Total Pets Enrolled: the number of pets subscribed to either our plan or one of the insurance products offered in our other business segment at the end of each period presented. We monitor total pets enrolled because it provides an indication of the growth of our consolidated business.

Total Subscription Pets Enrolled: the number of pets subscribed to the plan marketed by Trupanion to consumers at the end of each period presented. We monitor total subscription pets enrolled because it provides an indication of the growth of our subscription business.

Monthly Average Revenue per Pet: calculated as amounts billed in a given month for subscriptions divided by the total number of subscription pet months in the period. We monitor monthly average revenue per pet because it is an indicator of the per pet unit economics of our business.

  • Total Subscription Pet Months in a Period: the sum of all pets enrolled for each month during the period.

Lifetime Value of a Pet (LVP): calculated in part based on gross profit from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods, multiplied by the implied average subscriber life in months. We monitor LVP to assess how much lifetime value we might expect from new pets over their implied average subscriber life in months and to evaluate the amount of sales and marketing expenses we may want to incur to attract new pet enrollments.

  • Implied Average Subscriber Life in Months: calculated as the quotient obtained by dividing one by one minus the average monthly retention rate.

Average Pet Acquisition Cost (PAC): calculated as net acquisition cost divided by the total number of new subscription pets enrolled in that period. We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness using the ratio of our lifetime value of a pet to average pet acquisition cost.

  • Net Acquisition Cost (non- GAAP financial measure): calculated in a reporting period as sales and marketing expenses, excluding stock-based compensation expense, offset by sign-up fee revenue and other business segment sales and marketing expenses. We offset sales and marketing expenses with signup fee revenue since it is a one-time charge to new members used to partially offset initial setup costs, which are included in sales and marketing expenses.

Average Monthly Retention: measured as the monthly retention rate of enrolled subscription pets for each applicable period averaged over the 12 months prior to the period end date. As such, our average monthly retention rate as of December 31, 2016 is an average of each month’s retention from January 1, 2016 through December 31, 2016. We calculate monthly retention as the number of pets that remain after subtracting all pets that cancel during a month, including pets that enroll and cancel within that month, divided by the total pets enrolled at the beginning of that month. We monitor average monthly retention because it provides a measure of member satisfaction and allows us to calculate the implied average subscriber life in months.

Adjusted EBITDA (non- GAAP financial measure): calculated as net loss excluding stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, change in fair value of warrant liabilities, income tax expense (benefit) and loss (income) from equity method investment. A measure used by our management, board of directors, investors, securities analysts, rating agencies and other parties to evaluate and discuss our operating and financial performance as well as our debt service capabilities.

Q: What is Trupanion’s long-term target ratio for lifetime value of a pet (LVP) to pet acquisition cost (PAC)?

In years prior to 2015, we were not focused on scaling our fixed expenses. Instead, we made significant investments in infrastructure to support our growth. As a result, we targeted a 5:1 LVP:PAC ratio in order to achieve what we believed to be an appropriate internal rate of return on our pet acquisition investment. That being said, we have intentionally deviated from our ‘target’ during periods where we believed that our LVP was understated or overstated, such as in 2015; recall that LVP is calculated on a trailing twelve-month basis for our subscription business while PAC reflects net subscription business sales and marketing expenses for a particular period (excluding stock-based compensation expense and offset by sign-up fee revenue).

As we are able to scale our fixed expenses and as our adjusted operating margin progresses toward our target of 15% of revenue at operational scale, we expect to use our internal methodology for assessing the internal rate of return (IRR) on our pet acquisition spend to determine whether our targeted LVP:PAC ratio should vary from 5:1.

Our IRR methodology, as illustrated below, considers the return we expect to achieve on a single “average” pet taking into consideration the adjusted operating income we expect to achieve from that pet, the expected number of months we expect that pet to be enrolled with us (derived from our average monthly retention rate), surplus capital requirements and pet acquisition costs.

  1. Our illustrative example assumes an average pet will contribute adjusted operating income, calculated as the average monthly revenue of $48.81 factored by a constant adjusted operating margin of 7.9%, for an average subscriber life of 71.4 months (calculated as the quotient obtained by dividing one by one minus an average monthly retention rate of 98.60%).
  2. Our illustrative example also includes a capital charge adjustment to approximate the amount of interest we would expect to pay on debt to fund our operations to the extent we are required to invest operating cash flow to fund the capital requirements of our insurance company. This cost of capital is estimated assuming the average monthly revenue of $48.81 and a premium-to-surplus ratio of 6.0, factored by an interest rate of 5.00%, and is assumed to be incurred for the average subscriber life of 71.4 months.
  3. Pet acquisition cost of $123 is calculated by taking the 2016 LVP of $631 divided by 5.1, our LVP:PAC ratio for 2016.

Q: What is Adjusted Operating Margin?

Adjusted operating margin represents our operating income before any acquisition costs as a percentage of total revenue. At operational scale of 650,000 to 750,000 total enrolled pets, we expect to have an adjusted operating margin of 15%. To get to our target adjusted operating margin, we use a top-down approach: Revenue (100%), less the cost of veterinary invoices (approximately 70% including adjustment expenses), less variable expenses (approximately 10%), and less fixed expenses including general and administrative expenses and information technology expenses (approximately 5% at operational scale).