Hello and welcome to Goosehead Insurance Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your first speaker Dan Farrell. You may begin.

Thank you and good afternoon. Before we begin our formal remarks, I need to remind everyone that part of our discussion today may include forward-looking statements, which are based on the expectations, estimates, and projections of management as of today. Forward-looking statements in our discussion are subject to various assumptions, risks, uncertainties, and other factors that are difficult to predict and which could cause actual results to differ materially from those expressed or implied in the forward-looking statements. These statements are not guarantees of future performance; and therefore, undue reliance should not be placed upon them. We refer all of you to our recent SEC filings for a more detailed discussion of the risks and uncertainties that could impact future operating results and financial condition of Goosehead Insurance. We disclaim any intention or obligation to update or revise any forward-looking statements except to the extent required by applicable law. I would also like to point out that during the call, we will discuss certain financial measures that are not prepared in accordance with GAAP. Management uses these non-GAAP financial measures when planning, monitoring, and evaluating our performance. We consider these non-GAAP financial measures to be useful metrics for management and investors to facilitate operating performance comparisons from period-to-period by including potential differences caused by variations in capital structure, tax position, depreciation, and amortizations and certain other items that we believe are not representative of our core business. For more information regarding the use of non-GAAP financial measures including reconciliations of these measures to the most recent comparable GAAP financial measures, we refer you to today's earnings release. In addition this call is being webcast. An archived version will be available shortly after the call ends on the Investor Relations portion of the company's website at goosehead.com. Now, I'd like to turn the call over to our Chairman and CEO, Mark Jones.

Thanks Dan and welcome everyone on the call. Our third quarter results continue to demonstrate the strength and consistency of our business even in the face of substantial macro headwinds around both product availability and housing activity. For the third quarter of 2023, total written premiums increased 30%, total revenue grew 23%, adjusted EBITDA was up over 100% from a year ago, with adjusted EBITDA margin expansion of 13 points to 32%. I'm very pleased that we have continued to make strong progress on the strategic goals we laid out at the beginning of the year, driving producer productivity improvement in both corporate and franchise networks, upgrading the quality of our producer force by raising the standards of our recruiting process to ensure the best possible talent acquisition for the company, focusing our resources on scaling our highest potential franchise partners, investing in technology efforts to progress toward creating quote-to-issue capabilities for our agents, clients, and carrier partners, and strengthening our management capabilities to support accelerating growth and driving a culture of excellence throughout the organization. Our results this year are unfolding just as we expected. The strategic actions around quality in every part of the organization have resulted in significantly higher margins and a stronger more sustainable base to support re-accelerating growth. As we continue improving the quality and consistency of our distribution force, through the remainder of 2023 and beyond, the next phase of our execution will be driving re-accelerating new business production growth in 2024, which we expect to spring load into strong revenue and earnings growth in 2025 through a combination of producer headcount growth, further agent productivity improvements, particularly in franchise distribution, continued focus on retention, and increasing momentum of our digital business and partnerships. With our improved foundation, we're in a strong position to…

Thanks, Mark, and good afternoon, everyone. I'm very proud of the progress our team has made on our key strategic initiatives for 2023. In 2023, we have experienced the tightest insurance market in our company's 20-year history. But our team has rallied and dialed in on the things we can control. As a result we have seen significant lift in our new business productivity levels from both corporate and franchise agents. We've also refined and intensified our recruiting efforts to lock in a steady stream of high-quality talent for 2024 and beyond. Our service team has greatly improved many of our key performance indicators and we're now focused on driving cost efficiency across this team. From a technology perspective, we've quickly built a world-class team with technologists from outside the insurance industry. This team is rapidly implementing our QTI platform that will radically simplify the way insurance is sold and serviced in the future. This technology will help agents come down the learning curve significantly faster and dramatically increase efficiency. Instead of having to learn 20 different carrier systems, our agents will utilize one integrated platform. As compared to a year ago, I believe the changes we implemented have significantly strengthened our core operations and positioned us to move quickly and effectively in coming years. Turning to corporate distribution, we are now in a very strong position with our corporate sales team for both a quality and new business productivity perspective. We ended Q3 with 316 corporate agents, up from a low of 250 agents in May. As MJ noted average productivity is up substantially this year. On a year-to-date basis our new business productivity is up 28% for greater than one-year agents and 73% for less than one-year agents. I'm particularly excited about the color of the talent we…

Thanks, Mark. Before touching on key areas of results, I'd like to spend a moment on how we have been operating to mitigate the unique market headwinds on product availability and housing transaction declines. As we have previously indicated, product challenges are representing a larger headwind for our growth than the tailwinds we've been experiencing from carrier pricing actions. These headwinds have manifested in several ways. A pivot away from recruiting new franchises in certain geographies because of a lack of product and carrier appointments for new offices, some reduction in our bind rates and package rates on new business. Both measures that remain high, but are down from historically very consistent levels. And a modest decline in client retention despite significantly improving our service function, generating a Net Promoter Score at 92 compared to 90 a year ago. Our response to these challenges has been to improve our operations and processes across sales, service and technology to gain increasing market share and relentlessly focus on serving the needs of our clients and partners. On sales production, year-to-date we've added a record number of referral partners, despite intentionally reducing our producer headcount. Our lead generation is up 18% year-to-date, helping to offset the impact of lower bind rates and package rates amidst product challenges. This is allowing many of our agents to achieve record new business generation despite unprecedented challenges in our 20-year history. In this environment our value proposition is even more evident to our referral partners because rising insurance costs and interest rates affect an individual's buying power and our agents are able to add more value at the home closing process. We are also diversifying our lead generation from the housing transaction through partnerships and digital lead generation efforts. In the service function, we have significantly reduced…

Thank you. [Operator Instructions] Our first question comes from the line of Michael Zaremski with BMO. Your line is open.

Hey. Good afternoon. I guess first question maybe on your comment reminding us about your 40% long-term margin goal. Just curious would you be able to share any breadcrumbs on what level of productivity lift that would imply versus kind of today's levels or any kind of breadcrumbs around to help us kind of put our heads around a 40% margin?

Hey, Michael. This is Mark Jr. So in order to get to 40% you don't necessarily need to see massive productivity improvements. Now we've seen nice margin expansion this year. Some of that is driven by productivity improvements and generating profitability on new business. But naturally the way that this business works, as you get more and more renewal bias in the book, you just become more profitable given that the servicing on a renewal policy is significantly less than a new business policy. There's much less fulfillment effort all of those type of things and the compensation to an agent is roughly 50%. So over time as the renewal book becomes a larger and larger piece and you see the growth rate trend down, naturally you get a lot of operating leverage out of the business.

And maybe just sticking to productivity since it's been a big plus lately and from your comments you expect it to continue to increase. And I know that you gave different that you about it differently productivity franchise versus corporate. But I guess you said a number of things about why productivity is likely to improve in the coming year. You talked about more product availability knock on wood if the industry heals. You talked about the existing franchises being substantially more productive as they hire new folks and the corporate conversions being five times more productive. Are -- and then I guess there's QTI too. So I know there's a lot going on, but what -- it feels like there's a lot in the Mosaic that's going to be more of a big positive. Could you -- am I characterizing things correctly and there's kind of a lot of levers?

Yes, I think absolutely. And I would point to the product challenges we're seeing today are dramatically reducing where productivity could be today given the amount of leads we're receiving. So we mentioned in the prepared remarks that lead flow is up 18% year-over-year in a pretty challenging housing environment. Now if we can get the product environment and carrier underwriting profitability back at a level where there's a wide variety of carriers looking to grow. There's no reason why we shouldn't continue to see pretty strong productivity improvements on a year-over-year basis for a while to come along with all of the other technological efforts we're making with QTI and partnerships and things like that.

And this is Mark Miller. I would just add one thing on top of it. One thing we're also seeing is our retention rates of our employees is increasing. And as that happens, your tenure goes up, and there's a direct correlation between tenure and productivity. And so last year, a year before that, higher attrition rates, lower attrition rates now. So that also factors into your equation.

Okay. That's helpful. And maybe lastly, on QTI, and I think it's -- since an outsider looking in, we appreciate you're saying it's a heavy lift and whatnot. But I guess just trying to better articulate why its impact could be profound. Like, I guess if a majority of your carriers went into kind of a QTI type, I guess, KPI or plug-in with you all, like, is there, would it save your average employee like X amount of minutes per day that they could use that saved time to just sell more, or is that the way we should think about it, or is it more profound and have -- than just saving time and giving them more time to sell otherwise?

Yes. This is Mark Miller again. I would say in this world current state today, I would think of it as a significant efficiency play for the sales team. So if you -- all the trailing paperwork and everything else that has to happen after the sale of the policy, it helps with that greatly. And then the service team that has to service it afterwards, today they have to go into a native system of the carrier. What we want to do in the future is the QTI connections are the same ones that you would have to use in the service side to get into service a policy. So, great efficiency savings. And I think we mentioned, it will help direct exact type of customer to the exact type of policy we want in the future.

Yes. I think there's also kind of an ancillary benefit here that this is a technology that doesn't exist anywhere else in the marketplace. And so as you go to acquire new talent and people evaluate their options for an independent agency, why would you ever choose anywhere else that has lesser technology and something that they don't even have a roadmap to be able to accomplish. We already have it. We've got first-mover advantage there.

Interesting. Thank you.

Thank you. Our next question comes from the line of Paul Newsome with Piper Sandler. Your line is open. Check to see if you're on mute, Paul. Paul, are you there? Our next question comes from the line of Brian Meredith with UBS Securities. Your line is open.

Hey, thanks. A couple of quick ones here for you. First one, I'm just trying to understand a little bit the margin guide that you've got for the fourth quarter, just modest increase given what we saw this quarter. It looks like comp and benefits have stayed relatively low, and usually we see a ramp up there. Is there some seasonality or something going on that we're just not seeing?

Yes. So, typically, if you look at the seasonality of revenue from Q3 to Q4, you don't see a big lift in revenue from Q3 to Q4, and if you think about our revenue guide, you can get to where you would expect that to be for the fourth quarter. On the cost bar, I'm not expecting a big move from the third quarter to the fourth quarter. So, you can come up with what you should expect a margin number to be for Q4, I think.

Got you. Appreciate that. And then second question, I'm just curious, you gave contingent commission guide, I guess, for the year, but it was pretty strong in the third quarter. I'm just curious, what's driving that contingent commission? I know last quarter you talked about some volume benefits, but, you know, really stepped up again?

Yes. So, there's a couple of things going on there, one being, you're right, more volume benefits. So, the majority of our contingencies are made up of a handful of carriers, and if the premium in those carriers grow faster than the premium of the whole book, you'll see slightly outsized contingency. The other thing is there's a couple of smaller contingencies that are loss ratio based that we are, it looks like now at this point, tracking to hit, and the way that the revenue recognition would work on that is you've got to wait until you have that information to actually record it. And so, that could look more like 9 months of contingency in the third quarter as opposed to an even distribution throughout the year that you would see from a growth-based contingency.

Got you. And then last question just curious geographically if you kind of look at geographically where things are is there any kind of area that you see opening up a little bit more from a product perspective -- carrier perspective versus others in other areas of the country?

It's pretty tight across the board, but I think we're doing a good job of adding product where we can whether that be admitted product or E&S product and we have a few really, really good carrier partners that are keeping us open in places where they've shut down other agents. I think that's just the value of our model.

Great. Thank you.

Thank you. Please standby for our next question. Our next question comes from the line of Mark Hughes with Truist Securities. Your line is open.

Yes. Thank you. Good afternoon. In times past you've given the source of new business. I think you -- earlier on it was kind of 60% came from the mortgage market. I hear what you're saying that you're looking at expanding that going through other electronic sources. Is there an updated mix of new business you might be able to share?

So today that's still about right where it's in excess of 50% of the lead generation from new business comes out of a mortgage transaction. We're building up the partnership and the digital lead generation efforts which I think that's why it's even more impressive that our lead flow is up 18% year-over-year with fewer agents and considerably less housing transactions. Our agents have just been doing a really good job marketing out there and the value to referral partners today as we mentioned in our prepared remarks it's never more evident than it's been in our history. The insurance cost on a mortgage transaction now is a real consideration especially with rising interest rates. And so we're able to provide a really differentiated service today in the face of those headwinds.

I had a question about the geography or the flow in the income statement. When I think about renewal commissions say for this quarter the line items that flow into that would be renewal commissions in this quarter last year presumably that business would be renewing again and then the new business commissions those would also be up for renewal and therefore would be reflected in the renewal commissions. Is that right? It's those two categories from last year that flow into the renewal commissions this year and that's all corporate agent activity is that correct?

Yes. That's the right way to think about it.

And same with the renewal royalty fees that renews, but the new business royalty fees they step up kind of the 5% to 50% retention versus the 20%.

Right. So the way you would do the math with the royalty fees is you would just gross them up so you would do your new business royalties our portion of that is only the 20% so you gross that up and then same thing on the renewals our portion is the 50%. And then to get to the next years you obviously just multiply that by 50% that would be our portion.

Yes, yes exactly. Okay. And then one other quick question just the rate contribution to growth any meaningful changes this quarter by that I mean the kind of pricing the premiums that the policyholders are paying for auto and homeowner's insurance how has that contribution changed perhaps?

We're still seeing price inflation, but in our minds the product availability that's the other side of that price inflation has been a bigger headwind than the price inflation has been a tailwind. And you can see that in retention you can see that in some stats that we track internally like policies per lead we mentioned buying rate and package rate as well in our prepared remarks so we believe that the product environment is more of a headwind today than price inflation has been a tailwind.

Thank you.

Thank you. Please standby for our next question. Our next question comes from the line of Meyer Shields with Keefe, Bruyette & Woods.

Great. Thank you. A couple of small questions. First are there additional expenses associated with pursuing leads through the partnerships and digital channels? Does that change the equation at all?

So we -- the digital channel is A our digital agent as well as leads from our partnerships and other organizations. The digital agent all of that is already built in from previous spending. The partnership leads there's some reciprocal dollars that flow back and forth but there's not any more customer acquisition costs than would be a traditional go-to-market strategy.

Okay. Excellent. And going back to contingents, I'm probably a step behind, but if the increasing certainty with regard to loss ratio-based contingents is what drove the contingents in the quarter, shouldn't that and the year-to-date numbers imply more than 40 basis points for the full year?

Yeah. The language we use is around 40 basis points. Things could still happen in the fourth quarter that could have adverse impact on that, but we feel comfortable that we will be at least a 40 basis point flow.

Okay. That’s helpful. And I guess kind of a question just because I don't know if there was an explicit comment, but I think Mark you talked about some initial signs of carriers app sites expanding. Is there any initial change or inflection in what you're seeing with regard to housing?

We have not seen sort of a turnaround in the housing market yet, no.

Okay.

I wish it were different but it's not.

Absolutely understood.

Thank you. Please standby for our next question. Our next question comes from the line of Paul Newsome with Piper Sandler. Your line is open. Paul, check to see if you are on mute? Our next question comes from the line of Scott Heleniak with RBC Capital Markets. Your line is open.

Yeah. Thanks. I was just wondering with the franchise reductions probably just about over it seems like at least that's kind of what you had said on the last quarter of the call. Can you just comment on the franchise inquiries that you're getting and your plans to expand that in 2024 and beyond and just any kind of information or backlog information you can share on the franchise side?

Yeah. Scott, just to clarify one point. On the last call, we said we were over the halfway point in franchise terminations and those calling efforts. So in this quarter we had 89 terminations. We still think it will be high in the fourth quarter higher than historical average. We believe in 2024 we will trend back down towards that historical average of 15%. And we don't see a reason why kind of medium term it should be higher than a 10% to 15% range as we gross up the gene pool.

Yeah. Scott, this is Mark Miller. So if we just go back and think about franchises in general, the way that I think about it it's not about the absolute number of franchises. It's more about how many agents we have. And so where we're really doubling down is adding franchises or adding agencies back into the franchises that we feel really strongly about. What you're seeing in the numbers is kind of a net out number. So you're losing about quite a few agents that aren't very productive and replacing them with highly productive agents. That includes corporate agents that are converting to franchise ownership. We're also being very, very selective in the franchises that we're putting into the community now. So the number of launches you'll see are greatly reduced from what it was last year, but they're much more productive and they're in the geos that we want. And I think the final part of your question was how many kind of inbounds are we getting now? We've transformed the way we hunt for franchises if you will. Instead of doing a lot of outbound calling about 50% of our leads will be coming from, in this quarter from inbound digital marketing type of capabilities which is a new muscle for us and working tremendously well at finding really high-quality franchises.

Okay. That's helpful detail. And then just the agent to franchise conversions, you said expect to do 34 this year. Is there any kind of target you have in mind just annual conversions kind of going forward? Is that kind of a good number to use just assume the next few years?

I mean, it is our best source of high-quality franchises. I'd love to ramp that up. But I also don't want to jeopardize the health of the corporate business. So a lot of it depends on how big the incoming class is going to be, which we mentioned we're doing really, really well on college campuses. We're still in the budget process. And so, we literally budget out how many people we want to convert and how much we can take out of the corporate business. But I would say consistent with this year would be a good estimate for next year until we have information. And if the class grows bigger and we have more qualified people I'd certainly like to up that. But right now I would use what we had this year.

Okay. That makes sense. And then just final last question just the product availability that you're citing, I'm assuming that's in Florida, California, Texas. Are you seeing that anywhere else or is it just mostly those three states?

Hey this is Brian Pattillo. It's really across the board. Those are certainly the most difficult states. California and Florida have been difficult for a long time. In fact California we've actually seen in many ways a better market, because of many of the large captive carriers have shut down new business which has given us actually a lift on that. But really it's across most states. We're seeing many of these carriers are looking to slow down growth as they seek to restore profitability. So almost every single state has been challenged from a product perspective just some more pronounced than others.

Got it. Appreciate. Thanks.

Thank you. Please standby for our next question. Our next question comes from the line of Josh Shanker with Bank of America. Your line is open.

Yeah. Thank you. Good evening everybody. A couple quick numbers questions, what were onboarding the quarter? And how many contracts for new franchises, do you have pending?

Hey Josh we launched 30 franchises in the quarter. And I believe the signed, but not yet launched pools in the 200s.

Okay. I'm looking back to 2019 before the pandemic shook everything up. And by my count it seems like this is a winner or loser type environment you guys operate. And maybe about 30% of franchises didn't make it out of their first year could get traction. Is that a good way to think about long-term how the company ought to operate among new hires, a new franchisee hires?

I mean Josh, this is Mark Miller. I would assume that we can bring that number down with the way that we're like corporate franchises that are corporate agents that convert into franchise ownership are not going to fail at the same rate. I mean we're bringing in much higher quality franchises so we would certainly expect to bring that number down overtime.

Yeah. I would point to in this quarter franchises we launched in Q3 of 2023, were 48% more productive, excluding the corporate launches. So just ones we hunted in the wild compared to last year 48% more productive. So the quality of the franchise pool is going up dramatically which helps that we don't need as much volume. We still would like to see some increasing volume on new franchises but the productivity is so high at this point that we feel very good about the success rate of new launches.

And if I can …

Yeah and obviously the productivity correlates directly to the success, like they're going to stay in the system a lot longer if they're more profitable.

And if I can get one more in you talked about the opportunity to earn a seven-figure annual compensation from a college hire. Just to understand the pathway someone joins as a corporate agent they prove successful you convert them into a franchise agent and they work for a number of years and get up there. And do we have examples of corporate agents who have become seven-figure earners?

Yes. Yeah we do. And it's a pretty clear path. These are typically people that have had a team underneath them before. They know how to recruit. They know how to onboard and to get people down the ramp. And so it's a relatively I won't say easy proposition but it's simple for them to understand. They know how to be a good producer. They know how to get people up to be a good producer. So you don't need very aggressive hiring targets to get there. It's a very clear path and we have examples of it in the past.

Are the corporate agents still those seven-figure earners or are they franchisees at this point?

Franchisees.

Okay. Got it. Thank you.

Thank you. Please standby for our next question. Our next question comes from the line of Pablo Singzon with JPMorgan. Your line is open.

Hi. Thanks. Mark Jr. if I heard you correctly I think you suggested that revenues and costs would be roughly consistent sequentially when thinking about the 4Q? Would that then suggest a similar margin profile for the fourth quarter or are there discrete items that you should think about?

Yeah. So we've got the revenue guidance for the full year. I would point you to that for the fourth quarter revenue numbers. From a cost bar perspective those should be relatively consistent with the third quarter. We've on-boarded a few people but nothing that's going to move the employee common benefits line too dramatically. So I would just point you to the way seasonality looks from Q3 to Q4 historically, our revenue guidance and then a relatively consistent cost bar from Q3 to Q4.

Okay. Yes, that’s effective. Thanks. And then as I look at employee comps maybe beyond the fourth quarter, clearly this quarter grew much lower than revenues. I think partly you're reflecting what you said about the renewal book hitting a much leaner expense base. Do you think you can maintain this comp ratio as you scale up in 2024 and 2025 or is there some giveback as you ramp up and do more investment?

Yes, so as we stay laser focused on productivity, specifically with corporate agents that will help make sure we don't see that employee comp benefits start to lose scale. The other big piece of that and actually the biggest piece of that is the service department. And so making sure we can drive efficiencies and scale out of the service department will keep that employee comp benefits line continuing as a smaller and smaller piece of total core revenue. And then obviously, we'll make investments in areas that we need to make investments in things like technology and the partnerships department, franchise development, those type of areas. But you shouldn't see us losing scale dramatically in employee comp benefits as we onboard new agents. We're just too focused on productivity to let that happen.

Okay. And then last question for me also related to employee comp. If you look at stock comp as a percentage of overall employee comp, it's increased from let's call it high single-digit to mid-teens level now. Is that a consistent ratio to think about, right? So say mid-teens for the foreseeable future?

So we've talked about stock comp a lot. The way we think about it is the dilution effect on the total share count. And so what we've said historically is that 1% to 2% dilution rate in annual stock option awards. Obviously, the gap recognition of that is a Black-Scholes valuation, which has other factors of our control that drive that compensation number. And so as you go forward on an annual basis, you should expect a share count dilution in the 1% to 2% range. And the Black-Scholes calculation will be what it will be depending on volatility in the stock market and risk-free interest rates.

Got it. Thank you.

And it is a non-cash expense.

Thank you. At this time I would now like to turn the call back over to CEO, Mark Jones for closing remarks.

Thanks, everyone for your time and participation. We appreciate it and hope you have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.