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Edited Transcript of TRUP earnings conference call or presentation 1-May-18 8:30pm GMT

Q1 2018 Trupanion Inc Earnings Call

Seattle May 3, 2018 (Thomson StreetEvents) -- Edited Transcript of Trupanion Inc earnings conference call or presentation Tuesday, May 1, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Darryl Graham Andrew Rawlings

Trupanion, Inc. - Founder, President, CEO & Director

* Laura Bainbridge

Trupanion, Inc. - MD

* Tricia Lynn Plouf

Trupanion, Inc. - CFO & Principal Accounting Officer

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Conference Call Participants

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* David Michael Westenberg

CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst

* Dylan Haber

RBC Capital Markets, LLC, Research Division - Senior Associate

* Greg Gibas

* Jonathan David Block

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Mark Nicholas Argento

Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst

* Michael Patrick Graham

Canaccord Genuity Limited, Research Division - MD & Senior Equity Analyst

* Thomas Steven Champion

Cowen and Company, LLC, Research Division - VP

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Presentation

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Operator [1]

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Greetings, and welcome to the Trupanion First Quarter 2018 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Laura Bainbridge, with Investor Relations. Thank you. You may begin.

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Laura Bainbridge, Trupanion, Inc. - MD [2]

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Thank you, and good afternoon. Welcome to the Trupanion First Quarter 2018 Financial Results Conference Call. Participating on today's call are Darryl Rawlings, Chief Executive Officer; and Tricia Plouf, Chief Financial Officer.

Before we begin, I would like to remind everyone that during today's conference call, we'll 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 the 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 on margin, is intended to refer to our non-GAAP operating income or margin before pet acquisition. 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 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'd like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also will be available.

With that, I would like to turn the call over to Darryl.

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [3]

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Thanks, Laura, and good afternoon, everyone. It's an exciting and busy time here at Trupanion. Across the organization, we're working to deepen the competitive modes around our business. Just a few weeks ago, we held our 6th Annual Territory Partner Conference. It was an inspiring event and a great opportunity to share best practices.

A focus of this year's conference was Trupanion Express, our software that integrates with veterinary practice management software and allows us to pay veterinary invoices directly to hospitals at the time of treatment. The value of Trupanion Express would be limited without our Territory Partners, which is one of our largest competitive modes. I have more to say about Trupanion Express and some of the success we're having on this front in a moment.

I also want to mention that last week we published our 2017 annual report, which includes my annual shareholder letter. I'll touch upon a few highlights today, but I would encourage you all to give it a read as it provides more detailed insight into how we think about and operate our business. These topics will also be discussed in greater detail at our upcoming shareholder meeting here in Seattle on June 7.

As a reminder, our shareholder meeting is the best opportunity for our investors to thoroughly understand our achievements and challenges over the past 12 months and our strategy going forward. Most importantly, attendees will have the opportunity for direct Q&A with our entire leadership team, where we will cover the questions you care about most.

Turning now to our first quarter results. We're pleased with our start to the year. Results across our key financial metrics were strong, and we continue to move the ball forward on several important initiatives.

Revenue grew 27% year-over-year with our subscription business in line and our other businesses outperforming our expectations. In the quarter, we spent approximately $5.7 million to acquire 30,000 new subscription pets. Once again, we achieved strong rates of return on our core spend, and we continue to see encouraging results from our test initiatives.

Within our other business segment while not yet a significant piece of our revenue, our corporate employee benefits team has begun to gain some traction. We see this as an area of opportunity in the coming years.

Adjusted operating income, or the funds available to us to invest in pet acquisitions, increased 39% year-over-year to $6.1 million from $4.4 million in the prior year period. Expanding our adjusted operating margin is one of our key strategic initiatives, and we intend to dedicate a portion of our shareholder meeting to discussing our strategy to do so, along with our efforts to deploy these funds at strong internal rates of return.

Initiatives around our test spend will also be covered as part of this discussion. We continue to spend aggressively on our inside sales team. This team, which now totals about 15 full-time employees, compliments our Territory Partners, increasing the number of touch points we have with veterinary hospitals.

We ended 2017 with a 107 Territory Partners, visiting approximately 20,000 unique veterinary clinics. In total, we estimate that we made an additional 85,000 face-to-face visits during the year and in aggregate have made over 0.5 million visits since we entered the U.S. market a decade ago.

In 2017, we had approximately 8,500 active hospitals, up from approximately 8,100 at the end of 2016.

As I mentioned previously, one of our competitive modes is Trupanion Express. And at the end of the first quarter, Trupanion Express was installed in over 2,300 clinics, an increase of over 50% from Q1 2017.

Over the same time period, we paid over $40 million directly to veterinarians. We are proud of these results as they collectively represent $40 million that never left our customer's pocket and thus aided in our mission to help pet owners make the best medical decisions for their pets regardless of cost.

Because Trupanion Express enables us to pay hospitals directly at the time of treatment usually in less than 5 minutes, it is a critical component in facilitating an exceptional customer experience. Years ago, many thought it was crazy to try to pay a veterinary invoice in under 5 minutes. Now we think 5 minutes is too long. For multiple years, we've been working to automate this process to even further reduce the time it takes to pay the hospitals directly.

As we recently announced at our Territory Partners Conference, these automotive processes went live in April, with the first veterinary invoice submitted being processed and paid in just 12 seconds.

By this time next year, we are looking to automate an increasing number of Trupanion Express veterinary payments. We're encouraged by the results that we're seeing, and the accelerated deployment of Trupanion Express remains an important focus in 2018.

Today, over 1/3 of new pet enrollments are coming from hospitals enabled by Trupanion Express. We will provide more insights into these topics as well as other strategic initiatives at our Annual Shareholder Meeting in June.

Lastly, before I turn the call over to Trish, I want to take a moment to address some questions we fielded recently regarding Trupanion's relationship with vet hospitals, whether certain activities with veterinarians could be considered inconsistent with applicable regulations.

We have carefully reviewed these allegations, and we do not think they hold any merit. All of our customer experience practices are developed with the applicable regulations in mind, and we do not intend to modify our strategy.

With respect to licensing requirements for insurance sales specifically, the regulatory directive on this matter is very clear. One cannot pay for enrollments unless that pet is enrolled for license entity. We do not compensate veterinarians or their staff based on enrollments. We do have some programs aimed at enhancing the customer experience and lowering our cost to process veterinary invoices through the usage of Trupanion Express. We have provided some more detail about these programs on our IR website. We are comfortable that these programs comply with the letter and spirit of applicable regulations.

Furthermore and more fundamentally, we believe that our business model aligns closely with the goals of insurance regulators.

In general, regulators want to ensure customers get a high value proposition. There's a transparency and the customers are treated fairly. We want the same things. We believe we have the highest target pay out to pet owners in the industry. Combined with our commitment to provide exceptional 24/7 customer service, including paying veterinarians directly at the time of treatment, we believe we provide pet owners the highest value available.

Our 1 simple product with a broadest lifetime coverage provides pet owners with a high degree of transparency. And we treat pet owners fairly by having the most pricing subcategories to ensure that each pet owner pays the fairest price for their specific pet.

We're happy to address any questions regarding regulatory topics on today's call. And as mentioned previously, we will facilitate a more in-depth discussion at our Annual Shareholder Meeting.

And with that, I'll turn the call over to Trish.

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Tricia Lynn Plouf, Trupanion, Inc. - CFO & Principal Accounting Officer [4]

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Thanks, Darryl, and good afternoon, everyone. As Darryl mentioned, our first quarter financial results were strong and in line to slightly ahead of our expectations. Revenue of $69.8 million was up 27% year-over-year. We slightly exceeded the high end of our guidance range for the quarter, largely due to better-than-expected enrolled pet growth in our other business segment. As a result, total enrolled pets increased 23% over the prior year period to approximately 447,000.

Subscription revenue was $61.5 million, up 22% year-over-year. Total enrolled subscription pets increased 15% year-over-year to approximately 386,000 pets as of March 31st.

As Darryl mentioned, we continue to generate solid returns from our core spend, and we continue to see encouraging results from our test initiatives.

Monthly average revenue per pet for the quarter was $53.62, an increase of 6% year-over-year and in line with our historical average. Average monthly retention was 98.63%, up from 98.58% in the prior year period.

Our other business revenue, which generally is comprised of our revenue that has a B2B component, totaled $8.2 million for the quarter, an increase of 83% year-over-year. The primary driver of the increase was due to a new relationship that started with us in Q1 of last year and being with us the full quarter this year compared to only having a small number of pets with us in Q1 of last year.

Year-over-year growth in our other business segment was higher than we anticipated this quarter due to strong results in all areas, coupled with the slower-than-anticipated roll off of the group of pets we discussed last quarter.

On the last call, I discussed the revenue growth rate of our other business segments would be around 20% for the full year, but due to the roll-off of pets being a little slower than we anticipated, we now expect the full year revenue growth rate of this segment to be between 30% to 40% for the full year. Total enrolled pets in this segment was approximately 61,000 at quarter end.

Subscription gross margin was 17% in the quarter, while total gross margin was 16%. As a reminder, we do see some variability in gross margin on a quarterly basis. And when we install Trupanion Express, we typically see a slight increase in the frequency of veterinary invoices since the software makes it much easier to submit invoices compared to the typical reimbursement model. Once we have this data, we are able to include it in our pricing going forward. So we believe this is a temporary impact.

We believe this is a worthwhile trade-off to drive longer-term customer satisfaction.

For the full year, we expect gross margin to be near the lower end of our annual target range of 18% to 21% as we are accelerating the roll out of Trupanion Express.

For the quarter, fixed expenses represented 7% of total revenue, down from 9% in the prior year period, reflecting increased scale in our technology and general and administrative departments. Our long-term target is to scale these departments to 5% of revenue, and we are very pleased with the continued progress this quarter.

Turning to our pet acquisition spend. In the first quarter, we spent $5.7 million on pet acquisition for a PAC of $165 . This resulted in an LVP-to-PAC ratio of 4.4:1, which was right in line with our expectations and above our targeted internal rate of return.

In the prior year period, we spent $3.9 million for a PAC of $128, resulting in an LVP-to-PAC ratio of 5:1. As we have discussed in the past, expansion of our adjusted operating income provides more funds available to invest in growth. Our acquisition spend was higher this quarter compared to Q1 of 2017 due to spending incremental fund to increase the number of new subscription pets by over 4,000. This is a 16% increase from the prior year.

Adjusted operating income totaled $6.1 million in the first quarter, which was up 39% from the prior year period. As a percentage of revenue, adjusted operating margin expanded approximately 70 basis points year-over-year to 8.7%. While this is strong expansion relative to the prior year period, it fell a little short of our expectations. This is primarily due to the lower gross margin that I discussed earlier.

During the quarter, we had a net loss of $1.5 million or a $0.05 loss per basic and diluted share. Adjusted EBITDA was $0.4 million compared to adjusted EBITDA of $0.5 million in the prior year period.

Free cash flow was $1.1 million, including operating cash flow of $2.1 million for the quarter. This compares to free cash flow of $1.4 million in the first quarter of 2017, which included operating cash flow of $1.9 million.

At March 31, we had $70.1 million in cash, cash equivalents and short-term investments and $15 million of long-term debt.

I'll now turn to our outlook for the second quarter and full year of 2018. For the second quarter of 2018, we are forecasting revenue in the range of $72 million to $73 million, representing 24% year-over-year growth at the midpoint. At these revenue levels, we would expect adjusted EBITDA around breakeven.

For the full year, we are increasing our revenue guidance range to reflect our slight overperformance in Q1 and better visibility into our other business segment. As a result, we now expect revenue for the full year to be in the range of $295 million to $300 million, representing 23% year-over-year growth at the midpoint.

At our forecasted revenue levels, we expect to spend between $23 million and $25 million of our adjusted operating income to acquire new pets. As a reminder, if we have the opportunity to deploy more of our adjusted operating income on new pet acquisition to drive incremental growth, we will do this as long as we are achieving our overall targeted IRR and we are also EBITDA and cash flow positive.

We discussed our pet acquisition and IRR strategies in detail in our most recent shareholder letters. Please keep in mind that our revenue projections are subject to conversion rate fluctuations between the U.S. and Canadian currencies. For our second quarter and full year guidance, we used a 78% conversion rate in our projections, which was the approximate rate at the end of March.

Thank you for your time today. I will now turn the call back over to Darryl.

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [5]

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Thanks, Trish. Before we open the call up for questions, I want to remind investors that this weekend, we'll be hosting our second annual investor Q&A event to follow the Berkshire Hathaway Annual Meeting in Omaha. We're excited to use this platform as an opportunity to connect with like-minded, long-term investors. We hope to see you there. And in a few weeks, we'll be at the Cowen Technology Media and Telecom Conference and the Stifel Veterinary and Dental Conference, both in New York.

And with that, we'll open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of John Block with Stifel.

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Jonathan David Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [2]

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Darryl, maybe just the first one on the Territory Partners. So it seems like a couple of years ago per the shareholder letter, you increased from 84 to 104. Per the most recent letter, you went from 104 to 107. Maybe if you can talk about retention? I know that was an initiative of yours in the past. And then, are you now at the right number and do we see sort of shift some more resources to the inside sales teams that you alluded to earlier?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [3]

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Thanks, John. We have about 106 Territory Partners currently calling on about 20 -- little over 20,000 veterinary clinics. We're trying to have them visit about every 60 days. And we have added the addition of about 15 inside account managers, which we expect that number's going to grow over the next 2 to 3 years, so that they can have multiple touch points in between those 60-day intervals. There is about 15-ish markets that we would still like to expand to. So ultimately, we want to increase the number of Territory Partners in the field. A lot of the expansion that we've been doing that has been helpful has been adding additional Territory Partners inside of an existing region, increasing the touch points. And in the last 1.5 years, we have not been adding as many new regions. We still have the challenge that with the Territory Partners about -- only about 50% of them make it through the first 2 years. So -- and I don't think we want to lower the bar there. I don't think the goal is to have 90% to make it through. We want to every year increase the quality and capabilities of our Territory Partners. What we want to do is if we're going to make amends, try to do it as quickly as we can to be respectful for that person. So I'm happy with the progress we've made. I mentioned in the opening remarks, we just had our Territory Partner Conference that was a couple of weeks ago. To me, it was a really inspiring event. We had over a 106 Territory Partners attend and about another 80 people from the Seattle office. We spent 4 days working on best practices, rolling out some new tools, some strategic initiatives that we will be talking about at the shareholder meeting. And I feel really good about the field, I think, the quality and capabilities continue to increase.

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Jonathan David Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [4]

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Okay, great. And then I'll ask one more online and I'll follow up off-line on the others. But I do want to ask about the regulation noise or accusations. I think clearly it has been sort of overhang on the stock. So let me leave this out and hopefully it makes some sense. Internally, did you take a fresh look at some of your marketing initiatives? Or just that you did not want to follow up regulations in the past and nothing has changed. So you remain confident that everything is within the letter of the law? And maybe if you can clarify that and hopefully I laid it out appropriately?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [5]

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Sure. Thanks, John. So in general, we've have had some allegations that were written up in the last 30, 60 days. Most of these allegations are things that we reviewed, the issues we do not believe they hold any merits. But on a -- at a high level, what we are trying to do, as a company has got great alignment with the Department of Insurance. And I mentioned in my opening remarks about having transparency, high-value proposition and being able to be fair amongst all policy holders. What we do, the strategy that we've had and have had for over 10 years is very much related to Territory Partners and veterinarians. The reason we work so closely with veterinarians is we believe to have an exceptional customer experience, we need the cooperation of veterinarians. What we're doing on anything that have been brought up from these issues were all related to customer experience. So what we're doing is, we are monitoring and measuring the customer experience, which means being able to get medical records, but ultimately being able to pay directly at the time of invoice. And to do that, a veterinary clinic needs to be using Trupanion Express. They have to allow us to be able to pay their hospital directly. And when we're going through that entire process, we save money in our back-end expenses. And we're sharing some of those savings with the veterinarians. So those tactics that we have change from time-to-time, but our overall strategy has been very consistent for the last 10 years. And we believe everything that we're doing is in line with regulations in the Department of Insurance. So I hope that answers the question. If you have any more anybody else does, happy to answer those.

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Operator [6]

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Our next question comes from the line of David Westenberg with CL King.

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David Michael Westenberg, CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst [7]

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We have been seeing Wal-Mart and other retailers attempt to sort of copy -- what you've seen from Pet Smart and Banfield. Is there any opportunity in insurance rather than wellness plans in some of these new retailers? And what would that opportunity sort of look like?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [8]

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I think the question you're asking is Petco or PetSmart years ago worked with Banfield and have put veterinary clinics inside of their walls. And there is opportunities or talk of some of those things happening in other locations such as Wal-Mart. Our goal is to help support veterinarians and to help make sure that pet owners are able to get the best quality of care. I mean, overall, the problem we're solving is it makes it very difficult for pet owners to budget for the unexpected. We're happy to work with any veterinarians in any location. We know that our clients visit more frequently and spend more money on average about an extra $3,500 over the life of the pet. So I think regardless of where the veterinarians are, we're happy to work with them. We're not trying to dictate care or tell people where to go. Our coverage is, we pay 90% of an actual invoice regardless of -- if it's a 24 hours specialty or the place around the corner from your house or in a bigger location. So for us, we're just here to support pet owners and veterinarians and, however that evolves we think we can be good partners.

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David Michael Westenberg, CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst [9]

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And then can you just remind us with Trupanion Express, which practice management software system does it work with? And saying that, with Henry Schein spinning off, you worked well with AVImark and ImproMed and is there an opportunity there to maybe leverage that offering then with prescription management? Or is there any ways to think about insurance on how that could work with prescription management in the future?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [10]

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The first part of your question is which practice management software? So there -- for those around that's close to the industry, there is about 10 or 12 different softwares, but actually probably about 80 different versions of software that are sprinkled amongst 25,000-ish clinics in North America. We believe that we are concurrently compatible with kind of 85% to 90% of those. So all of the bigger ones that you mentioned were certainly compatible with. The second part of your question relates to some of the mergers and acquisitions that's happening in animal health. And ultimately, as I mentioned to John's question, our clients visit more frequently and spend more money. And the reason they do that is on day 1 of limping or day 1 of other clinical symptoms like vomiting, our clients go to the veterinarian. And when they go to the veterinarian, the veterinarian have -- might have 2 courses of treatment. Course A, which is their preferred course of treatment or course B, which is cheaper. And our clients are more likely to do the higher level of diagnostic care. So we think we're aligned well with the overall industry. And ultimately, the pet owners want the best care for the client. So, however, the industry plays out, if we stay in alignment with veterinarians and pet owners, I think that will work. And those that are supplying good services to the veterinarians, I think they see the benefit of Trupanion.

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David Michael Westenberg, CL King & Associates, Inc., Research Division - Senior VP & Senior Equity Analyst [11]

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All right. And just one more. I mean, LVP to PAC was within what your expectations. You've been experimenting with different channels in order to increase pet acquisition. So just can you give us more color in terms of what channels you think have been working more in terms of our expectations for -- what were you going to be spending specific -- channel specific in the back half of the year?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [12]

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Well, for competitive reasons, I'm not going to open up all the answers there. But we've been running a few test initiatives that we have talked about on previous calls. That's more direct-to-consumer as well as building out the inside account managers for more frequent touch points. We are probably a year into increasing the number of account managers. And we think it's probably going to be about a 3-year process. We like the results we're seeing there, and it's just more about more frequent touch points. The B2C, the more we have expansion in our adjusted operating income in pure dollars, but also the adjusted operating margin allows us to have a quicker payback period time, and therefore, allows us to increase PAC spend while still having strong returns. That's a lever we're turning on and off and we're testing in different markets. I expect that we'll continue to do it and with more AOM expansions, the more -- the heart of that will go. If the expansion is not as much as we would like, we'll probably pull back there.

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Operator [13]

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Our next question comes from the line of Michael Graham with Canaccord Genuity.

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Michael Patrick Graham, Canaccord Genuity Limited, Research Division - MD & Senior Equity Analyst [14]

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So I just wonder this is sort of the first -- this legal sort of situation is sort of the first one that I think has impacted your company that I'm aware of since you came public and I'm just wondering if you could give us an update on like how you're staffed from a legal perspective? How do you think you need to increase your investment there? And are you taking -- it sounds like you haven't really been contacted by any authorities, but are you taking proactive measures to try to reach out? Just maybe a little more context in terms of how you're dealing with it and how you plan on dealing with it?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [15]

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Sure. So I mean, I would say the first part of it is, just to provide greater context. Recent articles have brought up a few issues. None of those issues, as I mentioned before, we think are have -- hold any merit. The reason that we come to those conclusions is that in over the last 3 to 5 years, we have materially invested more and more on legal resources internally. 10 years ago, when we entered the marketplace, for the first time becoming an insurance company, the amount of money we had in resources to spend in this areas was limited. We have historically made a few mistakes that the Department of Insurance have pointed out to us and some of those we reacted slower then we should have. And I think we've learned from those experiences over the last number of years. What we're talking about what is being brought up recently, we do not think fall in the same category of mistakes that we've made previously. Previously, we did not have licensing for people inside of our contact center and we did react as quickly as we needed to and rightfully so had some fine from the Department of Insurance. But overall, we've been investing more and more. We have 3 full-time lawyers inside of the company. Today, we use outside attorneys as needed. We also have a regulatory team that is reviewing everything that we're doing. And we continue to get better. But on a broad basis, this is one of the reasons we're in a challenging category. We're not a company that's easy to copy. We are the only monoline company and we have 65 different jurisdictions that we deal with. So trying to be perfect in every jurisdiction every moment of the day is very, very difficult. The largest companies have problems with it. We will have problems coming and going in different times. But it's not because of intent, it's because -- it's very, very hard to do things perfectly. On the broad strategy, we feel very good about our broad strategy. And as I have mentioned before, tactics we review with Department of Insurance on a regular basis. They're contacting us on a daily, weekly, monthly basis and it could be anywhere from pricing questions to other tactics on how we communicate to customers or veterinarians. So we feel comfortable that we're in a good shape on it, and we continue to invest in the area.

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Michael Patrick Graham, Canaccord Genuity Limited, Research Division - MD & Senior Equity Analyst [16]

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Okay. That makes a lot of sense. Just another sort of bigger picture question. If you look at what's happened in human health insurance in the United States. You just had this steady escalation of sort of what's covered that has helped us on the lot of research and it seems like we're in the sort of upward spiral and can you kind of see the same thing starting to happen with the pet insurance where your product allows the vets to -- allows pet owners to get more things done to then pets and then that sort of starts to escalate the cost and you can see that in your metrics in terms of ARPP and things like that. Just wondering like do you have any thoughts on could this accelerate? Could we see health care costs for pets accelerate a lot like how are you just sort of thinking about that planning for?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [17]

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Well, I think as we've seen over the last close to 20 years that we've been in this business, the cost of veterinary care has been outpacing regular inflations. It's been averaging, we talk about 5% to 6% a year. That's not because it's 5% to 6% and the cost of an x-ray is going up year-over-year, it's because there is an expansion in the level of care moving from x-rays to diagnostic testing includes ultrasounds and CT scans. And it means that there has been more 24-hour emergency in specialty hospitals. The makeup of a veterinarian clinic is changing from having a average clinic have 1 to 2 veterinarians working 6 days a week to a larger clinic that have 3 to 5 veterinarians and referring out different types of cases like ACLs going to TPLOs. We expect over the next 20 years that the cost of veterinary care is going to continue to escalate and increase. And that is going to continue to increase the demand for our product. I mentioned in the shareholder letter and I'll reiterate again. The problem we're solving, it is very, very difficult for pet owners to be able to budget for the care. It's not only very difficult to budget for the care because -- and where you live and what the breed is, but obviously, pet owners don't know if they're going to have an average or an unlucky pet. But the backdrop is, we believe the cost of veterinary care will continue to increase. We have not seen any signs, nor do we believe there will be signs in the next 10 to 20 years the cost of veterinary care expanding beyond the wallets or needs of the consumer. And we just passed 1% penetration rate in North America. If we look 20 years ahead, we don't expect to be over 20% penetrated. And so 80% of pet owners are not going to be -- have the assistance of having high-quality medical insurance. And the pricing and availability is going to have to be dependent on what the market will bear and our clients will be able to come more frequently. So we hope that veterinarians continue to do more. I think the pet owners want to do more, and we expect it's going to go faster than inflation -- typical inflation.

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Operator [18]

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Our next question comes from the line of Dylan Haber with RBC Capital Markets.

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Dylan Haber, RBC Capital Markets, LLC, Research Division - Senior Associate [19]

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What learnings have you guys had so far from your TV marketing initiatives? And do you expect to ramp spend there in 2018? And then can you provide more color on the outlook for the other revenue line in 2018? Where you expect growth to normalize there over the course of the year? And do you see anymore partnerships coming online?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [20]

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I'll answer the first part of the question since it's more about the B2C and then hand the second part over to Trish. On the B2C, we would like to be more aggressive on B2C. I think it's going to be dependent on the margin expansion on our -- if it continues strong and gives us more money to play with. But what is not intuitive to many is, B2C is not a way of actually driving up more high quality leads. It does increase leads, but not necessarily more high-quality leads. What it's really doing is helping us increase our brand awareness and increase conversion rates. And the benefits of those, we have seen pretty good results. Now we don't tend to see that in a new market. So a market where we might have 5% or 10% of veterinary clinics recommending Trupanion or understanding how we work or having Trupanion Express, we don't get the full benefit of having a client learn about or hear about Trupanion and have higher conversion rates. But in a market where 50%, 60%, 70% of clinics are actively recommending Trupanion, we have a different outcome. So we don't think that we are able to broad based, go B2C and be able to do it cost-effectively. And once again, we don't think this is an awareness issue. This is really about increasing the conversion rates, which is not intuitive to many. On the other side of it, it will also tell you that somebody coming into this marketplace that has deep pockets but doesn't have relationships with veterinarians, we don't think is going to be a practical way to expand the category. We think it has to be done in conjunction. With that -- I'll hand it over to Trish and if you have follow-up come back to me.

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Tricia Lynn Plouf, Trupanion, Inc. - CFO & Principal Accounting Officer [21]

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With regards to your other business segment question. As I mentioned on the call, for the full year, we do expect it to be between 30% and 40% year-over-year growth, which is increase from our prior expectations that primarily related to slower roll off of one of our partners, but also all parts of that business are performing pretty well right now. And we would continue to expect that at about the same pace. We're not forecasting anything to dramatically change from the pace we're on. When it comes to how to look at that on a quarterly basis in terms of growth rates, the 83% that we saw this quarter, we expect to be the peak for the year. And then, we do expect sequential declines for the next 3 quarters to average to that 30% to 40%.

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Operator [22]

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(Operator Instructions) Our next question comes from the line of Mark Argento with Lake Street Capital Markets.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst [23]

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Obviously a, lot of questions have been asked and answered. But just had a couple of follow-ups or drill downs. One is the LVP lifetime value look to be fairly steady over the last couple quarters in particular. I would have thought maybe we would see that trend down a little bit as you got more aggressive in terms of the pet acquisition? So first question would be kind of better understanding the dynamic there? And then secondly, Trish. I know you talked about gross margins towards the lower end of that 18% to 21% range for the year. Can you talk -- drill down a little bit and talk about the -- I know you said, Trupanion Express are cranking up more Trupanion Express penetration rates there would have a negative impact, maybe you could get down a little bit and explain us how that would work?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [24]

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Mark, your first question was about LVP and how it's been trending over the last number of quarters. So as a reminder, Q1 of '16, it was $600 and it was -- in Q1 of '17, it was $637. And most recently, it has been about $727. With the mix of business that we have coming in and the margins we're running at, the retention rates are running at, which are the combinations that drive LVP, I would expect that it will stay relatively flat for the foreseeable maybe for the balance of the year. There's a couple of things that can do to increase it. So having our ARPU increasing 5% to 6% year-over-year obviously as a positive if retention stays the same. We have had margin expansion, but not quite as much margin expansion as we'd want it, so that would tell me that it's going to be more likely flat than going up dramatically. The mix of business as we accelerate our growth in the last 3 quarters, we've been adding more new pets. You are right, that in general, that will slightly lower LVP in general. But it's dependent on a referral sources and a bunch of other things. And last thing I'd mention is our LVP calculation is a 12-month backward looking average, so it tends to smooth things out a little bit. So moving forward, maybe it will expand or stay similar to what it has been over the most recent quarters.

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Tricia Lynn Plouf, Trupanion, Inc. - CFO & Principal Accounting Officer [25]

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And Mark to provide some more color on Trupanion Express. So what we generally see is a slight step up in the number of invoices that we receive. So when we added Trupanion Express hospital, it's really -- a lot of times it is the smaller dollar invoices but the pet owner maybe thought was too cumbersome to submit previously if they had to go through the reimbursement process. And now those don't fall through the cracks. We see all of that, which is good. It's providing more value to the customer and just emphasizing that experience that being paid now as we move towards in a matter of seconds can provide. So we think that, that is a trade-off that we're willing to make. What happens though is because we don't know exactly, which hospitals we're going to be installing it in or how frequently they are going to be using it. We have to wait for that data to come into us. And then, we can incorporate it into our pricing going forward. And so just like we do that in general, we're always looking at data, updating our pricing as needed. This is another thing coming through. And we're incorporating that into our pricing. As a matter of magnitude, we think if this level of Trupanion Express stays where it is, we need pricing increases of about 8% year-over-year versus the 6% we're seeing now. So that's about $0.88 impact to ARPU. And we're working through that. But just remember, those aren't instantaneous. It can take 12 to 18 months to just get things approved and then roll it through our book and we're working on that as we always do. It's just a little bit more (inaudible) because of that more dramatic acceleration that we mentioned in installments, but we think it's definitely worth it for the short term because of the benefit that Trupanion Express brings.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets & Senior Research Analyst [26]

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That's helpful. And then just pivoting back to kind of the exposure or awareness availability. So 8,500 hospitals up, I think was from 8,100 a year ago. Do you anticipate seeing that number move up materially as you bring on some of these 15 additional new markets? I mean, seems to me like that's the key driver here obviously you are doing a nice job with same store, same hospital growth, but actually increase that -- the breadth of hospitals would be key to the story you're going forward?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [27]

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Mark, I agree with you, but it has been historically very, very difficult for us to be going wide and deep at the same time. And we're having some nice success on having better, deeper relationships. And that's been lined up with our new inside account managers and more frequent touch points and Trupanion Express. So I think probably for the next year or 2, we need to kind of fine-tune and build that muscle and then likely start increasing the breadth of hospitals after that. I would love to be able to do both at the same time really well and if you know how to do it, now there is a job waiting for you here.

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Operator [28]

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Our next question comes from the line of Paul Penny with Northland Securities.

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Greg Gibas, [29]

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This is Greg on for Paul. Most of mine have been answered. But just getting what you said earlier about your B2C marketing and how do you expect this -- how do you expect the B2C spend return going forward? And what new markets are you planning on expanding B2C spend in this year?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [30]

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About specific markets and I'm not going to kind of provide that level of detail. I would suggest maybe coming to the shareholder meeting where the teams who are closer to B2C as well as some other initiatives will be able to happy to answer questions directly to you and in more detail then we can just do over a telephone call. But I would say that our desire to increase it is probably greater than our ability to increase it this year as we look at the initiatives we're driving with increasing the number of account managers, which is not nearly at scale yet and it's going to take us several years to build out. I would expect our B2C is probably going to be similar to the last 2 or 3 quarters and not really expanding for the balance of the year unless we get a higher margin expansion in Q3 or Q4 than the current visibility shows us.

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Operator [31]

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Our final question comes from the line of Tom Champion with Cowen and Company.

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Thomas Steven Champion, Cowen and Company, LLC, Research Division - VP [32]

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I'm wondering if you could just remind us of what portion of your hospital-base is using the system. I don't know if I have the numbers correct. It looks like about a quarter, but where do you think that number could get to over time? And I'm just curious why a hospital wouldn't choose to use it?

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Darryl Graham Andrew Rawlings, Trupanion, Inc. - Founder, President, CEO & Director [33]

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Thanks for the question, Tom. The number of clinics using Trupanion Express, those deployments, as I mentioned in my earlier remarks are up 50% year-over-year. I would say 2 years ago, we were holding back our ability to do this until we felt like we were getting it right. And there was a combination of the cost of deploying it. Our ability to absorb having a large enough adjusted operating margins so that we could put on the gas and fill up the cash flow to grow. As well as our ability to get all the benefits from it where we could really understand the customer experience, communicate it with the hospitals. I believe and we have seen markets where 60%, 70%, 80% of clinics can be on Trupanion Express and long-term, we believe that we can get to those numbers across North America. That would have a long-term being able to get to maybe 20,000 clinics. Now currently, we only have about 8,500 active clinics. So the first goal is to get those 70%, 80%, 90% of those active clinics on Trupanion Express. And then the second stage after that is going to be more about going wide and doing it the right way first. It is not going to happen overnight, but we're definitely putting our foot on this accelerator and want it to continue to grow. So it's a major initiative for us. And you compound that with the fact that we announced that we've started testing or started deploying automated claims and how we think that's going to continue to improve Trupanion Express. We look at all of the information. You can't automate a claim without Trupanion Express. We can't provide the level of service without Trupanion Express. So we want to go as fast as we can without stubbing our toes. And we think we're getting into a pretty good rhythm. I think the only other part of your question was why would a hospital not want to use it? And the short answer is I don't have any good reasons why a hospital would not want to use it. I think we have greater demand than we have our ability to deploy it, so the constraints are more on our side than the hospital demand.

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Operator [34]

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