Porch Group, Inc. (NASDAQ:PRCH) Q4 2022 Earnings Call Transcript March 14, 2023

Lois Perkins: Good afternoon, everyone, and thank you for participating in Porch Group's Full Year 2022 Conference Call. Today, we issued our fourth quarter earnings release and related Form 8-K to the SEC. The press release can be found on our Investor Relations website at ir.porchgroup.com. Joining me here today are Matt Ehrlichman, Porch Group's CEO, Chairman and Founder; Shawn Tabak, Porch Group's CFO; Matthew Neagle, Porch Group's COO; and Adam Kornick, President of Porch Group's Insurance Division. Before we go further, I'd like to take a moment to read the company's Safe Harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995, which provides important cautions regarding forward-looking statements.

Today's discussion, including responses to your questions, reflects management's views as of today, March 14, 2023. We do not undertake any obligations to update or revise this information. Additionally, we will make forward-looking statements about our expected future financial or business performance or conditions, business strategy and plans and anticipated impacts from pending or completed acquisitions based on current expectations and assumptions. These statements are subject to risks and uncertainties, which could cause our actual results to differ materially from these forward-looking statements. We encourage you to consider the risk factors described in our SEC filings as well as a risk factor information in these slides for additional information.

We will reference both GAAP and non-GAAP financial measures on today's call. Please refer to today's press release for reconciliations of non-GAAP measures to the most comparable GAAP measures discussed during this earnings call. As a reminder, this webcast will be available for replay along with the presentation shortly after this call on the company's website at ir.porchgroup.com. And with that, I'll turn the call over to Matt Ehrlichman, CEO, Chairman and Founder of Porch Group. Over to you, Matt.

Matt Ehrlichman: Thank you, Lois. Welcome aboard. Good afternoon, everybody. I founded Porch a decade ago now with the mission to simplify home ownership and over the years we have focused on building sustainable advantages that would allow us to win in key areas of focus for the most valuable services for the home, now with homeowners insurance at the center. So first off, I want to welcome Shawn, our new CFO. Fantastic to have you on board and I'll just start by saying that I am proud of the work and contributions from the entire Porch team in 2022 as we dealt with the impacts of inflation, challenging capital markets, unusual weather volatility and the housing market, how that slowed substantially. Many if not all home service and insurance businesses face these same headwinds, but we stayed focused on what we can control and we took advantage of 2022 to move forward in our strategy and toward near-term profitability.

We extended our market position and our software products in key verticals. We grew our insurance business with improved underwriting and increase in policies. We successfully integrated past acquisitions, we matured our financial systems and we diversified our Board by adding strong new members. So quickly looking at the financials, we ended 2022 with Q4 results of $64 million in revenue and $13 million in adjusted EBITDA loss. Q4 adjusted EBITDA would've been $7 million better if it hadn't been for Storm Elliott, which occurred in the last week of the year. For the 2022 full year year-over-year revenue growth was 43%. Over the two years since we've been a public company, we've now grown revenue at a CAGR of 95%. Shawn's going to share more details on the financial results here shortly.

I'd like to reflect on 2022 as there were some key successes that really did move us forward. During the last year, our software division expanded its leadership position in the home inspection industry, acquired Home Inspector Pro, an inspection software company that strengthened our SaaS offerings and residential warranty services, which has deepened our capabilities with home inspectors and home warranties. By selling software to now more than 30,000 home service companies, we have visibility into approximately 80% of all home buyers as well as unique insights into the underlying properties. In 2022, we launched our well received Porch App, which extends the experience we provide for consumers and continues to gain traction. We made great progress accessing more unique demand and data, a core competitive advantage, which gives us the opportunity to build a delightful consumer experience and eventually the most effectively priced homeowners insurance.

To accelerate our expansion in homeowners insurance in 2021, we acquired Homeowners of America or HOA, a company that provided us with both a regional insurance carrier and a managing general agency or MGA. We've expanded that business both with new geographies and distribution and I'm proud to share that in 2022, HOA was the fastest growing homeowners insurance carrier in the U.S. through the third quarter of the year. We accomplished this while having 2022 gross loss ratios of 72% better than other carriers, despite unexpected severe weather in our largest regions during the year. One of the reasons we chose HOA as the company to acquire is that uniquely had the characteristics that we liked, both in MGA and carrier business, a great leadership team, greater capital efficiency and less volatility than most by seeding much of the premiums to reinsurance companies, strong historic underwriting results, 15 years of historic claims data and a healthy financial position.

So we have the ambition to become an insurance company with a higher margin commission and fee-based model and to operate with limited seasonality and large swings and results from weather, all of which we believe would effectively create value for our shareholders long-term. While we continue to invest in strategic partnerships with reinsurance companies, we have been working for some time on the formation, structuring and strategy, programming and pricing of a Reciprocal Exchange. We will imminently file an application with the Texas Department of Insurance to create this reciprocal. If approved on the terms proposed by Porch, the Porch Insurance Reciprocal Exchange would be formed in Texas as an association owned by its policy holder members and not by Porch Group in our shareholders.

This new entity would purchase our HOA insurance carrier and would hold ongoing premiums and ordinary course claims costs. Initially, Porch Group would provide the required capital to operate the reciprocal and Adam is going to discuss the expected benefits and key considerations related to the strategy shortly in our deep dive. We have been looking forward to sharing more today as we believe this is a key time for our company and an attractive structure which allows us to better leverage our advantages and improve profitability over time. We'll now hand it over to Adam Kornick, President of our Insurance Division, who will kick off with this deep dive into this launch and to provide further context before Shawn takes over to cover results and guidance.

So Adam, over to you.

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Adam Kornick: Thanks, Matt. By way of background, I've been in the insurance industry for two decades and 2022 was one of the most difficult years in my experience. We saw inflation increasing claims costs along the storms with Hurricane Ian in Q3 and Winter Storm Elliott in Q4 plus increases in reinsurance pricing. We'll share updates today on how we're going to position for growth and profitability and our plans to mitigate volatile. First, let me take a step back and provide clarity on five different ways, one could operate in the home insurance industry so you can better understand how we operate today and how that compares to a reciprocal. So one selling leads. It is a simpler business, less regulated, but it lacks annuity of revenue streams and the ability to deliver a great consumer experience.

Two, as a retail insurance agency. So agencies commissions are limited and they also rely on carriers for underwriting risk. Three refer to managing general agency or MGA, care companies underwriting price for insurance products and use for capacity of insurers and reinsurers. Commissions increase, but there's exposure to reinsurance cycles. Four, the fourth is a carrier. Insurance carriers write their own products and hold all or some of the premiums and risk depending on what the seed to reinsurers, carriers have more upside if claims a row, but they require capital to grow and carry volatility. But today we operate under models two, three, and four.

. : So what is a reciprocal? Here's how we structure, assuming the Texas Department of Insurance also known as the TDI approves the application as we will file. The Porch Insurance Reciprocal Exchange will be an association owned by its policyholder members and not by Porch Group. A reciprocal will issue the policies, hold the premiums and capital requirements and pay claims from its balance sheet. Porch Group will continue to manage pricing and claims on behalf of the reciprocal, leveraging our data and consumer access. For these services, we expect to be paid fees comparable to the fees we've received in the past from reinsurance companies. Distribution is available through a variety of channels, including both Porch's B2B2C relationships, as well as third party agencies.

We expect to launch in Texas and as part of this, we would transfer our HOA carrier entity including the carrier's assets and liabilities to the reciprocal in exchange for our coupon bearing note. That means on day one of that transaction, all HOA carrier premiums from all of its current states will be moved into this newly formed entity. Although separate, the success and capitalization of the reciprocal will of course be important to Porch as we will be financially responsible for the success of the reciprocal initially and we'll also be earning significant fee income from that entity. To recap, we'll soon file the application with the TDI and then work through approval process. We would transfer the HOA carrier and premium from all states into the reciprocal in exchange for a coupon bearing.

We expect to launch a new Porch Insurance brand first in Texas. And lastly, Porch will provide operating services to reciprocal for which it will receive a fee. So the next slide is to bring all this together, I will highlight the long-term benefits of this reciprocal structure for stakeholders. First, policyholder members are expected to benefit from new value propositions Porch can provide such as a 90-day home warranty product and more also in this structure policyholders are the owners of the reciprocal, allowing them to benefit from any future dividends or distributions. At Porch, as we have mentioned, this structure will help us move towards our ambition to reduce direct exposure to seasonality and large swings and results to deliver and have higher margin, more predictable profitability.

In the future, Porch financing will be replaced with third-party capital and this we believe will create long-term value for our shareholders. So if we go one more, before turning over to call Shawn, I'll echo what Matt had said. This is an exciting time for Porch Group and should have this positioned well for growing profits in a more predictable way in the long-term. We expect 2023 to be a transition year. As we shift towards this reciprocal model, assuming it is approved by the TDI, which we now expect before Q3 of this year. In the interim, we expect to manage the business, the current HOA business with an eye on profitability. Let me share the key things we will do this year to facilitate a smooth transition in launch of the reciprocal, two key initiatives in this environment.

First, we expect to decrease the amount of reinsurance in 2023 to approximately 50% seeding levels, given a substantial increase in the cost of reinsurance in the market broadly and in support of the transition to the reciprocal which really expect to seed less and operate its reinsurance purchasing more efficiently. This means we'll have some additional exposure versus historical periods, in particular weather-related risks, which are typically more pronounced in the first half of the year. Additionally, given the cost of increased cost of reinsurance, we expect to non-renewal approximately 37,000 higher risk policies. This will obviously temper the near-term growth of our insurance business in 2023, but is expected to increase profitability in help insurer our reciprocal is appropriately capitalized at launch if approved by the TDI on terms when we propose.

To summarize, it's an exciting year and a long time coming, we are actively working towards filing and approval and therefore unique positioned to drive more consistent profitable growth with less direct exposure to lever inflation in quota share reinsurance. Shawn, over to you.

Shawn Tabak: Thanks Adam and good afternoon everyone. Before I dive into the fourth quarter results, I just wanted to express how excited I am to be here at Porch, working with Matt, Matthew, Adam, and the rest of the wonderful team. We have a tremendous opportunity to create value for our customers, our shareholders, and our employees by simplifying home ownership with insurance at the center. Taking a step back, 2022 presented a challenging macro environment for Porch with increases in weather-related events as well as rising inflation, a decline in home sales tightening and price increases with reinsurance and challenging capital markets. Each of these impacted short-term business results like many other home service and insurance businesses.

The key takeaway for the fourth quarter of 2022 is that despite all of this, we grew revenue 24% year-over-year driven by our Insurance segment. Adjusted EBITDA was also impacted by a large ice storm weather event at the end of the year, which drove higher than average claims. Winter Storm Elliot impacted much of the country and Texas in particular. In total CAT weather impacted our adjusted EBITDA loss by approximately $7 million in the fourth quarter. Starting now with our key financial metrics. Fourth quarter 2022 revenue was $64.1 million with the Insurance segment growth partially offset by the Vertical Software segment. Fourth quarter revenue growth, excluding recent acquisitions of filed by Residential Warranty Services and Home Inspector Pro was 19%.

Revenue, less cost of revenue was $43.9 million, resulting in a 69% revenue less cost of revenue margin lower than prior year, driven by higher CAT weather related insurance claims. Normalizing for the CAT weather revenue less cost of revenue would've grown 36% rather than 17%. Adjusted EBITDA loss was $13.3 million with CAT weather accounting for approximately $7 million of that loss and otherwise driven by strong performance in our warranty business and strong expense control. Gross written premium for our Insurance segment was $131 million, a 30% increase over the prior year, driven by continued growth in policies and higher premium per policy starting to flow through. Moving on to revenue by segment. Revenue in our Insurance segment was $31.2 million, a 94% increase over the prior year, driven by growth in policies, premium per policy in strong growth and home warranty.

Insurance segment revenue increased from 31% of total revenue in the fourth quarter of 2021 to 49% of revenue in the fourth quarter of 2022. Revenue in our Software segment was $33 million, which was a 7% decrease over the prior year due to our moving services group, which was directly impacted by a soft housing market that continued to face headwinds. Fourth quarter home sales declined 34% year-over-year industry-wide. Our software and services subscription groups were relatively flat year-over-year. As for adjusted EBITDA, our Insurance segment adjusted EBITDA was $700,000, a decrease from the prior year driven by CAT weather related insurance claims. Software segment adjusted EBITDA was $1.1 million, a decrease from their prior year driven by the housing market as mentioned.

Corporate expenses were $15.1 million, reducing to 24% a total revenue from 28% in 2021. We invested in our data platform and app, which was offset by strong expense control. Shifting now to our full year results. Revenue for the full year 2022 was $276 million, 43% growth over the prior year. Revenue growth excluding acquisitions from the prior year was approximately 21%. Insurance segment revenue grew 119% in 2022, driven by growth in policies, increased premium per policy and strong execution in our warranty business, including improvement in retention rates due to an improved value proposition per consumers. Revenue in our Vertical Software segment grew 13% in 2022 despite the housing market. Revenue less cost of revenue was $168 million, a 61% revenue less cost of revenue margin down from the prior year, primarily driven by CAT weather-related insurance claims as mentioned.

The adjusted EBITDA loss of $49.6 million was similarly impacted by these CAT weather-related insurance claims. And finally, gross written premiums in our Insurance segment was $536 million, growing 75% year-over-year. Shifting now to the balance sheet. We end of the year with unrestricted cash plus investments of $307 million versus $320 million as of the end of the third quarter. We hold convertible debt on our balance sheet of $425 million due in September, 2026 and in the fourth quarter of 2022; we repurchase approximately 2.4 million shares at an average price of $1.82 per share. Additionally, I wanted to provide that we do not currently hold any deposits with SVB . As a reminder, our HOA insurance carrier must hold a certain amount of capital that can vary based on premium, growth, and other factors.

Historically, we have offset some of this capital requirement through effectively transferring the amount of premiums and losses to reinsurance partners, either on a quota share or excess of loss basis. HOA has been and continues to be rated A exceptional by its rating agency. To maintain that rating and to ensure the entity is appropriately capitalized, Porch Group transferred $34 million to HOA in the fourth quarter, bringing HOA's unrestricted cash balance of $78 million at the end of the year and its investment balance of $92 million. We expect to transfer HOA to the Reciprocal in exchange for a coupon bearing note. Therefore, these cash and investment balances would transfer with the Reciprocal. And shifting now to our outlook for 2023.

We expect many of the headwinds faced in 2022 could continue into 2023, such as inflation, potential weather volatility and declines in the housing market. Given additional weather exposure as we prepare for the Reciprocal launch, we are providing a range for performance which assumes no catastrophic weather event. And with that, our guidance for 2023 is revenue of $330 million to $350 million, increasing at least 20% year-on-year. This assumes strong revenue growth expected in our insurance segment with relatively flat year-over-year revenues in our vertical software segment. Until we see the housing market turn, our starting assumption is for an 18% decline in industry-wide home sales in 2023 versus 2022. Revenue less cost of revenue of $170 million to $180 million.

In the first half of the year, our exposure to weather is the highest given this is historically when our largest states have seen the highest claims volumes. Therefore, we've assumed a 62% gross loss ratio for the year, excluding any cat weather higher than the historical average. And given the pricing increases that have gone into effect, this loss ratio would equate to approximately a 24% increase in claims costs per policy compared to 2022. Certainly, we hope for better weather and a slowing of inflationary costs which could create upside to this range, but we believe this is the appropriate assumption at this time. We have not assumed major losses for cat weather events, which would create downside outside of this range until the Reciprocal is formed.

Adjusted EBITDA loss of $30 million to $40 million. We are managing costs carefully and we remain on track for positive adjusted EBITDA for the second half of 2023 and beyond. And finally, gross written premium of approximately $500 million. We anticipate the TDI will review our Reciprocal application in the latter part of 2023. If approved, we will revise our guidance to present the new structure of the business, which we believe to be more attractive. Until this time, we continue to be directly exposed to potential catastrophic weather events and then know that under U.S. GAAP, we expect to consolidate the financial results of the Reciprocal with Porch Group for a period of time. As I mentioned, we continue to expect adjusted EBITDA profitability for the second half of 2023 and beyond, even with the continued expected housing market downturn in 2023 and substantial increase in reinsurance pricing.

Here's a bridge to demonstrate how we would achieve this. Comparing the adjusted EBITDA loss of $24 million in the second half of 2022 to the positive adjusted EBITDA expectation in the second half of 2023 is driven by a number of factors. We are modeling a $10 million improvement between approved premium per policy increases in insurance that are rolling out already and lower distribution costs. Our previously stated price increases of insurance policies in Texas and South Carolina are being ruled out at each customer renewal. And the impact by the second half of the year is substantial. Second, a decrease of expenses by $5 million from a variety of G&A savings initiatives already in place . And finally, given the underwriting actions we are taking and given the severe weather we saw in 2022, we expect more than $10 million improvement in claims costs between the second half of 2023 compared to 2022.

And finally, before I hand it over to Matthew, a few housekeeping items I wanted to cover. First, as I enter my first full calendar year as Porch CFO, I plan to look at our KPIs in additional or alternative metrics to share. You'll notice that in this presentation we have added certain disclosures such as the gross loss ratio for our insurance business. We expect to continue to provide this disclosure until we potentially transition to the Reciprocal and it becomes less applicable. Secondly, we plan to transition from reporting policy retention to a premium retention rate, which we believe is more meaningful as it also considers price increases and is more directly comparable to peers. Additionally, you'll note in our press release issue today that we are restating our unaudited financial statements for Q1 to Q3 of 2022, primarily due to the accounting related to reinsurance contracts.

The net impact of the restatement for the nine months ended September 30, 2022 is additional revenue of $3.1 million and additional adjusted EBITDA loss of $2.3 million. And finally, we have remediated the three material weaknesses that we had from 2021 and we want to thank the team for their significant efforts on that front. Separate from the progress we've made there, we have identified a new material weakness for our HOA subsidiary. And as a reminder, we acquired HOA in 2021 and was subject to SOX for the first time in 2022. We'll work towards remediating this weakness in 2023. With that, I'll turn it over to Matthew Neagle, our Chief Operating Officer to discuss our key performance indicators for the fourth quarter. Matthew?

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