Earnings Call Transcript - ROOT Q1 2024

Operator, Operator

Hello, and thank you for joining us. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the Root, Inc. First Quarter 2024 Earnings Conference Call. I would now like to turn the conference over to Matt LaMalva, Head of Investor Relations. Please go ahead.

Matthew LaMalva, Head of Investor Relations

Good afternoon, and thank you for joining us. Root is hosting this call to discuss its first quarter 2024 earnings results. Participating on today's call are Alex Timm, Co-Founder and Chief Executive Officer; and Megan Binkley, Chief Financial Officer. Root recently issued a shareholder letter announcing its financial results. While this call will reflect items discussed within that document, for more complete information about our financial performance, we also encourage you to read our first quarter 2024 Form 10-Q. Before we begin, I want to remind you that matters discussed on this call will include forward-looking statements related to our operating performance, financial goals and business outlook, which are based on management's current beliefs and assumptions. Please note that these forward-looking statements will reflect our opinions as of the date of this call, and we undertake no obligation to revise this information as a result of new developments that may occur. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause our actual results to differ materially from those expected and described today. In addition, we are subject to a number of risks that may significantly impact our business and financial results. For a more detailed description of our risk factors, please review our most recent 10-K, 10-Q and shareholder letter. A replay of this conference call will be available on our website under the Investor Relations section. I would also like to remind you that during the call, we will discuss some non-GAAP measures while talking about Root's performance. You can find reconciliations of those historical measures to the nearest comparable GAAP measures in our financial disclosures, all of which are posted on our website at ir.joinroot.com. I will now turn the call over to Alex Timm, Root's Co-Founder and CEO.

Alexander Timm, CEO

Thanks, Matt. For those new to Root, welcome. I'd love to take a minute to tell you a little bit more about the company before I jump into our results. We believe drivers should have more control and understanding of their insurance. So we've built car insurance that is transparent, easy to understand, and offers great prices. We do this through the Root app where customers can see how they are driving, manage their policy, and file a claim in seconds. We also do this through our partnership channel where we meet customers where they are in their moment of need. This includes, for example, embedding our insurance product at the point of vehicle sale. This is all enabled by our data science and technology, which allows us to create seamless, flexible customer experiences at what we believe to be some of the best prices. With that, I'd like to talk a little bit about the quarter. The first quarter of 2024 was an excellent quarter. For the first time in the company's history, we generated operating income and positive adjusted EBITDA. We did this while doubling gross written premiums and policies in force year-over-year. These results are a testament to our strong product offering, disciplined execution, and the power of our technology. While pleased with this performance, we are far from achieving what we believe we can as a company. Over the long term, we believe data science and technology will fundamentally change the way insurance is priced. And in the first quarter, we continued to significantly improve the predictive accuracy of our pricing and underwriting models. As we grow, our data set grows, which allows us to retrain our models and deliver better prices to customers. In turn, with better prices, we are able to grow more efficiently, leading to a virtuous cycle. Also core to our strategy is continuing to build differentiated access to customers through our partnerships channel. Offering a 3-click purchase experience via our partner platform continues to drive differentiated access to customers, and we're pleased to have grown new writings in our partnership channel 68% year-over-year. The expansion of this channel is foundational to our long-term growth strategy. Our direct channel also continued to have impressive growth in the quarter. We leverage advanced machine learning-based algorithms to optimize for our return targets. Our data science machine is constantly looking to see how the competitive environment is evolving. As such, this channel fluctuates due to seasonality and competitive dynamics. And as anticipated, we saw competition increase in the direct channel this quarter. We continue to optimize for target unit economics and believe being responsive to the changing environment in a smart way to profitably grow this business over the long term, even though it may lead to quarter-over-quarter variabilities. In the first quarter, the path to GAAP profitability looks stronger than ever. We continue to be excited by the long-term growth potential of the business by adding additional partners, expanding our footprint, and continuing to improve our prices and products. I am proud of our entire team for their dedication to driving our success in this quarter. I'll now turn the call over to Megan to discuss our operating results in more detail.

Megan Binkley, CFO

Thanks, Alex. Overall, it was an excellent start to 2024 with further improvements across nearly all of our key financial metrics. For the first quarter, our net loss was $6 million, an 85% improvement year-over-year. We are pleased to report for the first time a positive quarterly operating income of $5 million and positive adjusted EBITDA of $15 million. These metrics improved $35 million and $26 million year-over-year, respectively. This strong progress continues to be driven primarily by growth in net earned premium, continued loss ratio performance, a sustained fixed expense base, and responsible deployment of marketing investment. As we've consistently noted, we do not defer the majority of customer acquisition costs over the life of our customer, which leads to accelerated expense recognition relative to earned premiums. We grew new writings fourfold, and we more than doubled policies in force, gross written premium, and gross earned premium compared to the first quarter of 2023. We achieved this growth while delivering a gross combined ratio of 99.7%, marking the company's first gross combined ratio less than 100% and a 23-point improvement year-over-year. The gross accident period loss ratio was 61%, a 4-point improvement year-over-year, driven by our continued investment in data science and technology. Note that we benefit from a favorable seasonality trend in Q1 as there are fewer miles driven in the winter months and also higher purchasing power resulting from tax season refunds. In the first quarter of 2024, we ceded 16% of our gross earned premium and reduced the difference between our gross and net loss and LAE ratios to 2 points for the quarter, reflecting a reduction of 21 points year-over-year. Our improvements in reinsurance costs were made possible by our continued improvement in operating results. Overall, our results for the first quarter 2024 continue to reflect the sustained momentum towards management's top priority of reaching profitability with our existing capital. The first quarter also marked the third consecutive quarter of positive operating cash flow. This is a result of improved net loss, continued growth and loss ratio performance, even though the first quarter is consistently a high relative cash outflow quarter. As Alex noted in his remarks, it was a strong start to 2024 as we maintain the disciplined execution of our strategy and continue to build upon the momentum we achieved in 2023. As our market value appreciates, we will incur incremental expenses related to tax liabilities from the vesting of employee equity awards. The second quarter typically encompasses the largest proportion of vesting equity awards per year. As such, we expect to incur approximately $10.6 million in cash expenses in the second quarter to satisfy this tax liability. Moving forward, we intend to remain focused on thoughtful and disciplined growth and expect to continue investing in customer acquisition as long as targeted unit economics are achieved. We expect gross written premium levels in the second quarter to decrease relative to the first quarter due to seasonality and changes in the competitive landscape. Achieving GAAP net income profitability with our existing capital continues to be our primary objective. This quarter's results show that we are well on our way. We are excited for our future. Appreciate your time and look forward to your questions.

Operator, Operator

Our first question will come from Tommy McJoynt with KBW.

Thomas Mcjoynt-Griffith, Analyst

So you've demonstrated some really robust growth here in the policy count over the last few quarters with that growth having started really in the third quarter of 2023. So assuming most of those were 6-month policies, can you talk about the retention that you're seeing on those policies that were recently acquired over the past 9 months?

Alexander Timm, CEO

Thanks, Tommy. We're continuing to see retention improve. A big driver of retention is price. As we've continued to refine our approach, we were very early, thanks to our technology, in identifying a changing cost environment, which allowed us to implement many of our rate increases early. What we've been seeing as a result is that as our prices have stabilized over the last year or so, we're continuing to see improvements in retention year-over-year.

Thomas Mcjoynt-Griffith, Analyst

Given some good visibility into the broadly improving outlook across both you and your competitors, that certainly suggests that the competitive landscape will be intensifying as you've noted. So how do you envision your sales and marketing spend trending over the coming quarters, perhaps on an absolute basis would be most helpful?

Alexander Timm, CEO

First, I'd say we're very happy with our growth year-over-year, with doubling the count of customers that we've acquired, doubling our policies in force as well as revenue. We are always looking at the competitive environment and monitoring it closely, as well as considering seasonality. We know that in the first quarter, you see increased shopping for auto insurance. Thus, you should expect us to accelerate our sales and marketing spend in the first quarter relative to other quarters. As we've mentioned, we saw competition return. One important aspect at Root is that we monitor profitability and consistently optimize for it. Therefore, if we see an increase in competition, we will adjust our spending to ensure we are driving the company towards profitability. You can see evidence of this in our operating income trends this quarter as well.

Megan Binkley, CFO

And Tommy, if I could, just to reiterate what Alex stated. Q1 is another strong proof point that our model is working. We've delivered the best results in Q1 in company history. When looking year-over-year, we've more than doubled our gross written premium, gross earned premium, and policies in force. We are confident that we can continue to grow. However, I want to make it clear that if we're not reaching our unit economic profitability returns, growth going forward will moderate. Our growth strategy will continue to be very prudent and disciplined; we're not sacrificing our capital position for unprofitable growth. While we anticipate lower sales and marketing expenses in the subsequent quarters based on seasonality, we'll remain opportunistic with direct marketing spending and optimize our marketing bidding strategy within existing channels while testing new ones. We believe we have ample growth levers available. Currently, we're only in 34 states, and we ultimately desire to go national, continually investing in our differentiated distribution, which is growing and onboarding new partners.

Operator, Operator

Our next question will come from the line of Andrew Kligerman with TD Securities.

Andrew Kligerman, Analyst

Congrats on another great quarter. I guess my first question is around renewal premium as a percent of gross premium declining to 39%. As that happens and you're writing a lot more new business, should we expect to see a new business penalty on the terrific gross accident period loss ratio of 61% that could rise a bit?

Alexander Timm, CEO

Yes. I'd say we absolutely see similar trends, and there can be a new business penalty where the loss ratio on new business in the first six months' term is typically higher than that of renewal business. We're very pleased with our loss ratio and where it is. We've been diligent in pricing the business, and we feel good about our current loss ratio. We've been experiencing significant growth for many quarters, which means that a lot of that new business loss ratio penalty is already reflected in our current quarterly results.

Andrew Kligerman, Analyst

With regard to the competitive environment, you cited that in the last month of the first quarter, you saw a little dip in premium growth, and Megan added that gross written premium sequentially would probably decrease in the second quarter. Could you give us a sense of what we might expect in the second quarter? Any indication on how it's progressing so far compared to the first quarter?

Alexander Timm, CEO

Yes, I think from both seasonality and competitive dynamics, there will be more new writings generally in the first quarter than in the second quarter. This will lead to a higher amount of written premium in our first quarter than in our second quarter. That said, given the material growth in policies in force, you will see very strong earned premium growth year-over-year still. We feel good about where we are, and retention is strong. However, you should expect for the second quarter to reflect some seasonality impacts and competitive returns, causing written premium to be lower than in the first quarter.

Andrew Kligerman, Analyst

But it doesn't sound dramatic, right, Alex? Is that what I should read into it?

Megan Binkley, CFO

Andrew, we're not providing quantification at this point. We're continuing to be opportunistic in how we deploy direct marketing spend. We're laser-focused on profitability and maintaining the business long-term. We're not going to write policies for the sake of growth, and we believe this approach is the most strategic for long-term sustainable growth without losing sight of our quarter-over-quarter performance.

Operator, Operator

Your next question comes from the line of Yaron Kinar with Jefferies.

Charlie Rodgers, Analyst

This is Charlie on for Yaron. Congrats on the quarter. I was just curious if you guys were able to achieve $15 million in positive adjusted EBITDA this quarter, conceptually, should we anticipate this to be a step change? Or should we expect the potential for EBITDA to be negative quarter-over-quarter or here and there going forward?

Megan Binkley, CFO

Thanks, Charlie. That's a good question. So as we sit here today, Q1 was really a material milestone for the business for us to post both positive operating income and positive adjusted EBITDA of $15 million in the quarter. This achievement has been several years in the making. We've consistently focused on pricing and underwriting, which has resulted in significant improvements to our loss ratio. We will continue to drive profitable growth. And as we mentioned earlier, we remain opportunistic regarding how we deploy marketing investment going forward. If opportunities arise to grow share profitably, we will pursue them in a prudent and disciplined manner. On the expense side, we've diligently managed our spend, seeking to scale our fixed expenses appropriately. We're making modest investments in specific areas of the business in 2024, both to support the growth we've achieved over the past year and to continue advancing our product while maintaining profitable unit economics. To more directly answer your question, we are confident in our path towards GAAP profitability in the near term. However, we want to reiterate three key points for Q2. First, as we've covered, we expect growth to be slower in Q2 versus Q1 due to seasonality and changes in the competitive landscape. This means that we anticipate lower sales and marketing expenses in Q2. Secondly, we expect that Q2's loss ratio will be elevated compared to Q1 due to seasonal factors, with increased driving as we enter the spring and summer months. Finally, due to our stock price appreciation, we incurred approximately $10.6 million in tax liability related to the vesting of RSUs and PSUs. As April is our peak vesting month, the bulk of that tax liability—around 70%—will impact your G&A line item on the P&L, while the remainder will hit T&D. We have included further information in our 10-Q to assist users of the financial statements in understanding the magnitude of this for the rest of the year, but we remain confident in our trajectory towards GAAP net income profitability in the near term.

Charlie Rodgers, Analyst

Great, and thanks for breaking that out by line item on the vesting expense there. So another question. You guys have had two consecutive quarters now where discussions have kind of been below that 20% watermark, I think, 16% and 18%. How should we think about that going forward?

Megan Binkley, CFO

Thanks, Charlie. Excellent question. We continue to focus on our reinsurance strategy over the long term. It's important to keep in mind that we anticipate continuing to purchase per-risk and cat-reinsurance covers to protect the business from volatility. Looking ahead, if we see something opportunistic in reinsurance markets, we'll want to take advantage of that. As we stand today, we do not intend to exceed 25% of our gross written premium, but we want to ensure we maintain optionality. We're constantly looking to optimize our capital structure, and as our results improve, we have multiple decision points throughout the year to increase or decrease our sessions based on our appetite for reinsurance and market conditions. Our goal is to maintain flexibility across all capital structure options.

Charlie Rodgers, Analyst

And just one last one, if I could sneak it in. Building off of Tommy's question regarding retention, it looks like you guys are seeing improvement year-over-year. But how should we think about that relative to pre-IPO levels?

Alexander Timm, CEO

I would say that retention has continued to improve. If you look at the company's history, it's modestly improved since the time period of our IPO. The reason for this improvement is the pricing adjustments we've made and the shift in our mix towards a higher-retaining customer segment, which has been driven by improved pricing models and our partnership channel. Thus, you should expect modestly better retention than pre-IPO levels.

Operator, Operator

Your next question will come from Christian Gonzalez with Wells Fargo.

Unknown Analyst, Analyst

I had a question on the increased competition in the direct channel. Does that incentivize you guys to be more aggressive on the partnership side, potentially seeking a few more partners? I'm guessing the unit economics are favorable there given that the marketing expenses are different when compared to the direct channel. Does this motivate you to accelerate that channel's growth rather than waiting for the direct channel to stabilize?

Alexander Timm, CEO

I'd say we really like our partnerships channel. Our approach is to continue building that channel. Through our technology and the ability to offer a seamless embedded quote, we believe it is very differentiated. We have seen that channel grow, and the year-over-year growth is at 68%. It might be harder to see since it's from a smaller base than direct, but this growth has been consistent, and we anticipate it to continue in the future. We're enthusiastic about this channel due to its consistent growth. With respect to direct, we manage that business intelligently by constantly evaluating competitive dynamics and seasonality, while also ensuring our data science models are not overpaying for customers. Direct will grow long-term, but it may just be more exposed to quarterly fluctuations, which we accept as the right long-term business strategy. We are passionate about growing both channels in the long run.

Unknown Analyst, Analyst

For my second question, with the significant growth in the policies in force count over the last couple of quarters, has there been any dramatic shift in terms of your demographic build within the portfolio, such as greater exposure to certain states or age groups? Has anything shifted due to this growth?

Alexander Timm, CEO

We've continued to iterate on underwriting and pricing models. In terms of demographic shifts, it's subtle but likely leans more towards what would be classically defined as a preferred customer segment. This group is slightly higher in retention and slightly better in credit ratings. As we continue to evolve our pricing models, we are capturing more of that customer segment. Overall, that's the key change in our demographic mix.

Unknown Analyst, Analyst

One more clarification. I understand that growth will slow in Q2 compared to Q1, but regarding discounting, I assume you guys are still looking for growth, even if not at the 20% to 30% rates seen in the last half of the previous year?

Alexander Timm, CEO

We're very pleased with our policies in force growth year-to-date. We're constantly monitoring our environment to see how it changes. If keeping growth flat proves to be the best for the business, we will adopt that approach. We believe long-term growth is achievable, and we'll keep seeking opportunities to grow, but we're not going to provide specific quarterly guidance on policies in force.

Unknown Analyst, Analyst

Congrats on the quarter.

Alexander Timm, CEO

Thanks.

Operator, Operator

And your next question comes from the line of Matt Carletti with Citizens JMP.

Matthew Carletti, Analyst

I just had a question on the fee income line. It's grown significantly over the past few quarters. If you look at its percentage of premium, it has also been increasing. Could you clarify what is happening there and what we might expect moving forward?

Alexander Timm, CEO

Yes, certainly. When we review the past year or so, it became clear that we were off-market with our fees. There were many fees we weren't charging that the market was. We started to introduce these fees, which we believe is beneficial for us. As we pivot towards more fee revenue instead of premium revenue, we gain several advantages, including lower premium taxes. I think we've largely implemented all necessary filings. Consequently, we believe we have reached a new normal in this area.

Operator, Operator

With that, I'll hand the call back to Alex for any closing remarks.

Alexander Timm, CEO

Thank you, everybody, for joining today. We look forward to continuing our execution and sharing updates about the future of our company. I appreciate it.

Operator, Operator

That will conclude today's meeting. Thank you all for joining. You may now disconnect.