Trupanion Inc (TRUP) 2016 Q4 法說會逐字稿

Greetings and welcome to the Trupanion fourth-quarter and full year 2016 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, 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 begin, I would like to remind everyone that during today's conference call, 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 10Q and 8K 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 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 US 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 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 relation 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 CEO.

Thanks, Tyler, and good afternoon, everyone. I am 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 pets. As a reminder, we targeted 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 rear view mirror, I would 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 a LVP to PAC ratio of 4.5 to 1 in 2015. While we posted a strong year-over-year improvement on a blended basis, ideally, we would deliver our targeted LVP to PAC ratio of 5 to 1 in each of our sub categories. We are starting to make some progress in reducing our pet acquisition spend in unprofitable sub categories, but we have yet to make meaningful progress in increasing and optimizing pet acquisition spend in high LVP sub categories.

As I have acknowledged previously, this is very difficult to do and is a new learning for the organization. It will, however, remain a strategic focus for the organization as our efforts over time should result in a higher LVP opening up additional growth strategies for future years. I expect any improvement will take time to show up in our financials, particularly because our LVP metric is measured on a trailing 12-month basis.

It is hard to overstate the significance of this strategic initiative. We are not focused on growth at all cost. We are focused on creating long-term shareholder value which means maximizing profitable growth. Becoming more effective in our acquisition spend in pet sub categories should increase our internal rate of return and adjusted operating margin, two metrics that we think are the most important in measuring long-term shareholder value creation. As I mentioned earlier, we continued to scale our fixed expenses in 2016, the second focus area in my 2015 shareholder letter. Trish will discuss this in more detail.

Turning to our efforts to improve the messaging around our competitive value proposition to customers, we continue to believe that Trupanion has the most compelling value proposition in our industry, providing lifetime coverage for 90% of veterinary invoices including all congenital and hereditary conditions with no caps or limits. And we do not penalize pet owners for the aging of their pets or for their personal claims history. I believe our customer service is already best in class. With direct pay, we are eliminating the reimbursement model by paying veterinarians directly, without paperwork and without the pet owner needing to pay out of pocket.

In 2016, we paid approximately $30 million directly to veterinarians, up 41% from 2015. As I have mentioned before, we are in the early days of optimizing our messaging to communicate Trupanion's unique value proposition to customers. While we have made progress over the last year, particularly in creating content that helps demonstrate these benefits, we are still working on improving our ability to effectively deploy this information to consumers.

Lastly, I want to talk briefly about the development of our team members. We cannot simply hire experts in the field of medical insurance for pets. We must educate, train, and develop them. 2016 saw us significantly invest in the training programs that we provide to new team members and to territory partners.

Looking ahead, investing in the ongoing education and development of our existing team members will be a strategic priority. The move into our new headquarters was a key step in this process, and we are currently creating additional curriculum that will be rolled out in 2017. To summarize 2016, it was a productive year in which we delivered strong financial results and made progress against our outlined strategic initiatives.

While we are pleased with this strides we made in our financial metrics and free cash flow, cash constraints limited our ability to invest in the testing of additional strategic initiatives. In 2017 and beyond, we will increase our investment in long-term initiatives that may not immediately show up in our financial results, but rather are expected to better position us for the years to come.

We will continue to test ways to optimize our LVP to PAC by subcategory. Additionally, we are now beginning to focus more on same store sales. Same store sales have not been a strong growth driver in the past, but we are dedicated to testing different strategic initiatives that might improve same store performance.

Will also explore more ways to grow our other business segment that has developed through business to business partnerships. This may include developing new opportunities for white label products and new distribution channels. Corporate and veterinary employee benefits are additional areas we plan to further pursue. Finally, we are excited to test new direct to consumer channels while further expanding our Trupanion Express footprint. I will now hand the call over to Trish to review the details of our 2016 financial performance and 2017 outlook.

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 pet 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 million in the quarter, up 29% 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 pet.

Total subscription enrolled pets increased 19% year-over-year and totaled approximately 323,000 as of December 31. Monthly average revenue per pet was $49.17, an increase of 8% year-over-year. In local currency, monthly average revenue per pet increased by 9% from the prior year for our US members and by 5% from the prior year for our Canadian members.

Average monthly retention was 98.6%, down from 98.64% in the prior year period. As I mentioned on last quarter's call, we made billing system and process changes at the end of the third quarter to better update for credit cards that fail. We are happy with the new billing system and are still working on rolling out process enhancements.

Our other business revenue, which generally is comprised of our revenue that has a B2B component, totaled $3.9 million, up 13% from the fourth quarter of 2015, primarily due to an increased number of pets in this segment. Total gross profit for the quarter was $9.3 million, a 26% improvement over the prior year period.

Our subscription gross margin was 19%, in line with our annual target of 18% to 21%. For the quarter, fixed expenses represented 10% of total revenue, down from 13% in the prior year period, driven by scale in both our technology and general and administrative departments.

I now want to turn to our acquisition costs. In the fourth quarter, we spent an average of $133 to acquire a pet with an average lifetime value of $631. Our LVP to PAC ratio for the fourth quarter was 4.7 to 1, up from 4.5 to 1 in the prior year period.

Similar to the fourth quarter of 2015, the cost associated with our annual territory partner conference, which was held in October, resulted in our LVP to PAC being slightly lower than 5 to 1. Adjusted operating income totaled $4.1 million in the fourth quarter, or 8% of revenue compared to $2.2 million, or 6% of revenue in the prior year period. We generated a net loss of $1.7 million, or $0.06 per share during the quarter compared to a net loss of $3 million, or $0.11 per share in the prior year quarter.

We ended the fourth quarter with 29.5 million basic shares outstanding and 33 million shares outstanding on a fully dilutive basis. Adjusted EBITDA for the quarter was a positive $0.3 million compared to a $1.6 million loss in the prior year period and in line with our expectation of being around breakeven.

We generated positive free cash flow of $3 million in the quarter, aided from growth in our core subscription business, scale in fixed expenses, and continued discipline in new pet acquisition spends. We ended the quarter with $53.2 million in cash, cash equivalents and short-term investments. During the quarter, we drew down approximately $1 million against our line of credit to end the quarter with $4.8 million in long-term debt.

In December, we also increased our line of credit from $20 million to $30 million by syndicating our existing facility to include an additional lender. Turning now to our outlook for Q1 and full-year 2017, revenue for the first quarter of 2017 is expected to be in the range of $53 million to $54 million, representing 25% year-over-year growth at the midpoint.

Revenue for the full year 2017 is expected to be in the range of $230 million to $235 million, representing 24% year-over-year growth at the midpoint. At these revenue ranges, assuming a 5 to 1 LVP to PAC ratio, we would expect adjusted EBITDA to be around breakeven for Q1 and in the range of $2 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 US and Canadian currencies. For our first quarter and full-year guidance, we used a 76% conversion rate in our projections which was the approximate rate at the end of January. With that, I would like to thank you for your time today and will now turn the call back over to Darryl.

In closing, I am 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, I will open the call up to questions. Operator?

Thank you.

(Operator Instructions).

Andrew Bruckner, 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 experiments you are going to do in terms of acquisition channels, how you are thinking about going direct to consumer at all and what marketing channels you will use. 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. Your first question, more detail on some of the testing that we're hoping to do in direct to consumer. Let me start by saying 2016, because we were focused on cash flow breakeven, hitting our blended 5 to 1, and our LVP is a little bit 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 are 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 are going to have a material impact on the pet growth in a 2017. As Trish mentioned in her remarks, we are looking at 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 2019.

As part of your next question about mix, we will be trying to work on our mix of business, primarily on enrolling less of our subcategories that are unprofitable. To me, unprofitable is where our LVP to PAC ratio is at a 1 to 1 or less. I 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. That is trying to shut down certain areas and accelerate other areas. We are not planning on publicly disclosing which of our subcategories we are going after, which mix of business by geography or breed, but is something that we are focused on in it 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 to -- 2015 to about $15 million in 2016, and we expect that to compound over the years. As that number gets closer to $50 million, we need to be really good stewards at learning how to spend that money. So 2017 has really set us up for that.

So hopefully, that answers your questions, Andrew.

Great. Thank you.

Jon Block, Stifel Nicolaus.

Good afternoon. Maybe two or three questions. The first one is, Darryl, you just hit on it a little bit, and/or Trish, the guidance -- anymore color around adds or ARPU, or should we think maybe that high single-digit maybe a 7% or 8% increase in ARPU is a good place to be in back into the adds from the revenue guidance that you have given?

Sure, Jon. Yes, you are thinking about it the right way in terms of taking ARPU and then backing into adds. We would say although we are 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 adds that way.

Okay, great. And then Darryl, you mentioned the same store sales, a newer initiative for the Company or maybe getting a greater focus. Maybe if you can 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 historically, this Company has not grown by same store sales. Historically, it has grown by adding stores. By the time we look at the end of this decade, we need to become better at the same store sales.

We ran a pilot last year with a little over 100 hospitals and had some encouraging results. It is really around us trying to increase the number of touch points at a hospital in between visits of a territory partner. A territory partner is typically trying to visit on a 60 day cycle.

We realized 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 that might help us with same store sales. So what we are 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 60 day cycle.

We are leveraging Trupanion Express of all the data that we are receiving out of that to be passing that information back to the hospitals. So Trupanion Express is definitely a part of the strategy, but is just another tool in our toolkit.

Okay, great. Maybe one more quick one from me. I think you previously said about 20% of the adds were suboptimized, and I believe you just threw out 70% -- 17% suboptimized. Where is the optimal number, the right number, and I know you can say zero or 1%, but probably not realistic.

When you look at the organization, where do you want the Company to get? Is that a 5% number or a 10% number? Maybe just some context there. Thank you, guys.

First let's talk about suboptimized. In my mind, I have been defining suboptimized that places where our PAC spend, if it is $130, we are expecting to receive $130 or less. This is 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 took it from what was 20% down to 17% and then down to maybe 10% this year, that would be good progress. I think longer-term, we would like to see that in our bigger sub categories down to maybe 5%.

But then what we call suboptimized over the years will change maybe from a 1 to 1 or worse to ones that are making a modest profit but not as good as we could be. Right now, we are really focused on the ones that are really hurting our LVP and hurting our blended mix of business and trying to make progress there.

Got it. Very helpful. Thank you guys.

Michael Graham, Canaccord Genuity.

Thanks a lot. A couple of questions. One is on just the drivers of the ARPU for the average revenue per pet. I know we have got some mix improvements that are happening.

How much is related to just inflation of healthcare costs? I know that was a big driver in prior years. I just, Darryl, wanted to ask about your -- if you could just refresh us on your philosophy about how you are thinking about the percentage of profitability of the Company, just remind us what your guide rails are. What we should expect over a multi-year period. Thank you.

Thanks, Michael. Let's start off by talking about our general value proposition. What we are trying to do is understand the underlying cost and add about 30 points on top of it for the average pet owner. So if it is the average cost for a dog, it is going to be different than the average cost for a cat, same for a Golden Retriever, someone living in New York.

What we are trying to do is to have about our cost less model having -- our cost to pay veterinary invoices for the average pet owner, us paying back about $0.70 or $0.72 on the dollar. And then after we payout 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 our adjusted operating profit go from $3 million in 2015 to about $15 million in 2016.

In a percentage basis, that took it from 2% to 8%. Ultimately, we want to get that to 15%. We believe it will 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 are 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 are just a cost-plus model, it really is the cost of veterinary medicine for Trupanion clients. So 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 are looking at the inflationary cost for an insured client.

That includes referral and specialty hospitals and it includes advancements in technology. It includes utilization, but in aggregate, it is that inflationary costs that drives the ARPU, much more than mix.

Okay. Thanks. Then just one quick follow-up on the retention rate. So very minor changes, but it is drifting down a bit. Is this still the impact of the billing system changes, or can you just comment? What you expect to be the direction of that retention rate, say, in 2017?

Hello, Michael. I will answer this one. I mentioned in my remarks that we are happy with how the billing system rollout went, happy with that investment. What we are seeing preliminarily is some of that better technology as positive, but it can take a wild to roll through retention because our retention rate is backward looking.

That is also just one portion of our overall retention and cancellation reason. That being said, going from 98.64% last year to 98.6% this year, both are still very strong retention rates and above our 10-year historic average which is 98.5%. One thing that I do want to point out as we have been talking about these suboptimized pets that we have and one of the ways we are working on making those improvements is by getting those that are mispriced priced correctly.

So we will be rolling out that pricing over the course of this next year, which will be larger pricing increases for some of those pets that are not priced correctly. So we may see a bit of an impact to retention as those roll out. As I've said before, or as I just said, I wouldn't expect it to be overly significant though.

We still should be above our 10-year average of 98.5%. I think Darryl's recommended in the past modeling at 98.5%, which is our 10-year average, and we would continue to recommend to do so.

Okay. (multiple speakers) Sorry, Darryl.

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

Okay. That make sense. 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?

It is pretty close to that 17% number that I came up with.

Okay. Thank you.

Mark Argento, Lake Street Capital Market.

Good afternoon. Just a couple of high-level questions. I know the quarter, just after the quarter, we had a big acquisition in the vet space. Maybe 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 a veterinarian or a veterinarian hospitals. And then maybe dovetail that into the competitive environment. Is it a rational competitive environment out there? How are your competitors behaving from pricing perspective, and do you feel like you guys are -- continue to be well positioned there?

Thanks, Mark. I think the consolidation that you are 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 have been partnered with for the last couple of years. They have, I believe about 900 hospitals.

Mars now has four legs to their chair in the animal health side. One is Banfield, which have about I think about another 900 hospitals. Then there is a group called Pet Partners which, right now I believe has about 150 or 200 and is expanding rapidly. The fourth one is BluePearl, which is about 50 or so, I believe, referral and specialty hospitals that are doing amazing medicine.

We have had long-term relationships with three out of these four Mars entities for a number of years, so I think we are 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 is also going to be pressure to increase veterinarians' pay, which has been pretty stagnant over the years.

Because it Trupanion clients visit twice as frequently and spend twice as much money, we think we are very well aligned with the companies like Mars and others to help them do well in recouping their investment. I think that Mars who has been dedicated to the pet space, they also own food and a bunch of other areas, is a very long-term thinker, thinking out 10 and 20 years. And long-term thinking being aligned on trying to get the pets with the best medicine, trying to increase veterinary pay, trying to increase the availability of veterinary care, the fact that they own BluePearl referral and specialty and there's higher costs in those areas with amazing medicine I think are all very aligned with Trupanion.

So net, we are very encouraged. On a macro level, as a reminder, there is about 28,000 hospitals, and today, about 25,000 to 26,000 of them are independently owned. In aggregate, Mars is probably after the completion of VCA is about 2,000 rough numbers.

Your second question was how is the competitive environment? My short answer is it is pretty similar than it has been for the last 10 or 15 years that I have been competing in North America. At any given time, we've typically competed against about 15 to 20 brands.

I think we have competed against over 45 brands, closer to 50 brand over the years. So nothing in the number of entries or the number of companies is really different. The companies that are growing faster are companies that are covering congenital hereditary issues which is good for the entire category.

We don't see anybody else that is really making any strong inroads on a couple of our deeper motes which is our data, our ability to have a national sales force and of the desire and ability to have direct pay. So we think all of those motes are important. As we mentioned earlier, 17% of the pets, we have been of rolling over the last couple of years being what we would consider unprofitable.

That is with all of the data that we have and all the analytics that we have. I am very confident that we are doing exponentially better than others, and we will continue to do exponentially better than others. But there will always be people in the marketplace that are either unintentionally underpriced or unintentionally overpriced.

And in a few cases, people would be doing it as a short-term strategy, but if underlying, we can offer the highest value proposition because we have eliminated frictional cost, and we can afford to pay $0.72 on the dollar compared to other companies. And we continued to reduce our frictional expenses, we think that we can get to a 15% operating margin at a scale that will have taken us 20 years to get to. We think we are well-positioned in the category.

But we will have to continue to be face down running hard making sure our customers are getting the best by proposition and making sure that they understand that value.

That is helpful. Just one quick one for Tricia. And regards to the guidance that $2 million to $5 million in EBITDA, I am assuming that already takes into consideration the incremental testing and spend around some of these new initiatives. Is that right?

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

Great. Thanks, and congrats on a solid quarter.

Thank you.

Kevin Kopelman, Cowen and Company.

Hello. Thanks a lot. So my first question, I was just wondering if you can 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 and part of the direct consumer testing that you refer to?

Okay. So nothing on the online. Today, about 90 -- a little over 90%, it's closer to 94%, of all the pets that we enroll 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 are 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 is short-term or near-term is going to be cost-effective or somewhere that we plan on spending a lot of time or effort on. That being said, online is very important for our conversions.

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 rates 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 are leading in, is being, I believe, driven by veterinarian recommendations 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 as a new lead source.

Okay. Is that an area of investment then, just general R&D on the website in 2017?

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

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

We separate it out internally. So we are working on right now what we reported on a blended basis. We ideally would like to have 10% to 20% of our PAC spend being allocated for testing, which tells us, if you want to do the math on it, we have a lot of places where we are running at a 5.5 or a 6 to 1.

But as our adjusted operating margin improves, you'll see us be more focused on the internal rate of return and what that drives. 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.

Thanks, Darryl.

We are tracking that separately. We monitor that on a monthly basis.

Got it. Thank you.

Chris Merwin, Barclays.

Thank you. This is Mario Lu on for Chris. You mentioned earlier that you will continue to focus more on same store sales and corporate. Could you provide more color on the additional strategic initiatives that you mentioned that you couldn't go into because of cash restraints?

Yes. We would have liked to have been able to do a lot more testing last year. I am going to do two ones that are easy for people to imagine. We like to do more testing on radio and TV that we started to do in 2015 and quite friendly, we were 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 ones.

We just want to had latitude to be able to test and see if some of these will be larger growth drivers in the future. It takes us a while for those to test them out. One you have to test to see if you can get the cost of the lead and you need to understand the conversion rate. You understand the acquisition cost and then it takes some time for us to also realize what the short-term retention from that new pet is going to look like.

We just want to be able to do more of that. Does that answer your question or were you trying to get to something else?

Yes. No, that make sense. Thank you.

We have 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.