Hagerty, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022; unaudited. Hagerty provides enthusiast-vehicle insurance and related membership, marketplace and automotive services. The company reports one operating and reportable segment and had more than 2.6 million members. Comparisons below are to the corresponding 2021 periods unless noted.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | First nine months 2022 | First nine months 2021 |
|---|---|---|---|---|
| Total revenue | $216.8 million | $168.1 million | $590.6 million | $464.7 million |
| Operating income (loss) | $(21.2) million | $1.8 million | $(31.8) million | $10.9 million |
| Operating margin | (10)% | 1% | (5)% | 2% |
| Net income (loss) | $24.3 million | $(0.5) million | $34.6 million | $5.1 million |
| Adjusted EBITDA (non-GAAP) | $(10.0) million | $7.6 million | $0.1 million | $28.0 million |
| Basic / diluted Class A EPS | $0.18 / $0.07 | Not applicable | $0.44 / $0.03 | Not applicable |
- Revenue mix: Q3 commission and fee revenue was $85.5 million (+12.2%); earned premium was $107.5 million (+36.6%); membership, marketplace and other revenue was $23.8 million (+80.4%). Nine-month increases were 13.7%, 36.9% and 47.3%, respectively.
- Profit quality and margins: Revenue growth did not translate into operating profit: operating expenses rose 43.1% in Q3 and 37.2% for the nine-month period, outpacing revenue growth. GAAP net income included a $11.6 million Q3 ($37.9 million nine-month) noncash gain from lower warrant liabilities and a $34.7 million noncash Broad Arrow remeasurement gain. Adjusted EBITDA was negative in Q3 and nearly break-even year to date.
- Insurance indicators: Written premium was $222.1 million in Q3 (+15.6%) and $614.6 million year to date (+15.1%). Q3 loss ratio was 56.4%, versus 41.0%; nine-month loss ratio was 46.8%, versus 41.3%. Policies in force were 1.31 million, up from 1.25 million at year-end 2021; retention was 88.0%, down from 89.1%. Paid Hagerty Drivers Club membership increased to 749,740 from 718,583.
- Cash flow and liquidity: Nine-month operating cash flow was $93.6 million (prior year $85.4 million); investing cash outflow was $79.7 million (prior year $53.8 million); financing cash inflow was $0.5 million (prior year $44.9 million). At September 30, cash and cash equivalents were $180.4 million and restricted cash was $435.9 million, totaling $616.3 million. Management said available liquidity sources are expected to meet needs for at least 12 months; restricted cash is not equivalent to freely available cash.
- Debt: Long-term debt was $136.0 million, versus $135.5 million at year-end 2021. The $230 million revolving facility matures in October 2026; the effective borrowing rate was 5.15%, up from 1.61% at year-end. The company reported compliance with financial covenants. It had one $35 million-notional interest-rate swap, fixed at 0.81%, maturing December 2023.
Material changes and developments
- Revenue grew 29.0% in Q3 and 27.1% for the first nine months, led by earned premium and marketplace growth. In contrast, operating results deteriorated to a loss, primarily as expenses rose faster than revenue.
- Hagerty Re’s U.S. quota share rose from 60% in 2021 to 70% in 2022, increasing earned premiums and associated ceding commissions and losses. Management said the share is expected to increase to 80% in 2023 and thereafter under its Markel contract.
- In August, Hagerty acquired the remaining 60% of Broad Arrow for equity consideration valued at $73.3 million, making it wholly owned. The deal produced the $34.7 million remeasurement gain and $98.6 million of preliminary goodwill. Broad Arrow contributed approximately $5.9 million of revenue and $2.1 million of pretax income after acquisition. Q3 marketplace revenue growth also reflected Broad Arrow auctions.
- In April, Hagerty acquired Speed Digital for $15.0 million, including deferred installments. Speed Digital was indirectly owned by a company director, who is to receive the purchase proceeds. The filing also discloses related-party relationships with Markel and State Farm.
- The March amendment to the Legacy Unit Holders Exchange Agreement removed the company’s general cash-settlement option for exchanges, except when net proceeds come from a new permanent equity offering. Redeemable non-controlling interest was reclassified to permanent equity.
Outlook, risks and unusual items
- Guidance: The filing provides no quantified revenue, earnings or other formal forward guidance. Management expects liquidity to be sufficient for at least 12 months and identifies growth, operating costs, marketplace and membership investment, debt service, taxes and potential Tax Receivable Agreement payments as uses of liquidity.
- Claims and reserves: Q3 and nine-month results include $10.0 million of estimated net Hurricane Ian losses, equal to Hagerty Re’s retention, and a $6.5 million strengthening of 2022 U.S. auto liability reserves. Ian claims were still being reported; losses above $10.0 million were expected to be recoverable under catastrophe reinsurance. Management said these items added 9.3 and 6.1 percentage points, respectively, to the Q3 loss ratio, and 3.4 and 2.2 points to the nine-month ratio.
- Investment and execution: The company incurred $24.1 million of pre-revenue costs in the first nine months for infrastructure, systems and staffing tied to State Farm and other potential partnerships and Marketplace initiatives. It said these costs will weigh on operating profitability until related revenue is sufficient to cover ongoing costs. The State Farm program was expected to begin in the first half of 2023, subject to regulatory review and approvals.
- Other risks: Hagerty identifies competition and member retention, reliance on insurance carrier relationships, claim frequency and severity, technology and third-party service disruptions, regulation, macroeconomic conditions, litigation, and controlled-company risks. Commission revenue is seasonal, generally peaking in the middle of Q2 and declining toward Q4 and early Q1. Markel-affiliated carriers accounted for 94% of commission revenue in both the quarter and nine-month periods.
- Contingencies and controls: The company said ordinary-course litigation was not expected to have a material adverse effect, while noting outcomes cannot be predicted. Management concluded disclosure controls were effective at quarter-end; no material changes to internal control over financial reporting were reported. Adoption of lease accounting was expected to add a material right-of-use asset and liability.
Important facts for investors to verify
- Whether loss experience, including U.S. auto liability severity and Hurricane Ian claims, develops in line with reserves and reinsurance recoveries.
- How much operating performance depends on noncash warrant valuation and acquisition-related gains; compare GAAP results with Adjusted EBITDA and operating income.
- Whether the planned quota-share increase to 80% improves revenue contribution after ceding commissions and claims costs.
- Broad Arrow’s ongoing revenue, profitability and goodwill valuation, as the purchase price allocation was preliminary; also monitor Marketplace performance without acquisition-related effects.
- Availability of liquidity after accounting for restricted cash, operating lease commitments, capital spending, debt costs and potential tax-related payments.
- Execution, timing, regulatory approvals and eventual economics of the State Farm alliance and other growth initiatives, including the disclosed pre-revenue costs.
- The extent of related-party and carrier concentration, particularly Markel’s role in commission revenue, reinsurance and insurer balances.