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Edited Transcript of TRUP earnings conference call or presentation 2-May-17 8:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Trupanion Inc Earnings Call

Seattle May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Trupanion Inc earnings conference call or presentation Tuesday, May 2, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Asher Bearman

Trupanion, Inc. - Chief Administrative Officer and Secretary

* Darryl Rawlings

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

* Laura Bainbridge

ADDO Investor Relations - MD

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Conference Call Participants

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* Andrew David Bruckner

RBC Capital Markets, LLC, Research Division - Analyst

* Jonathan D. Block

Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst

* Mark Nicholas Argento

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

* Michael Patrick Graham

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

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Presentation

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Operator [1]

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Greetings, and welcome to the Trupanion First Quarter 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to Laura Bainbridge.

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Laura Bainbridge, ADDO Investor Relations - MD [2]

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Good afternoon, and welcome to the Trupanion First Quarter 2017 Financial Results Conference Call.

Before we begin, I would like to remind everyone that during today's conference call, we will make certain forward-looking statements regarding the future operations, opportunities and financial performance of Trupanion within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release, which can be found on our Investor Relations website as well as the company's most recent reports on Forms 10-K and 8-K filed with the Securities and Exchange Commission.

Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance including, without limitation, fixed expenses, variable expenses, adjusted operating income, acquisition cost, adjusted EBITDA and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to our non-GAAP operating income or margin before new pet acquisition. 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 U.S. GAAP. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures, which can be found in today's press release or on Trupanion's Investor Relations website under the quarterly earnings tab.

Lastly, I would like to remind everyone that today's call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. With that, I would like to turn the call over to Darryl, Trupanion's founder and Chief Executive Officer.

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [3]

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Thanks, Laura, and good afternoon, everyone. I'm joined today by Asher Bearman, our Chief Administrative Officer. Tricia Plouf, our Chief Financial Officer, is on maternity leave, having just given birth to her daughter a week ago.

Before I jump into the details of the first quarter, I want to highlight that on April 26, we published our 2016 annual report, which includes my third annual shareholder letter. I'll touch upon a few of the highlights today, but I encourage you all to give it a read as it provides some comprehensive insight into how we operate and think about our business. For a more in-depth discussion around the focus areas highlighted in the shareholder letter, I also would like to invite you to an upcoming meeting of shareholders, which will be held on June 7 at our headquarters here in Seattle. Our intention is for this event to be an annual opportunity for our shareholders to witness our culture, interact with our team and learn more about our key initiatives.

Turning now to our high-level results. It was another solid quarter financially. We grew total revenue by 28% year-over-year. We expanded our year-over-year adjusted operating margin by 170 basis points to 8%. We continued to leverage our fixed expenses. We delivered our fourth consecutive quarter of positive free cash flow. And we achieved our targeted LVP to PAC ratio of 5:1. We also continued to chip away at the key focus areas, as I laid out in our annual shareholder letter. In some areas, we've made more progress than others, but we're squarely focused on deepening the modes around the business.

One of our largest competitive modes is our national sales force of Territory Partners. In 2016, we increased the number of people in the field from 84 to 104, adding Territory Partners at both the new markets and in territories where we have a more established presence. 80% of hospitals are located within these territories, and we have a target of visiting these hospitals every 2 months.

One of our main focuses in 2016 and continuing in 2017 has been on increasing same-store sales. Historically, it has been difficult for us to focus on both adding new stores while increasing same-store sales. And our active hospital growth in 2016 reflects this challenge. In 2016, the number of hospitals actively recommending Trupanion peaked at just over 8,100 hospitals compared to the 7,660 at the end of 2015. This is below the expectations that we had set out for ourselves going into 2016, but was reflective of our shifting focus around the middle of 2016 towards growing same-store sales. As I discussed in the most recent shareholder letter, it's too early to tell whether this strategy will pay off, but I feel good about our progress thus far.

We've begun testing new strategies centered around providing partnering hospitals with more data and information, enabled largely by Trupanion Express and previously unavailable to us. And we're doing so with an increased frequency compared to our historical touch points, we expect that this will be an important multiyear initiative. We ended 2016 with over 1,400 Trupanion Express-enabled hospitals, up from 500 in the prior year, but slightly below our prior target of 1,500 to 2,000 hospitals. This was deliberate and reflective of our strategy to better leverage Trupanion Express as a tool to support our same-store sales initiatives. We paid over $30 million in claims directly to veterinary hospitals in 2016, up 41% from 2015. And we are working diligently towards a day when 95% of our members' invoices are paid directly and instantly to their veterinarian hospital.

Acquiring pets through the veterinary channel remains our primary focus. And today, approximately 80% of our new enrollments are generated from veterinarians or from our existing members. In more mature markets, where the majority of veterinarians are actively recommending Trupanion, we believe we will eventually be able to cost effectively use mediums, such as television and radio, to increase brand loyalty and conversion rates. We continue to test these alternative channels in strategic ways. In the first quarter, we were slightly more aggressive in our direct-to-consumer testing as compared to 2016. The results were encouraging, and we intend to continue targeted tests throughout the remainder of 2017.

Our ability to optimize LVP to PAC by subcategory remains an important aspect to this effort longer term. We spent quite a bit of time in prior calls talking about our work in this area, and at a high-level, we've made some progress by improving known pricing misses. That said, we have additional work to do to get our pricing as accurate as possible at the subcategory level. You can find some additional detailed thinking on this topic in our most recent shareholder letter.

Longer term, our strategy is to continue to optimize our business in a way that drives higher lifetime value pets, and thus, enables higher PAC spend. This should allow for alternative acquisition channels within our LVP to PAC discipline. We use the internal rate of return on our pet acquisition spend to help inform the appropriate target for LVP to PAC ratio, taking into account our current adjusted operating margin. Moving forward, as we continue to scale our adjusted operating margin, we may start to adjust our LVP to PAC target based on our estimated internal rates of return.

2017 also marks a renewed focus on using our insurance entity, American Pet Insurance Company to issue policies for other pet medical insurance brands. In the first quarter of 2017, our insurance entity began issuing policies for Pets Best, a well-established U.S. provider of medical insurance for pets. This relatively new underwriting relationship is not expected to materially affect our financial results this year, perhaps adding up to 20,000 pets to our total enrolled pet count over the course of 2017. But we hope that in partnering with Pets Best, we can help them continue to drive growth in their business over the longer term.

This is one example of our strategy to develop business-to-business partnerships to grow the category. Interesting product offerings and distribution models are likely to arrive, and we believe our infrastructure, people and data can help advance these models and these products without distracting from our focus to increase the acceptance of the category. We increased the acceptance of the category by providing high-quality medical insurance to the life of a pet and educating veterinarians and their staff of the benefits of Trupanion.

With that, I'll hand the call over to Asher to walk through the details of our first quarter results and to discuss our 2017 outlook in greater detail.

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Asher Bearman, Trupanion, Inc. - Chief Administrative Officer and Secretary [4]

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Thanks, Darryl, and good afternoon, everyone. On behalf of Tricia and the rest of the team, we are pleased with our financial performance in the first quarter of 2017.

Total revenue for the quarter was $54.7 million, up 28% year-over-year. Total enrolled pets increased 19% year-over-year to over 364,000 pets as of March 31. Subscription revenue was $50.2 million in the quarter, up 28% year-over-year and comprised 92% of total revenue. Growth was once again driven by increases in average revenue per pet as well as growth in subscription enrolled pets. Total subscription enrolled pets increased 17% year-over-year to approximately 335,000 pets as of March 31.

Monthly average revenue per pet was $50.50, an increase of 9% year-over-year. In local currency, monthly average revenue per pet increased by 9% from the prior year for our U.S. members and by 6% from the prior year for our Canadian members. Average monthly retention was 98.58%, a decrease from 98.65% in the prior year period.

Our other business revenue, which generally is comprised of our revenue that has a B2B component, totaled $4.5 million. This 27% year-over-year increase reflects an increase in the number of pets in this segment attributable to our relationship with Pets Best. The total enrolled pets in our other business segment was over 29,000 at quarter-end.

Subscription gross margin was 18% in the quarter, within our annual target of 18% to 21%. For the quarter, fixed expenses represented 9% of total revenue, down from 11% in the prior year period, reflecting increased scale in our technology and general and administrative departments.

Adjusted operating income totaled $4.4 million in the first quarter compared to $2.7 million in the prior year period. Net loss was $1.5 million in the quarter. As a percent of revenues, adjusted operating margin expanded to 8% from 6% in the prior year period. We view expansion in adjusted operating income as one of the most important measures of shareholder value creation longer term, as it represents income generated from our existing book of business that is available to invest in new pet acquisition.

I now want to turn to our acquisition costs. In the first quarter, we spent $3.9 million on pet acquisitions compared to $3.8 million in the prior year period. This equated to an average of $128 per acquired pet with a corresponding average lifetime value of $637. Our LVP to PAC ratio for the first quarter was 5:1 compared to 4.9:1 in the prior year period. Adjusted EBITDA for the quarter was a positive $0.5 million compared to a loss of $1.1 million in the prior year period.

We generated positive free cash flow of $1.4 million in the quarter. We are pleased with our ability to deliver 4 consecutive quarters of positive free cash flow, and our goal is to continue this trend. We generated a net loss of $1.5 million or $0.05 per share during the quarter compared to a net loss of $2.6 million or $0.09 per share in the prior year period.

We ended the first quarter with 29.8 million basic shares outstanding and 33.4 million shares outstanding on a fully diluted basis. At March 31, we had $52.7 million in cash, cash equivalents and short-term investments.

I'll now turn to our outlook for the second quarter and full year 2017. Revenue for the second quarter of 2017 is expected to be in the range of $57 million to $58 million, representing 25% year-over-year growth at the midpoint. At this revenue range, assuming we do not adjust our target and we continue to hit a 5:1 LVP to PAC ratio, we would expect adjusted EBITDA to be around breakeven for Q2.

Based on our performance in Q1, we are increasing our outlook for the full year. Revenue for the full year is now expected to be in the range of $233 million to $237 million, representing 25% year-over-year growth at the midpoint. At this revenue range, and again assuming we deliver an acquisition spend in line with the 5:1 LVP to PAC ratio, we would expect adjusted EBITDA to be in the range of $3 million to $5 million for the full year. Also, 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 75% conversion rate in our projections, which was the approximate rate at the end of the March.

With that, I would like to thank you for your time today and will now turn the call back over to Darryl.

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [5]

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Thanks, Asher. Before we open it up for questions, I want to take a moment to thank our investors for their continued support. For those of you who are considering becoming a shareholder of Trupanion, we encourage you to review our 2016 annual shareholder letter, which is now available on our Investor Relations website.

We also have many Investor Relations activities planned over the coming weeks, including hosting an investor Q&A session following the Berkshire Annual Meeting, May 6, in Omaha; participation at the upcoming Stifel Dental and Veterinary Conference; and the Cowen TMT Conference, both to be held in New York on May 31 and June 1, respectively. And as I mentioned earlier, hosting our upcoming Annual Meeting of Shareholders at our headquarters in Seattle. We look forward to speaking with many of you at one of these events. And with that, we'll open the call up for questions. Operator?

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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 Jon Block with Stifel.

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Jonathan D. Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst [2]

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Darryl, maybe just to start on the Territory Partners, the 104 that you called out versus the 84 -- 104 at the end of '16 versus 84 at the end of '15. But 104 was a little bit higher than I would have anticipated. I think in the early days, you thought maybe 90 or 100 was close to a full sales force. So maybe if you could just take a step back, and what are your expectations for the Territory Partners over the next 12-or-so months? Will that continue to grow? Or you're sort of in the training mode right now, get them up to speed and working that sort of same-store sales utilization?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [3]

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Thanks, Jon. I would expect that we're going to have modest growth over 2017, but we're definitely in a training mode. We've got a lot of Territory Partners that are in year 1 or year 2. When we talked earlier several years ago about the number of Territory Partners, we were thinking more about the number of regions. And what we've been doing as we're starting to test same-store sales and a bunch of other things is we're starting to add some additional Territory Partners in some of our existing more mature markets. So if you take like a second Coca-Cola distributor adding a second Coca-Cola truck to an area, so we're going to continue to test and see how that goes. But I'd expect modest growth and a lot more training in 2017. We've got probably 10 open territories that are, like, Charlotte, St. Louis, Pittsburgh, Minneapolis that we're trying to fill. We'll have some that will turn over this year. As we know, it's a challenge to get a Territory Partner through the first couple of years. But we're encouraged with what we see.

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Jonathan D. Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst [4]

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Okay, great. Maybe just 2 more from me. Sort of backing into a flattish gross add number year-over-year. But that was against your toughest comp in 1Q '16. So maybe just your thoughts around the gross additions this year. I know you've got some initiatives out there that may gain traction throughout 2017. So as we get to the back part of the year, Darryl, is this a situation where you think, as a company, you recapture some growth in that gross addition number?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [5]

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Well, you're right that we're looking at a lot of testing of long-term initiatives, same-store sales and direct-to-consumer. We're also trying to fix some of our pricing by subcategories. But as I've -- we're -- Asher gave in the guidance earlier, we're on the top end of our range and trying to grow in the 20% to 30% year-over-year. I think we're more going to be focused on learning and getting our initiatives right this year, which will set us up for longer term for '18, '19 and '20 to have sustained consistent growth rather than trying to put our foot on the accelerator just on the back half of the year.

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Jonathan D. Block, Stifel, Nicolaus & Company, Incorporated, Research Division - MD and Analyst [6]

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Okay. And last one from me. In the shareholder letter that you alluded to, I believe there was a part of the letter where you talked about an initiative or maybe a couple of initiatives that were yielding good returns. It was early. You seemed somewhat cautious in the writing. But anything that you can provide more color on what that may be? I mean, even at higher level, is it specific to direct-to-consumer? I'm not sure if you want to give some more color there.

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [7]

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Thanks, Jon. I'm not going to give a lot of color on it. But I will say that this is more about us trying to increase brand awareness, and therefore, increase conversion rates in some of our more established markets rather than initiatives trying to drive new leads. The majority of the people that end up enrolling with us are puppies and kittens. Those people -- all types of veterinarians and we're trying to reinforce in regions and markets where we have a high number of active hospitals. So most of our testing is driven around places where we have density, have already built up brand recognition and seeing if can continue with that trend.

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Operator [8]

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Our next question comes from the line of Mark Argento with Lake Street Capital.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets and Senior Research Analyst [9]

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Just wanted to drill down a little bit. You made a comment about looking at kind of market-by-market, depending upon kind of penetration rates, maybe thinking about adjusting that LVP to PAC ratio. Is there anything in terms of -- I'm assuming maybe getting a little more aggressive on the customer acquisition side. Is there anything -- any type of penetration rates that you're looking at? Or what would be some of the things that we could witness or you'd like to witness before you got a little more more aggressive in the ratio in some of those markets?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [10]

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Well, the biggest thing to drive -- our adjusting our target ratio is really seeing continued trend in our adjusted operating margin. So 2 years ago, that was at about 1%, and we're trying to get now kind of in the 8% range. When we start to get it to the 9% and 10% range, if you look at my most recent shareholder, you'll see that we can start to get internal rates of return that are higher than what we've achieved in '15 and '16 while targeting an LVP to PAC ratio, which will allow us to be a little more aggressive. So that's the principle driver for us. So our adjusted operating income is something that's been compounding over time. So it's getting bigger, because our book of business grows, but it's also compounding because we're getting margin expansion. That gives us a bigger pool of money to be able to reinvest. The second thing is by having better internal rates of return means we get to cash flow breakeven earlier, which can have us being more aggressive. We will probably be testing those in markets where we probably have a greater establishment and maybe higher conversion rates than brand new markets for us, because this is not about just any company writing a check and creating awareness. This is really about trying to create acceptance for this category. And acceptance is driven by the vet. And if we can help the veterinarians so that when they initiate a conversation about Trupanion that the client says, I've has heard about them or can you tell me more about them, I think that's where we're going to go. But it's still -- it's really early days. And I don't know if it's going to be radio or TV or Facebook or magazines that's going to be the best outcome for us. So this year, we're just going to try to continue to test until we see things that are repeatable.

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Mark Nicholas Argento, Lake Street Capital Markets, LLC, Research Division - Head of Capital Markets and Senior Research Analyst [11]

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Right. Anything on the competitive environment side? Any new entrants in the market? Obviously, a unique twist here of providing underwriting services to, I guess, technically a competitor. Any thoughts on what you're seeing out there right now?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [12]

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Yes, I mean, no big changes. The total number of brands in the marketplace has been fairly consistent for the last 5 years. There's nothing that has us changing our short-term or long-term strategy. Competitors ebb and flow over time. I mean, who were our strongest competitors 3 and 4 years ago change. But the short answer to it is no, nothing significant. What we're doing with Pets Best is -- demonstrates how we think we can be good partners for people trying to enter the space. With our data, the team of people that we have, our focus -- if there are companies that have unique distribution channels or unique products, we think we can actually be really helpful, and that helps create growth in the category and acceptance in the category without distracting from our focus on the veterinarian channel and the key to growing this business.

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Operator [13]

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The next question is from the line of Michael Graham with Canaccord.

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

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Darryl, just wanted to ask -- well, first of all, if you gave this, I apologize. But last quarter, you said 17% of pets were unprofitable. I'm just wondering how that's changed and sort of what you've done there over the last 3 months. And then I just wanted to also ask about the lifestyle of a vet once the life cycle of a vet once they come onboard? In other words, in the first year versus like the second and third years, do you see a much higher penetration of the pets that they're caring for? Do they end up steering more of them over towards your products?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [15]

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Let me take your second question first, which is a really intuitive and smart question about what behaviors change as years pass with a veterinarian recommending us. Historically, that has been the only driver that we've had for same-store sales. So a hospital has been recommending us for one year does not recommend as many pets in a given month or a period of time and somebody that's been recommending us for 5 years. So the more that people get used to it, we live up to what we say. They get pets enrolled and they may have to wait 1 year or 2 until they have major medical problem. Then they see us doing what we say. Then they recommend us with more confidence in the future. So that is something that's been historical, a trend that we've seen for the last 15 years. We're trying to do a few things to try to accelerate that. When we talk about some of our same-store sales initiative, that's mainly driven around using some of the information that we get from Trupanion Express, trying to have more touch points, so we can get back to them more on a frequent basis. But you are -- your intuition that a hospital recommending us for 5 years recommends us more than one at 3 years or 1 year is correct. And it's an important part of our business model. The first part of your question was about -- we've mentioned in the past, and there is a lot more details about this in the shareholder letter, if you haven't had a chance to read it yet, about how we're looking to have each of our subcategories optimize where we're providing $0.70 cents on the $1 value proposition to all of our pet owners and then trying to let -- line up our acquisition spend to the appropriate dollar amount. We continue to chip away at it. We're making progress. It's not something that I plan on giving visibility to on a quarterly basis, because quarter-to-quarter, it doesn't mean much. But I would say on an annual basis, I'm expecting to see good progress a year from now. I'd like to see that number eventually less than 5%. And I think in 2017, we will definitely chip away at that and feel good about at the end of the year.

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Operator [16]

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(Operator Instructions) The next question is from the line of Andrew Bruckner with RBC.

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Andrew David Bruckner, RBC Capital Markets, LLC, Research Division - Analyst [17]

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I just wanted to follow up to a question on Express. And given the hospitals are quite where you thought they were going to be, are you seeing actually more revenue dollars flow through them than you had initially thought or claims dollars rather? And do you have any details on -- do new hospitals rather actually ever go on Express immediately, or are they only for more seasoned hospitals? It's not worth the initial setup expense?

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Darryl Rawlings, Trupanion, Inc. - Founder, CEO, President and Director [18]

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So let me give you some insight into it. We went from about 500 hospitals to 1,400 with Trupanion Express enabled, slightly below what we would have anticipated going into the year. What we have found is Trupanion Express, beyond having a great customer experience, is giving us information to help us with other initiatives. But to do that, we wanted to slow down a little bit and train people appropriately. So we're trying to balance the "go out quickly and have lighter touch" with having kind of appropriate return. We are seeing slight revenue improvements in these hospitals. Claims costs are coming in right where we expect them to be, so no surprises there. But what we are really happy about is Trupanion Express is a more valuable tool than we originally initiated from all aspects of our relationships. And that includes brand new hospitals that are coming onboard and saying, I otherwise would not be interested in this category without it. So hospitals that have had no previous experience to ones that have been working with us for years that are saying, when can I get onboard. We have greater demand than we do have our ability to deploy at this point. Our biggest constraints are really internal and making sure that we do it effectively. If I look at our operational challenges over the years, when I've tried to accelerate just for the sake of acceleration, I've wanted to go back and slow things down. And this one, I think, we're balancing it between speed and quality. Does that answer your question?

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Operator [19]

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There are no additional questions at this time. This will conclude today's teleconference. Thank you for your participation. And you may now disconnect your lines at this time.