Earnings Call Transcript - QNST Q2 2023

Operator, Operator

Thank you, everyone, for joining us as we report QuinStreet's second quarter fiscal 2023 financial results. Joining me on the call today are CEO, Doug Valenti; and CFO, Greg Wong. Before I 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 forward-looking statements are discussed in our recent SEC filings, including our most recent 8-K filing made today and our upcoming 10-Q. 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, sir.

Doug Valenti, CEO

Thank you, Laine. Welcome, everyone. Well, first the headline. The anticipated sharp reramp of Auto Insurance client marketing spending has begun. And it looks like it's up into the right from here. Our Auto Insurance revenue is expected to jump by over 60% this quarter, the March quarter, versus the December quarter. So we are seeing the significant positive inflection we anticipated. Excitingly though, even with the January search and its immediate positive impact on our results, we are so early in the full recovery and reramp of Auto Insurance. We expect much more to come. We've been predicting this significant positive inflection in Auto Insurance, our biggest client vertical, for some time and we have been preparing for it. We believe that we are at the beginning of a ramp that over coming quarters will lead back to Auto Insurance client spending levels seen prior to the inflation challenges of the past couple of years and then, to further strong growth from there, as the share of marketing budgets and consumer shopping, represented by digital media, continues its relentless march up into the right. The return of Auto Insurance marketing spending is due mainly to carrier progress adjusting their products and increasing their rates to offset higher costs and to the resetting of carrier combined ratio targets as of January 1. Consumer shopping, traffic, online fraud insurance is also up as expected, spurred largely by the rate increases. QuinStreet revenue and margins are increasing rapidly, as growth in insurance, combined with already strong momentum in our other two nine-figure annual revenue client verticals, those of course being Home Services and credit-driven Financial Services. As a result, we expect record total company revenue in the current March quarter and a significant jump in adjusted EBITDA. We expect record revenue again and a further jump in adjusted EBITDA in the June quarter. Looking back at the December quarter, which was our fiscal Q2, results were good, especially given conditions in Auto Insurance and the shifting macroeconomic environment in the quarter. Our business model, once again, demonstrated its resilience. And we, once again, demonstrated our ability to successfully and profitably navigate even the most complicated environment. We grew revenue year-over-year in Q2 and generated positive EBITDA in what is our softest seasonal quarter and despite facing both the bottom of the Auto Insurance market and the shifting macroeconomic environment. December quarter results also included continued investment spending on exciting long-term growth initiatives and capabilities as promised. And as our positive results demonstrate, we are making those investments with the efficiency and margin and cost discipline you have come to expect from QuinStreet. Our commitment to continue our disciplined investment in long-term initiatives through the transitory challenges in the insurance market is paying off. Revenue and margins are rebounding quickly. We expect them to continue to ramp in coming quarters and that our long-term prospects have never been better. I want to make some brief comments about the macroeconomic environment, which we continue to assess and that we believe is reflected in our outlook. Most importantly, we expect the reramp of Auto Insurance client spending to be the dominant driver of our performance trends in FY Q3 or the March quarter and likely in quarters to come as carrier spending continues to reramp. Related and in addition, consumer shopping for auto insurance typically increases during periods of economic uncertainty. We would expect that to be another net positive for our insurance results, especially given rate increases. As for our non-insurance client verticals, the majority of our business there is leveraged to homeowners and to prime and near-prime consumers. As you have heard from the banks and credit card companies, the balance sheets, credit and spending levels of those consumers continue to be in good shape. Turning to our outlook. We expect total revenue in fiscal Q3 to be between $160 million and $170 million, a company record. We expect adjusted EBITDA in fiscal Q3 to be between $7 million and $8 million, reflecting the immediate, significant, but still early impact of top line leverage on reramping insurance revenue. For full fiscal year 2023 ending in June, we expect revenue to be between $610 million and $630 million. And we expect full fiscal year adjusted EBITDA to be between $25 million and $30 million. Our financial position remains excellent with a strong balance sheet with almost $80 million of cash and no bank debt. And we are entering a period that we believe will be represented by ramping revenues, expanding margins, and strong cash flows. 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. The December quarter demonstrated the strength and resilience of our business model and client vertical footprint. We delivered solid year-over-year revenue growth of 7% to $134 million despite challenges in Auto Insurance as well as a shifting macroeconomic environment. Our non-insurance client verticals represented 64% of total Q2 revenue and grew 31% year-over-year. Looking at revenue by client vertical. Our Financial Services client vertical represented 67% of Q2 revenue and was $89.3 million approximately flat year-over-year. This was a result of the continued strength in our credit-driven and banking client verticals, which largely offset expected challenges in the insurance for the quarter. Within insurance, carriers continued to limit their marketing spend in the December quarter to manage calendar year 2022 combined ratio targets. That said, as anticipated, we have now seen the significant positive inflection in revenue beginning in January. This carrier combined ratios reset, carriers begin to benefit from rate increases and consumer shopping intensifies in response to higher rates. Most importantly, we expect insurance revenue to continue the ramp up into the right over the coming quarters, as we believe we're in the early stages of the full recovery of that market. Our credit client verticals of personal loans and credit cards as well as our banking business delivered excellent results in Q2 growing a combined 35% year-over-year. Revenue in our Home Services client vertical grew 27% year-over-year to $43 million or 32% of total revenue. As we've discussed in the past, Home Services may be our largest addressable market and our strategy to drive long-term growth here is simple. One, grow from existing service offerings, like window replacements, solar system sales and installation, and bathroom remodeling none of which we believe are anywhere close to their full potential. And two, expand into new service offerings, where we see the opportunity to at least triple the number of these sub-verticals we currently serve. This multi-pronged growth strategy is expected to drive double-digit organic growth for the foreseeable future. Other revenue was the remaining $1.8 million of Q2 revenue. Adjusted EBITDA for fiscal Q2 was $1 million. Turning to the balance sheet, we closed the quarter with $79.1 million of cash and equivalents and no bank debt. In closing, we are excited about our business and financial model as we head into the back half of our fiscal year. The significant positive inflection we are seeing in insurance combined with the continued strength of non-insurance client verticals is expected to drive strong total company revenue growth and rapid expansion of both adjusted EBITDA and cash flow in the March quarter. We also expect revenue growth, adjusted EBITDA, and cash flow to strengthen again in the June quarter. With that, I'll turn the call over to the operator for Q&A.

Jason Kreyer, Analyst

Thank you, gentlemen. Just wondering if you can help us bridge the profitability gap because I certainly appreciate the record revenue that you're forecasting over the next couple of quarters. But if we go back a couple of years like the back half of 2021 the last time you were kind of at revenues at these levels we were seeing EBITDA margins in kind of the double-digit range. So I'm just wondering, what's different about it this time? Or do you expect that to maybe occur a couple of quarters out from now?

Doug Valenti, CEO

Thank you for the question, Jason. In short, we expect improvements to come shortly. Longer term, we're investing in growth initiatives across the company, including insurance, because we see significant growth opportunities with strong variable margins. We have the capacity to invest and are seeing good results, but we have not fully realized the potential in insurance yet. Currently, we're earning about $20 million a quarter in insurance, which is still below the peak we reached before the downturn. Additionally, we're not maximizing our media margins because not all carriers are fully operational, leading to lower efficiency and yields. However, we anticipate moving from breakeven in December to a 5% adjusted EBITDA margin in March, showing fast progress. We're confident that we'll continue to improve our top-line performance and media efficiency, expecting further expansion of adjusted EBITDA margins into the June quarter and beyond. Our spending on growth is being managed effectively, as evidenced by a 31% increase in non-insurance work year-over-year in December. As insurers return, we are well-positioned to capitalize on our growth across all sectors, including insurance, as it rebounds. We are not seeing a decline in variable margins in non-insurance, which remain attractive. While the top line and media efficiency in insurance are not yet fully restored, we continuously see positive indicators as more carriers return. We've invested significantly in growth initiatives and still achieved $1 million in EBITDA in December. We're focusing on long-term opportunities while maintaining our capacity for growth and margins. Although we’d prefer to see insurance recover more quickly, we believe it is returning sustainably, and feedback from carriers supports this outlook. Overall, we are pleased with our current position and the developments align with our expectations.

Jason Kreyer, Analyst

Thank you for that. I have a three-part question about Auto Insurance. First, could you provide more clarity on what you've observed so far in early 2023, especially since January was a tougher comparison and February seems to be easing up? Second, can you share any details about how traffic is increasing, including any specific numbers? Lastly, as you implement these rate increases, are you seeing higher profits from the opportunities you're providing to the carriers?

Doug Valenti, CEO

The trends in early 2023 align with our expectations: we are experiencing a quick recovery from some of the larger client carriers that have progressed in their rate and product adjustments. This is reflected in the 60% increase in Auto Insurance from the December quarter to the March quarter. We are also seeing other carriers returning to the market significantly. Communication with carriers reveals that they are at various stages of re-entering, with some actively participating and others planning to return soon. However, we haven’t heard anyone indicate that they will not be significant players in 2023. At present, we are still $20 million short of the pre-downturn peak in Auto Insurance revenue per quarter, indicating potential for more top-line growth. As more carriers return, we will have increased opportunities to connect consumers, resulting in improved media efficiency, wider margins, and better overall profitability. The current growth is notable, with a 60% quarter-over-quarter increase. We anticipate additional growth as industry indicators suggest a favorable environment regarding rates and inflation, especially related to used car prices and supply chains. Additionally, recent reports indicate a surge in consumer shopping behavior, the highest levels since tracking began. This makes sense, given the significant rate increases consumers have faced over the past year. Even if the economy is stable, consumers will likely seek ways to save money. Many of those shopping will find our QuinStreet insurance marketplaces. This positive consumer engagement is expected to drive revenue and insurance growth for us. While the rate increases don’t directly correlate with our pricing, they do provide clients with additional resources for marketing and enhanced lifetime value. This creates a strong indirect connection between rate increases and carrier spending. Carriers that have adjusted their rates accordingly are seeing solid demand and favorable pricing across the board, which supports a healthy economic model. This allows them to invest in attracting consumers and underwriting as they would in a typical positive market cycle.

Jason Kreyer, Analyst

That's perfect. Thank you, Doug, I appreciate it.

John Campbell, Analyst

Hey, guys. Good afternoon and Happy New Year.

Doug Valenti, CEO

Hey, John.

John Campbell, Analyst

Hey. Doug back to the guidance, I mean, really good revenue outlook. Obviously, the midpoint on the EBITDA it looks like 90 bps of kind of compression year-over-year. And you just touched on this, but I want to make sure, I get a good grip on it. So it sounds like it's not a mix shift issue. It's basically you guys staffed up a good bit to basically handle a higher level of insurance than what you're seeing today and maybe what you're expecting to see in the quarter or two ahead. But as the top line continues to kind of lift from here we should – I guess, are we expected to see better-than-average incremental margins maybe as you move into the next fiscal year? Is that the way to think about it?

Doug Valenti, CEO

We currently have strong incremental margins across the board, except for insurance, where the margins are improving but not where we anticipate they will be as we generate more revenue from that sector and achieve greater media efficiency with the involvement of more carriers. We've maintained our investment in long-term growth and major initiatives despite the insurance downturn, which we recognized as temporary, in order to be prepared for the recovery. We've continued to perform well, even during a challenging quarter, managing to achieve $1 million in adjusted EBITDA. We understand how to generate profit, and despite our aggressive spending on significant opportunities, we've still managed to be profitable. We expect to continue increasing our profitability in the upcoming quarters as we see a rebound in insurance.

John Campbell, Analyst

Okay. Makes a lot of sense. And then also on the consumer credit-driven verticals, there's a lot of fear out there around kind of deteriorating consumer balance sheets. That's not necessarily bad, for some of those businesses I guess, maybe personal loans, if you can go a little bit deeper down the spectrum. But I'm looking for a little bit of commentary or just some color around, how that progressed in the quarter, maybe start of the quarter and maybe even up until January, kind of what you guys are seeing in that channel, what the consumer appetite looks like versus the sources of credit.

Doug Valenti, CEO

Sure. Let's begin with credit cards, which is a significant area for us and is performing well. We are experiencing robust consumer demand, especially for travel-related cards, which is where we have the most leverage. This segment makes up the largest portion of our offerings. Particularly in travel-related cards aimed at prime and near-prime consumers, who represent the majority of our customer base in the credit card business, we are seeing strong momentum. Regarding issuers and their credit standards, we have not observed any major changes. There is strong demand, enthusiasm, and successful limited-time offers. Any modifications we've noted have been minimal and likely represent less than a 5% impact on their marketing efforts. Therefore, it's full speed ahead with the major banks and credit card issuers, and we monitor the situation closely. They are also paying close attention, but their balance sheets are in excellent condition. Consumers have not yet returned to pre-pandemic credit card balances or delinquency rates, indicating that consumers are in a strong position. In contrast, we are observing some deterioration in credit related to personal loans. This is fully integrated into our outlook and balanced out by other aspects of the same business. We are seeing a bit more tightening in personal loans compared to credit cards, as lower-income consumers are understandably under more pressure from inflation than prime and near-prime consumers. We have witnessed some effects in this area, although not significant. This is partially offset by the fact that in our personal loans business, we also cater to credit repair, counseling, and debt settlement clients. There are two key drivers for our personal loans business regarding credit. One is that as consumers seek to increase their credit card balances, we are noticing an uptick in demand for credit card debt consolidation through personal loans, which is starting to occur. The other is that more consumers, particularly at lower income levels, face challenges with credit and often require assistance through services like credit repair and debt settlement, which we offer with our substantial client base. Overall, the credit aspect of our business is in very good shape.

John Campbell, Analyst

Okay, very helpful. Thank you, Doug.

Doug Valenti, CEO

Thanks, John.

Max Michaelis, Analyst

Hi, guys. Thanks for taking my question. I just want to touch on the guide for next quarter. So you had a nice quarter out of Home Services. I think they grew 27%, maybe not growing that fast next quarter but let's think mid-teens low 20%. Do you think Q3 grows at similar rates? Just trying to get a gauge on how much growth we could see out of the Auto Insurance and Fin Services segment? Thanks.

Doug Valenti, CEO

Thanks, Matt. Greg, I'm not certain, but I think the year-over-year growth indicated in the guidance is what Greg mentioned for the March quarter?

Greg Wong, CFO

Yes, at the midpoint in the March quarter it's 10% year-over-year growth. And so...

Max Michaelis, Analyst

Yes. But, I guess, I'm trying to gauge whether or not we should see similar type growth out of the Home Services segment because I'm trying to gauge how much Financial Services would grow year-over-year. I guess, that's what I'm trying to ask.

Greg Wong, CFO

We don't provide specific guidance by verticals. The numbers I mentioned are not projections; however, I do expect Home Services to maintain double-digit organic growth rates, which can fluctuate between 15 and 27 percent depending on the quarter. I anticipate that this business will continue to perform well and deliver double-digit growth.

Doug Valenti, CEO

It's going to be in the same range as it has been in the 20-ish percent range is not a bad assumption. You might be off plus or minus a couple of points, but that business is pretty solid 20% year-over-year growth quarter-to-quarter and has been for a while and we expect will be into the future. We had a particularly strong quarter last quarter of course and we'll have those as well. But it's not a bad range to consider it being in that that's all.

Max Michaelis, Analyst

Okay. Thanks. And then the last one for me. Were you guys active in the buyback this quarter?

Greg Wong, CFO

We were not this past quarter.

Max Michaelis, Analyst

Okay. Thanks, guys.

Greg Wong, CFO

Thanks, Max.

Jim Goss, Analyst

Hi. Thank you. All right a couple of questions. The first one – one of the trends recently has been auto sales have been at low levels for both new and used cars over the past couple of years and the mix has varied. And I'm wondering if that mix element does have any impact on the demand for your insurance, sort of, the pricing of the policies. I imagine it would but wondering what you actually thought.

Doug Valenti, CEO

Demand does not significantly influence the market in a substantial way. We haven't received feedback from carriers, nor have we observed changes in budget allocations that suggest otherwise. As you know, most insurance is primarily purchased for existing ownership. While there are some policies sold for new ownership, the majority are for existing. The softening observed in those markets is incremental. Therefore, it doesn't constitute a significant portion of the overall annual mix. Although it is relevant, it is relatively minor regarding what's occurring with new ownership, whether that be brand new or used. As a result, the impact is not significant, and we have not seen or heard anything different from our carrier partners.

Jim Goss, Analyst

Okay. Doug, I was wondering if the recent soft period has provided you an opportunity to capture a larger share of budgets from some of the key carriers. I know that Progressive has always been significant, but have you been able to increase your share with some of the others? Has this been part of your experience?

Doug Valenti, CEO

It's part of why we've been spending so aggressively. We wanted to position ourselves to gain as much as possible when the market comes back.

Jim Goss, Analyst

Okay.

Doug Valenti, CEO

We believe we have gained share from the clients in both the media side and the budget side.

Jim Goss, Analyst

Okay. And one last one. I was wondering about the comment that was made earlier about tripling potentially the subverticals served in the consumer products area and consumer services. And I'm wondering how you would pace such growth in terms of the cost positioning that would be required to enter new markets relative to embedding yourself further in existing markets?

Doug Valenti, CEO

Yes. It's in the Home Services categories that Greg mentioned, such as kitchen remodeling. We currently operate in about a dozen areas and believe we can expand that significantly, potentially tripling our presence. The rate of this expansion depends on how quickly we can do it while maintaining a reasonable contribution margin. We invest heavily in Home Services due to the vast opportunities available. Our growth is more constrained by our operational capacity than by our financial resources. We haven't experienced any setbacks, and Home Services remains one of our top-performing business segments. By contribution, I mean that we have various layers of margin. The first layer pertains to media efficiency, followed by accounting for personnel costs. After deducting media and personnel costs, we reach the contribution margin. We're advancing Home Services as quickly as our execution allows, and it's still a leading contributor in both percentage and dollar terms. Thus, our financial capabilities are not a limitation in Home Services.

Jim Goss, Analyst

All right. Thanks very much. Appreciate it.

Doug Valenti, CEO

Thank you, Jim.

Chris Sakai, Analyst

Hi, Doug and Greg.

Doug Valenti, CEO

Hey, Chris.

Chris Sakai, Analyst

Sounds like a great quarter. Just wanted to ask about insurance, I know you've talked about Q3 and Q4. Just wanted to get your feeling and color on how it would continue into Q1 of next year?

Doug Valenti, CEO

Yes, it's a good question. We expect it to continue to ramp up. We believe we are in a multi-quarter ramp as these carriers recover economically with the rate increases. As they align their products and states with those rate increases to shape their portfolios, they have a lot of ground to regain after having to significantly reduce their marketing and expansion efforts in recent years due to challenges with combined ratios. Every indication points to a continued ramp. A few quarters ago, I mentioned that we might be entering a super cycle. We are likely looking at a strong, multi-year cycle in insurance because the rate increases have been healthy and well-considered. Carriers will continue to optimize their economics and reflect that in their market activities. We anticipate a favorable long-term upward trend in insurance, driven by rates that now better reflect the new cost environment on both the catastrophe and repair sides.

Chris Sakai, Analyst

Okay. Thanks, and then, can you help me understand more about the increase in product development expense? Is this going to occur basically as long as insurance continues to ramp? Can you help me understand that?

Doug Valenti, CEO

I think we won't keep increasing it. I think we're kind of at the level we're going to be at for a while. And then what's going to happen is, it won't grow like it's been growing or like it grew this past couple of years, but revenue will. And so that's how you get the margin expansion, right? You get more revenue driving more incremental variable margin on top of a semi-fixed, relatively fixed product development and other cost base, which is why you're going to see that margin continue to expand and why you're seeing the jump like it did like we expected to in the March quarter from, again, breakeven to 5% already in adjusted EBITDA in the March quarter and more than that in the June quarter. As you run your numbers, you'll see our assumptions there that they're going to expand another point or two in June.

Chris Sakai, Analyst

Okay. Okay. Thanks for the answers.

Doug Valenti, CEO

You’re welcome, Chris.

Operator, Operator

Thank you. And there are no further questions at this time today. Thank you everyone for taking the time to join QuinStreet's earnings call. For a replay of this call, please dial 844-512-2921 domestic or 412-317-6671 international and use the passcode 13735822. Once again that passcode is 13735822. This replay information is also available on the earnings press release issued this afternoon. This concludes today's call. Thank you.