Earnings Call Transcript - ROOT Q3 2024

Operator, Operator

Ladies and gentlemen, greetings and welcome to the Root Inc. 3Q 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Matt LaMalva. Please go ahead.

Matt LaMalva, Host

Thank you for joining us today. Root is hosting this call to discuss its third quarter 2024 earnings results. Participating on today's call are Alex Timm, Co-Founder and Chief Executive Officer; and Megan Binkley, Chief Financial Officer. Earlier today, Root 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 third quarter 2024 form 10-Q, which was filed with the Securities and Exchange Commission earlier today. Before we begin, I want to remind you that matters discussed on today's 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 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.

Alex Timm, CEO

Thanks, Matt. Our third quarter performance was a landmark quarter for Root. We have consistently said that our top priority has been to reach profitability, and in the third quarter, we delivered it. This is a pivotal moment for Root and a firm validation of our business model, technology, and delightful customer experience. Our success is a direct result of the steadfast hard work of our entire team, and I could not be prouder. To build upon this success and support future growth, we amended our term loan with our longstanding partner, Blackrock, and significantly improved our cost of capital moving forward. Megan will provide more details shortly. With profitability now achieved, we have the opportunity to reinvest our profits into the business in the quarters ahead, particularly investing in our growth engines in both the direct and partnerships channels. During the quarter, we continued to expand and test new areas of the marketing funnel, and we expect that to continue in the quarters ahead. This includes investing more in R&D marketing, which typically takes more time to produce results. With these investments, we expect to accelerate our policies in force growth over the long term. As a reminder, we came out of a hyper-growth period in the first quarter of this year, which weighted our book toward newer policyholders. This dynamic typically results in lower retention in the near-term following rapid growth. We are now two quarters past the hyper-growth period, and as a result, we expect to see more contributions from renewals and therefore a gradual return to policies in force growth. Looking ahead, we believe there are material opportunities to expand our competitive advantage to additional data-rich channels. As always, we will explore these channels in a disciplined, rigorous manner and quickly grow or jettison these experiments based on results. We also made fantastic progress in our partnerships channel in the quarter, where we meet customers at contextually relevant times. New writings in the channel more than doubled from the prior year, and we launched several exciting new partnerships. Notably, we launched a partnership with Goosehead Insurance, where our technology has enabled agents to respond faster and more efficiently, thereby providing their clients with a great experience at a great price. The partnership channel is key to our continued long-term success, given the differentiated access to customers it provides. Our pipeline of partnership opportunities remains robust, and we believe we are well poised to drive strong growth in this channel in 2025 and beyond. Our laser-focused mindset on disciplined underwriting, driven by our proprietary technology platform and data science algorithms, led to what we believe is an industry-best gross loss ratio of 57%. Thanks to our consistently strong underwriting, we have the opportunity to reduce rates in select states while not compromising our target returns. While we certainly believe lower rates for the best drivers can further improve growth, when you're not setting prices with the primary goal of gaining market share, our goal is to set prices accurately, and our data science acumen and high telematics adoption rates allow us to effectively price and realize our target returns. As our data sets grow and we continue to retrain our models, we build an even stronger moat around our business. As we look at 2025, we're excited by the growth opportunities in front of us. We expect to add new partners, drive additional profitable growth, expand our geographic footprint, and deliver even better products at better prices to customers. Our team's determination to become the largest and most profitable personalized insurance carrier in the United States is stronger than ever, and achieving net income profitability is an important milestone on that journey. Yet our momentum does not stop here. We maintain a culture of discipline and innovation, which we believe translates to long-term value for all of our stakeholders. I'll now turn the call over to Megan to discuss our operating results in more detail.

Megan Binkley, CFO

Thanks, Alex, and good evening, everyone. We could not be happier with our operating results. For the third quarter and on a year-to-date basis, we achieved net income profitability. This is a testament to our data advantages, disciplined underwriting, and unwavering focus on expense management. For the third quarter, we delivered net income of $23 million, a $69 million improvement year-over-year. Along with this milestone achievement, we generated an operating income of $34 million and adjusted EBITDA of $42 million, year-over-year improvements of $68 million and $61 million, respectively. Our outstanding results continue to be driven primarily by growth in our net earned premium, loss ratio performance, closely managed expense base, and the 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 premium. We saw significant increases in new writings, policies in force, gross written premium, and gross earned premium compared to the third quarter of 2023. We achieved this growth while delivering a gross combined ratio of 89%, a nearly 30-point improvement year-over-year. The gross accident period loss ratio was 58%, a four-point improvement year-over-year, driven by our continued investment in data science and technology. In the third quarter of 2024, we ceded approximately 12% of our gross earned premium. We reduced the difference between our gross and net loss and LAE ratios to just one point, reflecting a reduction of 10 points year-over-year. Our improvements in reinsurance costs were made possible through our continued improvements in underwriting results. Operating cash flow was nearly $50 million in the quarter, primarily driven by net income, continued growth, and strong loss ratio performance. In the fourth quarter, we successfully refinanced our term loan with Blackrock. We reduced the size of the facility from $300 million to $200 million while maintaining $150 million of available growth capital. We improved our cost of capital from the original facility by at least 300 basis points. As a result, we expect to see an approximate 50% run rate reduction in our interest expense moving forward. This will enhance our operating performance and enable further investment in our growth. Overall, we are thrilled to reach net income profitability in the quarter. Our progress is far from over. We remain focused on prioritizing long-term profitable growth, expanding our geographic footprint and distribution channels, and investing in opportunities for the business that present high return potential. These investments will modestly increase operating expenses from our third quarter print; however, we believe it's the right decision to drive long-term success and shareholder value. We are excited for our future, and we appreciate your continued support. With that, Alex and I look forward to your questions.

Operator, Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. The first question is from Tommy McJoynt with KBW. Please go ahead.

Tommy McJoynt, Analyst

Hey, good evening, guys. Thanks for taking my questions. It sounded like you are expecting your appetite for growth spend to increase. I think you said modestly going forward. Could you talk about sort of where you're looking to spend that? Is that consistent with geographic expansion? And in any way you could help us think about the magnitude of where that sales and marketing spend could go from 3Q level?

Alex Timm, CEO

Yes. Thanks, Tommy. We continue to look at our current marketing footprint and our partnerships, and there's still a lot of opportunity for us to continue to reinvest the profit that we've generated into growth in the business. You know, obviously, we're very proud of the milestone we hit of becoming profitable, but it is a milestone. It is not the finish line, and we think that we can still build a much larger, more meaningful company, and we're going to continue to do that. What we're planning to do is to continue to expand our growth investments. That's going to be in our partnerships channel, and you will see some of that reflected in acquisition expense. So bringing on new partnerships in the automotive and financial services and independent agency spaces, and then as well as mid to upper funnel marketing channels. We are still in a minority of marketing channels that most in the industry use. We think that there's a lot of opportunity there. In terms of geography, we're actively working in state expansion. We're only in 75% of the population, and there's no reason we shouldn't be in 100%. So I think that when we expand geographies, you're also going to see us deploy more growth capital into those new geographies to drive profitable growth over the long term. Megan can comment a bit more on the magnitude and what we're expecting in the near term.

Megan Binkley, CFO

Yes. Thanks, Alex. Just to reiterate what Alex said, we are just getting started. We're really proud of the results this quarter, and we are looking to continue reinvesting in key areas of the business. We believe that this quarter is really proof that our model is working. We will continue our disciplined and opportunistic approach to performance marketing and investing in the partnership channels. As it relates to sales and marketing expectations, our focus remains on driving new business at our target return levels. We expect to invest as we continue to identify and source profitable growth opportunities. What we spend in sales and marketing in a given quarter is heavily dependent on the competitive environment, and we expect that our direct marketing machine will react as it always does to ensure that we're continuing to hit our target unit economics. Overall, I would say we're not really in a position where we're going to give a specific target on marketing investment for Q4 or really into 2025, but we're going to continue the same approach that we've had in the past on driving profitable new business.

Tommy McJoynt, Analyst

Thanks for those comments. And you may have touched on it a little bit there, but can you give us an update on how you guys are seeing the retention rates of your book of business, especially the perhaps policies that you put on over the last 12 months? When you think about the potential to reduce rates in certain markets, do you anticipate that will help your retention rates further?

Alex Timm, CEO

Yes. Thanks for that question, Tommy. I think the first thing to note is, as I said in my prepared remarks, we've nearly doubled the size of the business on a year-over-year basis. When we've done that in that real hyper-growth period, it results in a lot of brand-new PIF. We had a very young PIF, and that young PIF tends to churn a little faster than older PIF. As our PIF has continued to age, we've seen churn come down, and we've seen that continue to improve through this quarter. We don't think we're at normalized levels yet, so we expect that to continue. Part of that has created a nice tailwind in the business where it has allowed us to grow PIF a little bit more gradually in this quarter-to-date. We are seeing those favorable trends on PIF churn. In terms of rate reductions, we absolutely expect that this will help retention. The lower your rates are, with those rate reductions, you will see better retention rates, and we should also experience higher conversion rates. We believe both of those two things will be good news for the business.

Tommy McJoynt, Analyst

Thanks. Just one quick question on the retention side that I forgot to ask one element of that. The partnership channel versus the direct-to-consumer, do their retention rates differ materially?

Alex Timm, CEO

Yes. The partnerships channel has much higher retention rates. We see that really across most of our partnerships, particularly when you're building that differentiated access to customers where many of your customers are buying for the customer experience and the ease of technology, which helps create a stickier customer. We have seen that. Those policies are also often higher average premium with more vehicles per policy, which has been really helpful as well.

Operator, Operator

Thank you. The next question is from Yaron Kinar with Jefferies. Please go ahead.

Yaron Kinar, Analyst

Thanks. Good afternoon. Maybe to follow up on some of the churn and retention questions. If we were to look at cohorts, are you seeing churn improving? Namely, if we have a first-year cohort from the most recent year, is the churn there better than the first-year cohort from a year ago and two years ago and the like? And the same, I guess, would be true for other cohorts; I just used first year as an example.

Alex Timm, CEO

Yes, that's a good question, Yaron. We have seen when we look at churn, and you have to control for what channel it's coming from because again if you look at it on a blended basis, you see those partnership new writings. Those cohorts are retaining longer, and those new cohorts are going to have higher retention as a result. Over the last couple of years, as we've seen the rate environment stabilize, you've definitely seen improved retention rates. I think it's modest, but we are seeing improvement in cohort-based retention.

Yaron Kinar, Analyst

Got it. Would you expect that to accelerate, or just for me, kind of a modest improvement cohort by cohort?

Alex Timm, CEO

You know, I think there are a couple of things that might accelerate it. One is certainly the continued expansion of the partnerships channel as a percent of our new writings. That distribution channel has grown 130% for us year-over-year, which is tremendous, and we don’t see that slowing down. That's definitely going to continue to improve retention. The second is as we continue to expand to more preferred customers into some other marketing channels that aren't just lower level, lower funnel marketing channels, you tend to see a more preferred mix of business and a bit stickier business. We do anticipate some improvements. We're also making changes to the product that we believe makes it easier for customers to stay with Root in the long term. We certainly have a lot of actions we want to take to continue to improve retention.

Yaron Kinar, Analyst

Okay. One question on pricing. I appreciate you saying that you're looking to maybe lower rates a bit here just given where the loss ratio is. Recent data shows we haven't seen much of that yet, maybe a little bit in the past few weeks. With the loss ratio running well below target for the last four quarters, why is this something that is only now coming about? How aggressive would you be willing to be given where the loss ratio is?

Alex Timm, CEO

What we're always doing is looking at each market, making sure that we are, to the best of our ability, hitting our target loss ratios; ensuring we are not too high or too low. We set those target loss ratios where we believe the most efficient place to operate is. There have been a handful of states where we have reduced rates, but we're not going to reduce rates just to gain market share. We're always looking to hit our targets. When we observe credible enough data to indicate that lowering rates is appropriate, we'll do that. Another important point is, we're not just lowering base rates; we're also improving segmentation. As we improve segmentation through our new loss models and telematics models that we are constantly iterating and innovating on, you should also anticipate real benefits in the loss ratio. As that develops, we should respond with base rate decreases. We are actively looking at this and we think we're very fast to react.

Yaron Kinar, Analyst

Thank you, and congrats on the quarter and the debt refinancing.

Alex Timm, CEO

Thank you, Yaron.

Operator, Operator

Thank you. Ladies and gentlemen, as there are no further questions, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.