $3 million in 2015 to about $15 million in 2016 and we expect that to compound over the years. And as that number gets closer to $50 million we need to be really good stewards of learning how to spend that money. So ‘17 has really set us up for that. So hopefully that answers your questions, Andrew.

Our next question comes from Jon Block from Stifel.

Great. Thanks and good afternoon guys. Maybe two or three questions; the first one, Darryl, you just hit on it a little bit, and/or Trish, the guidance, any more color around ads or ARPU, or should we think maybe that high single digit, maybe a 7% to 8% increase in ARPU is a good place to be and sort of back into the ads from the revenue guidance that you've given?

Sure, Jon. Yes, you're thinking about it the right way in terms of taking ARPU and then backing into ads. We would say we’re higher than our average has been this year on ARPU around 7% to 8%. We would recommend modeling it around our normal average of 5% to 6% and then backing into the ads that way.

And then, Darryl, you mentioned the same store sales sort of a new initiative for the company or maybe getting a greater focus. So maybe if you could touch on, what are some of the investments needed to drive that process? Is it additional reps, is it bifurcating the sales force? And then maybe if you can comment, if you are seeing Express direct pay helping to aid that process of driving same store sales?

Well, so historically this company has not grown by same store sales. Historically, it’s grown by adding stores. And by the time we look at the end of this decade we need to become better at same store sales. We ran a pilot last year with little over 100 hospitals and had some encouraging results and it's really around us trying to increase the number of touch points at a hospital in between visits of our territory partners. So our territory partners typically try to visit on a 60 day cycle. And we realize that if we have touch points on a weekly basis or even a couple times during the week either with data or information, that we believe that might help us with same store sales. So what we're trying to do is really to build out a new inside sales force that is going to be able to augment or help our territory partners remain in the field and remain their kind of a 60 cycle. We are leveraging Trupanion Express of all the data that we're receiving out of that to be passing that information back to the hospitals. So Trupanion Express is definitely a part of the strategy but it's just another tool in our kind of toolkit.

Maybe one more quick one for me, and you previously said that about 20% of the ads were sub-optimized and I believe you just threw out 70% -- 17% sub-optimized. Where is the optimal number, the right number, that I know you could say zero or 1%, and probably not realistic. So when you look at the organization, where do you want the company to get, is that a 5% number, 10% number, maybe just some context there? Thanks guys.

Yeah. So let's first talk about sub-optimized because in my mind I've been defining sub-optimized, that places where our PAC spend, if it’s $130 we're expecting to receive $130 or less. So this might be places where we are currently losing money at our present pricing strategy. Obviously spending $100 and getting less than $100 back is not a good business model. Ultimately this year if we could get from what was 20% down to 17% and then down to maybe 10% this year and that would be good progress. I think longer term we'd like to see that in our big -- bigger subcategories down to maybe 5%. But then what we call sub-optimized over the years will change from maybe from a one to one or worse to one for making a modest profit but not as good as we could be. So right now we're really focused on the ones that are really kind of hurting our LVP and hurting our blended mix of business and trying to make progress there.

Our next question comes from Michael Graham from Canaccord Genuity.

Thanks a lot. Couple questions, one is on just the drivers of the ARPU for the average revenue per pet, I know we've got some mix improvements that are happening. How much is related to just inflation of health care costs? I know that was a big driver in prior years. And I just, Darryl, wanted to ask about your -- if you could just refresh us on your philosophy about how you're thinking about the percentage of profitability of the company. Just remind us what your guide rails are and what we should expect over a multi-year period? Thanks.

Thanks, Michael. So let's start off by talking about our general value proposition. So what we're trying to do is understand the underlying costs and add about 30 points on top of it for the average pet owner. So if the average cost for a dog is going to be different than an average cost for a cat, same a Golden Retriever or somebody living in New York. What we are trying to do is to have about our cost plus model having our cost to paying veterinary invoices for the average pet owner, paying back about $0.70 or $0.72 on the dollar. And then after we pay out our variable expenses and fixed expenses, at scale we would look at having about a 15% operating profit before we acquire new pets. In Trish’s opening remarks, we saw that our adjusted operating profit go from $3 million in 2015 to about $15 million in 2016. On a percentage basis that took it from 2% to 8%. Ultimately we want to get that to 15%. We believe it's going to take us until we get about 650,000 to 750,000 enrolled pets, until we can get to that scale. And the major scale that we're getting there is, our revenue growing faster than our fixed expenses. To the other part of your question about what is driving our ARPU, because we're just a cost plus model, it really is the cost of veterinary medicine for Trupanion clients. But as a reminder, clients with Trupanion visit veterinary hospitals twice as frequently and spend twice as much money as clients that do not have any insurance. So we're looking at the inflationary cost for an insured client that includes referral in speciality hospitals. It includes investments in technology. It includes utilization but in aggregate, it’s that inflationary cost that drives the ARPU, much more than mix.

And then just one quick follow up on the retention rate. So very minor changes but it's drifting down a bit. Is this still the impact of the billing system changes or can you just comment on what do you expect to be the direction of that retention rate say in 2017?

Hi Michael. I'll answer this one. So I mentioned in my remarks that we're happy with how the billing system rollout went, happy with that investment. What we're seeing preliminarily in some of that better technology is positive, but it can take a while to roll through retention because our retention rate is backward looking. And that’s also just one portion of our overall retention and cancellation reasons. That being said, going from 98.64% last year to 98.60% this year, both are still very strong retention rates and above our ten year historic average which is 98.5%. One thing that -- if you want to point out, as we've been talking about these sub-optimized pets that we have and one of the ways we're working on making those improvements is by getting those that are mispriced, priced correctly and so we'll be rolling out that pricing over the course of this next year which will be larger price increases for some of those pets that are not priced correctly. And so we may see a bit of an impact to retention as those roll out as I said before. As I just said I wouldn't expect it to be overly significant, though, and we still should be above our ten year average of 98.5%. But I think Darryl recommended in the past modeling at 98.5% which is our ten year average and we would continue to recommend to do so.

I would I just add to that quickly. I just -- with everything that we're working on in 2017, I don't think this is going to be a year that one should be expecting an uptick on retention. But I think Trish has got it right on.

Okay, that makes sense and then I'll just ask one more and then I'll be done; it is just a follow up on that. Roughly what percentage of the pets do you think might be mispriced currently?

So it’s about -- pretty close to that 175 number that I came up with.

Our next question comes from Mark Argento from Lake Street Capital.

Good afternoon. A couple higher level questions. I know the quarter, just after the quarter we had a big acquisition in the pet space. Maybe if you could talk a little bit about how you guys see pet insurance in particular your role in what might be a consolidating market for kind of veterinarian or veterinarian hospitals, and maybe dovetail that into kind of the competitive environment, is there a rational competitive environment out there, how are your competitors behaving, pricing perspective, and do you feel like you guys are -- continue to be well positioned there?

Thanks, Mark. So I think the consolidation that you're talking about is going to be that Mars who has been in the pet space for many many years announced an acquisition of VCA. So VCA is somebody we've been partnered with for the last couple of years. They have, I believe, about 900 hospitals. Mars now has all of four legs to their chair in the animal health side, one is Banfield which have -- I think about another 900 hospitals. Then there's a group called Pet Partners which right now I believe is about 150 or 200 and is expanding rapidly. And then the fourth one is BluePearl which is about 50 or so I believe referral and speciality hospitals that are doing amazing medicine. And we have had long term relationships with three out of these four Mars entities for a number of years. So I think we're well positioned. When you talk about just the consolidation, what is happening is that these hospitals are being purchased at high multiples. So the acquirers buying at a high multiple for them to get a reasonable rate of return are going to have pressure to do two things: increase same store sales and there's also going to be pressure to increase veterinarian pay, which has been pretty stagnant over the years. Because Trupanion clients visit twice as frequently and spend twice as much money we think we're very well aligned with the companies like Mars and others to help them do well and recouping their investment. I think that Mars who's been dedicated to the pet space, they also own food and a bunch of other areas. It’s a very long term thinker, thinking out 10 and 20 years, and long term thinking being aligned on trying to get the…

And then just one quick one for Tricia, in regards to the guidance about $2 million to $5 million in EBITDA, I'm assuming that already takes into consideration the incremental testing and spend around some of these new initiatives, is that right?

Yes, that's right. It takes into account that some of our PAC spend will be used for this initiative. We are not projecting, though, the impact on revenue that this initiative could have, we'll wait until those are proven to include them in our forecast.

Our next question comes from Kevin Kopelman from Cowen and Company.

Hi, thanks a lot. So my first question, I was just wondering if you could give us an update on the online channel, how meaningful is that channel for you today? And do you see online as a key area of investment in part of the direct to consumer testing that you referred to?

So an update on the online, today about 90% -- little over 90%, closer to 94% of all the pets that we enrolled either come to us directly via the telephone or they come to us directly by typing in Trupanion. Less than -- about 6% of our business is people typing in pet insurance or some other keyword where they're just generally looking at the category and stumbling across us. We think that is a very crowded expensive channel. So trying to create leads through the online, we do not think short term or near term is going to be cost effective but it’s somewhere that we plan on spending a lot of time or effort on. That being said, online is very important for our conversion. So we believe that we are building this category by getting more veterinarian referrals and we need to do a better job leveraging online to make sure that the leads go to us and that we maintain the highest conversion rate both online and on the telephone so that we can spend more money trying to acquire and get more leads out there. We don’t see as a category in general the term pet insurance growing dramatically. The growth of the category which we are leading -- we believe we're leading in is being I believe driven by veterinarian recommendation and existing pet owners telling their friends. So think about, for us we think about online, we need to do a better job there on explaining our value proposition and conversion rates versus as a new lead source.

Is that an area of investment then just kind of just general R&D on a website in 2017?

Yes, that will be ongoing. But in addition to that we will be doing some outreach for testing some direct to consumer leads. I mentioned TV and radio and at least some online places we will be constantly testing. But in general we want to have continued focus on being able to explain our value proposition and make sure the leads that are looking for us find us, they don't get -- turn off the Trupanion highway on to the pet insurance side roads.

And then a separate question on the PAC spend. Given your testing, increased testing, does it make sense to separate that out so that's not weighing on your ability to put money to work that you know is working as a 5 to 1 ratio in the establish channels?

We separate it out internally. So we're working on right now what we reported kind of on a blended basis. We ideally would like to have 10% to 20% of our PAC spend being used -- allocated for testing, which tells us if you want to do the math on it, we've got a lot of places where we're running at kind of a 5.5 or a 6 to 1. But as our adjusted operating margin improves you will see us be more focused on the internal rate of return, and what that drives. So over the years we might get the same internal rate of return at a 4 to 1 LVP to PAC as what we do today at a 5 to 1. We're tracking that separately and we monitor that on a monthly basis.

Our next question comes from Chris Merwin from Barclays.

This is Maya Lou [ph] on for Chris. So you mentioned earlier that you'll continue to focus more on same store sales and in corporate. But could you provide more color on the additional strategic initiatives that you mentioned, that you couldn’t go into because of cash constraints?

Yeah, well we would have liked to have been able to do a lot more testing last year. I'm going to do to ones that are easy for people to imagine. We like to do more testing on radio and TV that we started doing in ’15 and quite frankly we were kind of playing defensively in 2016. So we did very little TV and very little radio as well as we didn't do as much testing in some other partnership channels and other one. So we just want to have the latitude to be able to test and see if some of these will become larger growth drivers in the future. But it takes us a while for those to test them out. One, you've got to test to see if you can get the cost of a lead, then you need to understand the conversion rate, you understand the acquisition cost and then it takes some time for us also to realize what the short term retention from that new pet is going to look like. So we just want to be able to do more of that. Does that answer your question or are you trying to get to something else?

Yes, that makes sense. Thank you. End of Q&A

Thank you. We’ve reached the end of our question and answer session. This does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.