SelectQuote, Inc. (NYSE:SLQT) Q3 2024 Earnings Call Transcript

SelectQuote, Inc. (NYSE:SLQT) Q3 2024 Earnings Call Transcript May 9, 2024

SelectQuote, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, all, and welcome to SelectQuote’s Fiscal Third Quarter Earnings Conference Call. [Operator instructions]. It’s now my pleasure to introduce Matt Gunter, SelectQuote Investor Relations. Mr. Gunter, you may begin your conference.

Matt Gunter: Thank you, and good morning, everyone, and welcome to SelectQuote’s Fiscal Third Quarter Earnings Call. Before we begin our call, I would like to mention that on our website, we have provided a slide presentation to help guide our discussion. After today’s call, a replay will also be available on our website. Joining me from the company, I have our Chief Executive Officer, Tim Danker; and Chief Financial Officer, Ryan Clement. Following Tim and Ryan’s comments today, we will have a question-and-answer session. As referenced on Slide 2, during this call, we will be discussing some non-GAAP financial measures. The most directly comparable GAAP financial measures and a reconciliation of the differences between the GAAP and non-GAAP financial measures are available in our earnings release and investor presentation on our website.

And finally, a reminder that certain statements made today may be forward-looking statements. These statements are made based upon management’s current expectations and beliefs concerning future events impacting the company and therefore, involve a number of uncertainties and risks, including, but not limited to, those described in our earnings release, Form 10-Q for the period ended March 31, 2024, and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in our forward-looking statements. And with that, I’d like to turn the call over to our Chief Executive Officer, Tim Danker. Tim?

Tim Danker: Good morning, and thanks to everyone for joining. It was an exciting quarter for SelectQuote across a number of fronts, and I’ll begin today’s call summarising our accomplishments across three main categories. First, our Senior Medicare Advantage business continues to leverage the foundational changes we made more than two years ago. The business continues to drive strong policy production with stable and attractive unit economics. The quarter marks the ninth in a row that it’s over delivered against our internal expectations. Specifically, we generated $204 million in revenue within our senior business at a 30% EBITDA margin. The result is one of our highest senior revenue for an OEP and SelectQuote’s history, which is a great accomplishment considering the conservatism built into our LTV assumptions over the past two years, delivering this top-line performance at attractive margins despite modest year-over-year increases in operating and marketing expense is a testament to our focus on operating efficiency.

Additionally, our success in health care services continued in the third quarter with better-than-expected membership growth yet again. Our membership now exceeds 75,000, which is well beyond our forecast set at the beginning of the year. We are extremely pleased with the growth achieved in the segment but are even more excited by the embedded profit potential and immediate cash flow benefit the business provides our overall company. Third, as we’ve spoken about, we continue to advance down the path of improving our funding cost and overall leverage through the securitization of our receivables balance, which at quarter end stood at over $1 billion. I’ll provide a general overview of how a securitization structure would help improve returns and cash efficiency for SelectQuote in a minute, but we’re excited about the progress we’ve made since our last call and look forward to sharing more information about the potential transaction when we can.

In sum, SelectQuote has never been better positioned to continue executing on our goal of becoming a comprehensive health care services provider to a large and growing range of Americans. We’re excited to see our operational improvements bear increasingly tangible results. Given we expect to drive positive operating cash flow in fiscal 2024, which will compound in the years ahead, we believe 2024 will be remembered as an evolutionary milestone to ultimately deliver the returns we know our model can generate for shareholders. If we turn to Slide 4, let me give an update on the operating stability we continue to see in our Singer Medicare Advantage business for the second straight year and a different type of MA selling season, locked has maintained the cost and operating efficiency improvements at the core of our strategic redesign.

Our operating expense per policy remains nearly 30% below the levels from our 2021 vintage driven primarily by the shift away from Flex agents. Our core senior agents, as you will remember, are approximately 2 times more efficient compared to less tenured agents. We’ve maintained a strategy not just to overweight this population of agents but to train them earlier and arm them with increasingly advanced tools. This clearly benefits CECO’s operating efficiency but better yet, the alignment with policyholders is where everyone wins, that is best evidenced by our stable persistency in LTV, happy policyholders to keep their policies, which is a win for them, SelectQuote and our carrier partners. Given our laser focus on high-quality growth, SelectQuote has also realized efficiency benefits in our marketing cost per approved policy.

On average, these costs are down more than 30% in each of the past two years compared to 2021. Again, we believe this strong performance is sustainable and scalable and a range of MA selling seasons, not because we have a crystal ball and policy features or competition, but instead, because we are purposely targeting in the leads we pursue. This helps manage our marketing costs and improves the overall quality and throughput of the policies we sell. Lastly, as we’ve noted in recent quarters, the process improvements we made in our senior business, combined with the synergistic growth of our Select Rx business has made a meaningful difference in the revenue multiple we’re driving on our customer acquisition costs. For the third quarter, our revenue to CAC again eclipsed 4 times, which is now more than double where it was two years ago.

On the next page, let me spend a few minutes on the dynamics of a potential securitization deal and why it is an attractive funding option for our business. Securitization could help improve the selected balance sheet in three key ways: First, the proceeds would allow us to repay a considerable portion of our existing term loan. The second benefit would be the potential to extend maturities on our existing term loans beyond 2025. Given these two benefits, the aggregate debt load and maturity ladder for SelectQuote could be materially improved, and we believe there could be more opportunity to further improve our overall capitalization and cost of capital. That further improvement is the third step to improving our balance sheet, which would take place in the future through debt pay down and refinancing.

Beyond the balance sheet benefits, there are operational benefits from a potential securitization, specifically, securitization can accelerate cash flows for our Medicare Advantage business and drive better returns and cash efficiency, which are the heart of our overall value proposition to shareholders. On this slide, we’ve presented an illustration of how a potential securitization of new policy tranches could positively impact the cash flows of the single Medicare Advantage policy compared to our current model. As you can see, the key benefit would be the pull forward of our payback and the policy creation. In securitization, we would anticipate a marked acceleration compared to our historical payback of just over two years. The upfront cash flow from this potential funding structure could further improve our returns on new policies.

To be clear, a securitization structure would not impact LTVs or our cost to sell a policy, but instead simply delivers cash returns sooner. In addition, while a securitization would be structured at a loan-to-value below the sum of cash flows, SelectQuote would maintain the policy and the residual value once the bonds have been repaid. The final key benefits this cash efficiency would have for our model is a growing ability to self-fund our business with forward securitizations. To be very clear, the use of securitization funding would not change our strategic imperative to prioritise profitability and returns over growth. Just because securitization would provide additional liquidity to grow MA policies, our discipline in how we would approach the MA business would not change.

In parallel with debt reduction, we believe securitization funding could accelerate how SelectQuote leverages our holistic model to further differentiate and broaden our growth and profit opportunities with new value-added services for Americans within a shifting health care ecosystem. On the next page, I’ll briefly speak to our consolidated results for the third quarter. As mentioned, we’re very pleased with the stability in both policy growth and margin for our core senior business. Similarly, we again saw strong membership growth for our Select Rx business and health care services, which increased over 12,000 this past quarter alone. As we’ve discussed in recent quarters, the rapid growth of our membership comes at near-term dilution to our overall EBITDA margins, which you can see here on the year-over-year compare.

That said, it’s margin pressure we’ve been happy to incur based on the embedded economics that exist in our Select RX and broader health care services segment. To be clear, we remain confident that our Healthcare Services business has the ability to generate double-digit EBITDA margins, which on the base of revenues we are producing become significant as the model matures. Before I turn it to Ryan, I’ll conclude by reiterating my message that SelectQuote has never been better positioned with a strong operating foundation to pursue the large market and value creation opportunity that we know is ours to take. With that, let me turn the call over to Ryan to detail our financial results and updated outlook for 2024. Ryan?

Ryan Clement : Thanks, Tim. I’ll begin my remarks with additional details on the strong results for SelectQuote Senior Medicare Advantage business on Slide 7. As Tim mentioned, the key takeaway is the stability of our financial results this season compared to last. Stable and repeatable financial results were our primary aim when we redesigned our strategy two years ago, and results like these continue to validate our strategy. We drove a strong OED with $204 million of revenue in the third quarter, representing double-digit growth compared to last year. As Tim noted, we had another successful quarter for profitability with a 30% EBITDA margin. We credit the operating efficiency and the resulting profitability to the higher mix of tenured agents, enhanced desktop tools to ensure best policy fit and more focused approach to lead targeting.

Put simply, we believe SelectQuote’s approach in the market is fundamentally different and our nine consecutive quarters of strong results as evidence of that. If we flip to Slide 8, let’s reuse SelectQuote through the lens of policies and LTV. First, we grew approved Medicare Advantage policies by 12% during the quarter. This was made possible through a blend of strong close rates with our core agents as well as the focused lead sourcing we referenced before. This also outpaced overall industry growth, which is a testament to SelectQuote’s strong customer acquisition engine. As we spoke to last quarter, the Medicare Advantage policy features were competitive this season, and we grew policy count without sacrificing quality. This is all the more impressive when considering the strength of the market in 2023 and the comparisons we were up against.

In fact, our LTV increased to $995 per policy, which is up 3% from a year ago and is now up 7% from the low recognized in fiscal 2022. The increase in LTV has been made possible by stable policyholder behavior, which we largely credit to our core agent mix and the resulting improvement in quality policy matching with our customers. Turning to Slide 9. I’ll detail our Healthcare Services segment and Select Rx specifically. As Tim mentioned, growth remains robust, and our platform surpassed expectations again, both on member growth and revenue. Specifically, our members grew to $75,000, which is 20% higher than a quarter ago. Similarly, revenue of $124 million in the third quarter improved rapidly, driven both by new members, but also by the maturation of members we have added over the course of the year.

Third quarter revenue growth of 76% compared to a year ago is a significant increase and one that we are proud of. Beth said, we acknowledge a growing need to balance our growth with profitability in health care services. And I’d like to take a minute to give context both on our third quarter EBITDA results but also on our near-term strategy for this segment as a whole. As you can see, our Healthcare Services EBITDA of $2 million remains muted, primarily as a function of onboarding the over 12,000 members that signed up for Select Rx this past quarter. This was the largest quarterly number increase on record. The onboarding costs associated with these new members masked the stable and attractive margins we earn on prescription sales. As new member onboarding moderates in the future, we maintain that our health care services business can generate double-digit EBITDA margins.

Next, I’ll briefly summarize our Life & Auto & Home segment, which also had a stable quarter for both revenue and adjusted EBITDA, which were $50 million and $7 million, respectively. Similar to prior quarters, the Auto and Home division’s strong performance was once again driven primarily by a combination of strong agent productivity and higher industry-wide premiums. The Life division grew revenues by over 10%, fueled in particular by a strong quarter for the final expense business. As a reminder, these business lines continue to benefit SelectQuote’s overall cash efficiency. Lastly, let me review our updated fiscal ’24 outlook on Slide 11. As Tim mentioned, we are raising our revenue expectations to $1.25 billion to $1.3 billion, which at the midpoint represents growth of 27% year-over-year.

This is the second consecutive quarter; increasing our top line outlook and is primarily driven by the rapid adoption we have seen in our SelectRx membership. For SelectRx specifically, we would note that our fiscal fourth quarter is in a seasonally slower period for member growth than AEP for OEP. While we still expect member growth into our fiscal year-end, the pace will be modest compared to the past quarter. We also raised our outlook for adjusted EBITDA, which is now $100 million to $110 million. At the midpoint, this represents growth of 41% year-over-year. As I’ve spoken to, we are happy to raise our profit outlook despite the additional onboarding expense driven by our rapid SelectRx growth. With that, let me turn the call back to the operator to take your questions.

Operator: [Operator Instructions]. Our first question comes from Ben Hendrix with RBC. Please go ahead. Your line is open.

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Q&A Session

Ben Hendrix : Thank you, very much and congratulations on the results. I wanted to get some more detail on Slide 5, the securitization and the pull forward of the payback period seems like a very compelling structure here. But just wondering kind of for this with now, it seems like your debt levels would be directly linked to sales in any given year now. I just wondered how you think about balance sheet management and leverage profile of the company going forward under this structure?

Ryan Clement : Yes, I mean, with respect to securitization, we do see it as a flexible structure where as we produce more policies, we can securitize those policies and access to proceed. So as a result, it does create an environment where we can delever and pay down the term debt but it also creates an environment where it is self-funding in nature. And so, on a go-forward basis, we would expect to securitize policies as we produce them kind of on a perpetual basis.

Ben Hendrix: And I appreciate the commentary about being able to retain all your tail commissions, and that seems definitely like a positive. The problem is does this amplify on the downside in an event. I know you guys have done a really good job of decreasing the quality of your commissions receivable and having a really strong confidence there. But could this amplify any downside risk of negative tail revenue?

Ryan Clement: I mean ultimately, with respect to our cash flows, — to the extent persistency were to come in worse than anticipated, we would not recognize those cash flows. So, I don’t know that like the risk is amplified. It is — obviously, we are securitizing — and obviously, when you are securitizing policies, those policies are based off actuarial studies, and they’re not securitized at a loan-to-value that is 100%, but it actually had a pretty significant reduction from 100%. So, kind of there are mechanisms in place to derisk the overall structure. We do believe that securitization is an attractive form of financing for the business for shareholders. And it makes a lot of sense.

Ben Hendrix: Great. Thank you. Just one last one on the regulatory environment, the commission rules that we’ve seen come through from CMS. Just wanted to get your latest interpretation there and how you believe it relates to your business line?

Tim Danker : Ben, this is Tim. Thanks for joining. Thanks for the question. Yes, our interpretation of the final rule really seems to delineate. There are different rules that apply to different participants in the industry. So specifically, SelectQuote considered a third-party marketing organization or TPMO and based upon the new language that came out, we believe it’s CMS’ intention to exclude TPMOs from the fee limitations related to broker comp. So — we’ve been actively engaged with our carrier partners on this issue. They have reiterated the critical role we play in MA distribution, the value that we provide beneficiaries and kind of underscored some of the differences in our model versus others. So, we — at the bottom line of all this is we don’t see this materially impacting our business.

Operator: [Operator Instructions] Our next question comes from Pat McCann of Noble Capital Markets. Please go ahead.

Pat McCann : Congrats on the quarter and thank you for taking my question. My first question is about the pharmacy business. You mentioned during the presentation the focus on improving margins as we go forward. I was wondering if you could talk a little bit about some of the levers you pull to do that.

Bob Grant : Yes, I can start from a business standpoint and then have Ryan kind of take it from a just general economic standpoint. It’s a business, obviously, that we don’t book in the same way that we book our senior business. And as a customer gets more tenured, they add more drugs per customer or more scripts as we get to more of a full box, their churn actually reduces then the unit economics on the boxes actually get better and better. And I think we’ve seen that play out as we’ve kind of made more money during, I’d say, periods where we aren’t growing quite as fast. And then like last quarter, we grew really, really quickly on the back of AEP, and you see the economics reduce just a little bit. But over time, that gets more and more stable and more and more profitable per box, and that’s how we really see that playing out.

Our unit economics on the lifetime of a box have actually gotten significantly better because we’ve reduced our churn. We’ve increased the percentage that have full boxes and just gotten better operationally I’d say the other area that we’ll really focus on operationally is just as we’ve got an economy of scale, one, we get to buy scripts at a lower price, right? And then two, more importantly, actually, is the automation efficiency we can gain within the facilities and factory itself and we are hyper-focused on that right now as we get bigger and bigger and we get more tenured. So that’s why we have such confidence on where we’re going from an economic standpoint and feel really, really good about where we are. But it’s just a maturity of the business and ultimately, as those customers play out.

Pat McCann: Great. And then… Help… Sorry, go ahead.

Ryan Clement: Yes. No, I was going to call out, obviously, we on boarded 12,000-plus customers, which is — we were incredibly pleased with. There is a short-term cost associated with that enrollment and onboarding. But drug margins are strong, and we believe that we’re building a business with a lot of embedded value. This is a recurring business model. We recognise revenue as those drugs are being shipped out. So as Bob alluded to, as customers mature more and more going out with full boxes, and we’ll see the margin progression.