Quinstreet, Inc Q2 FY2021 Earnings Call

Thank you, Carina. And thank you to everyone joining us as we report QuinStreet's second quarter of fiscal year 2021 financial results. Joining me on the call today are Chief Executive Officer, Doug Valenti; and Chief Financial Officer, Greg Wong. Before we begin, I would like to remind you that the following discussion will contain forward-looking statements. Forward-looking statements involve a number of risks and uncertainties that may cause actual results to differ materially from those projected by such statements and are not guarantees of future performance. Factors that may cause results to differ from our forward-looking statements are discussed in our recent SEC filings, including our most recent 8-K filing made today and our 10-K filing made on August 28, 2020. Forward-looking statements are based on assumptions as of today, and the company undertakes no obligation to update these statements. Today, we will be discussing both GAAP and non-GAAP measures. A reconciliation of GAAP to non-GAAP financial measures is included in today's earnings press release, which is available on our Investor Relations website at investor.quinstreet.com. With that, I will turn the call over to Doug Valenti. Please go ahead.

Thank you, Hayden, and thank you all for joining us today. Our business momentum is strong. We delivered excellent results in fiscal Q2. A sure sign of the strong momentum is that revenue, excluding divested businesses, grew sequentially by 6% in the quarter. This is significantly better than typical seasonal declines. Year-over-year, revenue, excluding divested businesses, grew 36%. The results are driven by strength in Insurance and Home Services, our two largest businesses. Auto Insurance once again grew 57% year-over-year, and Home Services grew 165%. All that, while continuing to show strong cash flow and maintaining an exceptionally strong balance sheet. We continue to make excellent progress on a wide range of short- and long-term growth initiatives and continue to strengthen our products, technologies, and operations for future growth, competitive advantage, and efficiency. We are well ahead of schedule with our integration and synergies for the Modernize acquisition. Our tailwinds are strong. Marketing budgets and consumer activity continue to shift to digital at an unprecedented rate, increasingly toward our core business of performance marketing and media. Within those megatrends, QuinStreet Performance Marketplace Solutions are increasingly recognized by the most advanced clients as their most productive and consistent digital marketing channels at scale. We continue to make good progress with QRP in the quarter, both with the agency client pipeline and with more and deeper carrier integrations. We are in process with integrations and ramps of several of the biggest opportunities in that market. Revenue is still early, but ramping. Our long-term expectations for QRP remain exciting. Trends in credit-driven client verticals, specifically personal loans and credit cards, continued to improve in fiscal Q2. I continue to be excited about our position in those enormous markets as the economy improves. They are future growth engines, highly synergistic with Insurance and Home Services. Looking ahead to the current quarter for fiscal Q3, we expect continued strong momentum and revenue growth in the Insurance and Home Services client verticals, continued improvement in personal loans and credit cards, and continued strong overall company performance as a result. We expect revenue in fiscal Q3 to be between $145 million and $150 million, which at the midpoint of the range represents 34% year-over-year growth in revenue, excluding divested businesses. We expect adjusted EBITDA to be between $13 million and $14 million. With that, I'll turn the call over to Greg.

Thank you, Doug. Hello, and thanks to everyone for joining us today. We continued to see strong performance in Q2, feeding typical seasonality and once again exceeding our expectations and outlook for both revenue and adjusted EBITDA in the quarter. Total revenue was $135 million and grew 36% year-over-year, excluding divested businesses. Adjusted EBITDA was $10 million, and adjusted net income was $7 million, or $0.13 per share. Looking at revenue by client vertical, our Financial Services client vertical represented 77% of Q2 revenue and grew 18% year-over-year to $104.2 million. Auto Insurance, our largest business, delivered another record revenue quarter and grew 57% year-over-year. This reflects strong spending and growth from a broad range of major carrier clients and excellent progress on a number of growth initiatives in the quarter. Also in Financial Services, our credit-driven personal loans and credit card businesses continued to improve in fiscal Q2. Combined, they grew 25% sequentially and were up 80% from the June quarter. We expect these businesses to be good long-term growth drivers for QuinStreet as the economy improves. Our Home Services client vertical represented 22% of Q2 revenue and grew 165% year-over-year to $29.2 million. As a reminder, on July 1, we acquired Modernize to add to our scale and capabilities in Home Services. We once again outpaced our expectations in the quarter, demonstrating the continued success of the integration and capturing of synergies from that acquisition. Other, which consists primarily of performance marketing agency and technology services, was the remaining $1.6 million of Q2 revenue. Turning to the balance sheet, we closed the quarter with $102.6 million of cash and equivalents. During the quarter, we generated $5.6 million of operating cash flow. Normalized free cash flow for the quarter was $7.5 million, or 6% of revenue. Most of our adjusted EBITDA drops to normalized free cash flow due to the low capital requirements of our business model. In summary, we continue to see strong performance from Insurance and Home Services, our two largest businesses, and are encouraged by the substantial improvement of our credit-driven businesses. This has all resulted in us exceeding our expectations and outlook for the quarter. Our success in narrowing the footprint to our best-performing and fastest-growing opportunities is evident. Trailing 12-month revenue, excluding divested businesses, was $475.7 million, reflecting a three-year compound annual growth rate of 30%. Looking ahead to the March quarter, we expect the strong momentum to continue, resulting in a record revenue quarter and expanding adjusted EBITDA. With that, I'll turn the call over to the operator for Q&A.

We'll now take the first question from John Campbell with Stephens. Please go ahead.

Congrats on a phenomenal quarter. Absolutely. So growth, obviously, for you guys, is really good right now. You still got personal loans and credit cards kind of weighing down that overall growth rate. I think you guys said it was up 25% sequentially. Just curious if you could kind of unpack that. If you could talk about kind of progression month-to-month, how that's looked thus far into January? And if you could maybe piece out which of the two is rebounding quicker?

We're continuing to see good improvement incrementally and sequentially, whether it be kind of month-to-month or quarter-to-quarter. So we continue to see improvement trends in both of those businesses. We've gone from most of the clients being out of the channel just a quarter to two quarters ago to pretty much all of the clients being back in the channel now. And now it's a matter really of them continuing to expand their filters and their budgets, their spending. They'll do that as the economy improves and as they get more comfortable with the environment. In terms of between the two, I don't know, Greg, it's been pretty similar trends in the two. And the other thing Greg pointed out, they're up 80% from the June quarter, which was the bottom of the two. But Greg, do you have any more for John on the split between the two? But from a looking at the business progression from my seat, and the numbers are pretty similar.

Yes. I mean, for the most part, personal loans have probably progressed a little bit faster, but we're seeing progression across both credit cards and personal loans. And John, just to give you a little color, what we saw in the June quarter of last fiscal year, we were down combined 70% on those businesses. In the September quarter, we were down 60% of those businesses. This quarter year-over-year, in the December quarter, we were down about 42% year-over-year.

Okay. Great. I'm in the right direction. Last question for me. On Home Services, you guys, I think your core base business you guys have always had was growing nicely, and then it seems like Modernize is obviously seeing that growth up. You guys have done your integration work. But I know once you've done some of the integration, it gets tough to kind of piece out which is which at this point. But am I kind of in the right territory, calling for like 30%-or-so organic growth out-of-home services? Is that in the right kind of ZIP code?

I think you’re right, John. It's challenging for us to separate the components. We had an integration plan for Modernize even before finalizing the deal, and we immediately began integrating it. Therefore, it's difficult to determine what constitutes organic growth, but I can assure you that we are experiencing strong double-digit organic growth. I can't confirm whether 30% is the correct figure, but the growth is indeed substantial, driven by various factors. Additionally, this organic growth is occurring in a COVID environment. We're seeing significant benefits from synergy work where one plus one is yielding even greater returns, alongside solid execution in expanding our core business. We're enjoying robust organic growth in addition to impressive inorganic growth and synergies that are exceeding our expectations and timelines. We are extremely pleased with Modernize and are very optimistic about Home Services as a whole. It's a massive market, likely our biggest total addressable market, where we believe we are well-positioned to continue achieving strong growth and delivering excellent results for our clients, media partners, and financially. I am very enthusiastic about our position in Home Services, thrilled about Modernize, and couldn’t be happier with how that business is performing and our future outlook. We are indeed seeing strong organic growth as well.

Yes. Great work across the board. And once you guys get personal loans and credit cards back as a tailwind, you guys are going to really be cooking. So nice work.

We'll go ahead and take our next question from Jason Kreyer with Craig-Hallum.

Just taking the Home service for a second. Is there anything you can highlight regarding specific categories that are experiencing particularly strong growth right now? Additionally, are there any lingering COVID impacts on categories that are underperforming due to being indoors, which may result in pent-up demand over the next couple of quarters?

Yes, absolutely. We have six core trades in Home Services that are performing very well. We've discussed these trades before, and in addition, we are expanding into a number of additional growth trades, which number between five and ten significant areas. We also have plans to explore even more growth trades. These trades include home security, solar, HVAC, roofing, and siding. Most of the current growth is coming from the core trades where we are effectively executing synergies as we scale. Additionally, we are making good progress in expanding our presence in the growth trades I mentioned. We believe we can enter dozens of trades and consider ourselves early in our journey to expand our footprint in Home Services, which is why I emphasize the large total addressable market. As for general trends, it certainly appears that we are seeing strong growth in core trades due to the synergies we've created, combining our media and products with those of our clients. However, there is a noticeable softness in indoor projects compared to outdoor ones. We observe greater strength in exterior projects while interior projects remain weak, mainly because people are reluctant to allow strangers into their homes due to COVID. We think the strong growth we're experiencing in Home Services is somewhat limited by the ongoing effects of COVID on demand and consumer behavior in several trades. Regarding the trades, it seems to be roughly equal between exterior and interior projects, though this is not an exact measure, it gives a good indication of our involvement in both categories.

I think that's right.

I appreciate that. Greg, one for you. Just curious if you had any call-outs on the margins. We talk a lot about your semi-fixed cost operating structure. And typically, when we see the growth acceleration like we did this quarter, the gross profit usually follows that. Kind of broke away from that a little bit. So you saw the nice profit on the bottom line, just not as much quarter-over-quarter on the gross margin side. Just wondering if there's any influencing that number?

No, not really, Jason. From a quarter-over-quarter perspective, it's really, as we talked about, it's a seasonally lighter quarter. So it's really the loss of top line leverage on a very similar fixed cost from that standpoint.

We'll go ahead and take our next question from Jim Goss with Barrington Research. Please go ahead.

Okay. The half a dozen core segments you're operating in the Home Services area. Could you say about what share of the revenue base in that categorization are in those six segments? And then also in terms of the likelihood of how you pace yourself in executing a growth strategy in that area? Understandably, there are hundreds of categories you can get into. How do you intend to pursue it in terms of selectivity within those categories before you and filling those out before you move into new sub-verticals because I'm sure you can't be spread too thin and be effective?

I don't have the exact numbers in terms of that split in front of me, Jim, but it's more than 50% of the revenue today in Home Services is in our six core trades. The trades that have gotten to some semblance of scale, although they are still well short of the scale we believe they can eventually achieve and still ramping pretty aggressively for us. In terms of it, you're exactly right. Part of the magic of executing in that business is making sure that we have a smart alignment of resources with how much goes into scaling the core trades and how many new growth trades we take on. And at what rate we pace them with how many resources. And that's a decision that's done very iteratively with that management team and that leadership group. But you can imagine, in general terms, it has to do with the attractiveness of a new trade to us, generally speaking, which usually has to do with marketing budgets, annual marketing spend, lifetime value of customers, media availability, and media economics. These are the main kind of screens we put them through. And then there's the tactical considerations like have we been able to sign enough clients in a particular trade to give us critical mass of demand that we can then use to get media efficiency that we can then use to go get more budget that we can use to get more media efficiency and start working that virtuous cycle up. It's a combination of top-down assessment of the attractiveness based on the metrics that matter to our business. So not every Home Services trade is attractive to QuinStreet. We need things like strong lifetime value, strong marketing spend, good media availability in digital, and the ability to make the media economics work in digital. Even with that, you go from there being hundreds to we think dozens that we can be in. We think there are dozens we can be in. And then it's the tactical work to have some groups focused on the core, some groups focused on the new, and how much progress we make with specific client demand which will shift resources if you’ve got seven candidate new growth verticals you're working on at any given moment. When one of those happens to sign a national service provider or a super-regional service provider, then that one will get more attention. That sometimes just has to do with pipeline flow, client activity, client personnel, client priorities, things like that. So that's how we look at it.

Okay. And just a couple of other things. One other thing in Home Services, I was wondering if you could describe the competitive situation there now that you've merged one of your existing key competitors. How does that stack up relative to what you do with on the Insurance side? And then on the Financial Services area, within personal loans and credit cards, is there a concentration with a number of large customers in the way progressive and a couple of other insurance companies factor in, importantly, in your insurance group?

In Home Services, it’s much, much less competitive intensity than we see in most of our other verticals, including Insurance, which is highly competitive. It's a tougher business to execute in because it is represented by so many more service trades and therefore, a lot more clients. You have to be able to go kind of multi-vertical in Home Services. The clients themselves are much more fragmented, and the media is much more fragmented. It aligns very well with our operating capabilities and our technology platform, which was built to be multi-vertical. So we think we're advantaged there, and I think that helps explain why there's less competitive intensity. In Insurance, if you get the 10 biggest carriers, you can make an insurance marketplace. You might argue you can do that with less than that. In Home Services, if you get 10 clients, you haven't even started. You have not gotten going. Maybe if they are all in one trade, you can get going. But we think we need to get to thousands of clients in Home Services to eventually get where we want to get, where I think we're already out of a thousand versus, say, 50 carriers in Auto Insurance, which includes a lot of smaller carriers. So very different operating requirements align very well with our technology and capabilities and the way we implement and execute. I think that's part of the reason we see a lot less competitive intensity. The biggest player in the vertical, of course, is Home Advisor, Angie HomeAdvisor or Angie Services, which is a very different model than us. They are in hundreds and hundreds of trades, and they are much more of a broad-based marketplace. We are, as we usually are, a much narrower, deeper player that gets much more deeply integrated with both our clients and with our media sources. We think we're very complementary with Angie HomeAdvisor. They are a partner of ours, so we do a lot of joint revenue together. The size of the two of us, there's a pretty big white space between us and the next player. So you can see it's a much less competitively intensive market. In terms of personal loans and credit cards concentration, again, I don't have the numbers in front of me, but the short answer is not nearly as concentrated as, say, Insurance. We don't have a progressive in personal loans and credit cards; they are much more broadly spread out. Both are generally bigger and have generally more players in the market, though credit cards probably have six major issuers that do dominate the market. So we are not dominated by any one of those. In personal loans, there are a lot more players than that. Again, we don't have any single player that's significantly bigger than the others. The short answer is, no, we're not as concentrated in those verticals as we are in Insurance, where we don't have a big client like we do in Insurance.

And we'll go ahead and take our next question from Eric Martinuzzi with Lake Street.

A follow-up there on the personal loans, credit card side of the house. Just wondering, you've obviously seen a sequential step-up there on the demand side. If we were to focus on one or two kind of leading indicators, does that business get better if we're to look at stimulus or employment numbers or vaccine rollout? What's a good indicator as to where that business is going?

Yes, Eric, I think the best indicator is probably economic activity and employment. As employment numbers improve, consumer credit usually strengthens, leading to increased demand in those businesses. Interestingly, stimulus doesn't really benefit personal loans since people tend to postpone taking them if they expect to receive a stimulus check. However, it may be beneficial for credit cards, as they do not move in sync with what benefits personal loans. The best overall indicator is related to consumer credit conditions in Middle America, which will enhance the strength of both credit cards and personal loans.

Okay. Curious to know, this one is for Greg. It looks like based on the guidance, we've got a nice adjusted EBITDA margin expansion baked into the Q3 guidance. Now I know Q3 is seasonally, I think it's your strongest. Is that just a result of the incremental step-up in revenue? Or are there other things going on in that margin expansion?

Yes, Eric, the biggest component is just exactly what you said. Our top-line leverage-driven model means that as we drive more revenue, we see margin expansion happen because we have a very similar semi-fixed cost base. So really, the margin expansion that you're seeing is driven by a better top line.

Okay, right. And then lastly for me. We're benefiting from a shift to digital marketing over the past three quarters. Certainly, you guys are benefiting most digital marketing, performance marketing, business models are benefiting. In your world, specifically Financial Services, are you concerned at all about swings back, economy reopens, more sporting events, more live broadcasts. Is there a shift back to traditional advertising and away from performance marketing at risk here?

It's a great question. And the short answer is we dig into this with clients; no, these do not appear to be temporary shifts. These appear to be and make sense to be, if you look at kind of the share of spend based on activity in the channel, permanent changes that we've accelerated the migration curve that was already happening. We do not expect that. We expect that these shifts will stay with us, and that this has just taken a curve that was already moving up to the right in digital marketing and increased the slope of it because it caused companies to have to go faster and to adapt faster. We do not expect a meaningful shift back to non-digital channels.

Just to add on to that, Doug, as well as Eric, we've been growing even through the pandemic. You've been seeing that shift. This is just an acceleration of that shift from offline to online. You could see that in our three-year compound annual growth rate in our business now, which has been 30%. So we've seen that shift has been happening, and we've seen long-term growth out of those businesses already.

We'll take our next question from Chris Sakai with Singular Research.

Just had a question. I just had a question on for your Auto Insurance and Home Services are growing pretty well now. I wanted to see what you guys thought about post-pandemic. Do you think you'll see maybe a switch to more credit-driven businesses growth and less of Auto Insurance and Home Services? I just wanted to see what you thought there.

It's hard to predict, Chris. We believe that a lot of the shift to digital, which was accelerated by COVID, cannot be reversed. In response to Eric's question, we do not anticipate a significant decline in non-digital channels after COVID. The rate of our growth will depend more on our activities and initiatives moving forward rather than COVID itself as we continue to expand. We expect the credit-driven businesses to return to growth as the economy improves, which will contribute more to our overall growth. Additionally, we will be comparing results following the Modernize acquisition on July 1. Overall, I'm optimistic about the timing of the credit-driven businesses, the progress we are making, and the positive feedback from clients regarding our initiatives. We are confident about our growth prospects for the foreseeable future.

Okay, all right. And then one thing I just wanted to ask about the Home Services segment. Could that be, I guess, is it related or negatively related to the interest rates? So as interest rates are down, do Home Services go up and vice versa?

I'm not sure. I don't anticipate that it will have a significant impact because we're still in the early stages of entering the Home Services market. This market is large, and we're just beginning to penetrate performance marketing and digital advertising. In terms of insurance, we are still relatively new. I believe that macroeconomic factors like interest rates are unlikely to significantly influence demand compared to the ongoing natural shift and increase in marketing budgets for digital performance marketing in the future. I wouldn't expect that to be a major factor driving demand for these services at this time.

And it appears that we have no further questions at this time. And everyone, there will be a replay available for this call. It will be available today at 7:00 p.m. Central Time, and the availability will end on February 10, 2021, at 7:00 p.m. Central Time. The phone number you can call is 1 (719) 457-0820, toll free is (888) 203-1112. You will enter a passcode, and that passcode will be 1730393. Thank you so much for your participation. You may now disconnect your phone lines.