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HAGERTY, INC. – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide the reader of the financial statements with a narrative from the perspective of management on the financial condition, results of operations, liquidity and certain other factors that may affect our operating results. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8 of Part II of this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed within "Risk Factors" in Item 1A of this report. Unless otherwise indicated or the context otherwise requires, references in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" to "we", "our", "Hagerty" and "the Company" refer to the business and operations ofThe Hagerty Group, LLC and its consolidated subsidiaries prior to the Business Combination and toHagerty, Inc. and its consolidated subsidiaries, following the consummation of the Business Combination.
Overview
Hagerty is a global market leader in providing insurance for classic cars and enthusiast vehicles. We consistently earn strong net promoter scores by providing auto enthusiasts superior insurance coverage with excellent customer service and at lower prices than traditional carriers. We have also leveraged our trusted insurance brand to build a leading automotive lifestyle brand. We offer an automotive enthusiast platform that protects, engages, entertains and connects with our Members and other car enthusiasts. Our goal is to save driving and car culture for future generations.
Recent Developments Affecting Comparability
Broad Arrow Acquisition
InJanuary 2022 , we entered into a joint venture with Broad Arrow, pursuant to which we invested$15.3 million in exchange for equity ownership of approximately 40% of Broad Arrow. InAugust 2022 , we acquired the remaining 60% outstanding equity interest of Broad Arrow, in exchange for$73.3 million of equity consideration of bothHagerty, Inc. andThe Hagerty Group . Prior to the acquisition, we accounted for our approximately 40% ownership interest in Broad Arrow using the equity method of accounting under which we recognized our share of Broad Arrow's income (loss) within Income (loss) from equity method investment, net of tax in the Consolidated Statements of Operations. Subsequent to the acquisition, Broad Arrow became a wholly-owned subsidiary of the Company and as a result, the financial statements of Broad Arrow are now consolidated as a part of Hagerty. Revenue from Broad Arrow is included with our existing revenue from Marketplace and recorded within "Membership, marketplace and other revenue" in our Consolidated Statements of Operations. Also, as a result of the acquisition, we remeasured our pre-existing 40% equity ownership interest to its estimated fair value of approximately$48.3 million , which resulted in a$34.7 million gain within our Consolidated Statements of Operations for the year endedDecember 31, 2022 . Refer to Note 9 - Acquisitions and Investments - in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the consideration paid for the Broad Arrow Acquisition. 40 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Business Combination OnDecember 2, 2021 ,The Hagerty Group completed a business combination pursuant to the Business Combination Agreement with Aldel and Merger Sub. In connection with the Closing, Aldel changed its name fromAldel Financial Inc. toHagerty, Inc. Following the Closing,Hagerty, Inc. owns an equity interest inThe Hagerty Group in what is commonly known as an "Up-C" structure. Under this structure, substantially all ofHagerty, Inc.'s assets and liabilities are held byThe Hagerty Group .Hagerty, Inc. owned 24.5% and 24.7% ofThe Hagerty Group as ofDecember 31, 2022 and 2021, respectively. Refer to Note 1 - Summary of Significant Accounting Policies and New Accounting Standards and Note 8 - Business Combination in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the Business Combination.
Key Performance Indicators and Certain Non-GAAP Financial Measures
Key Performance Indicators
The table below presents a summary of our Key Performance Indicators, including important operational metrics, as well as certain GAAP and non-GAAP financial measures as of and for the years endedDecember 31, 2022 and 2021. We use these Key Performance Indicators to evaluate our business, measure our performance, identify trends against planned initiatives, prepare financial projections and make strategic decisions. We believe these Key Performance Indicators are useful in evaluating the Company's performance when read together with our Consolidated Financial Statements prepared in accordance with GAAP. Year EndedDecember 31, 2022
2021
Operational Metrics (period of time) Total Written Premium (in thousands) (1)$776,664
Loss Ratio (2) 45.3%
41.3%
New Business Count (Insurance) (3) 234,520
244,478
Operational Metrics (point in time) Policies in Force (4) 1,315,977
1,247,056
Policies in Force Retention (5) 88.0% 89.1% Vehicles in Force (6) 2,234,461 2,103,185 HDC Paid Member Count (7) 752,754 718,583 Net Promoter Score (8) 83.0 82.0 GAAP Measures Total Revenue (in thousands)$787,588 $619,079 Operating Income (Loss) (in thousands)$(67,566)
Net Income (Loss) (in thousands)$2,403
Basic Earnings (Loss) Per Share$0.39
Non-GAAP Measures Adjusted EBITDA (in thousands) (9)$(1,940)
Adjusted Earnings (Loss) Per Share (9)$(0.20)
41 -------------------------------------------------------------------------------- TA BLE OF CONTENTS (1) Total Written Premium is the total amount of insurance premium written on policies that were bound by our insurance carrier partners during the period. We view Total Written Premium as an important metric as it most closely correlates with our growth in insurance commission revenue and Hagerty Re earned premium. Total Written Premium reflects the actual business volume and direct economic benefit generated from our policy acquisition efforts. (2) Loss Ratio, expressed as a percentage, is the ratio of (1) losses and loss adjustment expenses incurred to (2) earned premium in Hagerty Re. We view Loss Ratio as an important metric because it is a powerful benchmark for profitability. The benchmark allows us to evaluate our historical loss patterns including incurred losses and make necessary and appropriate adjustments. Hurricane Ian, which made landfall in the third quarter of 2022, generated$10.0 million of net losses and added 2.5% to the loss ratio for the year endedDecember 31, 2022 . Additionally, we strengthened reserves forU.S. auto liability by$6.5 million for the 2022 accident year, which added 1.6% to the loss ratio for the year endedDecember 31, 2022 . These two items account for the significant increase in the 2022 loss ratio compared to 2021. (3) New Business Count represents the number of new insurance policies issued during the applicable period. We view New Business Count as an important metric to assess our financial performance because it is critical to achieving our growth objectives. While Hagerty benefits from strong renewal retention, new business policies more than offset those cancelled or non-renewed at expiration. Often new policies mean new relationships and an opportunity to sell additional products and services. (4) Policies in Force ("PIF") are the number of current and active insurance policies as of the applicable period end date. We view PIF as an important metric to assess our financial performance because policy growth drives our revenue growth, increases brand awareness and market penetration, generates additional insight to improve the performance of our platform, and provides key data to assist strategic decision making for the Company. (5) PIF Retention is the percentage of expiring policies that are renewed on the renewal effective date, calculated on a rolling twelve months basis. We view PIF Retention as an important measurement of the number of policies retained each year, which contributes to recurring revenue streams from MGA commissions, membership fees and earned premiums. It also contributes to maintaining our NPS as discussed below. (6) Vehicles in Force are the number of current insured vehicles as of the applicable period end date. We view Vehicles in Force as an important metric to assess our financial performance because insured vehicle growth drives our revenue growth and increases market penetration. Vehicles in Force generates additional insight to support Marketplace and Hagerty Media, and provides key data to assist strategic decision making for the Company. (7) HDC Paid Member Count is the number of current Members who pay an annual membership subscription as of an applicable period end date. We view HDC Paid Member Count as important because it helps us measure membership revenue growth and provides an opportunity to customize our value proposition and benefits to specific types of enthusiasts, both by demographic and vehicle interest. (8) Hagerty uses Net Promoter Score ("NPS") as an important measure of the overall strength of our relationship with Members. NPS is measured twice annually through a web-based survey sent by email invitation to a random sample of existing Members, and is reported annually using an average of the two surveys. Often referred to as a barometer of brand loyalty and Member engagement, NPS is well-known in our industry as a strong indicator of growth and retention.
(9) Refer to "Non-GAAP Financial Measures" below for a description of this
non-GAAP financial measure and a reconciliation to the most comparable GAAP
amount.
42 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Components of Our Results of Operations
Revenue
We generate commission and fee-based revenue primarily from the sale of automotive insurance policies on behalf of our insurance carrier partners and reinsurance premiums from participating in the underwriting of these policies. To a lesser extent, we also generate fee-based revenue from HDC membership subscriptions, media and entertainment and Marketplace services. Our revenue model incorporates multiple touchpoints in the insurance and lifestyle value chains, built on data collection and Member experience.
Commission and fee revenue
Certain of our insurance affiliated subsidiaries act as MGAs who, among other
things, write collector vehicle and marine policies on behalf of our insurance
carrier partners, in exchange for commissions. Commissions are earned for new
and renewed policies. Additionally, policyholders pay fees directly to us
related to their insurance coverage. Commission and fee revenue is earned when
the policy becomes effective, net of policy changes and cancellations, as our
performance obligation is complete when the policy is issued.
Under the terms of many of our contracts with insurance carriers, we have the
opportunity to earn an annual contingent underwriting commission ("CUC"), or
profit-share, based on the calendar-year performance of the insurance book of
business. Our CUC agreements are based on written or earned premium and loss
ratio results. Each insurance carrier partner contract and related CUC is
calculated independently. Revenue from CUC is accrued throughout the year and
settled annually.
Earned premium
Reinsurance premiums are earned by Hagerty Re, which reinsures the collector
vehicle and marine risks written through our affiliated MGAs in the U.S. , Canada
and the U.K. Hagerty Re is a Bermuda -domiciled, Class 3A reinsurer.
Earned premium represents the earned portion of written premiums that Hagerty Re
has assumed under quota share reinsurance agreements with our insurance carrier
partners. Earned premium is recognized over the term of the policy, which is
generally 12 months.
Membership, marketplace and other revenue
We earn subscription revenue through bundled HDC membership offerings, which include access to products and services such as,Hagerty Drivers Club Magazine , automotive enthusiast events, our proprietary vehicle valuation tool, emergency roadside assistance and special vehicle-related discounts. We also earn fee-based revenue fromHagerty Garage + Social memberships, which include storage in addition to the HDC Member benefits. Revenue from the sale of HDC and storage memberships is recognized ratably over the period of the membership. The membership is treated as a single performance obligation to provide access to stated Member benefits over the life of the membership, which is currently one year. Marketplace earns fee-based revenue from the sale of collector cars through classified listings, live and time-based online auctions and brokered private sales, as well as finance revenue from term loans to high-net-worth individuals and businesses secured by collector cars. Fee-based revenue earned by Marketplace is recognized when the underlying sale is completed. Finance revenue is recognized when earned based on the amount of the outstanding loan, the applicable interest rate on the loan and the length of time the loan was outstanding during the period.
Other revenue includes sponsorship, admission, advertising, valuation and
registration income. Other revenue is recognized when the performance obligation
for the related product or service is satisfied.
Operating Expenses
Our operating expenses typically consist of salaries and benefits, ceding
commission, losses and loss adjustment expenses, sales expenses, general and
administrative services and depreciation and amortization.
43 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Salaries and benefits Salaries and benefits consist primarily of costs related to employee compensation, payroll taxes, employee benefits and employee development costs. Employee compensation includes wages paid to employees, as well as various incentive compensation plans. Employee benefits include the costs of various employee benefits plans, including medical, dental insurance and wellness plans. Costs related to employee education, training and recruiting are included in employee development costs. Salaries and benefits costs are expensed as incurred except for those costs which are required to be capitalized, which are then amortized over the useful life of the asset created (generally software or media content). Salaries and benefits are expected to increase over time as the business continues to grow but will likely decrease as a percent of revenue.
Ceding commission
Ceding commission consists of the commission paid by Hagerty Re to insurance carriers for our pro-rata share of policy acquisition costs (primarily the commission earned by our MGA affiliates), general and administrative services and other costs. Hagerty Re pays a fixed rate ceding commission which varies by insurance carrier partner, averaging approximately 47% and 48% of net earned premium for the years endedDecember 31, 2022 and 2021, respectively. Ceding commission is recognized into expense over the annual policy term. In future periods, ceding commission will change in proportion to earned premium assumed through our various quota share reinsurance agreements.
Losses and loss adjustment expenses
Losses and loss adjustment expenses represent management's best estimate of the share of losses assumed by Hagerty Re, including its share of the net cost to settle claims submitted by insureds. Losses consist of claims paid, case reserves and IBNR, net of estimated recoveries for reinsurance, salvage and subrogation. Loss adjustment expenses consist of the cost associated with the investigation and settling of claims. The estimates utilized in determining the amount of losses and loss adjustment expenses recorded in a period are based on statistical analysis performed by our internal and external actuarial team. Reserves are reviewed regularly and adjusted as necessary to reflect management's estimate of the ultimate cost of settlement.
Sales expense
Sales expense includes costs related to the sales and servicing of insurance policies, as well as costs related to our Membership and Marketplace offerings, such as broker expense, cost of sales, promotion expense and travel and entertainment expenses. Broker expense is the compensation paid to our agent partners and national broker partners when an insurance policy is written through a broker relationship. Broker expense generally tracks with written premium growth. Cost of sales includes postage, document costs, payment processing fees, emergency roadside service costs and other variable costs associated with the sale and servicing of a policy. Cost of sales also includes costs associated with the vehicle sales through Marketplace. Promotion expense includes various expenses related to branding, events, advertising, marketing, and acquisition. Promotion expense and travel and entertainment expense will likely decrease as a percent of revenue over the long-term. Sales expenses, in general, are expensed as incurred and will trend with revenue growth.
General and administrative services
General and administrative services primarily consist of professional services, occupancy costs and hardware and software. These costs are expensed as incurred. We expect this expense category to increase commensurate with our expected business volume and growth expectations and be managed lower as a percent of revenue over the next few years after we reach scale to handle incoming business from new partnerships.
Depreciation and amortization
Depreciation and amortization reflects the recognition of the cost of our
investments in various assets over their useful lives. Depreciation expense
relates to leasehold improvements, furniture and equipment, vehicles, hardware
and purchased software. Amortization relates to investments related to recent
acquisitions, SaaS implementation, internal software development and investments
made in digital media and content assets. Depreciation and amortization are
expected to increase in dollar amount over time but will likely decrease as a
percent of revenue as investments in platform technology reach scale.
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Other Items
Change in fair value of warrant liabilities
Our warrants are accounted for as liabilities in accordance with ASC Topic 815,
Derivatives and Hedging ("ASC 815"), and are measured at fair value each
reporting period, with changes in fair value recognized as non-operating income
(expense). In general, under the fair value accounting model, in periods when
our stock price increases, the warrant liability increases, and we recognize
additional expense in our Consolidated Statements of Operations. In periods when
our stock price decreases, the warrant liability decreases, and we recognize
additional income in our Consolidated Statements of Operations.
Income tax expense
The Hagerty Group is taxed as a pass-through ownership structure under provisions of the IRC and a similar section of state income tax law, except certainU.S. corporate subsidiaries and foreign subsidiaries. Any taxable income or loss generated byThe Hagerty Group is passed through to and included in the taxable income or loss of all holders of Hagerty Group Units, includingHagerty, Inc. Hagerty, Inc. is taxed as a corporation and pays corporate federal, state, and local taxes with respect to income allocated fromThe Hagerty Group .
Results of Operations
Year Ended
The following table summarizes our results of operations for the years endedDecember 31, 2022 and 2021, and the dollar and percentage change between the two years: Year Ended December 31, 2022 2021 $ Change % Change REVENUE: in thousands (except percentages) Commission and fee revenue$ 307,238 $ 271,571 $ 35,667 13.1 % Earned premium 403,061 295,824 107,237 36.3 % Membership, marketplace and other revenue 77,289 51,684 25,605 49.5 % Total revenue 787,588 619,079 168,509 27.2 % OPERATING EXPENSES: Salaries and benefits 199,542 171,901 27,641 16.1 % Ceding commission 191,150 140,983 50,167 35.6 % Losses and loss adjustment expenses 182,402 122,080 60,322 49.4 % Sales expense 140,781 107,483 33,298 31.0 % General and administrative services 89,068 64,558 24,510 38.0 % Depreciation and amortization 33,887 22,144 11,743 53.0 % Restructuring, impairment and related charges, net 18,324 - 18,324 100.0 % Total operating expenses 855,154 629,149 226,005 35.9 % OPERATING INCOME (LOSS) (67,566) (10,070) (57,496) 571.0 % Change in fair value of warrant liabilities 41,899 (42,540) 84,439 198.5 % Revaluation gain on previously held equity method investment 34,735 - 34,735 100.0 % Interest and other income (expense) 2,028 (1,993) 4,021 201.8 % INCOME (LOSS) BEFORE INCOME TAX EXPENSE 11,096 (54,603) 65,699 120.3 % Income tax benefit (expense) (7,017) (6,751) (266) (3.9) % Income (loss) from equity method investment, net of tax (1,676) - (1,676) (100.0) % NET INCOME (LOSS)$ 2,403 $ (61,354) $ 63,757 103.9 % 45
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TA BLE OF CONTENTS Revenue Commission and fee revenue Commission and fee revenue was$307.2 million for the year endedDecember 31, 2022 , an increase of$35.7 million , or 13.1%, compared to 2021, consisting of an increase of$31.6 million in revenue from renewal policies, as well as an increase of$4.3 million in revenue from new policies. The increase in revenue from renewal policies was primarily related to a 6.5% increase in renewal policy premiums as well as continued strong retention. The increase in renewal policy premiums for the year endedDecember 31, 2022 compared to 2021 reflects sustained year-over-year growth in our business and rate increases in several states due to inflation and appreciation of vehicle values, all of which contribute to higher premiums and, in turn, higher commission revenue. The increase in revenue from new policies was related to sustained year-over-year growth in our business, as well as rate actions and higher vehicle values. The average premium on a newly issued policy has increased 14.5% year-over-year as a result of writing accounts with higher insured values at higher rates. As a result, premiums from newly insured policies increased$13.2 million , or 9.9% during the year endedDecember 31, 2022 . In turn, commission revenue from newly issued policies grew by$4.1 million over the same period. The overall increase in commission and fee revenue during the year endedDecember 31, 2022 was partially offset by a downward adjustment of$4.1 million associated with a reduction in the expected CUC payout percentage for 2022 due to higher loss ratios during the year. Our loss ratio for the year endedDecember 31, 2022 was adversely impacted by the increased severity inU.S. auto liability claims in the 2022 accident year and net losses related to Hurricane Ian. Earned premium Earned premium revenue was$403.1 million for the year endedDecember 31, 2022 , an increase of$107.2 million , or 36.3%, compared to 2021. Earned premium is a function of written premium and is recognized over the term of the policy, which is generally 12 months. The increase in earned premium generally correlates with an increase in written premiums assumed by us, which increased$120.4 million , or 34.0%, compared to 2021. In theU.S. , the increase in premiums assumed by Hagerty Re during the year endedDecember 31, 2022 compared to 2021 was primarily due to Hagerty Re'sU.S. quota share increasing from 60% in 2021 to 70% in 2022, which accounted for$64.4 million of the overall$120.4 million increase. The remaining increase was primarily a result of consistent underlying growth in the premiums assumed across all geographic areas in which we operate.
Membership, marketplace and other revenue
Membership, marketplace and other revenue was
Membership fee revenue was$45.2 million for the year endedDecember 31, 2022 , an increase of$4.6 million , or 11.4%, compared 2021, which was primarily attributable to the increase in the issuance of new policies bundled with an HDC membership as well as an increase in storage revenue related to ourHagerty Garage + Social locations. For the year endedDecember 31, 2022 , membership fees were 58.5% of the Membership, marketplace and other revenue total.
Marketplace revenue was
which was primarily generated by Broad Arrow auctions. For the year ended
and other revenue total.
Other revenue was$18.4 million for the year endedDecember 31, 2022 , an increase of$7.3 million , or 66.0%, compared to 2021, primarily due to newly acquired events, resulting in increases of$3.3 million and$2.6 million in sponsorship revenue and admission revenue, respectively. Other revenue includes sponsorship, admission, advertising, valuation and registration revenue and accounts for 23.8% of the Membership, marketplace and other revenue total.
Operating Expenses
Salaries and benefits
Salaries and benefits expenses were$199.5 million for the year endedDecember 31, 2022 , an increase of$27.6 million , or 16.1%, compared to 2021. The increase was primarily attributable to a net increase of approximately 200 employees, or 12%, year over year. In 2022, headcount increased to support current and anticipated growth, such as the additions of several new large national insurance partnerships and our continued development of new systems and digital transformation technology investments, as well as several acquisitions, including the Broad Arrow Acquisition. 46 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Ceding commission Ceding commission expense was$191.2 million for the year endedDecember 31, 2022 , an increase of$50.2 million , or 35.6%, compared to 2021. The higher level of ceding commission expense was primarily attributable to an increase in ourU.S. quota share percentage from 60% in 2021 to 70% in 2022, which accounted for$30.7 million of the increase, as well as higherU.S. premium volume ceded to Hagerty Re from our insurance carrier partner, which added approximately$16.4 million . The following table presents the amount of premiums assumed and related ceding commission, as well as the quota share percentages for the year endedDecember 31, 2022 and 2021: U.S. Canada U.K. Total in thousands (except percentages) Year Ended December 31, 2022 Subject premium$ 643,777 $ 50,434 $ 8,569 $ 702,780 Quota share percentage 70.0 % 35.0 % 70.0 % 67.5 % Assumed premium in Hagerty Re$ 450,644 $ 17,652 $ 5,998 $ 474,294 Net ceding commission$ 181,590 $ 7,026 $ 2,534 $ 191,150 Year Ended December 31, 2021 Subject premium$ 558,297 $ 43,844 $ 6,003 $ 608,144 Quota share percentage 60.0 % 35.0 % 60.0 % 58.2 % Assumed premium in Hagerty Re$ 334,978 $ 15,345 $ 3,602 $ 353,925 Net ceding commission$ 134,469 $ 6,037 $ 477 $ 140,983
Losses and loss adjustment expenses
Losses and loss adjustment expenses were$182.4 million for the year endedDecember 31, 2022 , an increase of$60.3 million , or 49.4%, compared to 2021. This increase was primarily driven by Hagerty Re'sU.S. quota share increasing from 60% in 2021 to 70% in 2022,$10.0 million in net losses related to Hurricane Ian and a$6.5 million loss related to the strengthening of reserves recorded forU.S. auto liability for the 2022 accident year. The Company's loss ratio, including catastrophe losses, was 45.3% and 41.3% for the year endedDecember 31, 2022 and 2021, respectively. Hurricane Ian and the increase in IBNR reserves added 2.5% and 1.6%, respectively, to the loss ratio for the year endedDecember 31, 2022 . The Company's loss ratio excluding Hurricane Ian was 42.8% for the year endedDecember 31, 2022 .
Sales expense
Sales expense was$140.8 million for the year endedDecember 31, 2022 , an increase of$33.3 million , or 31.0%, compared to 2021. This increase was primarily driven by a$19.0 million increase in travel and promotion costs, primarily related to newly acquired events and increased advertising and a$7.6 million increase in broker expense which was driven by additional premium volume across our independent agent and broker distribution channel.
General and administrative services
General and administrative services expenses were$89.1 million for the year endedDecember 31, 2022 , an increase of$24.5 million , or 38.0%, compared to 2021, which was primarily driven by an$11.2 million increase in expenses related to operating as a public company, a$3.7 million increase in software subscription licenses and a$2.5 million increase in occupancy costs, primarily attributable to additionalHagerty Garage + Social locations.
Depreciation and amortization
Depreciation and amortization expense was$33.9 million for the year endedDecember 31, 2022 , an increase of$11.7 million , or 53.0%, compared to 2021. The increase was primarily attributable to a higher base of capital assets from our software development investment. Amortization on these capital assets increased by$8.9 million . Amorization expense also increased as a result of intangible asset additions due to acquisitions, such as Broad Arrow and Speed Digital. Total amortization expense related to these acquisitions was$1.8 million . 47 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Restructuring, impairment and related charges, net During the year endedDecember 31, 2022 , we recognized restructuring, impairment and related charges of$18.3 million , which primarily consisted of$12.2 million in expenses related to our voluntary retirement program and reduction in force and$6.2 million related to operating lease ROU asset impairments and related leasehold disposals. Refer to Note 14 - Restructuring, Impairment and Related Charges in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to the restructuring initiatives implemented in 2022.
Other Items
Change in fair value of warrant liabilities
During the years endedDecember 31, 2022 and 2021, the change in fair value of warrant liabilities resulted in a gain of$41.9 million and a loss of$42.5 million , respectively, which represents the net change in our valuation of warrant liabilities. Refer to Note 20 - Warrant Liabilities in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to our warrants.
Revaluation gain on previously held equity method investment
During the year endedDecember 31, 2022 , we recognized a revaluation gain on a previously held equity method investment of$34.7 million , which represents the remeasurement of our 40% equity interest in Broad Arrow immediately prior to the Broad Arrow Acquisition inAugust 2022 . Refer to Note 9 - Acquisitions and Investments in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to our acquisition of Broad Arrow.
Income tax benefit (expense)
Income tax expense was$7.0 million for the year endedDecember 31, 2022 , an increase of$0.3 million , or 3.9%, compared to 2021. The increase was primarily due to an increase in income before income tax expense of$1.4 million within Broad Arrow, which is taxed as a corporation. Refer to Note 22 - Taxation in Item 8 of Part II of this Annual Report on Form 10-K for additional information with respect to items affecting our effective tax rate. InAugust 2022 , the Inflation Reduction Act ("IRA") was enacted into law. Among the provisions in the IRA was a 15% corporate minimum tax effect rate for years beginning afterDecember 31, 2022 , and a 1% tax on share repurchases afterDecember 31, 2022 . We do not expect the tax provisions of the IRA to have a material impact on our results.
Liquidity and Capital Resources
Maintaining a strong balance sheet and capital position is a top priority for
us. We manage liquidity globally and across all operating subsidiaries.
Future Sources and Uses of Liquidity
Our sources of liquidity include our: (1) cash on hand; (2) short-term investments; (3) net working capital; (4) cash flows from operations; and (5) our Credit Facility (as defined below). Based on our current expectations, we believe that these sources of liquidity will be sufficient to meet our needs for at least the next 12 months. We expect that our primary liquidity needs will include cash used to: (1) fund business operations including continued investments in technology; (2) service borrowings under the Credit Agreement (as defined below); (3) pay income taxes; and (4) make payments under the TRA.
Capital and Dividend Restrictions
Through our reinsurance subsidiary, Hagerty Re, we reinsure the same personal lines risks that are underwritten by our affiliated MGA subsidiaries on behalf of our insurance carrier partners. Our reinsurance operations are self-funded primarily through existing capital and net cash flows from operations. As ofDecember 31, 2022 , Hagerty Re had approximately$398.8 million in Cash and cash equivalents and Restricted cash and cash equivalents. We, and particularly Hagerty Re, pay close attention to the underlying underwriting and reserving risks by monitoring the pricing and loss development of the underlying business written through our affiliated MGAs. Additionally, Hagerty Re seeks to minimize its investment risk by investing in low yield cash, money market accounts and investment grade municipal securities. 48 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Capital Restrictions InBermuda , Hagerty Re is subject to the BSCR administered by the BMA. No regulatory action is taken by the BMA if an insurer's capital and surplus is equal to or in excess of their enhanced capital requirement as determined by the BSCR model. In addition, the BMA has established a target capital level for each insurer which is 120% of the enhanced capital requirement. Hagerty Re maintained sufficient statutory capital and surplus to comply with regulatory requirements as ofDecember 31, 2022 . Dividend Restrictions UnderBermuda law, Hagerty Re is prohibited from declaring or issuing a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. Prior approval from the BMA is also required if Hagerty Re's proposed dividend payments would exceed 25% of its prior year-end total statutory capital and surplus. The amount of dividends which could be paid by Hagerty Re in 2023 without prior approval is$32.9 million . Regulation relating to insurer solvency is generally for the protection of the policyholders rather than for the benefit of the stockholders of an insurance company. We believe that our existing cash and cash equivalents and municipal securities and cash flow from operations will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our reinsurance premium growth rate, renewal rates, the introduction of new and enhanced products, entry into, and successful entry in new geographic markets, and the continuing market adoption of our product offerings.
Comparative Cash Flows
The following table summarizes our cash flow data for the years endedDecember 31, 2022 and 2021: Year Ended December 31, 2022 2021 $ Change % Change in thousands (except percentages) Net cash provided by operating activities$ 55,328 $ 42,281 $ 13,047 30.9 %
Net cash used in investing activities
(32.7) % Net cash provided by (used in) financing activities$ (28,084) $ 332,071 $ (360,155) (108.5) % Operating Activities
Cash provided by operating activities primarily consists of net income (loss)
adjusted for non-cash items and changes in working capital balances.
Net cash provided by operating activities is presented below:
Year Ended December 31,
2022 2021 $ Change % Change
in thousands (except percentages)
Net income (loss) $ 2,403 $ (61,354) $ 63,757 (103.9) %
Non-cash adjustments to net income (loss) (5,547) 70,302 (75,849) (107.9) %
Changes in operating assets and liabilities 58,472 33,333
25,139 75.4 %
Net cash provided by operating activities
Net cash provided by operating activities for the year endedDecember 31, 2022 was$55.3 million , an increase of$13.0 million , or 30.9%, compared to 2021, which was due to a$25.1 million increase in cash from operating assets and liabilities, partially offset by a$12.1 million decrease in Net income (loss) after excluding non-cash adjustments. The increase in cash from operating assets and liabilities was primarily due to the increase in ourU.S. quota share percentage from 60% in 2021 to 70% in 2022, severity of claims and timing of Hurricane Ian, all of which resulted in an increase in Provision for unpaid losses and loss adjustment expenses and Losses payable of approximately$25.5 million during the year endedDecember 31, 2022 , with associated cash outflow expected in 2023. Additionally, we collected approximately$7.8 million of cash from buyers in Broad Arrow transactions during the year endedDecember 31, 2022 that was not paid to sellers until 2023. The decrease in Net income (loss) after excluding non-cash adjustments was primarily driven by the impact of Hurricane Ian, increased loss reserves and restructuring charges. 49 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Investing Activities Cash used in investing activities for the year endedDecember 31, 2022 was$91.5 million , an increase of$22.5 million , or 32.7%, compared to 2021. We invested approximately$44.4 million in property, equipment and software (excluding acquisitions) which was primarily driven by internally developed software, as compared to$43.4 million in the prior year, and had payments related to acquisitions, net of cash acquired, totaling$15.4 million for the year endedDecember 31, 2022 , as compared to$14.6 million in the prior year. Additionally, inJanuary 2022 we invested approximately$15.3 million for an interest in an equity method investment and joint venture with Broad Arrow. We subsequently acquired the remaining 60% outstanding equity interest of Broad Arrow in an all equity transaction. Subsequent to the acquisition, we issued$6.1 million in notes receivable related to Broad Arrow's asset-backed financing activity. For additional information regarding our 2022 acquisitions and equity method investments, refer to Note 9 - Acquisitions and Investments in Item 8 of Part II of this Annual Report on Form 10-K.
Financing Activities
Cash used in financing activities for the year endedDecember 31, 2022 was$28.1 million , compared to$332.1 million provided by financing activities in 2021. During the year endedDecember 31, 2022 , there were net repayments of$28.1 million related to our long-term debt, primarily our Credit Facility, compared to$66.5 million in net borrowings in 2021. In 2021, net cash inflows from the Business Combination were$269.0 million , including proceeds of$789.7 million , offset by$489.7 million of distributions to the Legacy Unit Holders and$31.0 million of capitalized transaction costs. Refer to Note 8 - Business Combination in Item 8 of Part II of this Annual Report on Form 10-K for additional information on the Business Combination.
Financing Arrangements
Multi-bank Credit Facility
InSeptember 2022 andDecember 2022 ,The Hagerty Group entered into a Fourth and Fifth Amendment to the Amended and Restated Credit Agreement ("Credit Agreement"), which amended the terms of our revolving credit facility ("Credit Facility") withJPMorgan Chase Bank, N.A ., as administrative agent, and the other financial institutions party thereto from time to time as lenders. The aggregate amount of commitments available to the Company under the Credit Facility is$230.0 million . The current term of the Credit Agreement expires inOctober 2026 and may be extended by one year on an annual basis if agreed to by us and the lenders party thereto. Any unpaid balance on the Credit Facility is due at maturity. As ofDecember 31, 2022 , total outstanding borrowings under the Credit Facility were$105.0 million .
The Credit Facility borrowings are collateralized by our assets, except for the
assets of our
subsidiaries. In
Capital UK Limited
Under the Credit Agreement, we are required, among other things, to meet certain financial covenants, including a fixed charge coverage ratio and a leverage ratio. We were in compliance with these financial covenants as ofDecember 31, 2022 .
Refer to Note 16 - Debt in Item 8 of Part II of this Annual Report on Form 10-K
for additional information on the Credit Facility.
Interest Rate Swap
Interest rate swap agreements are contracts to exchange floating rate for fixed
rate interest payments over the life of the agreement without the exchange of
the underlying notional amounts. The notional amounts of the interest rate swap
agreements are used to measure interest to be paid or received and do not
represent the amount of exposure to credit loss. The differential paid or
received on the interest rate swap agreements is recognized as an adjustment to
interest expense.
The purpose of the interest rate swap agreement is to fix the interest rate on a
portion of our existing variable rate debt in order to reduce exposure to
interest rate fluctuations. Under such agreements, we pay the counterparty
interest at a fixed rate. In exchange, the counterparty pays us interest at a
variable rate, adjusted quarterly and based on the Secured Overnight Financing
Rate ("SOFR"). The amount exchanged is calculated based on the notional amount.
The significant inputs, primarily the SOFR forward curve, used to determine the
fair value are considered Level 2 observable market inputs. We monitor the
credit and nonperformance risk associated with our counterparty and believe the
risk to be insignificant and does not warrant a credit adjustment at
December 31, 2022 .
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In December 2020 , we entered into a 5-year interest rate swap agreement with an
original notional amount of $35.0 million . In September 2022 , the interest rate
swap was amended to replace LIBOR with SOFR and the fixed swap rate is now
0.81%. This interest rate swap matures in December 2025 .
In March 2017 , we entered into an interest rate swap agreement with an original
notional amount of $15.0 million at a fixed swap rate of 2.20%. This interest
rate swap matured in March 2022 .
Tax Receivable Agreement
Hagerty, Inc. expects to have adequate capital resources to meet the requirements and obligations under the TRA entered into with the Legacy Unit Holders onDecember 2, 2021 that provides for the payment byHagerty, Inc. to the Legacy Unit Holders of 85% of the amount of cash savings, if any, underU.S. federal, state and local income tax or franchise tax realized as a result of (1) any increase in tax basis ofHagerty, Inc.'s assets resulting from (a) purchase of Hagerty Group Units from any of the Legacy Unit Holders using the net proceeds from any future offering, (b) redemptions or exchanges by the Legacy Unit Holders of Class V Common Stock and Hagerty Group Units for shares of Class A Common Stock or (c) payments under the TRA and (2) tax benefits related to imputed interest deemed arising as a result of payments made under the TRA. Legacy Unit Holders may, subject to certain conditions and transfer restrictions described above, redeem or exchange theirClass V Common Stock and Hagerty Group Units for shares of Class A Common Stock ofHagerty, Inc. on a one-for-one basis.The Hagerty Group intends to have in effect an election under Section 754 of the IRC of 1986, as amended, and the regulations thereunder for each taxable year in which a redemption or exchange ofClass V Common Stock and Hagerty Group Units for shares of Class A Common Stock occurs, which is expected to result in increases to the tax basis of the assets ofThe Hagerty Group at the time of a redemption or exchange of Hagerty Group Units. The redemptions and exchanges are expected to result in increases in the tax basis of the tangible and intangible assets ofThe Hagerty Group . These increases in tax basis may reduce the amount of tax thatHagerty, Inc. would otherwise be required to pay in the future. This payment obligation as a part of the TRA is an obligation ofHagerty, Inc. and not ofThe Hagerty Group . For purposes of the TRA, the cash tax savings in income tax will be computed by comparing the actual income tax liability ofHagerty, Inc. (calculated with certain assumptions) to the amount of such taxes thatHagerty, Inc. would have been required to pay had there been no increase to the tax basis of the assets ofThe Hagerty Group as a result of the redemptions or exchanges and hadHagerty, Inc. not entered into the TRA. Estimating the amount of payments that may be made under the TRA is by nature imprecise, insofar as the calculation of amounts payable depends on a variety of factors.
Contractual Obligations
The following table summarizes significant contractual obligations and other
commitments as of
Total 2023 2024 2025 2026 2027 Thereafter
in thousands
Debt $ 108,280 $ - $ 3,280 $ - $ 105,000 $ - $ -
Interest payments 1,304 529 490 285 - - -
Operating leases 116,790 12,129 12,206 11,765 11,176 10,984 58,530
Purchase commitments 14,477 10,772 3,705 - - - -
Total $ 240,851 $ 23,430 $ 19,681 $ 12,050 $ 116,176 $ 10,984 $ 58,530
Interest payments excludes variable rate debt interest payments and commitment
fees related to our Credit Facility.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet financing arrangements as of
51 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Critical Accounting Estimates Our significant accounting policies are described in Note 1 - Summary of Significant Accounting Policies and New Accounting Standards, in Item 8 of Part II of this Annual Report on Form 10-K. Our Consolidated Financial Statements are prepared in accordance with GAAP. The preparation of our Consolidated Financial Statements requires management to make assumptions and estimates that affect the reported results of operations and financial position, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. The following is a discussion of the accounting estimates and judgments that management believes are most significant in the application of GAAP used in the preparation of our Consolidated Financial Statements. These accounting estimates, among others, may involve a high degree of complexity and judgment on the part of management. Further, these estimates and other factors could have a significant impact to our financial condition, results of operations and cash flows. Management evaluates its significant accounting estimates on an ongoing basis using historical experience and various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from management's estimates.
Unpaid Losses and Loss Adjustment Expenses
Unpaid losses and loss adjustment expenses are the difference between the estimated ultimate cost of losses incurred and the amount of paid losses as of the reporting date. These reserves reflect management's best estimate of unpaid losses related to both reported claims and IBNR claims. The reserves also include estimates of all expenses associated with processing and settling reported and unreported claims. We regularly review our reserve estimates and update those estimates as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Updates made to reserve estimates based on new information may cause changes in prior reserve estimates. These changes are recorded as losses and loss adjustment expenses in the period such changes are determined. Estimating the ultimate cost of claims and claims expenses is an inherently complex and subjective process that involves a high degree of judgment. The judgments made by management in estimating the provision for unpaid losses and loss adjustment expenses are impacted by:
•uncertainty around inflationary costs, both economic and social inflation;
•estimates of expected losses through the use of historical loss data;
•the changing mix of business due to the large growth in modern collectible cars
which carry a different risk profile than the risks associated with classic
cars;
•legislative and judicial changes in the jurisdictions in which we write
insurance; and
•management's industry experience.
Claims are analyzed and reported based on the accident year or the year in which
the claims occurred. Accident year data is classified and utilized within
actuarial models to prepare estimates of required reserves for payments to be
made in the future. The timing of claim settlement varies and depends on the
type of claim being reported (i.e. property damage as compared to personal
injury claims). Claims involving property damage are generally settled faster
than personal injury claims. Historical loss patterns are then applied to actual
paid losses and reported losses by accident year to develop expectations of
future payments. Implicit within the actuarial models are estimates of the
impacts of inflation, especially for claims with longer expected cycle times.
Refer to Note 11 - Provision for Unpaid Losses and Loss Adjustment Expenses in
Item 8 of Part II of this Annual Report on Form 10-K for additional information
regarding the methodologies used to estimate loss and loss adjustment expense
reserves.
Given the inherent complexity and uncertainty regarding the estimate of our
ultimate cost of settling claims, reserves are reviewed quarterly and
periodically throughout the year by combining historical results and current
actual results to calculate new development factors. In estimating loss and loss
adjustment expense reserves, our actuarial reserving group considers claim cycle
time, claims settlement practices, adequacy of case reserves over time, and
current economic conditions. Because actual experience can differ from key
assumptions used in estimating reserves, there may be significant variation in
the development of these reserves and the actual losses and loss adjustment
expenses ultimately paid in the future. These adjustments to the loss and loss
adjustment expense reserves are recognized in our Consolidated Statements of
Operations in the period in which the change occurs.
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The following table presents our gross and net provision for losses and loss
adjustment expenses as of December 31, 2022 and 2021:
Gross % of Total Net % of Total
in thousands (except percentages)
As of December 31, 2022 Outstanding losses reported$ 66,824 59.8 %$ 65,981 59.5 % IBNR 44,917 40.2 % 44,917 40.5 % Total provision for unpaid losses and loss adjustment expenses$ 111,741 100.0 %$ 110,898 100.0 % As of December 31, 2021 Outstanding losses reported$ 38,207 51.0 %$ 38,207 51.0 % IBNR 36,662 49.0 % 36,662 49.0 % Total provision for unpaid losses and loss adjustment expenses$ 74,869 100.0 %$ 74,869 100.0 % The following table summarizes our gross losses and loss adjustment expenses, and net losses and loss adjustment expenses by accident years as ofDecember 31, 2022 and 2021: Gross Ultimate Loss & Loss Adjustment Expenses Net Ultimate Loss & Loss Adjustment Expenses Accident Year 2022 2021 Change 2022 2021 Change in thousands 2017$ 18,467 $ 18,592 $ (125) $ 18,467 $ 18,592 $ (125) 2018 38,405 38,405 - 38,005 38,005 - 2019 60,495 60,495 - 60,495 60,495 - 2020 86,113 87,583 (1,470) 86,113 87,583 (1,470) 2021 130,016 132,497 (2,481) 130,016 132,497 (2,481) 2022 191,815 N/A N/A 186,463 N/A N/A Total$ 525,311 $ 337,572 $ (4,076) $ 519,559 $ 337,172 $ (4,076)
Warrant Liabilities
Our warrants are accounted for in accordance with ASC 815. The warrants do not meet the criteria for equity treatment and as such, are recorded at fair value as a liability. The fair value of this liability is subject to remeasurement each reporting period. Our Public Warrants are Level 1 within the fair value hierarchy as they are measured utilizing quoted market prices. We determined that our Private Placement Warrants, OTM Warrants, Underwriter Warrants and PIPE Warrants are Level 3 within the fair value hierarchy. We utilize a Monte Carlo simulation model to measure the fair value of these warrants. Our Monte Carlo simulation model includes assumptions related to the expected stock-price volatility, expected term, dividend yield and risk-free interest rate. The impact of remeasuring the fair value of the warrants is recognized within Change in fair value of warrant liabilities in the Consolidated Statements of Operations each reporting period.
Refer to Note 15 - Fair Value Measurements, in Item 8 of Part II of this Annual
Report on Form 10-K, for additional information related to the significant
inputs to the Monte Carlo simulation model.
53 -------------------------------------------------------------------------------- TA BLE OF CONTENTS Liabilities under the Tax Receivable Agreement In connection with the Business Combination,Hagerty, Inc. entered into a TRA with the Legacy Unit Holders. The amount and timing of any payments under the TRA will vary depending on a number of factors, including, but not limited to, the increase in tax basis ofThe Hagerty Group's assets, the timing of any future redemptions, exchanges or purchases of Hagerty Group Units held by Legacy Unit Holders, the price of Class A Common Stock at the time of the purchase, redemption or exchange, the extent to which redemptions or exchanges are taxable, the amount and timing of the taxable income thatHagerty, Inc. generates in the future, the tax rates then applicable and the portion of the payments under the TRA constituting imputed interest.Hagerty, Inc. recognized a liability of$3.2 million and$3.5 million relating to obligations under the TRA for the years endedDecember 31, 2022 and 2021, respectively. Refer to Note 1 - Summary of Significant Accounting Policies and New Accounting Standards, in Item 8 of Part II of this Annual Report on Form 10-K, for additional information related to the TRA.
Acquisitions and Investments
A component of our growth strategy has been to acquire and integrate businesses that complement our existing operations. We account for business combinations in accordance with the guidance for business combinations and related literature. Accordingly, we allocate the purchase price of acquired businesses to the identifiable tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Any purchase consideration in excess of the estimated fair values of the net assets acquired is recorded as goodwill. In determining the estimated fair values of assets acquired and liabilities assumed in a business combination, we use various recognized valuation methods including the income, market and cost approaches. Valuations are performed by management or independent valuation specialists under management's supervision, where appropriate. Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date, including our estimates for intangible assets, contractual obligations assumed and contingent consideration, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired include, but are not limited to: determination of weighted average cost of capital, market participant assumptions, royalty rates, terminal multiples and estimates of future cash flows to be generated by the acquired assets. In addition to the estimates and assumptions applied to valuing intangible assets acquired, the determination of the estimated fair value of contingent consideration, including estimating the likelihood and timing of achieving the relevant thresholds for contingent consideration payments, requires the use of subjective judgments. We believe that the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions that a marketplace participant would use. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the estimated fair values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments would be recorded in our Consolidated Statements of Operations. We recognize the fair value of contingent consideration at the date of acquisition as part of the consideration transferred to acquire a business. The liability associated with contingent consideration is remeasured to fair value at each reporting period subsequent to the date of acquisition taking into consideration changes in financial projections and long-term growth rates, among other factors, that may impact the timing and amount of contingent consideration payments until the term of the agreement has expired or the contingency is resolved. Increases in the fair value of contingent consideration are recorded as losses in our Consolidated Statements of Operations, while decreases in fair value are recorded as gains.
Goodwill is tested for impairment at least annually as ofOctober 1 or between annual events if an event occurs or circumstances change that would more likely than not reduce the estimated fair value of a reporting unit below its carrying value. As ofOctober 1, 2022 , we performed a qualitative analysis in which we determined that it was not more likely than not that the fair values of our reporting units with goodwill were less than their carrying values. Our intangible assets are evaluated for impairment only when there is evidence that events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Application of the goodwill impairment test requires judgment, including the identification of reporting units and the determination of the estimated fair value of reporting units. For reporting units with goodwill, we perform a qualitative analysis to determine whether it is more likely than not the fair value of the reporting unit is less than its carrying amount. When assessing goodwill for impairment, our decision to perform a qualitative assessment for an individual reporting unit is based on a number of factors, including the carrying value of the reporting unit's goodwill, the amount of time in 54 -------------------------------------------------------------------------------- TA BLE OF CONTENTS between quantitative fair value assessments, macro-economic conditions, industry and market conditions and the operating performance of the reporting unit. If it is determined, based on qualitative factors, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount, a quantitative impairment test is performed, in which we determine the estimated fair value of the reporting unit using a discounted cash flow analysis. This analysis requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, available industry/market data (to the extent available), estimation of the long-term rate of growth for the reporting unit including expectations and assumptions regarding the impact of general economic conditions on the reporting unit, estimation of the useful life over which cash flows will occur (including terminal multiples), determination of the respective weighted average cost of capital and market participant assumptions. Changes in these estimates and assumptions could materially affect the determination of estimated fair value and potential impairment for each reporting unit. Fair value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be an accurate prediction of the future. Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as: (1) failure to meet business plans; (2) deterioration of theU.S. economy; (3) an increase in interest rates; or (4) other unanticipated events and circumstances that may decrease the projected cash flows or increase the discounts rates and could potentially result in an impairment charge. While historical performance and current expectations have generally resulted in the conclusion that our goodwill is not impaired, if our assumptions are not realized, it is possible that an impairment charge may need to be recorded in the future. There can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment tests will prove to be an accurate prediction of the future.
New Accounting Standards
New accounting standards are described in Note 1 - Summary of Significant
Accounting Policies and New Accounting Standards, in Item 8 of Part II of this
Annual Report on Form 10-K.
Non-GAAP Financial Measures Adjusted EBITDA We define Adjusted EBITDA as consolidated net income (loss) (the most directly comparable GAAP measure) before interest and other income (expense), income tax (expense) benefit, and depreciation and amortization, adjusted to exclude (i) restructuring, impairment and related charges, net, (ii) changes in the fair value of warrant liabilities, (iii) stock-based compensation expense, (iv) the revaluation gain on a previously held equity method investment, (v) expense associated with the accelerated vesting of incentive plans, (vi) net gains and losses from asset disposals and (vii) certain other unusual items. We present Adjusted EBITDA because we consider it to be an important supplemental measure of our performance and believe it is frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in our industry.
Our management uses Adjusted EBITDA:
•as a measurement of operating performance of our business on a consistent basis, as it removes the impact of items not directly resulting from our core operations;
•for planning purposes, including the preparation of our internal annual
operating budget and financial projections;
•to evaluate the performance and effectiveness of our operational strategies;
•to evaluate our capacity to expand our business;
•as a performance factor in measuring performance under our executive
compensation plan; and
•as a predictor of core operating performance, comparisons to prior periods and
competitive positioning.
By providing this non-GAAP financial measure, together with a reconciliation to
net income (loss), which is the most directly comparable GAAP measure, we
believe we are enhancing investors' understanding of our business and our
results of operations, as well as assisting investors in evaluating how well we
are executing our strategic initiatives. However, Adjusted EBITDA has
limitations as an analytical tool, and should not be considered in isolation, or
as an alternative to, or a substitute for net income (loss) or other financial
statement data presented in our Consolidated Financial Statements as indicators
of financial performance. Hagerty's Adjusted EBITDA may be determined or
calculated differently than similarly titled measures of other companies in our
industry, which could reduce the usefulness of this non-GAAP financial measure
when comparing our performance to that of other companies.
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The following table reconciles Adjusted EBITDA to the most directly comparable
GAAP measure, which is Net income (loss):
Year Ended December 31,
2022 2021
in thousands
Net income (loss) $ 2,403 $ (61,354)
Interest and other (income) expense (2,028) 1,993
Income tax (benefit) expense 7,017 6,751
Depreciation and amortization 33,887 22,144
Restructuring, impairment and related charges, net 18,324 -
Change in fair value of warrant liabilities (41,899) 42,540
Stock-based compensation expense 12,129 -
Revaluation gain on previously held equity method investment (34,735) -
Accelerated vesting of incentive plans - 9,321
Net (gain) loss from asset disposals 1,970 1,764
Other unusual items (1) 992 2,191
Adjusted EBITDA $ (1,940) $ 25,350
(1) Other unusual items in 2021 relates to expenses incurred related to the
Business Combination. Other unusual items in 2022 relates to certain severance
and legal settlement expenses.
Net income (loss) and Adjusted EBITDA for the year endedDecember 31, 2022 include$10.0 million of estimated net losses related to Hurricane Ian. Additionally, we strengthened reserves forU.S. auto liability by$6.5 million for the 2022 accident year. Both of these events adversely impacted the 2022 results compared to the year endedDecember 31, 2021 . We incurred$29.8 million and$31.0 million during the years endedDecember 31, 2022 and 2021, respectively, for certain pre-revenue costs related to scaling our infrastructure, newly-developed digital platforms and legacy systems, human resources and occupancy to accommodate our alliance withState Farm and other potential distribution partnerships as well as to further develop our Marketplace initiatives. These costs were not included in the Adjusted EBITDA reconciliation above.
Pursuant to a defined set of activities and objectives, these expenses are
adding entirely new capabilities for us, integrating our new and legacy
policyholder, membership and Marketplace systems with
and agent management systems and other third-party platforms.
Adjusted EPS
We define Adjusted Earnings (Loss) Per Share ("Adjusted EPS") as consolidated
Net income (loss) attributable to both our controlling and non-controlling
interest, less the change in fair value of our warrants and the revaluation gain
on previously held equity method investment, divided by our outstanding and
total potentially dilutive securities. The total potentially dilutive securities
includes (1) the weighted-average issued and outstanding shares of Class A
Common Stock, (2) all issued and outstanding non-controlling interest Hagerty
Group Units, (3) all unexercised warrants and (4) all unissued stock-based
compensation awards.
In the third quarter of 2022, we began removing (1) the change in fair value of
our warrants and (2) the revaluation gain on previously held equity method
investment from consolidated Net income (loss) attributable to both our
controlling and non-controlling interest for purposes of calculating Adjusted
EPS. For comparability, references to prior period non-GAAP measures have been
updated to show the effect of removing the change in the fair value of our
warrants from Adjusted EPS. We believe this updated presentation of Adjusted EPS
enhances investors' understanding of our financial performance from activities
occurring in the ordinary course of our business.
The most directly comparable GAAP measure is basic earnings per share ("Basic
EPS"), which is calculated as Net income (loss) attributable to controlling
interest divided by the weighted average of Class A Common Stock outstanding
during the period.
We present Adjusted EPS because we consider it to be an important supplemental
measure of our operating performance and believe it is used by investors and
securities analysts in evaluating the consolidated performance of other
companies in our industry. We also believe that Adjusted EPS, which compares our
consolidated Net income (loss) (which includes our controlling and
non-controlling interest) with our outstanding and potentially dilutive shares,
provides useful information to investors regarding our performance on a fully
consolidated basis.
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Our management uses Adjusted EPS:
•as a measurement of operating performance of our business on a fully
consolidated basis;
•to evaluate the performance and effectiveness of our operational strategies;
•to evaluate our capacity to expand our business; and
•as a preferred predictor of core operating performance, comparisons to prior
periods and competitive positioning.
We caution investors that Adjusted EPS is not a recognized measure under GAAP
and should not be considered in isolation or as a substitute for, or superior
to, the financial information prepared and presented in accordance with GAAP,
including Basic EPS, and that Adjusted EPS, as we define it, may be defined or
calculated differently by other companies. In addition, Adjusted EPS has
limitations as an analytical tool and should not be considered as a measure of
profit or loss per share.
The following table reconciles Adjusted EPS to the most directly comparable GAAP
measure, which is Basic EPS:
Year Ended December 31,
2022 2021
in thousands (except per share
amounts)
Numerator:
Net income (loss) attributable to controlling interest(1)$ 32,078 $ (46,358) Net income (loss) attributable to non-controlling interest (29,675) (398)
Net income (loss) attributable to redeemable non-controlling interest
- (14,598) Consolidated net income (loss)$ 2,403 $ (61,354) Change in fair value of warrant liabilities (41,899) 42,540 Revaluation gain on previously held equity method investment (34,735) - Adjusted consolidated net income (loss)(2) $
(74,231)
Denominator:
Weighted-average shares of Class A Common Stock outstanding - Basic(1)
82,728 82,327
Total potentially dilutive securities outstanding:
Conversion of non-controlling interest Hagerty Group Units to Class A
Common Stock
255,758 251,034 Total warrants outstanding 19,484 20,006 Total unissued stock-based compensation 6,902 - Potentially dilutive shares outstanding 282,144 271,040 Fully dilutive shares outstanding(2) 364,872 353,367
Basic EPS = (Net income (loss) attributable to controlling interest /
Weighted-average shares of Class A Common Stock outstanding)(1) $
0.39
Adjusted EPS = (Adjusted consolidated net income (loss) / Fully
dilutive shares outstanding)(2)
$
(0.20)
(1) Numerator and Denominator of the GAAP measure Basic EPS
(2) Numerator and Denominator of the non-GAAP measure Adjusted EPS
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