Baldwin Insurance Group - Q3 2022

Transcript

Operator (participant)

Greetings, and welcome to the BRP Group, Inc. Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A formal question and answer session will follow the presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Bonnie Bishop, Executive Director, Investor Relations. Please go ahead.

Bonnie Bishop (Executive Director of Investor Relations)

Thank you, operator. Welcome to the BRP Group's Third Quarter 2022 Earnings Call. Today's call is being recorded. Third quarter financial results, supplemental information and Form 10-Q were issued earlier this afternoon and are available on the company's website at ir.baldwinriskpartners.com. Please note that remarks made today may include forward-looking statements subject to various assumptions, risks and uncertainties. The company's actual results may differ materially from those contemplated by such statements. For a more detailed discussion, please refer to the note regarding forward-looking statements in the company's earnings release for this quarter and to our most recent 10-K and subsequent periodic filings, including our most recent Form 10-Q, all of which are available on the BRP website. During the call today, the company may also discuss certain non-GAAP financial measures.

For a more detailed discussion of these non-GAAP financial measures and historical reconciliations to the most closely comparable GAAP measures, please refer to the company's earnings announcement and supplemental information, both of which have been posted on the company's website at ir.baldwinriskpartners.com. I will now turn the call over to Trevor Baldwin, Chief Executive Officer of The Baldwin Insurance Group.

Trevor Baldwin (CEO)

Thank you, Bonnie. Good afternoon, everyone, and thank you for joining us on our third quarter of 2022 earnings call. I will start with a few remarks, followed by Brad, who will address select financial and business highlights from the quarter. Then Brad, Chris and I will take questions. Before I get into our results, I would like to take a moment to talk about Hurricane Ian, a storm of significant proportion and impact to a number of the communities in which we live and work. The Category 4 strength, slow pace of movement, and sheer scale of the storm led to a severity of loss that will likely make Hurricane Ian the costliest insured loss event in Florida history and among the costliest our industry has seen.

I'm incredibly proud of the response from our colleagues across the country who have been working tirelessly with our clients, insurers, and community stakeholders to facilitate much needed support for the recovery and rebuilding. Beyond the obvious and severe impacts to individuals, families, and communities, there will be meaningful reverberations across our industry relative to availability, cost, and terms of insurance capacity. This is the type of market in which we excel, where a depth of expertise, breadth of market access, and innovative solutions can solve real challenges for prospects and clients, positioning us to take share. This was demonstrated in our third quarter results with accelerating financial performance on top of exceptionally strong prior year results, highlighted by organic growth of 28%, with all 4 of our segments achieving record or near record organic growth, including 80% organic growth in the MGA, its best quarter ever.

Adjusted EBITDA for the quarter was up 118% compared to the third quarter of 2021 as a result of our strong top line growth and margin expansion of nearly 200 basis points, evidencing early signs that the investments we have made in our business are beginning to show a return. In addition to the outsized financial performance we've generated during the quarter and year to date, we continue to be even more encouraged by the positive underlying momentum we're seeing across all segments of the business. In middle market, sales execution and new client wins continued to accelerate as a result of our investments in advisor talent and deployment of go-to-market capabilities and expertise across our national footprint. In the MGA, our pipeline of new distribution partners remains incredibly strong.

Our home insurance product rollout continues to meaningfully impact our organic growth results, and we're seeing solid results from our newer MGA partner firms that have started to roll into our organic growth numbers and will fully be in our results in the fourth quarter and over the course of 2023. In Mainstreet, the early success of our national rollout has been a driving factor of 2 consecutive quarters of organic growth in excess of 20%. In Westwood, while not yet in our organic results, grew revenue over 20% during the quarter despite a meaningful erosion in housing market fundamentals. In Medicare, we've seen a solid start to the annual enrollment period as a result of growth in agent count and increased efficiency being driven by an improved digital enrollment platform we launched in early October.

The prudent investments we've made into the business and the overall durability of our business model should result in strong organic growth through the fourth quarter and into 2023. While global economic conditions are certainly challenged and are likely to continue to be so for the foreseeable future, our business remains incredibly resilient and well-positioned, especially given the mandatory nature of insurance purchasing and largely domestic footprint of our client base. As I mentioned earlier, we believe our unique approach and breadth of solutions positions us well to take share during times of insurance market stress and economic volatility. Our colleagues have been delivering exceptional value to our clients with advice, counsel, and purpose-built solutions to help navigate the growing complexity and ever-changing risk environment of today's world. I want to thank our clients, our trading partners, and in particular, our outstanding colleagues who propel our continued outperformance.

With that, I will now turn the call over to Brad.

Brad Hale (CFO)

Thanks, Trevor, and good afternoon, everyone. For the third quarter, revenue grew 91% to $259 million. Organic growth in the third quarter was 28%, with all four segments achieving double-digit organic growth. The strength of these results on top of strong prior year organic growth of 26% highlights the growing momentum we have in our business today and early signs of success we are seeing in the growth investments we have been making. We recorded GAAP net loss for the third quarter of $47 million or a loss of $0.43 per fully diluted share. Adjusted net income for the third quarter of 2022, which excludes share-based compensation amortization and other one-time expenses, was $20.8 million or $0.18 per fully diluted share.

A table reconciling GAAP net loss to adjusted net income can be found in our earnings release and our 10-Q filed with the SEC. The largest reconciling items were amortization of $23 million, the change in fair value of earn outs of $22 million, and one-time partnership and integration costs of $12 million, largely tied to significant integration costs associated with the Westwood partnership. Adjusted EBITDA for the third quarter of 2022 rose 118% to $41.9 million compared to $19.2 million in the prior year period. Adjusted EBITDA margin was 16% compared to 14% in the third quarter of 2021.

Adjusting for the change in accounts receivable and accounts payable related to our holding fiduciary cash as well as earn outs flowing through operating cash flow, free cash flow from operations improved by approximately $2.2 million compared to year-to-date 2021. Next, I'll summarize a few items regarding expectations for the fourth quarter and the full year of 2022. First, for the fourth quarter of 2022, we expect to generate organic growth in the high teens, which should equate to organic growth for the full year of approximately 20%. In addition, we expect adjusted EBITDA for the fourth quarter of approximately $35 million-$37 million and adjusted EPS of approximately $0.10-$0.12.

We now expect full year 2022 adjusted EBITDA of $192 million-$194 million, which based on better than anticipated fiscal year revenue growth represents roughly flat margins to 2021 levels. Note that in the back half of 2022, we have seen an acceleration of new client wins, which comes at a higher level of variable compensation that will normalize and be accretive to margin as those clients renew in the following year. We do not plan to regularly give guidance for the following year during our Q3 call, but in advance of our inaugural Investor Day next week, we want to provide a preliminary look at 2023.

At this time, we expect 2023 organic growth at the high end of our 10%-15% range, revenue of $1.14 billion-$1.17 billion, and adjusted EBITDA of $250 million-$260 million. We also expect to bring net leverage down near the high end of our 3.5x-4.5x long-term range through organic growth and free cash flow generation. In developing our expectations, we anticipate slightly negative GDP for the broader economy, but remain confident in the strong economic resilience of our business and our runway for growth ahead. We'd also note that these expectations conservatively assume no acquired revenue in 2023.

We will continue to engage with prospective partners, but given the combination of much higher cost of capital, which has not worked its way into pricing and return models industry-wide and still buoyant private market valuations, we are entering the year with measured expectations. In summary, we had excellent performance across all of our business and carry strong momentum into the fourth quarter. I want to thank all of our colleagues whose grit and tenacity powers these results and has enabled us to deliver exceptional outcomes for our stakeholders. With that, I thank you for your time and your interest in BRP. We look forward to speaking with you again on November 15th at our inaugural Investor Day. We will now open up the call for Q&A. Operator?

Operator (participant)

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. We have a first question from the line of Greg Peters with Raymond James. Please go ahead.

Greg Peters (Managing Director)

Hey, good afternoon, everyone. The first question will be on organic revenue growth results, specifically in middle markets and specialty. For middle markets, you know, I'm intrigued that you're reporting relatively strong results.

Compared to the peer group, and you mentioned some client wins. Maybe you can unpack some of the detail that's going on to that result. Then in specialty, Trevor, you talked about the headwinds or the challenges of the property market in Florida, and I'm just curious how that might manifest itself with organic as we think about that going forward.

Trevor Baldwin (CEO)

Yeah. Good afternoon, Greg, and appreciate the question. To start with middle market, one, we're exceptionally proud of the results, and we believe that it showcases the value that our colleagues are delivering to clients every day. The reality is, those results are being driven by an acceleration of new client wins that's a result of the investments that we've been making in national resources, building out depth in client industry sector capabilities and risk product centers of excellence that enable us to bring the best of our organization to our clients no matter where they reside and how they access us. That's showing through and showing up in new wins. It's showing up in larger wins and broad-based strength across our footprint.

As we think about the specialty business, you know, the property market in particular, we're anticipating is gonna enter a period of dislocation, that the industry hasn't seen in decades. As I mentioned, that's the type of market where we excel, where our depth of expertise, our breadth of market access, and the uniqueness of the solutions that we're developing and bringing to market enable us to solve real problems for our clients, ultimately positioning us to take more share.

Specifically in the specialty business, we believe the responsible job we've done managing capacity and delivering profitable underwriting results to our capacity providers is gonna position us uniquely in what's setting up to be a very difficult reinsurance marketplace, so that we'll be able to access capacity more nimbly and at more scale than many of our competitors and bring that capacity to market for our clients.

Greg Peters (Managing Director)

All right. There's a lot to unpack in that answer. I'll take that offline. I'm gonna pivot to the guidance for next year. You know, I'm trying to crunch the numbers pretty quickly. You know, the revenue guidance for the full year and the adjusted EBITDA guidance for the full year. I was wondering if you could talk, Brad, for a minute about what the implied adjusted EBITDA margin is, with that guidance and how that compares with what your guidance is for this year.

Brad Hale (CFO)

Yeah, good afternoon, Greg. So if you look at the range we put forth, and you know, I will note that we're continuing to work through the budgeting process and fine-tune that, as we finish Q4 here, which is why we provided a relatively broad range. But it would look at about 200 basis points of margin expansion next year. And that's in light of you know, still absorbing a significant amount of investments that we've made in the business in the last two years. You know, we've said before it takes approximately three years for those to roll in and be sort of fully funding in our results. So we're continuing to see the growth really impact the organic numbers you're seeing.

You saw that in Q2, you saw that again in Q3. We expect that to have even more impact in 2023. But we are continuing to absorb those investments as they mature in the business.

Greg Peters (Managing Director)

Got it. Thanks for the clarification.

Trevor Baldwin (CEO)

Thanks, Greg.

Operator (participant)

Thank you. We have next question from the line of Meyer Shields with KBW. Please go ahead.

Meyer Shields ) (Managing Director)

Thanks. Two questions, and again, I guess on the guidance going forward. Brad, when you talk about GDP contraction, is that real or nominal, in terms of the expectations? I'm wondering specifically whether there's a consideration of maybe more distracted clients that are less inclined to shop in addition to just attrition.

Trevor Baldwin (CEO)

Hey, Meyer. I'll let Brad take the question on GDP, but then I'll add in some commentary around the client distraction. What we're anticipating relative to client buying behavior next year is that it's gonna be a real opportunity for us to pick up share as a result of the difficulty of securing limits, the type of terms and conditions that clients are seeking and just the general kind of dislocation we're anticipating in the insurance marketplace. As I mentioned earlier, that's the type of market where we tend to really excel, where our breadth and depth of expertise and capabilities enable us to really stand out, take share, and also deliver fantastic solutions to existing clients so that they don't feel like they need to look for advice and for outcomes from others.

Brad Hale (CFO)

That's real GDP, Meyer.

Meyer Shields ) (Managing Director)

Okay, thanks. That's helpful. Just one final question on that, if I can. Is there any explicit debt paydown in the debt leverage guidance?

Brad Hale (CFO)

Yeah, Mayer. If you step through that, conservatively on a $250 million or $260 million adjusted EBITDA number, you know, we generate, let's call it $100 million, $125 million of free cash flow. We are assuming that we'll be generating, again, a conservative amount of free cash flow to contribute to our net leverage coming down.

Meyer Shields ) (Managing Director)

All right. Perfect. Thanks so much.

Trevor Baldwin (CEO)

Thanks, Meyer.

Operator (participant)

Thank you. We have next question from the line of, Elyse Greenspan with Wells Fargo. Please go ahead.

Elyse Greenspan (Managing Director and Senior Equity Analyst)

Hi. Thanks. Good evening. My first question is on the organic guide for 2023, right? You guys, you know, have had a string of periods, right, where you've been coming in better than your expectations. You know, you said the high end of that 10%-15% range, but, you know, it sounds like we could get a really strong pricing environment next year, especially in the lines impacted by Ian. As you're trying to conservatively guide, like, is there a chance that, you know, you could, you know, come in above that range? Or can you maybe give us a sense of the baseline pricing expectations that, you know, support the 10%-15% target?

Trevor Baldwin (CEO)

Hey, Elyse. Good afternoon. You know, there's a lot of puts and takes to the type of an insurance environment we're anticipating next year. All of that is contemplated in the organic guide. What I would tell you is, while we're expecting pretty meaningful rate, particularly in cat property, that tends to also change clients' buying behaviors. You'll see them take larger deductibles, you'll see them buy less limit. You wouldn't expect a straight kind of path through or correlation from the level of rate we're expecting into the organic growth overall. We feel, you know, appropriately conservative in how we're thinking about the results and expectations for next year, and feel like we're well positioned to continue to drive fantastic outcomes to all of our stakeholders.

Elyse Greenspan (Managing Director and Senior Equity Analyst)

Also within that organic guide, I guess another question, right? You talked about, you know, starting to see an impact of, you know, the new hires and the investments you made this quarter, but then you also said, right, that it takes about three years for those to fully roll in. So what's the revenue impact that you're assuming from the new hires embedded within that 10%-15% full year guide for next year?

Trevor Baldwin (CEO)

Yeah. Elyse, I'm not gonna break out specifics relative to kind of new hires versus the ongoing business. What I can tell you is, you know, you saw a meaningful acceleration in growth for our business, both quarter over quarter and year-over-year in third quarter. Part of that acceleration is a result of the success from the investments we've been making over the past couple years beginning to earn through and show up in actual results and client wins. We expect that to continue to be a meaningful contributor to our results next year.

We're feeling really good about how the business is positioned, and the strength of our business model is gonna enable us to deliver consistency and strong execution for our clients, despite what we are expecting to be a relatively volatile insurance marketplace and somewhat difficult economic environment.

Brad Hale (CFO)

Elyse, I'd add in just to clarify, you know, it's high end of the 10%-15%.

Elyse Greenspan (Managing Director and Senior Equity Analyst)

Yes. Within that high end of 10%-15%, do you expect all of your segments, you know, will be within that range? Or any color you can give us, well, on the segments relative to the guide?

Trevor Baldwin (CEO)

We're not gonna get into segments at this point, Elyse, but we'll plan to provide some more color around, you know, segment-level performance during our Investor Day next week.

Elyse Greenspan (Managing Director and Senior Equity Analyst)

Okay. One last one on the M&A side. You said, within the guide, right, you're not assuming any acquired revenue next year as you work to kind of, you know, get your leverage down. You know, what could cause you, I mean, if there's deals that come along, is that what's gonna determine whether or not there's, you know, acquired revenue? Or are you just on the sidelines until you get your debt within that range? Or are you just trying to put out a conservative guide? I'm just trying to get a sense of, you know, when the acquisitions could start to ramp up again.

Trevor Baldwin (CEO)

Yeah. Elyse, a few things. One, the pulling M&A out of expectations for next year is not overwhelmingly as a result of where leverage sits. It's a broader input than that. As a management team, what I would tell you is we view part of our role to be allocating capital. As we assess the overall environment today, you know, the pricing in the external environment has not changed to reflect the increasing cost of capital. In conjunction with that, we're having tremendous success and fantastic results on the investments we've been making into the business. From a capital allocation perspective, that's what we're prioritizing today and focusing on strengthening our balance sheet during a period of volatility. With that said, we remain opportunistic.

We continue to have dialogue with a number of high-quality opportunities. For the right opportunities, we will, you know, responsibly look to get things done. Based on today's backdrop, we don't expect that next year, but that can evolve.

Elyse Greenspan (Managing Director and Senior Equity Analyst)

Thank you.

Trevor Baldwin (CEO)

Thanks, Elyse.

Operator (participant)

Thank you. We have next question from the line of Joshua Shanker with Bank of America. Please go ahead.

Joshua Shanker (Managing Director)

Yeah, thank you for taking my question. You know, I don't imagine you would give this kind of detail in most quarters, but given some of the noise in the third quarter, can you talk a little about how much revenue was generated from the QBE relationship you picked up with Westwood? Obviously, 80% MGA, the future growth is significant, but I assume some of that growth is one time in nature.

Trevor Baldwin (CEO)

Yeah, great question, Josh. So a few things to clarify. One, the MGA growth sans the QBE program administrator agreement was 44%, so still incredibly strong. You know, the other thing to clarify is that the 36% growth you're seeing from the QBE program administrator agreement contribution to the MGA's organic growth for the quarter, I wouldn't necessarily characterize as one time, 'cause while that program is rolling into our results and that kind of overall uplift is somewhat one time in nature, that's a reoccurring book of business that has growth built into it in the 36% results that you see. If you had just taken a flat line of the book at the start of the program administrator agreement, the contribution wouldn't have been 36%, it would have been something less than that.

because of the growth that we're driving into that program, we're seeing accelerated results, and we would expect that to continue.

Brad Hale (CFO)

Hey, Josh, I'd also add, you know, we tried to provide some additional disclosure on organic growth, you know, with the PAA, with the interplay between Westwood and MSI, and the intercompany elimination in calculating organic growth. I think it's page seven of the supplement. You know, you can walk through that calculation 'cause I think there's been some confusion and, you know, clearly we were backing out intercompany transactions in calculating organic growth.

Joshua Shanker (Managing Director)

That's great. Then, you sort of started along my answer. The 36% growth in the QBE relationship, 20% at Westwood. Can you give us any color, and you've given a lot there, in general, what is the organic growth within the acquisitions that you did over the past 12 months?

Trevor Baldwin (CEO)

Yeah. If you look at page three of the supplement, Josh.

Joshua Shanker (Managing Director)

Yeah

Trevor Baldwin (CEO)

At the very bottom line there, you'll see total revenue of business owned as of 12/31/2021. That gives you a sense of the growth of the overall business in, including acquired businesses or proxy for organic growth to the business, for everything that was acquired last year, including those parts of the business not yet today contributing to our organic growth calculation. You can see it's actually higher than the 28%, it's 36%, which highlights the fact that the businesses that we partnered with it last year are actually growing faster than BRP as a whole. Which I think is a testament to, you know, the capital allocation that you saw from our team last year and the focus on partnering with businesses that make us better and that we can help make better as well.

You're certainly seeing that play out.

Joshua Shanker (Managing Director)

One more, please, and I may not get an answer out of you. You've always been very careful about giving margin information out about MGA of the future. Could you maybe look into the future and talk about how many years out you think it will be when the MGA of the future's EBITDA margin is greater than the BRP as a whole? Is that three years out, is that four years out? It doesn't have to be the exact number, but how far out should we be thinking?

Trevor Baldwin (CEO)

Josh, I think we'll shed some light on that for you next week at the Investor Day.

Joshua Shanker (Managing Director)

All right, I'll take that. Thank you very much.

Trevor Baldwin (CEO)

Thanks, Josh.

Operator (participant)

Thank you. We have next question from the line of Weston Bloomer with UBS. Please go ahead.

Weston Bloomer (Director, Equity Research)

Hi, thanks. My question is on your margin and the investments you're making in your business. I may have missed this, but did you disclose how much of the $50 million has been put to work year-to-date? What are your expectations for 2023 as well? I'm just trying to get a sense of kind of the year-over-year comps on those investments.

Trevor Baldwin (CEO)

Yeah, Weston. We did not give that update. As far as the investments we're making this year, you can think of those as basically ratably rolling into the year. We are on pace with the commitment we made earlier this year of I believe it was the $60 million we were gonna make in year. As you look to next year, we are currently not specifying any other de novo investments outside of normal course for the business. What I would say, as I described before, we continue to get, you know, rollover impact of the significant investment we've made over the last two years as that sort of matures in the business.

Weston Bloomer (Director, Equity Research)

Got it. I think last quarter you had said 850 new hires in the first half of the year. Do you have that number for the 3Q? Do you expect most of the investments to be hires as you move forward as well, or will it be kind of other investments in technology and things of that nature?

Trevor Baldwin (CEO)

Yeah, Weston. We hired approximately 450 people in the third quarter, so, you know, basically on trend with the first half of the year. What I would tell you is our investments in the business are largely talent related. Even, you know, the investments that are technology oriented, they tend to be in the technologists who come and build technology in, into and for our business.

Weston Bloomer (Director, Equity Research)

Great. Thanks for taking my questions.

Trevor Baldwin (CEO)

Thanks, Weston.

Operator (participant)

Thank you. We have our next question from the line of Pablo Singzon with JPMorgan. Please go ahead.

Pablo Singzon (Executive Director)

Hi, good afternoon. I was hoping you could provide perspective on your expectations for, I guess, interest expense next year, just given where rates are and, you know, the pay down you're planning for your debt. Thanks.

Brad Hale (CFO)

Yeah. You know, Pablo, we already are experiencing, you know, pretty significant cash interest increases. You know, we were able to increase year-to-date free cash flow even in light of, you know, a 170% increase in what we're paying in cash interest. We do outline in the earnings supplement our exact debt outstanding, and we effectively use the, you know, the forward curve to build our expectation as to what our variable rate debt will look like, going into next year.

Trevor Baldwin (CEO)

Pablo, I'd add, Brad talked about it earlier, you know, we think we can get $100 million-$125 million of free cash flow next year, you know, after paying interest from that EBITDA guide we provided. You know, still significant capital created to manage the debt levels down to, you know, closer to near our 3.5x-4.5x long-term range that we've talked about.

Pablo Singzon (Executive Director)

Got it. My second question is, I just wanna get your guys' perspective on, I guess, you know, the trajectory of free cash flow so far and, you know, basically the bridge from where we are to $100 million-$125 million next year, right? 'Cause as I look at what you've done year to date, $59 million, that's about 30% of adjusted EBITDA. I think last year, cash was actually negative in the fourth quarter. I guess, you know, just sort of how to think of the bridge from where we are to, you know, what gives you a pretty good result for next year. You know, just given the pattern from last year and, you know, what do you guys have planned for the next years? Thanks.

Brad Hale (CFO)

Yeah, I can give you a really high level bridge, Pablo, and again, we're continuing to work through our 2023 finalization on budgets. You know, the way we're thinking about a high level is if you take, you know, our range of adjusted EBITDA provided, the $250 million-$260 million, if you calculate, you know, somewhere in the range of $100 million-$110 million of cash interest next year, as well as, you know, we've been at a run rate of about $20 million-$30 million of partnership and integration-related costs. You know, that's how we're backing into our range we provided on free cash flow. You know, the main adjustments for us in bridging from adjusted EBITDA to free cash flow are those two elements.

Trevor Baldwin (CEO)

Pablo, I'd also add when you're comparing the year-to-date free cash flow to prior year, there's a pretty big timing mismatch in partnership expenses between this year and last, where they're very much front-loaded with the Westwood partnership this year. Whereas last year it was very much Q4 weighted. There's not kind of a perfect year-over-year comparison there. In addition to that, because the Westwood business is being, you know, absorbed out of QBE, there's pretty significant integration and transition services expenses that are one time in nature, that are in the partnership expenses bucket this year, which we would not expect to reoccur over.

Pablo Singzon (Executive Director)

Got it. That makes sense. Thank you.

Trevor Baldwin (CEO)

Thanks, Pablo.

Operator (participant)

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session, and I'd like to turn the call back to Trevor Baldwin, CEO, for closing remarks. Over to you, sir.

Trevor Baldwin (CEO)

Thank you all for joining us for our third quarter 2022 earnings call, and we look forward to speaking with you next week at our inaugural Investor Day presentation. Take care.

Operator (participant)

Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.