Earnings Call Transcript - QNST Q3 2020

Operator, Operator

Good day, ladies and gentlemen, and welcome to the QuinStreet Third Quarter Fiscal 2020 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Erica Abrams. Please go ahead.

Erica Abrams, Moderator

Thank you, Keith. Good afternoon, ladies and gentlemen. Thanks for joining us today as we report QuinStreet's Third Quarter Fiscal 2020 financial results. Joining me on the call today are Doug Valenti, CEO; and Greg Wong, CFO of QuinStreet. This call is being simultaneously webcast on the Investor Relations section of our website at www.quinstreet.com. Before we get started, I would like to remind you that the following discussion contains forward-looking statements. These statements involve a number of risks and uncertainties that could 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 under the legal notice section in our Form 8-K filed with the SEC today, including disclosure about the effects of coronavirus and related restrictions on our business and are also discussed in more detail under the Risk Factors section in our SEC filings, including our most recent 10-Q filing. 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 has been included in today's press release, which is available on the Investor Relations website. With that, I'll turn the call over to Doug, CEO of QuinStreet. Please go ahead.

Doug Valenti, CEO

Thank you, Erica, and thank you all for joining us today. QuinStreet's business fundamentals and financial position remain strong and resilient despite the challenges posed by coronavirus. We rapidly and successfully shifted to working remotely in all geographies in March, and productivity and progress have continued to be excellent. The execution of our team throughout this period has really been outstanding, first, by moving so rapidly to working effectively remotely in all locations and functions, and since then, by adapting quickly to the changes in our client and media markets caused by the pandemic. Due to that great work combined with the scale of our opportunity, the strength of our core capabilities, and our variabilized business model, we expect to deliver continued solid EBITDA and cash flow during this challenging period. Our balance sheet is also strong, with cash approaching $100 million and no bank debt. So again, QuinStreet's business fundamentals and financial position remain strong and resilient. Beyond coronavirus, we are confident that our future has never been brighter. Fiscal Q3 results were impacted by coronavirus-related reductions in client marketing budgets and consumer traffic in some areas of our business. Those effects accelerated during the quarter, with year-over-year growth in revenue, excluding divested businesses, dropping from 20% in January to 9% in March. Adjusted EBITDA margin fell from 10% in January to an average of 6% in February and March, due mainly to the loss of top-line leverage and related lower media efficiency. Our insurance client vertical has been performing best in the face of coronavirus. Auto insurance, our biggest business, grew 30% year-over-year. QRP also continues to progress well and promises to be one of the most exciting business opportunities in the history of the company, providing a strong value proposition for agency clients and big-scale, SaaS-like margins for QuinStreet. Among its many advantages, QRP increases agent productivity and helps agencies work more effectively remotely to serve consumers online. Launched QRP clients already represent over $6 million in estimated annual revenue opportunity once fully ramped. Signed and near-signed clients, not yet launched, represent $12 million of additional estimated annual revenue opportunity. The balance of clients in the advanced pipeline, not yet at the signing stage, represent $36 million more of estimated annual revenue opportunity. That means we believe we already have visibility to over $50 million of estimated annual QRP revenue. We believe the full pipeline and market represent an estimated revenue opportunity of well over $100 million per year. We made good progress on strategic initiatives in the quarter, narrowing our business footprint by successfully divesting our B2B client vertical in a sale to another firm and by also selling or spinning off all of our Brazil operations. As you would probably expect, the Goldman Sachs-led process to review strategic alternatives has paused due to current market uncertainties. We have four main focus areas and objectives during the pandemic period, including best serving the needs of clients and media partners to maintain long-term market position and share. A second core objective is to continue making progress on key new product, media, and business expansion initiatives. A third core objective is to preserve cash and cash flow. Finally, but equally important, is protecting our employees from health risks and economic uncertainty during the pandemic period. We feel good about those objectives for driving long-term shareholder value and about delivering on that. Turning to our outlook, we expect revenue growth and EBITDA in the near term to continue to be impacted by coronavirus-related disruptions and uncertainty. We anticipate continued volatility in client budgets and media, particularly in non-insurance client verticals. Forecasting specifics in these uncertain times is challenging. Our current estimate is for fiscal Q4 revenue, excluding divested businesses, to be down between 5% and 10% year-over-year. Adjusted EBITDA and cash flow margins are expected to be positive but in the lower single digits as we absorb full quarter effects of coronavirus-related drops in top-line leverage and media efficiency. We will look to avoid layoffs during this pandemic that would be required to offset those drops. It seems unjust and bad corporate citizenship to lay off productive employees just to increase already positive profits and cash flow, especially given our strong balance sheet. Not to mention the fact that those layoffs would also hinder progress on important longer-term initiatives. Looking post-coronavirus, we are confident and enthusiastic about our strategy to narrow our footprint and focus our efforts on a smaller number of our biggest and best long-term business opportunities. Those opportunities would include a heavier mix of QRP and likely other high-margin technology products with deeper integrations into our clients and our networks. We still expect annual revenue of well over $400 million in the new format even before our plan to aggressively invest in the remaining businesses. We also expect revenue and EBITDA growth to be more predictable and even faster than our pre-coronavirus footprint, which in turn we expect to drive greater shareholder value. Trailing 12 months revenue for our go-forward core financial services and home services businesses was $414 million through March 31, representing a three-year compound annual growth rate of 34%. With that, I'll turn the call over to Greg.

Greg Wong, CFO

Thank you, Doug. Hello, and thanks to everyone for joining us today. To start, I hope everyone is staying safe and healthy during these unprecedented times. Total revenue for the third quarter grew 11% year-over-year to $128.7 million, a record quarter for QuinStreet. Revenue, excluding divested businesses, grew 15% year-over-year to $126.3 million. Adjusted EBITDA for the quarter was $9.3 million or 7% of revenue. Adjusted net income was $7 million or $0.13 per share on a fully diluted basis. We grew our cash balance by $21 million to close the quarter with $97.1 million of cash and equivalents and no bank debt. Looking at revenue by client vertical, our financial services client vertical represented 77% of Q3 revenue and grew 15% year-over-year to $99.5 million. During the quarter, the most significant impact from the coronavirus was seen in our credit cards and personal loans businesses, where client marketing spend was down due to concerns about deteriorating economic activity and consumer credit quality. Auto insurance, our largest business, performed best in the face of the pandemic, with revenue increasing 30% year-over-year, reflecting strong spending from a broad range of large carrier clients. The client vertical we historically referred to as 'other,' which includes home services and B2B, represented 11% of Q3 revenue and declined 6% year-over-year to $13.8 million. As Doug discussed, we divested our B2B business in the middle of February. Moving forward, we will refer to our other client vertical as simply home services. Home services revenue for the third quarter grew 8% year-over-year to $11.5 million. Year-over-year revenue growth in home services slowed due to coronavirus as consumers limited their exposure to outsiders in their homes. Our education client vertical represented 12% of Q3 revenue and grew 4% year-over-year to $15.4 million. Moving on to adjusted EBITDA, adjusted EBITDA was $9.3 million or 7% of revenue. Profitability in the quarter was negatively impacted by the loss of top-line leverage and media buying efficiency primarily due to pandemic-related client budget cuts and media drops in the quarter. Turning to the balance sheet, we had a good quarter overall, growing our cash balance by $21 million, including $11.1 million of proceeds from the sale of our B2B business and Brazil operations. We closed the quarter with $97.1 million and no bank debt. Cash flow from operations was $15.2 million, and normalized free cash flow was $7.4 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. Looking ahead to our fiscal Q4, forecasting with any level of certainty during this pandemic is challenging to say the least. Our current estimate is for Q4 revenue, excluding divested businesses, to be down between 5% and 10% year-over-year. Adjusted EBITDA and cash flow margins are expected to be positive in the lower single digits as we absorb full quarter effects of coronavirus-related drops in top-line leverage and media efficiency. For your modeling purposes, Q4 2019 revenue, excluding divested businesses, was $116.1 million. In summary, despite the impact of coronavirus during the quarter, we are pleased with our financial performance and remain optimistic about the underlying strength of our business over the long term. QuinStreet has a highly resilient business model, and we've proven our ability to perform well over the past 20 years during economic downturns. There are three key points that can help investors better understand our business model. First, we have a highly variablized financial model, which has allowed us to be adjusted EBITDA and cash flow positive during difficult times. The largest cost on our P&L is media, which fluctuates with revenue. So when revenue goes down, our largest cost also declines. Second, during difficult economic times, consumers tend to shop to lower their monthly expenses. QuinStreet's performance marketplaces embedded across the world's largest shopping channel, the Internet, help consumers save money. And finally, we have a great balance sheet with nearly $100 million of cash, low bank debt, and expect to continue to generate positive cash flows from our business moving forward. With that, I'll turn the call over to the operator for questions.

Operator, Operator

Thank you, sir. We'll take our first question from Carter Trent with Stephens. Please go ahead.

Carter Trent, Analyst

Hey, guys. Thanks for taking my question. Just wondering, what kind of feedback have you been getting from the carriers who are already using the QRP platform? And also, what do you attribute to the recent pipeline growth?

Doug Valenti, CEO

Thanks, Carter. I'll take the first question. The feedback has been very positive, in fact, unanimously positive about the performance of the platform and about how it's helping their operations. We just had a client – I was sent a text from a client just a few days ago, the most recently launched client, that said, 'We don't need any more testing. We're rolling this out across the floor. This thing is as good as it can be.' So we're super pleased with the performance of the platform. The feedback again has been unanimously positive and in some cases, like I just covered, growing as well, so very good progress on QRP. In terms of what I think you said about the growth of the platform, you mean the QRP platform?

Carter Trent, Analyst

Yes, the pipeline. Yes.

Doug Valenti, CEO

Yes. We have an extraordinarily strong pipeline that has been built by industry veterans with great connections. The feedback from the pilot clients and pilot efforts that we did a year or two ago has been very positive, and folks knew about that. Some of our carrier partners are actively working the pipeline for us. This is something I think we've talked about in individual sessions. I'm not sure I've ever talked about it on the calls, but this is not just a QuinStreet initiative. The largest carriers in the independent agent channel are very aggressively backing this platform. In many cases, the majority of our launched and advanced pipeline clients, at least the ones at the signing stage, were referrals from large agency partners. I think that the combination of having a great product with proven performance, positive feedback from initial pilot clients, and carriers pushing it alongside us with a well-connected team in the industry are all working in our favor, and there are very strong winds at our back. This platform reportedly delivers upwards of a 40% improvement in productivity for the agents, which is staggering in terms of the benefits it provides. It's a unified platform, allowing users to enter the data once and get multiple competing quotes. Because we have the most integrations end-to-end with the big carriers, these quotes are much more accurate than previous quotes. You don’t get a lot of requoting, misquoting, or need to enter the data multiple times. You want to get two, three, or four quotes from different carriers, and it’s a benefit on top of benefit. This is a fundamental improvement in the channel. For our carrier partners, they not only gain more productivity out of the channel, which is important for them, but they also gain much better workflow management, control, reduced costs, better quality, and vastly improved reporting from every angle. It's just a great product at the right time in a good channel, and everyone benefits. I would say that's the QRP report.

Carter Trent, Analyst

Got you. That's helpful. Thanks, Doug.

Operator, Operator

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

Jason Kreyer, Analyst

Good afternoon, gentlemen. Apologies if I ask a question that's already been addressed. I was waiting to get into the queue for a bit here. But just wondering if you can walk through the last several weeks' financial performance on a channel basis. I think you called out that auto insurance has remained pretty strong through this market, so I'm curious about what components of the business are seeing the most impact from the economic slowdown or COVID.

Doug Valenti, CEO

You bet. Let's start with auto insurance. Auto insurance remains strong throughout the quarter and actually gained steam. And March was, I think, Greg, the strongest month of the quarter. Correct me if I misspoke.

Greg Wong, CFO

That's right. We accelerated throughout the quarter in our auto insurance business, which resulted in March being a record month in the history of the company for auto insurance.

Doug Valenti, CEO

Auto insurance remains strong, a combination of several factors. First of all, all the carriers are doing pretty well because of reduced driving and incident rates, enabling them to allocate more funds to marketing and share gains. They expect this to be a period of heavy shopping, both because consumers are at home more and because a lot of consumers are going to be financially challenged. Consumers tend to shop the line items, including insurance, seeking savings when financially strained. Reports from our carrier partners indicate that when we ran our own shopping service, insurance.com, we observed that switching insurance providers saved consumers an average of around $400 a year. So insurance, as our largest business, is doing well and is now over 50% of our revenue, I think. The businesses that have fared the worst during the pandemic were credit cards and personal loans, both of which were down considerably in the quarter and began deteriorating in late January, continuing down in March. They seem to have plateaued or hit equilibrium near the end of March and certainly in April. This deterioration is due to banks and lenders struggling to keep up with the rapid changes in the macroeconomic environment and consumer credit. With a few weeks having unemployment rates spiking from about 3% to nearly 20%, there has been a natural pulling back and raising of standards. These businesses were impacted most severely. They have been – knock on wood – stabilizing in late March and April, suggesting a more sustainable bottom; however, we have not seen much easing back yet. Our home services businesses are more diverse. We have about 10 to 12 services or verticals, and services requiring in-home visits have faced challenges comparable to the declines seen in credit cards and personal loans. The factors driving this are primarily social isolation and shelter-in-place orders. On the other hand, services related to the exterior of homes, home security, or health-related products are performing well. Overall, in home services, business is down less than the declines seen in personal loans and credit cards as we could shift efforts more quickly to areas with tailwinds. Our banking business, which is growing rapidly, has performed well, with good activity in marketing for sources of funds and investment management. We’re shifting many of our banking efforts over while we wait out some concerns with credit cards. So that provides a picture of the business mix.

Jason Kreyer, Analyst

I appreciate all the color you gave there. I wanted to focus on one of those components you talked about in personal loans. I know when you made the AmOne acquisition a year or so ago, one of the components was the turndown service – credit repair and credit monitoring service. Has that held in there a little bit, helping to offset some of the challenges in there? Or has that not really seen a meaningful bounce either?

Doug Valenti, CEO

It has. It experienced an initial drop and shutdown because once people go through these credit repair and/or debt forgiveness processes, they still have some obligations. There was fear that trapping consumers into new obligations in such a rapidly changing environment was risky, leading to a dramatic drop in activity and client demand. However, we've noticed a much quicker recovery compared to the lending side. We anticipate this to be a growth area, unfortunately, as more consumers will need those services given continued economic challenges.

Jason Kreyer, Analyst

Okay. Great. And then two quick ones on QRP. First, with everyone working from home, are there any delays in the rollout for particular carriers or agents? And second, could you address the opportunity for captive agents in relation to QRP?

Doug Valenti, CEO

I'd say that if you ask the team working the pipeline for QRP, they would say there are not any meaningful effects. They refuse to use this as an excuse. Realistically, some agency launch timelines have shifted due to remote work and the resulting challenges for engineering staff at those agencies. However, I would emphasize those delays, while measurable, do not alter our outlook for growth in that business. We remain very bullish and are excited about the robust growth we expect over the next year or two. Some delays exist, but progress has been substantial, and we have a healthy pipeline. We’re excited about the clients we have launched and the ramp we expect. Each quarter, we'll provide updates on what we know. We now have some revenue from those clients; it's just not significant yet since they are still in testing and training phases. But one client recently said, 'We don't need any more training. We're rolling this out broadly.' That opens the door for more clients soon, and we're eager to share more concrete revenue as it becomes meaningful. Regarding captive agents, there is a smaller but still non-zero opportunity for QRP as they mainly represent one carrier's product. We are having productive discussions with many carriers about using QRP. Their agents could expand their product lines using QRP, even though it's not guaranteed. The discussions with carriers span the full range of captive, independent, and direct models.

Jason Kreyer, Analyst

All right. Thanks for the color. Appreciate it.

Operator, Operator

We'll take our next question from Jim Goss with Barrington Research.

Jim Goss, Analyst

Thanks. I have a couple as well. One, you've talked about having SaaS-type margin levels for QRP. Could you flesh out a little about what type of margin profile you expect either earlier or at maturity?

Doug Valenti, CEO

Sure. While QRP is highly complementary to our core business and originated from it, the key difference is that it has no media costs. Historically, media has represented approximately 70% of our revenue. We expect gross margins on QRP to exceed 90%. With a small engineering team and select sales and account management personnel, we expect a contribution margin after direct expenses to be in the range of 70% to 80%. This is achievable when we hit mid-single-digit millions of dollars in revenue.

Jim Goss, Analyst

Okay. And there was a comment you made about a $400 million plus revenue base. Is that the current revenue base adjusted for just the areas you've divested, Brazil and B2B? Or is it after you've adjusted out perhaps some other areas, whether it's credit card and personal loans, if you thought that was more than temporary, or other areas you might choose to divest?

Doug Valenti, CEO

Yes. The revenue numbers I mentioned exclude only the B2B and Brazil components. We are not yet done evaluating divestiture opportunities in other areas of our business. We are aggressively assessing whether certain businesses will effectively compete in our core focus and if they can grow predictably. We've noted that both Brazil and our B2B sector did not meet our criteria in that regard, so we divested those operations. Meanwhile, we will continue evaluating other areas and determining if they can compete, necessitating potential cuts to investments if necessary.

Jim Goss, Analyst

Just one last question. Have you – and I know you said the Goldman Sachs-led process is on hold due to the coronavirus issue. Do you have a time frame you would like to target to determine your core businesses? Is that another year or two, or is it more of a rolling process?

Doug Valenti, CEO

We aim to wrap this up much sooner than a year or two. Ideally, we would like to make decisions and execute options by the beginning of the next fiscal year. Whether we can meet that timeline remains to be seen, but I intend to know exactly what we will pursue for each business by the start of the next fiscal year, which is just two months away.

Operator, Operator

We'll take our next question from Adam Klauber with William Blair. Please go ahead.

Adam Klauber, Analyst

Thanks. Good afternoon. How has the credit repair business done since COVID set in, and is that something you expect to see growth in during a tougher economy?

Doug Valenti, CEO

Initially, it did not perform well. But we have seen it rebound much quicker than the lending side. We agree that the demand for credit repair services will likely increase as consumers face continued economic challenges.

Adam Klauber, Analyst

Great. And then as far as your fourth-quarter forecast, insurance again was very strong, with a record March. Did you conservatively state that this business may not grow as much in your forecast for the fourth quarter?

Doug Valenti, CEO

Our current forecast indicates that the insurance business is expected to grow at a rate similar to what we saw in the third quarter.

Adam Klauber, Analyst

Okay. And then, as for the education business, sorry if you mentioned this earlier, but how are the traditional non-profit schools doing? Are they still spending money?

Doug Valenti, CEO

They are still engaging, particularly with online programs. However, we observed a drastic drop in budgets for campus-based marketing because there’s uncertainty about whether they'll have students on campus in the fall. Before the pandemic, campus-associated spending was a significant portion of our education business; my rough estimate would be around 30%. Many of our education efforts pivoted quickly to online programs, including non-profit institutions. Our education team managed to achieve modest growth during the quarter, demonstrating resilience amidst the crisis.

Adam Klauber, Analyst

Thanks. One last question on QRP. Are you expecting revenue to materialize next quarter, or is that still a few quarters out?

Doug Valenti, CEO

We do have revenue now, but it's minimal. I would say we will likely not reach significant numbers until next fiscal year, just two months away. I can't foresee generating substantial revenue from the agency clients during testing and training phases. However, given the strength of our pipeline and current launches, we could see revenue ramping up meaningfully in the year ahead.

Operator, Operator

At this time, this will conclude today's question-and-answer session. A replay of today's call will be available starting today, May 6, 2020, at 7:00 PM Central Time Zone and ending on May 13, 2020, at 7:00 PM Central Time Zone by dialing (719) 457-0820 or toll-free at (888) 203-1112 with the passcode 7941495. Thank you. This concludes today's conference. We appreciate everyone's participation. You may now disconnect.