Root, Inc. — Q3 2020 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2020. Root is a technology-enabled personal insurance company, primarily writing auto insurance, with renters and agency-distributed homeowners offerings. It operated in 30 states and was licensed in 36 states and the District of Columbia at quarter-end.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $50.5 million | $79.6 million | $295.9 million | $183.7 million |
| Net premiums earned | $44.9 million | $75.8 million | $278.4 million | $174.4 million |
| Net loss | $(85.2) million | $(100.2) million | $(229.7) million | $(197.2) million |
| Loss per share, basic and diluted | $(2.20) | $(2.88) | $(5.94) | $(5.99) |
| Gross profit/(loss); gross margin | $0.7 million; 1.4% | $(36.5) million; (45.9)% | $(7.7) million; (2.6)% | $(60.9) million; (33.2)% |
| Adjusted gross profit/(loss), non-GAAP | $9.7 million | $(27.2) million | $17.1 million | $(40.0) million |
Q3 direct written premium was $164.6 million, up 37.6%; direct earned premium was $154.4 million, up 54.6%. Nine-month direct written premium was $471.1 million, up 53.3%, and direct earned premium was $450.2 million, up 93.0%. Policies in force were 322,423 auto and 7,367 renters. Auto premiums per policy were $929, compared with $877 a year earlier.
Q3 direct loss ratio improved to 89.8% from 113.3%, and direct LAE ratio to 9.9% from 12.7%. For the nine-month period, these ratios were 84.2% and 9.7%, respectively, versus 103.6% and 11.4%. The filing attributes improved accident-period loss performance to underwriting and rating changes and, for the first half of 2020, reduced driving during COVID-19. Adjusted gross profit is a company-defined non-GAAP measure and should not be treated as a substitute for GAAP results.
Liquidity, cash flow and debt
- At September 30, cash and cash equivalents were $217.8 million, restricted cash $1.0 million, and investments $224.5 million. Cash and cash equivalents plus investments totaled $442.3 million.
- Nine-month operating cash flow was $(94.8) million, investing cash flow $(103.1) million, and financing cash flow $0.1 million. Cash, cash equivalents and restricted cash ended at $218.8 million, down $197.8 million from year-end 2019.
- Long-term debt and warrants on the balance sheet totaled $220.0 million, including a $36.3 million warrant liability. Term Loan A and B balances were approximately $99.8 million and $100.0 million before accrued interest, discounts and issuance costs. The company also had a fully available $100 million revolving facility at quarter-end.
- Root amended its debt facilities in September: Term Loan A maturity was extended to October 15, 2021; Term Loan B interest was scheduled to rise by 3.5 percentage points starting March 2021, and PIK interest ends after October 15, 2021. Root had elected to capitalize Term Loan B interest through September 30.
Material changes and unusual items
- A new quota-share reinsurance program began July 1, 2020. Root ceded approximately 70.9% of Q3 direct earned premiums to third-party reinsurers, compared with 24.1% in Q3 2019. Higher cessions reduced net premiums earned even as direct premium volume grew; ceding commissions were the main reason other insurance expense became a Q3 benefit of $26.3 million.
- Root recorded $7.0 million of additional held reserves in Q3 for accident periods before July 2020, primarily 2019 and earlier. Nine-month prior-period adverse development was $21.3 million, mainly for higher-than-expected bodily injury and collision losses from 2019.
- Interest expense included a $13.7 million Q3 fair-value adjustment on warrants; the nine-month warrant adjustment was $16.0 million. Nine-month share-based compensation included $25.1 million related to a March tender offer priced above the fair value of the shares.
- After quarter-end, Root completed its October IPO and concurrent private placements. It sold 24.2 million IPO shares at $27.00 and 18.5 million private-placement shares at the same price. The filing reports approximately $614.7 million net IPO proceeds and approximately $1.1 billion net proceeds from the IPO and private placements combined. Preferred stock converted to common stock and warrants were exercised.
- In November, Root acquired a shell insurance company for $22.8 million, including $8.4 million of insurance-license intangibles; the acquisition was expected to expand its ability to sell auto insurance in 48 states and the District of Columbia.
Outlook, commentary and risks
The filing gives no quantified revenue, earnings or loss-ratio guidance. Management said it expects to continue investing in marketing, with sales and marketing expense likely to rise in absolute dollars near term; technology and development and general and administrative costs were also expected to increase near term. Root stated that cash, investments, operating cash flow and IPO proceeds were expected to fund working capital and capital expenditure needs for at least the next 12 months.
Key uncertainties include ongoing net losses, the adequacy of pricing and loss reserves, reinsurance availability and counterparty performance, and regulatory capital requirements. COVID-19 relief measures affected premium collection, policy cancellations and rate changes; the filing says the pandemic’s full financial impact was not reasonably estimable. Root also disclosed that it was working to determine the extent of policy-cancellation notice timing failures, which could leave policies in force and expose it to claims; the impact could be material. Its Ohio Department of Insurance five-year financial examination, including review of pricing, underwriting and capital, was ongoing, as were market conduct examinations in Delaware and Virginia. The Ohio regulator had required monthly financial reports after determining Root met certain hazardous-financial-condition standards, while taking no corrective action based on certain risk-based capital indicators. No pending litigation was identified as expected to have a material financial effect.
Other significant risks include competition and customer acquisition costs; reliance on mobile platforms and telematics data; restrictions on data use, pricing models or rate increases; catastrophe losses; privacy and cybersecurity; and the concentration of voting power in Class B shares. Root reported that disclosure controls were effective at the reasonable-assurance level and that no material quarter-specific change in internal control over financial reporting was identified.
Important facts for investors to verify
- Whether improved direct loss ratios persist after COVID-related driving changes and after the $21.3 million nine-month prior-year reserve strengthening.
- How the July reinsurance structure affects net revenue, ceding commissions, retained risk and cash requirements over subsequent periods.
- The outcome and potential financial or regulatory consequences of the Ohio examination, other state examinations, and the policy-cancellation notice issue.
- Post-IPO cash and capital position, debt repayment plans, and the effect of the October financing and November license acquisition on liquidity and dilution.
- Whether growth in direct premiums and policies in force can translate into sustainable GAAP profitability without continued substantial marketing and operating investment.