Baldwin Insurance Group, Inc. Q3 FY2022 Earnings Call

Greetings, and welcome to the BRP Group, Inc. Third Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A formal question-and-answer session will follow the presentation. Please follow the operator's instructions as they are given. As a reminder, this conference is being recorded. I will now turn the conference over to your host, Bonnie Bishop, Executive Director, Investor Relations. Please go ahead.

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 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 Form 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 BRP Group.

Thank you, Bonnie. Good afternoon, everyone, and thank you for joining us on our Third Quarter 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'd 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 and cost in 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 four of our segments achieving record or near-record organic growth, including 80% organic growth in the MGA. It was our 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've 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 much 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 continue 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 partnered firm 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 two consecutive quarters of organic growth in excess of 20%. And 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 in 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 the largely domestic footprint of our client base. As I mentioned earlier, we believe our unique approach and breadth of solutions position 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'll now turn the call over to Brad.

Thanks, Trevor. 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 earnouts 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 earnout 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 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 to be approximately $35 million to $37 million and adjusted EPS of approximately $0.10 to $0.12. We now expect for year 2022 adjusted EBITDA of $192 million to $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% to 15% range, revenue of $1.14 billion to $1.17 billion, and adjusted EBITDA of $250 million to $260 million. We also expect to bring net leverage down near the high end of our 3.5 to 4.5 times 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 15 at our inaugural Investor Day. We will now open up the call for Q&A. Operator?

Thank you. At this time, we will be conducting a question-and-answer session. Please follow the operator's instructions. We have a first question from the line of Greg Peters with Raymond James. Please go ahead.

Hey, good afternoon, everyone. The first question will be on organic revenue growth results, specifically in middle market and specialty. For middle market, 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. And then in specialty, Trevor, you talked about the headwinds or the challenges of the property market in Florida. I'm just curious how that might manifest itself with organic as we think about that going forward.

Yeah, good afternoon, Greg, and appreciate the question. To start with middle market, 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 our depth of 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 up in newer wins, larger wins, and broad-based strength across our footprint. As we think about the specialty business, the property market in particular, we're anticipating it is going to enter a period of dislocation that the industry hasn't seen in decades. But, 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 going to position us uniquely in what is setting up to be a very difficult reinsurance marketplace. 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.

All right. There's a lot to unpack and I'll probably take that offline. I'm going to pivot to the guidance for next year. I'm trying to crunch the numbers pretty quickly on 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.

Yeah, good afternoon, Greg. If you look at the range we put forth — and I will note that we're continuing to work through the budgeting process and fine-tune that as we finish Q4, which is why we provided a relatively broad range — it would look like about 200 basis points of margin expansion next year. That's in light of still absorbing a significant amount of investments that we've made in the business in the last two years. We've said before it takes approximately three years for those to roll in and be fully reflected 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.

Got it. Thanks for the clarification.

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

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

Hey, Meyer. I'll let Brad take the question on GDP, but then I'll add some commentary around client distraction. What we're anticipating relative to client buying behavior next year is that it's going to be a real opportunity for us to pick up share as a result of the difficulty of securing limits and the type of terms and conditions that clients are seeking, and just the general 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 elsewhere for advice and outcomes.

And that's real GDP, Meyer.

Okay, thanks. That's helpful. And then just one final question on that if I can: Is there any explicit debt paydown in the debt leverage side?

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

All right, perfect. Thanks so much.

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

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

Hey, Elyse. There's a lot of puts and takes to the type of insurance environment we're anticipating next year, and all of that is contemplated in the organic guide. What I would tell you is while we're expecting pretty meaningful rate, particularly in property, that tends to also change clients' buying behaviors — you'll see them take larger deductibles, you'll see them buy less limit. So you wouldn't expect a straight pass-through or correlation from the level of rate we're expecting into organic growth overall. We feel 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 strong outcomes for all of our stakeholders.

Also, within that organic guide — you talked about starting to see an impact of the new hires and the investments you made this quarter, but you also said it takes about three years for those to fully roll in. So what revenue impact are you assuming from the new hires embedded within that 10% to 15% full year guide for next year?

Elyse, I'm not going to break out specifics relative to new hires versus the ongoing business. But what I can tell you is you saw meaningful acceleration in growth for our business both quarter-over-quarter and year-over-year in the third quarter. Part of that acceleration is a result of success from the investments we've been making over the past couple of 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, which will enable us to deliver consistent and strong execution for our clients despite what we're expecting to be a relatively volatile insurance marketplace and somewhat difficult economic environment.

At least to clarify, it's the high end of the 10% to 15% range.

Yes — and within that high end of 10% to 15%, do you expect all of your segments will be within that range? Any color you can give us on the segments relative to the guide?

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

Okay. And then one last one on the M&A side — you said within the guide you're not assuming any acquired revenue next year as you work to get your leverage down. What could cause you to change that? If deals come along, is that what's going to determine whether or not there's acquired revenue, or are you on the sidelines until you get your debt within that range? I'm trying to get a sense of when acquisitions could start to ramp up again.

Elyse, two things. One, pulling M&A out of expectations for next year is not overwhelmingly about where leverage sets — it's a broader input. As a management team, part of our role is allocating capital. As we assess the overall environment today, pricing in the external environment has not changed to reflect the increase in cost of capital. In conjunction with that, we've had tremendous success on the investments we've been making into the business. From a capital allocation perspective, that's what we're prioritizing today — 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 and for the right opportunities we will responsibly look to get things done given today's backdrop. We don't expect that next year, but that can evolve.

Thank you.

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

Yeah, thank you for taking my question. I don't imagine you would give this kind of detail in most calls, 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% organic growth in the MGA — the future growth is significant, but I assume some of that growth is one-time in nature.

Great question, Josh. A few things to clarify. The MGA growth and the QBE program administrator agreement contributed 44% growth. That's still incredibly strong. The 36% growth you're seeing from the QBE program administrator agreement's contribution to the MGA's organic growth for the quarter I wouldn't necessarily characterize as one-time, because while that program is rolling into our results and that overall uplift is somewhat one-time in nature, it's a recurring book of business that has growth built into it in the 36% result that you see. If you had 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 we're driving into that program, we're seeing accelerated results and we would expect that to continue.

Hey, Josh — I'd also add that we tried to provide additional disclosure on organic growth with the program administrator and the interplay between Westwood and MSI and the intercompany consolidation eliminations in calculating organic growth. I think it's on Page 7 of the supplement; you can walk through that calculation because I think there's been some confusion. Clearly, we were backing out intercompany transactions in calculating organic growth.

That's great. And then, you said 36% growth in the QBE relationship and 20% Westwood — can you give any color on the organic growth within the acquisitions you did over the past 12 months?

If you look at Page 3 of the supplement, at the very bottom line you'll see total revenue of businesses owned as of 12/31/2021. That gives you a sense of the growth of the overall business, including acquired businesses, as a proxy for organic growth. For everything that was acquired last year, including those parts of the business not yet 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 we partnered with last year are actually growing faster than BRP as a whole. I think that's a testament to the capital allocation 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.

And one more, please. I may not get an answer, but given the growth profile, could you discuss how many years out you think the MGA operating EBITDA margin would be greater than BRP as a whole? Is that three years out? Four years out? It doesn't have to be an exact number, but how far out should we be thinking?

Josh, I think we'll shed some light on that at our investor day next week.

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

Thanks, Josh.

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

Hi, thanks. My question is on 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? And then what are your expectations for 2023 as well? I'm trying to get a sense of the year-over-year comps on those investments.

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

Got it. And I think last quarter you'd said 850 new hires in the first half of the year. Do you have that number for 3Q? And do you expect most of the investments to be hires going forward, or will there be other investments in technology and things of that nature?

Weston — we hired approximately 450 people in the third quarter, so we're basically on trend with the first half of the year. Our investments in the business are largely talent related; even the investments that are technology oriented tend to be into technologists who come in to build technology into and for our business.

Great, thanks for taking my questions.

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

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

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

And from a free cash flow perspective, as Brad talked about earlier, we think we can get $100 million to $125 million of free cash flow next year after paying interest from that EBITDA guide we provided. So still significant cash generated to manage debt levels down toward our 3.5 to 4.5 times long-term range.

Got it. And then my second question is on the trajectory of free cash flow so far. We see the bridge from where we are to about $100 to $125 million next year, because year-to-date you've done $59 million, which is about 30% of adjusted EBITDA, and last year cash was actually negative in the fourth quarter. How should we think about the pattern for next year and what you have planned?

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

Pablo, I'll also add that when you're comparing year-to-date free cash flow to the prior year, there's a significant timing mismatch in partnership expenses between this year and last. They're very much front-loaded with the Westwood partnership this year, whereas last year they were Q4 weighted. Because of Westwood businesses being absorbed out of QBE, there's significant integration and transition services expenses that are one-time in nature in the partnership expenses bucket this year, which we would not expect to reoccur.

Got it. That makes sense. Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call back to Trevor Baldwin, CEO, for closing remarks. Please go ahead.

Thank you all for joining us for our Third Quarter 2022 earnings call. We look forward to speaking with you next week at our inaugural Investor Day presentation. Take care.

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