We are a rapidly growing personal lines independent insurance agency, reinventing the traditional approach to distributing personal lines products and services throughout the United States. We were founded with one vision in mind-to provide consumers with superior insurance coverage at the best available price and in a timely manner. By leveraging our differentiated business model and innovative technology platform, we are able to deliver a superior insurance experience to our clients.
The following discussion contains references to the years ended December 31, 2019 and December 31, 2018.
•Adjusted EBITDA*, a non-GAAP measure, increased 19% from 2018 to $17.5 million, or 23% of total revenues; if reported under ASC 605, Adjusted EBITDA would have been $22.9 million or 27% of total revenues.
•Basic earnings per share was $0.24 and Adjusted EPS*, a non-GAAP measure, was $0.28 for the year ended December 31, 2019.
◦As of December 31, 2019, 141 of these Corporate sales agents had less than one year of tenure and 107 had greater than one year of tenure.
•Operating franchises increased 34% from December 31, 2018 to 614 at December 31, 2019.
◦Outside of Texas as of December 31, 2019, 215 operating franchises had less than one year of tenure and 201 had greater than one year of tenure.
*Adjusted EBITDA and Adjusted EPS are non-GAAP measures. Reconciliation of Adjusted EBITDA to net income (loss) and Adjusted EPS to EPS, the most directly comparable financial measures presented in accordance with GAAP, are set forth in the "Key performance indicators" section of Management’s discussion and analysis of financial condition and results of operations of this Form 10-K.
•Continued retention of existing Book of Business. We have made significant progress in recent years in Client Retention metrics, and maintaining these high levels of Client Retention is key to future profitability. A key lever in driving Client Retention is selling multiple lines of business to clients at the point of initial sale. In our Corporate Channel, we have made significant progress in recent years in this area. We expect to continue to maintain our high levels of cross-selling in the Corporate Channel, and we expect to see improvement in our Franchise Channel as we bring best demonstrated practices to our field of Franchisees.
•Strength of the insurance market or particular lines of business. We generate the majority of our revenues through commissions, which are calculated as a percentage of the total insurance policy premium. A softening of the insurance market or the particular lines of business that are our focus, characterized by a period of declining premium rates, could negatively impact our profitability.
•Effect of natural or man-made disasters. Any increases in loss ratios due to natural or man-made disasters could impact our Contingent Commissions, which are primarily driven by both growth and loss ratio metrics.
Effective Annual Report on Form 10-K for the year ended December 31, 2019, the Company adopted new accounting guidance, ASU 2014-09 - Revenue from Contracts with Customers ("Topic 606"), related to revenue from contracts with customers. The Company adopted Topic 606 using the modified retrospective method, which applies the new guidance prospectively, beginning as of 2019, the year of adoption. Accordingly, the adoption of Topic 606 using the modified retrospective method does not impact prior years' financial statements.
•Renewal Commissions - highly predictable, higher-margin revenue stream, which is managed by our service team.
•New Business Royalty Fees - predictable based on franchise count and consistent ramp-up of franchises, but lower margin than Renewal Royalty Fees because the Company only receives a royalty fee of 20% on the commissions paid by the Carrier in the first term of every policy and higher back-office costs associated with policies in their first term. This revenue stream has predictably convert into higher-margin Renewal Royalty Fees historically, and we expect this to continue moving forward.
•Agency Fees - although predictable based on agent count, Agency Fees do not renew like New Business Commissions and Renewal Commissions.
•Interest Income - like Initial Franchise Fees, interest income is a Cost Recovery Revenue stream that reimburses the Company for those franchises on a payment plan.
•Contingent Commissions - although high margin, Contingent Commissions are unpredictable and susceptible to weather events and Carrier underwriting results. Management does not rely on Contingent Commissions for operating cash flow or budget planning.
As discussed later in this “Item 7. Management’s discussion and analysis of financial condition and results of operations”, Core Revenue was not significantly impacted by the adoption of Topic 606. The total impact to Core Revenue in 2019 due to the adoption of Topic 606 was a decrease of $53 thousand.
With certain Carriers, the Company has the opportunity to earn additional revenue in the form of Contingent Commissions, typically based on the growth and loss ratio of the business placed with the select Carriers. The Contingent Commissions are extremely difficult to predict in any given period. Although the Company can control the amount of business placed with the Carriers, loss ratios depend on many factors that are outside of our control, such as weather events and Carrier underwriting accuracy. As such, we view these Contingent Commissions as a bonus and have historically returned the cash from the Continent Commissions to shareholders by way of a special dividend. The Company has historically recognized the Contingent Commission revenue when the cash or statement showing the amount to be paid was received from the Carriers, which was typically in the first quarter following the year in which the Contingent Commissions were earned. Under Topic 606, however, we must estimate the amount to be received during the period over which the Contingent Commissions are earned.
Due to our purely organic-focused growth strategy, virtually all of our investments in future growth are in people and certain technologies. Therefore, the majority of our investments are not capitalizable and are recognized immediately on our statement of income.
The below illustrates the impact of Topic 606 on the Company's income statement line items for the year ended December 31, 2019.
(2) Renewal Royalty Fees, New Business Royalty Fees, Initial Franchise Fees, and Other Income are included in "Franchise revenues" as shown on the Consolidated statements of income.
New Business Revenue is commissions received from the Carrier, Agency Fees received from clients, and Royalty Fees relating to policies in their first term.
(1) Adjusted EBITDA Margin is calculated as Adjusted EBITDA divided by Total Revenue ($17,530 / $77,486) for the year ended December 31, 2019 under ASC 606, ($22,928/$84,098) for the year ended December 31, 2019 under ASC 605, and ($14,752 /$60,148) for the year ended December 31, 2018.
(2) Calculated as the income prior to the Reorganization Transactions, times the controlling interest percentage at the time of IPO, times the assumed effective tax rate of 25%, divided by the count of Class A shares at the time of the IPO [ $4.4 million * 37.3% * 25% / 13.5 million ].
(4) Calculated as equity-based compensation divided by the weighted average of Class A and Class B shares outstanding during the period 2019 - [ $1.5 million / ( 14.9 million + 21.4 million )] 2018 - [ $27.1 million / ( 13.6 million + 22.7 million )]
The following table summarizes our results of operations for the years ended December 31, 2019 and 2018:
New Business Commissions increased by $2.6 million, or 28%, to $12.0 million for the year ended December 31, 2019 from $9.3 million for the year ended December 31, 2018. Revenue from Agency Fees increased by $0.9 million, or 17%, to $6.1 million for the year ended December 31, 2019 from $5.2 million for the year ended December 31, 2018. These increases were primarily attributable to an increase in total sales agent head count to 248 at December 31, 2019, from 167 at December 31, 2018, a 49% increase.
Interest Income increased $195 thousand, or 46% to $617 thousand for 2019 from $422 thousand for 2018. This increase was primarily attributable to additional Franchise Agreements signed under the payment plan option.
Employee compensation and benefits expenses decreased by $16.5 million, or 28%, to $41.7 million for 2019 from $58.3 million for 2018. This was primarily attributable to a $26.1 million decrease in Class B unit compensation (of which $19.8 million was non-cash vesting of certain Pre-IPO LLC members' equity during 2018), offset by a $0.6 million increase in non-cash stock option expense and an increase in total headcount from 2018 to 2019.
During 2018 the Company incurred expenses of $22 thousand related to the disposal of fixed assets located in the previous headquarters, compared to other income of $0 in 2019.
Interest expenses decreased by $1.9 million, or 44%, to $2.4 million for 2019 from $4.3 million for 2018. This decrease was attributable to a decrease in the average note outstanding and a lower average interest rate throughout year. Additionally, during 2018, $871 thousand of origination fees from previous debt were immediately recognized upon refinance on August 3, 2018.
We have managed our historical liquidity and capital requirements primarily through the receipt of revenues from our Corporate Channel and our Franchise Channel. Our primary cash flow activities involve: (1) generating cash flow from Corporate Channel operations, which largely includes Renewal Revenue (Corporate) and New Business Revenue (Corporate); (2) generating cash flow from Franchise Channel operations, which largely includes Royalty Fees and Initial Franchise Fees; (3) making distributions to the Goosehead Management Holders and Texas Wasatch Holders; and (4) borrowings, interest payments and repayments under our Credit Agreement. As of December 31, 2019, our unrestricted cash and cash equivalents, and restricted cash was $15.3 million. We have used cash flow from operations primarily to pay compensation and related expenses, general, administrative and other expenses, debt service and distributions to our owners.
See "Note 9. Debt" for a discussion of the Company's credit facilities. The Company refinanced its credit facilities on March 6, 2020; see "Note 16: Subsequent Events."
Net cash used in financing activities was $20.9 million for 2019 as compared to net cash provided by financing activities of $5.6 million for 2018. This increase in net cash used financing activities is due to the $15.0 million dividend paid in 2019. During 2018, there was activity related to the Offering, during which $86.9 million was received as proceeds net of offering costs, offset by distributions of $80.1 million.
•we will record 85% of the estimated realizable tax benefit (which is the recorded deferred tax asset less any recorded valuation allowance) as an increase to the liability due under the tax receivable agreement and the remaining 15% of the estimated realizable tax benefit as an increase to additional paid-in capital.
The following table represents our contractual obligations as of December 31, 2019, aggregated by type.
(1)The Company leases its facilities under non-cancelable operating leases. In addition to monthly lease payments, the lease agreements require the Company to reimburse the lessors for its portion of operating costs each year. Rent expense was $1.9 million for year ending December 31, 2019 and $1.6 million for the year ending December 31, 2018.
The adoption of the new revenue standard on January 1, 2019 has increased the significance of judgments and estimates management must make to apply the guidance. In particular, judgments related to the amount of variable revenue consideration to ultimately be received on commission revenue, royalty fees, and contingent commissions, which was previously recognized when the Company received notification from the insurance carrier, now requires significant judgments and estimates.
federal, state and local income tax or franchise tax that we actually realize as a result of (i) any increase in tax basis in Goosehead Financial, LLC’s assets resulting from (a) the acquisition of LLC Units using the net proceeds from any future offering, (b) redemptions or exchanges by the Pre-IPO LLC Members of LLC Units and the corresponding number of shares of Class B common stock for shares of our Class A common stock or (c) payments under the tax receivable agreement, and (ii) tax benefits related to imputed interest deemed arising as a result of payments made under the tax receivable agreement.
During the 2019, as a result of the redemption of LLC Units, we recognized liabilities totaling $13.4 million relating to our obligations under the Tax Receivable Agreement.
As discussed in Note 2 to the financial statements, effective January 1, 2019, the Company adopted Revenue from Contracts with Customers (ASU2014-09) (“Topic 606”), as amended, using the modified retrospective method.
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
The operations of the franchise units are recorded in Goosehead Insurance Agency, LLC (“GIA”)-a Delaware limited liability company headquartered in Westlake, TX and operating since 2011. GIA is 100% owned by Goosehead Insurance Holdings ("GIH"), which is 100% owned by GF. Franchisees are provided access to insurance Carrier Appointments, product training, technology infrastructure, client service centers and back office services. During years ended December 31, 2019 and 2018, the Company onboarded 247 and 214 franchise locations, respectively and had 614 and 457 operating franchise locations as of December 31, 2019 and 2018, respectively. No franchises were purchased by the Company during the years ended December 31, 2019 and 2018.
In connection with the Offering, the Company completed the following transactions (the "Reorganization Transactions"):
•The Goosehead Management Holders and Texas Wasatch Holders indirectly transferred their ownership interests in GM and TWIHG, respectively, to GSHD in exchange for the Goosehead Management Note and Texas Wasatch Note. The aggregate principal amount of the Goosehead Management Note and the Texas Wasatch Note was approximately $114 million. Because the net proceeds from the Offering were insufficient to repay the aggregate principal amount of the notes, 3,724 thousand shares of Class A common stock were issued to the Goosehead Management Holders and the Texas Wasatch Holders for the difference. GSHD contributed direct and indirect ownership interests in each of TWIHG and GM to GF.
The following is a reconciliation of our cash and restricted cash balances as presented in the consolidated statement of cash flows for the years ended December 31, 2019 and 2018 (in thousands):
In select states, agents have the option to charge an agency fee for the placement of the insurance policy. These non-refundable fees are recorded as receivable on the date the policy is effective with the insurance carrier.
The Company records agency fees receivable net of an allowance for estimated uncollectible accounts to reflect any loss anticipated for the related agency fees receivable balances and charge to bad debts. The agency fees receivable balance consists of numerous small-balance, homogeneous accounts. The Company calculates the allowance based on collection history and writes off all uncollected agency fee balances outstanding over ninety days.
Intangible assets are stated at cost less accumulated amortization and reflect amounts paid for the Company’s web domain and computer software costs. The web domain is amortized over a useful life of fifteen years and software costs are amortized over a useful life of three years.
included in unearned revenue related to initial franchise fees were $0 and $530 thousand at December 31, 2019 and 2018, respectively.
Deferred rent consists of rent abatement affecting the timing of cash rent payments related to the Company’s corporate office leases, as well as lease incentives such as construction allowances. Deferred rent is record as a liability and is amortized over the lease term as a reduction to rent expense.
The Company expenses advertising costs as they are incurred. Advertising expense for the years ended December 31, 2019 and 2018 was $812 thousand and $521 thousand.
The following tables summarize the impacts of adopting the revenue recognition standard on the Company’s consolidated financial statements:
(1) Changes in the equity balances are a resulted of the cumulative effect of the adoption ASC 606 on beginning balances, and the impact to the current period net income.
The Company earns new and renewal commissions paid by insurance carriers and fees paid by its clients for the binding of insurance coverage. The transactions price is set as the estimated commissions to be received over the term of the policy, net of a constraint for policy changes and cancellations. These commissions and fees are earned at a point in time upon the effective date of bound insurance coverage, as no performance obligation exists after coverage is bound. The company also earns contingent commissions from the insurance carriers based on the growth and the profitability of the premiums being placed with the insurance carrier.
The following table provides information about receivables, cost to obtain, and contract liabilities from contracts with customers:
The following table reflects the estimated initial franchise fees (contract liability) to be recognized in the future related to performance obligations that are unsatisfied at the end of the period (in thousands):
Activity in the allowance for uncollectible agency fees was as follows:
Amortization expense was $204 thousand and $117 thousand for the years ended December 31, 2019 and 2018, respectively.
Matching contributions may be changed at the discretion of the Company. Company contributions totaled $592 thousand and $529 thousand for the years ended years ended December 31, 2019 and 2018.
The $13.0 million revolving credit facility accrues interest on amounts drawn at an initial interest rate of LIBOR plus 2.50%, then at an interest rate determined by the Company's leverage ratio for the preceding period. As of December 31, 2019, the Company was in the greater than 1.50x leverage ratio tranche, accruing interest of LIBOR plus 2.00%. At December 31, 2019, the Company had $10.0 million drawn against the revolver. At December 31, 2019, the Company had a letter of credit of $333 thousand applied against the maximum borrowing availability, thus amounts available to draw totaled $2.7 million. The revolving credit facility is collateralized by substantially all the Company’s assets, which includes rights to future commissions. Interest payment on the revolving credit facility totaled $450 thousand and $198 thousand for the years ended December 31, 2019 and 2018, respectively.
The $40.0 million term note accrues interest at an initial interest rate of LIBOR plus 2.00%, then at an interest rate determined by the Company's leverage ratio for the preceding period. As of December 31, 2019, the Company was in the greater than 1.50x leverage ratio tranche, accruing interest of LIBOR plus 2.00%. The aggregate principal amount of the term note as of December 31, 2019 is $36.5 million, payable in quarterly installments of (x) $750 thousand from the fiscal quarter ending 3/31/2020 through the fiscal quarter ending 6/30/2020 and (y) $1.25 million
from the fiscal quarter ending 9/30/2020 through the fiscal quarter ending 6/30/2021, with a balloon payment of the entire unpaid principal amount of the term note on 8/3/2021.The term note is collateralized by substantially all the Company’s assets, which includes rights to future commissions.
The framework for measuring fair value provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described as follows:
The Company leases its facilities under non-cancelable operating leases. In addition to monthly lease payments, the lease agreements require the Company to reimburse the lessors for its portion of operating costs each year. Rent expense was $1.9 million and $1.6 million for the years ended December 31, 2019 and 2018.
As a result of the Reorganization Transactions and the Offering, GSHD became the sole managing member of GF, which is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, GF is not subject to U.S. federal and certain state and local income taxes. Any taxable income or loss generated by GF is passed through to and included in the taxable income or loss of its members, including GSHD, on a pro rata basis. GSHD is subject to U.S. federal income taxes, in addition to state and local income taxes, with respect to GSHD's allocable share of income of GF.
A reconciliation of income tax expense computed at the U.S. federal statutory income tax rate to the income tax expense recognized is as follows (in thousands):
GSHD has a total of 15,238 thousand and 13,800 thousand shares of its Class A common stock outstanding at December 31, 2019 and 2018, respectively. Each share of Class A common stock holds economic rights and entitles its holder to one vote per share on all matters submitted to a vote of the stockholders of GSHD.
The previously reported amounts within the Company’s consolidated statement of stockholders’ equity for the year ended December 31, 2018 and the corresponding amounts in the consolidated balance sheet as of December 31, 2018 have been revised to reflect the corrected balances as presented below (in thousands):
share amounts). Diluted earnings per share of Class A common stock is computed by dividing net income attributable to GSHD by the weighted average number of shares of Class A common stock outstanding adjusted to give effect to potentially dilutive securities. The Company has not included the effects of conversion of Class B shares to Class A shares in the diluted EPS calculation using the "if-converted" method, because doing so has no impact on diluted EPS.
(2) 1,650 thousand stock options were excluded from the computation of diluted earnings per share of Class A common stock for the year ended December 31, 2018 because the effect would have been anti-dilutive, as GSHD recorded a net loss for the period.
On a quarterly basis, GF makes distributions to the LLC Unit holders on a pro rata basis. For the years ended December 31, 2019 and 2018, GF made distributions of $6.3 million and $3.9 million, respectively, of which $3.7 million and $3.0 million, respectively, were made to Pre-IPO LLC Members. The remaining $2.6 million and $0.9 million, respectively, were made to GSHD and was eliminated in consolidation.
The following table summarizes the ownership interest in GF as of December 31, 2019 (in thousands).
Prior to the Offering, certain Pre-IPO LLC Members held non-vesting and non-voting Class B units. In accordance with accounting guidance, any dividends paid to Class B unit holders are recognized as compensation expense when declared, as the Class B non-vesting units are considered to be a non-substantive class of equity. Dividends paid to Class B unit holders prior to the Offering, included in employee compensation and benefits, totaled $122 thousand for the year ended December 31, 2018.
In connection with the Reorganization Transactions, immediately prior to the Offering, historical Class B interests in TWIHG and GM vested by converting to the Texas Wasatch Note and Goosehead Management Note, respectively, paid with a combination of proceeds from the Offering and shares of Class A common stock. This conversion changed the nature of the Class B interests from a profit sharing arrangement to a substantive class of equity and were expensed under the guidance of ASC 718. At the Offering price of $10.00 per share, GSHD incurred total compensation expense of $6.2 million in connection with the conversion, recognized in the second quarter of 2018.
In April 2018, GSHD adopted the Omnibus Incentive Plan, which reserved 1.5 million shares of Class A Common Stock for delivery to directors, officers, and managing directors in connection with future awards granted under the plan. GSHD also adopted an Employee Stock Purchase Plan ("ESPP"), which reserved 20 thousand shares of Class A Common Stock for delivery to employees. On March 7, 2019, GSHD’s Board of Directors amended the Omnibus Incentive Plan, increasing the number of shares available under the plan to 3.0 million shares. On the same date, GSHD’s Board of Directors approved an increase in the total number of shares available under the ESPP to 30 thousand shares. There were 13 thousand and 5 thousand shares outstanding related to the Employee Stock Purchase Plan at December 31, 2019 and 2018.
Any future extraordinary dividends will be declared at the sole discretion of GF's managing members with respect to GF and the Company's board of directors with respect to GSHD. In determining whether a future extraordinary dividend will be declared by the Company, the board of directors may, at its sole discretion, consider the following: the Company's financial condition and operating results, the Company's available cash and current and anticipated cash needs, the Company's capital requirements, any contractual, legal, tax and regulatory restrictions, general economic and business conditions, and such other factors or conditions as the board of directors deems relevant.
The Company has two reportable segments: Corporate Channel and Franchise Channel. The Corporate Channel consists of company-owned and financed operations with employees who are hired, trained, and managed by Goosehead. The Franchise Channel network consists of franchisee operations that are owned and managed by individual business owners. These business owners have a contractual relationship with Goosehead to use the Company's processes, systems, and back-office support team to sell insurance and manage their business. In exchange, Goosehead is entitled to an initial franchise fee and ongoing royalty fees. Allocations of contingent commissions and certain operating expenses are based on reasonable assumptions and estimates primarily using revenue, headcount and other information. The Company’s chief operating decision maker uses net income before interest, income taxes, depreciation and amortization, adjusted to exclude equity-based compensation and other non-operating items, including, among other things, certain non-cash charges and certain non-recurring or non-operating gains or losses (“Adjusted EBITDA”) as a performance measure to manage resources and make decisions about the business. Summarized financial information concerning the Company’s reportable segments is shown in the following tables (in thousands). There are no intersegment sales, only interest income and interest expense related to an intersegment line of credit, all of which eliminate in consolidation. The “Other” column
From time to time, the Company may be involved in various legal proceedings, lawsuits and claims incidental to the conduct of our business. The amount of any loss from the ultimate outcomes is not probable or reasonably estimable. It is the opinion of management that the resolution of outstanding claims will not have a material adverse effect on the financial position or results of operations of the Company.
The $25.0 million revolving credit facility accrues interest on amounts drawn at an initial interest rate of LIBOR plus 2.50%, then at an interest rate determined by the Company's leverage ratio for the preceding period. At March 6, 2020, the Company had $5.0 million drawn against the revolver and had a letter of credit of $333 thousand applied against the maximum borrowing availability. Thus, amounts available to draw totaled $19.7 million. The revolving credit facility is collateralized by substantially all the Company’s assets, which includes rights to future commissions.
The $80.0 million term note is payable in quarterly installments of $500 thousand the first twelve months, $1 million the next twelve months and $2 million the last twelve months, with a balloon payment on March 6, 2023. The note is collateralized by substantially all of the Company’s assets, which includes rights to future commissions. Interest is calculated initially at LIBOR plus 2.50%, then at an interest rate based on the Company's leverage ratio for the preceding period.
The Company’s note payable agreement contains certain restrictions and covenants. Under these restrictions, the Company is limited in the amount of debt incurred and distributions payable. In addition, the credit agreement contains certain change of control provisions that, if broken, would trigger a default. Finally, the Company must maintain certain financial ratios. As of March 6, 2020, the Company was in compliance with these covenants.
(3) Basic and diluted earnings per share for the first quarter of 2018 are shown on a pro-forma basis, as there was no Class A or Class B common stock outstanding as of March 31, 2018.