MediaAlpha, Inc. Q1 FY2023 Earnings Call

Hello, my name is Chris, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the MediaAlpha Q1 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Denise Garcia, Investor Relations. You may begin.

Thank you, Chris. After the market closed today, MediaAlpha issued a press release and shareholder letter announcing results for the first quarter ended March 31, 2023. These documents are available in the Investors section of our website, and we will be referring to them on this call. Our discussion today will include forward-looking statements about our business and our outlook for future financial results, including our financial guidance for the second quarter of 2023, which are based on assumptions, forecasts, expectations and information currently available to management. These forward-looking statements are subject to risks and uncertainties that could cause future results or events to differ materially from those reflected in those statements. Please refer to the company’s SEC filings, including its Annual Report on Form 10-K and its quarterly reports on Form 10-Q for a fuller explanation of those risks and uncertainties and the limits applicable to forward-looking statements. These forward-looking statements are based on assumptions as of today, May 4, 2023, and the company undertakes no obligation to revise or update them. In addition, on today’s call, we will be referring to certain actual and projected financial metrics of MediaAlpha that are presented on a non-GAAP basis, including adjusted EBITDA, which we present in order to supplement your understanding and assessment of our financial performance. Non-GAAP measures should not be considered as a substitute for or superior to financial measures calculated in accordance with GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our press release and shareholder letter issued today. Finally, I’d like to remind everyone that this call is being recorded and will be made available for replay via a link on the Investors section of the company’s website at investors.mediaalpha.com. Now, I’ll turn the call over to Steve and Pat for a few introductory remarks before opening the call to your questions.

Hey, thanks, Denise. Hi, everyone. Welcome to our first-quarter earnings call. I’d like to make a few observations before turning the call over to our CFO, Pat Thompson, for his comments. As we discussed in our shareholder letter, after a strong start to the year, our largest P&C carrier partner sharply pulled back their marketing investments in light of renewed profitability concerns. As a result, we expect the inevitable market recovery in our P&C vertical to be pushed back several quarters relative to our prior expectations. We responded to this unexpected change in our near-term outlook by making a difficult but necessary decision to reduce our workforce by 16%. As a result, we’re guiding to positive adjusted EBITDA in Q2 despite an expected 40% to 50% year-over-year reduction in P&C transaction value and the typical seasonal slowness in our health insurance vertical. While the magnitude and duration of the P&C hard market cycle have been frustrating for us, both as the management team and as significant shareholders, we remain confident in the fundamental competitive advantages of our marketplace model and our ability to capture an increasing share of the multibillion-dollar opportunity across all of our insurance verticals. We will emerge from the current P&C market downturn with a stronger and more efficient organization, which will, in turn, enable us to generate significant operating leverage as our top-line results recover.

Thanks, Steve. We delivered a solid first quarter with results above the mid-point of our guidance ranges across all metrics. This outperformance was driven by 108% quarter-over-quarter transaction value growth in our P&C vertical, which was slightly ahead of the roughly 100% sequential growth expectation we discussed on last quarter’s call. Moving to our Q2 guidance. As Steve mentioned earlier, we expect P&C transaction value to decline 40% to 50% year-over-year. In our health insurance vertical, we expect transaction value to remain roughly flat year-over-year. And in our life and other verticals, we expect transaction value to decline at a similar rate to Q1. As a result, we expect Q2 transaction value to be between $107 million and $122 million, a year-over-year decrease of 37% at the mid-point. We expect revenue to be between $74 million and $84 million, a year-over-year decrease of 24% at the mid-point. Lastly, we expect adjusted EBITDA to be between $500,000 and $2.5 million, a year-over-year decrease of 67% at the mid-point. We expect our recently initiated workforce reduction to result in approximately $6 million of annual cash expense savings. We are therefore projecting operating expenses after adjusted EBITDA add-backs to be approximately $1.5 million lower than Q1 levels and to remain at these levels in Q3. I’d now like to touch on a couple of housekeeping items related to our adjusted EBITDA add-backs. First, we expect to add back roughly $1.3 million of cash severance in Q2 related to our workforce reduction. Second, in Q1, we added back $300,000 of legal fees related to the ongoing FTC inquiry, and we expect to incur a similar to slightly higher amounts for the next few quarters. We believe we have been and remain fully compliant with all laws and regulations, and we are cooperating with the FTC as they continue their inquiry. We are adding back both of these items as we believe they do not reflect the ongoing operating performance of the business. Turning to the balance sheet. We are focused on reducing net debt and expect to continue to be in compliance with our debt covenants. We generated positive cash flow from operations in Q1 and due to our transaction-based revenue model and low capital requirements. We expect cash flows to improve sharply and in line with adjusted EBITDA coming out of the P&C hard market cycle.

Thank you. The first question is from Michael Graham with Canaccord. Your line is open.

Thanks for the color on the quarter, guys. Maybe just reflecting on the shareholder letter and you talked about how we had a major carrier returning to spend. And then in the last days of March, sort of saw higher loss ratios. Can you just maybe go a layer deeper in terms of like what do you think is going on at the carrier level and just any more color you can share on sort of like what you see as the cadence within P&C as we move throughout the rest of the year here?

Yes. Hey Michael, this is Steve. So I’ll take that question. So I think that really, the pullback by this major carrier who believe that they had achieved rate adequacy is an indication of how unusual this hard market cycle is and how uncertain the current underwriting environment remains. It’s difficult to foresee and predict exactly when they’re going to return to the marketplace. Based on their comments and our discussions with them, I think our best estimate is that they’ll come back into the marketplace two to three quarters from now as they get more comfortable with what their profitability looks like for the remainder of the year. What we’re seeing is just the magnitude of this hard market cycle and the lingering inflationary pressures that insurance carriers continue to face. Overall, this means that the P&C market recovery is very likely going to be delayed a few quarters from what our original expectations were. I would like to remind everyone that the Q1 results we had and the growth investments we saw from this carrier, which were immediately back to normal historical levels when they felt confident about their profitability is a sign that when the carriers get comfortable with where the rates are and the stability of the underwriting environment, these growth investments and investments into our marketplace to acquire new customers and policies will return quickly and can return sharply. Ultimately, when the market does turn and these advertising budgets come back, we expect to see a sudden influx of investment from these carriers, which will then meet the heightened shopping that we see from consumers as their rates have gone up 15%, 20%, 25%.

Okay. Thanks, Steve. That’s helpful. And can I just ask a follow-up on the health side? When you think about the Medicare products, have there been any structural changes there? There was some chatter during the quarter regarding some regulatory changes that would make it more difficult for bidding activity to happen and might end up being a factor for businesses like yours as we get into open enrollment later in the year. Can you just maybe talk about are you seeing any changes on that front?

Yes. Hey Michael, this is Steve again. I think what you’re referring to are some of the new CMS regulations around how you can market Medicare Advantage policies. Some final rules were released in April of this year. Even though the final rules have been released, it’s too early to say exactly what the impact will be in our marketplace. There’s some interpretation needed from these rules, particularly to figure out exactly how they’ll apply to an online advertising environment. At this point, we’re working closely with all of our major partners, especially our major carrier partners, to figure out exactly how these rules will be interpreted and applied to the online marketing context. That said, just seeing these rules and based on our early discussions with these carriers, we’re optimistic about the limited impact that we expect them to have in our upcoming enrollment period. What’s foreseeable is that there may be some downward pressure in pricing for outbound data leads, specifically leads that are purchased by brokers and carriers that call on consumers who are interested in Medicare, depending on the interpretation of a 48-hour waiting period requirement and whether that actually applies to these data leads. Notwithstanding that, we don’t expect a lot of impact on the two primary ad products that we have in our marketplace, which are inbound calls and clicks. In fact, if we see some downward pressure and lower demand for these data leads, we could foreseeably see increased pricing for inbound calls and clicks, which would be a net positive for our marketplace.

And this is Pat. I’ll just add one thing to what Steve said, and he hinted at it, but the outbound data leads are a very small percentage of our overall Medicare business.

Okay. Great. Thank you, guys.

Thanks, Michael.

The next question is from Daniel Grosslight with Citi. Your line is open.

Hi guys, thanks for taking the question. I want to stick with that line of questioning on the 48-hour rule in Medicare Advantage. So you think you’re understanding that the 48-hour rule will not apply to incoming calls, it’s just to outbound calls that it will?

Yes. Hey Daniel, sorry to interrupt you. Yes, that’s just our interpretation. That’s the interpretation we’re getting from our partners, including our health insurance partners. It’s something we’re working through to get clarity on. But initially, that is the interpretation that most in our space have taken.

Got it. Okay. And I guess, if it were to apply to both inbound and outbound calls, I wonder how much flexibility you have right now to transition away from the Medicare Advantage product into other products, which might not be subject to the rule like Medicare supplement and ancillary products. Obviously, you have an under-65 segment, which may do well amid potential redetermination this year. So I’m just curious how you’re thinking about the potential shift away from Medicare Advantage should those rules be more onerous than originally thought?

Yes. Honestly, I don’t know that there’s a lot of controversy around whether the 48-hour waiting period requirement would apply to inbound leads. We haven’t spoken to a single health insurance carrier who’s interpreting it that way. Ultimately, how these rules are interpreted will be based on what the major carriers decide. If there is an interpretation that goes against our and the industry’s expectations, we certainly have a strong presence in under-65 insurance. Some partners focused on Medicare are worried about the potential impact of these new marketing regulations on data leads. Some of those partners are starting to shift to other products like Medicare supplemental as well as under-65 health insurance. The whole space and our marketplace will adapt to areas that won’t be impacted by these regulations. However, I think there’s very low likelihood that the waiting requirement will be interpreted to apply to inbound calls.

Yes. And Dan, this is Pat. I would add that a healthy portion of our overall Medicare business is clicks as well. There’s no rational interpretation you can take of any regulations that would change the ability to find policies from clicks in a timely manner. Our view is that portion of the business has performed well over time as more consumers go online, and particularly as older consumers get comfortable going online. We believe that’s a trend that will continue in the years to come.

Got it. Very helpful. Thank you.

Sure.

The next question is from Ben Hendrix with RBC Capital Markets. Your line is open.

Hey, thank you very much. You’ve really answered my question. It’s all about the 48-hour rule, but I know one of your partners, eHealth, talked about the potential for further rationalization in the market. I’m just wondering if you had any thoughts on how this might impact the e-brokers versus the carrier partners and if there’s anything that applies differently to the two groups?

Yes. I think that if the 48-hour waiting rule is deemed to apply to third-party leads, it would have a disproportionate impact on the broker universe because they tend to buy more third-party leads for their call center agents compared to carriers. That said, a lot of cleanup happened with the e-brokers looking at the lifetime value of the policies they’re selling. One of the channels they cut was these third-party leads. I think there will be some impact on the e-broker universe, certainly greater than that on carriers, but overall, the impact from all of that, based on how much they cut back on these types of marketing channels, will likely be limited for brokers as well.

Yes. And I would just add two things. As a reminder, we have a healthy mix of demand from both carriers and brokers, and the carrier piece has been growing at a faster rate consistently over the last three to five years, and that’s a trend we believe will continue. Brokers do clearly meet a consumer need when it comes to comparison shopping across plans.

Thank you very much.

Sure, Ben.

The next question is from KBW. Your line is open.

Hey guys, this is Tommy McJoynt at KBW. Thanks for taking our questions here. Looking at the P&C insurance side, can you give us your latest thoughts about how MediaAlpha fits competitively against some of the other lead generation and customer acquisition offerings from other companies? Do you think that your platform is in any way better positioned to weather this downturn or to better capitalize on the eventual rebound in advertising budgets?

Yes. Thanks for the question. I think competitively, where we sit is, vis-à-vis our competitors, we’re a marketplace model, and that’s really what differentiates us. We have hundreds of supply partners who we connect with insurance carriers primarily for the national advertising budgets they have. Other companies are more straightforward lead generators while they rely on these national click budgets from carriers but also on lead budgets that agents have. These lead budgets from agents tend to hold up relatively well during hard market periods. We’ve been more impacted by the decline of national carrier budgets compared to some competitors. However, when recovery happens, it will be driven by the return of carrier budgets, not by additional spending from agents for leads. That spending tends to stay relatively constant. Our focus remains on working with these carriers to be ready for the day when these budgets return. We certainly expect to outgrow our competition with our marketplace model because it has demonstrated its ability to scale up quickly due to its network of hundreds of third-party supply partners, and we expect to outgrow our competition when this hard market ends, as we did last time.

Yes, and I would add that the Q1 numbers give you a sneak peek of what a recovery could look like. We grew transaction value of P&C 108% sequentially from Q4 to Q1, driven almost entirely by one major carrier leaning back into marketing. It’s not a stretch to say that when carriers achieve underwriting results they’re comfortable with, they will lean into marketing. We would expect to see significant upticks in all our financial metrics, with disproportionate growth in EBITDA. In Q1, transaction value was down about 20% year-over-year, and EBITDA was up. We’ve leaned up the cost structure and are ready to take advantage when that happens.

Thanks. And along the same lines, obviously, it’s always tough to do a workforce reduction. Do you consider that reduction more permanent or something that you might need to rehire capacity to the extent there’s a rebound sooner than expected?

Yes. Thanks for that question. It’s hard to do a reduction. We focused primarily on roles that weren’t revenue-generating. We were careful to ensure we could continue to invest in key areas, such as our health insurance business and, notably, our Medicare product. We also ensured that we had our core P&C capabilities intact so we can work with carriers and be ready for when the rebound happens. In terms of whether we’ll need to replace specific roles, I don’t think that’s something we’ll need to do in the near term. It’s foreseeable that in nine months to 12 months, we’ll start looking for people to fill some roles again, as we think longer-term. But generally speaking, we can grow back with the current team, and our team continues to invest in important areas. So in the near and midterm, we don’t see any specific role replacements necessary, but as we grow, it will be dynamic, and we’ll hire again when the situation improves.

Makes sense. Appreciate the answers.

Thanks.

We have no further questions at this time, and that will conclude today’s conference call. Thank you, everyone, for participating. You may now disconnect.