MediaAlpha, Inc. (NYSE:MAX) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Denise Garcia – Investor Relations
Steven Yi – Chief Executive Officer
Pat Thompson – Chief Financial Officer
Conference Call Participants
Michael Graham – Canaccord
Daniel Grosslight – Citi
Meyer Shields – KBW
Ben Hendrix – RBC
Operator
Good day, everyone. My name is Kellyanne and I will be your conference operator for today. At this time, I’d like to welcome everyone to the MediaAlpha Q3 2022 Earnings Conference Call. Today’s call is being recorded. [Operator Instructions] At this time, I’d like to turn the conference over to Ms. Denise Garcia of Investor Relations. Please go ahead, ma’am.
Denise Garcia
Thank you, Kellyanne. After the market closed today, MediaAlpha issued a press release and shareholder letter announcing results for the third quarter ended September 30, 2022. These documents are available in the Investors section of our website and we will be referring to them on this call.
Our discussion today will include forward-looking statements about our business and our outlook for future financial results, including our financial guidance for the fourth quarter of 2022, which are based on assumptions, forecasts, expectations and information currently available to management. These forward-looking statements are subject to risks and uncertainties that could cause future results or events to differ materially from those reflected in those statements. Please refer to the company’s SEC filings, including its annual report on Form 10-K and its quarterly reports on Form 10-Q for a fuller explanation of those risks and uncertainties and the limits applicable to forward-looking statements. These forward-looking statements are based on assumptions as of today, November 3, 2022 and the company undertakes no obligation to revise or update them.
In addition, on today’s call, we will be referring to certain actual and projected financial metrics of MediaAlpha that are presented on a non-GAAP basis. This includes adjusted EBITDA, which we present in order to supplement your understanding and assessment of our financial performance. Non-GAAP measures should not be considered as a substitute for or superior to financial measures calculated in accordance with GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our press release and shareholder letter issued today.
Finally, I’d like to remind everyone that this call is being recorded and will be made available for replay via a link on the Investors section of the company’s website at investors.mediaalpha.com.
Now I’ll turn the call over to Steve and Pat for a few introductory remarks before opening the call to your questions. Go ahead, Steve.
Steven Yi
Thanks, Denise. Hi, everyone and welcome to our third quarter earnings call. I’d like to make a few observations about the quarter before turning the call over to our CFO, Pat Thompson, for his comments.
Due to ongoing inflation driven underwriting losses, auto insurance carriers continue to limit their variable marketing investments in Q3 and that spend remains extremely depressed relative to normal levels. Recently, the profitability pressures on P&C carriers have been compounded by the large insured losses from Hurricane Ian, which we expect to lead to a further pullback in marketing spend by carriers in Q4.
On the positive side, carriers continue to pursue and gain approval for rate increases in many states, which will ultimately lead them to resume their growth focus as profitability improves. As a result, we anticipate improved performance in our P&C verticals when the industry begins to emerge from the current hard market cycle and carriers once again turned to MediaAlpha to help them meet their growth objectives. In our health insurance vertical, we expect transaction value to be down slightly year-over-year as robust spend from our carrier partners is offset by lower spend from brokers. We continue to be very optimistic about the long-term growth outlook for this vertical, which is in the very early innings of the shift to online shopping and enrollment.
Given this difficult marketing environment, we are continuing our disciplined approach to expense management while maintaining our capacity to outgrow our peers coming out of the P&C hard market cycle. Our outstanding team remains strongly engaged and committed to our mission. While this has been a challenging year, we remain as bullish as ever regarding our prospects for long-term profitable growth once market conditions improve. The secular shift to direct-to-consumer distribution and digital marketing continues across all of our insurance verticals, and our marketplace remains unparalleled in its scale, scope and capabilities.
With that, I will turn the call over to Pat to say a few words before we open the call to your questions.
Pat Thompson
Great. Thank you, Steve. I’ll take a moment to point out a few items regarding this quarter. I’m pleased that we were able to exceed our guidance ranges and create positive adjusted EBITDA and free cash flow during the quarter. Operating expenses, excluding non-cash items, came in below our forecast. And we remain intensely disciplined on expense management as we await a return to growth in our P&C vertical.
Next, I would like to remind investors of the seasonality of our business. In our P&C vertical, Q4 transaction value typically declines relative to Q3 and is the slowest quarter of the year. In our health vertical, Q4 is our strongest quarter due to the timing of annual enrollment periods for ACA and Medicare plans with Q4 transaction value usually representing approximately 40% of the full year total. Our fourth quarter guidance reflects these seasonal trends.
Turning to the balance sheet, we paid down $17.5 million of debt during the quarter and ended the quarter with $30 million of cash and cash equivalents. Our term loan matures in July of 2026 and we have significant headroom relative to our debt covenants. These covenants are based on consolidated EBITDA, as defined in the credit agreement, which includes a number of significant add-backs not included in adjusted EBITDA, such as public company costs and is therefore materially higher than adjusted EBITDA.
Looking ahead to Q4, our guidance reflects a similar year-over-year decline in P&C transaction value as in the third quarter now that we have crossed the first anniversary of the start of this hard market cycle. Within our health insurance vertical, we expect transaction value to be down slightly year-over-year as robust spend from our carrier partners is offset by lower spend for brokers. As a result, we expect transaction value to range from $155 million to $170 million, a year-over-year decrease of 34% at the midpoint. We expect revenue to range from $110 million to $120 million, a year-over-year decrease of 29% at the midpoint.
Lastly, we expect adjusted EBITDA to range from $5 million to $7 million, a year-over-year decrease of 55% at the midpoint. We are projecting our operating expenses, excluding non-cash items, to be $1.2 million to $1.7 million higher than Q3 2022 levels driven by both temporary and seasonal increases in non-headcount operating expenses.
With that, operator, we are ready for the first question.
Question-and-Answer Session
Operator
[Operator Instructions] We will hear first today from Michael Graham with Canaccord.
Michael Graham
Hey. Thanks a lot guys for the question. I wanted to ask you, the first one is just another player in the space mentioned that one big carrier had achieved rate adequacy and it started spending again. And I just wanted to ask you to maybe put a little more depth around your comment that carriers in general were still working on rates. Is there any depth you can add to that in terms of like percent complete, or do you think any of the carriers are close to being done? That’s the first one, and then I will ask a follow-up.
Steven Yi
Okay. Hey Michael, it’s Steve. Thanks for your question. Yes. I mean we thought something similar. I think overall, what we are seeing isn’t that different from what we talked about in the past, which is that I think as we are seeing from the Q3 results from a lot of the P&C carriers. The carriers are at very different stages of achieving rate adequacy. And certainly, there are some carriers who feel like they are there. And we have seen them lean back into growth mode, increasing the marketing investments. And certainly, here, notwithstanding the effects of Hurricane Ian and the pullback that we alluded to in Q4, we continue to expect to see quarter-over-quarter increases in their marketing budgets as we get into 2023. I think it’s fair to say that the majority of other carriers, though, are still in the middle of the process of getting their rates increase to achieve rate adequacy. And I think what we are seeing is that contrary to some of the thoughts that we had very early in this period that they are at very different stages. And so what we are expecting and planning on is really through 2023 on a carrier-specific basis, market recovery to happen, marketing budgets to return. And so I think it’s fair to say that through 2023, we are expecting recovery to start, but that it might be a little bit lumpy, non-linear because it will be based on each specific carrier achieving rate adequacy.
Michael Graham
Okay. Thanks for that and that’s helpful. And then just with experience with hurricanes, if this had happened – if Ian happened in a vacuum, like how long would you typically expect a hurricane, a major hurricane to impact carrier spending? Is it a quarter or two quarters, or what are your thoughts there?
Steven Yi
Yes. Again, I think that’s a great question. And so I think that the – I think the impact is largely near-term. I think it depends on where the carriers are with their overall combined ratios for the year. And so I think what you are seeing with respect to the carriers who have achieved rate adequacy and pulled back in Q4 due to the effect of Hurricane Ian. I think the primary driver behind that was really to get their combined ratios in line and hit their targets for the year. And so I think that reaction isn’t unlike what you would see in a normal market period. And again, it depends on the severity of the event, as well as what carriers are expecting in terms of the overall combined ratio for the year. I think overall, as we think about how the markets can recover, certainly, the effects of Hurricane Ian could linger into early 2023. But with the discussions that we have had with carriers who achieved rate adequacy and started to lead back into marketing. The feedback has been that in Q1, they will lean back in and certainly by the time that other carriers follow suit later in the year. We don’t anticipate that hurricane Ian and the effect of Hurricane Ian will continue to have an effect.
Michael Graham
Okay. Thank you, Steve.
Operator
[Operator Instructions] We will hear next from Daniel Grosslight with Citi.
Daniel Grosslight
Hi guys. Thanks for taking the question. I want to focus on the health segment for a little bit. You mentioned you are seeing strength in the under 65 market in your shareholder letter, given the extension of subsidies. Can you give us a general idea of how big that business is as a percent of your overall health business? And any thoughts around transitioning your recent acquisition of the Customer Helper Team from more of a Medicare Advantage focus to an under 65 focus?
Pat Thompson
And – this is Pat. Thank you for the question, Dan. The – on the breakdown of our health vertical between Medicare and under 65, that’s not a number that we disclose. The thing I can tell you is that it’s a healthy mix between the two, and it’s – it’s not like it’s 80-20 skewed in one direction. But it’s a very healthy blend of the two. And as we think about the Customer Helper Team acquisition, that business was pretty heavily focused on Medicare when we bought it. The Medicare market, I think is you and most investors know, has been relatively challenged over the course of this year. Part of the deal thesis on that was that the capabilities they had in Medicare could be extended to other areas, for the area we chose for that is under 65 health. So, the team at CHT has been working there. We have real revenue with real gross profit. In that area in Q3, we are in the third day of OEP right now, and the business is seeing kind of the expected uplift you would see in that period. And we kind of remain long-term bullish about the opportunity for CHT, both in Medicare and in other verticals like under 65 health.
Daniel Grosslight
Got it. Okay. And all of the carriers themselves have made comments that they are investing heavily in their own sales force and their own lead acquisitions. I am just curious if you can provide any commentary around the strength you have seen ahead of carriers versus brokers and how you think that’s going to shape up, not just this year, but over the coming 2 years to 3 years?
Pat Thompson
Yes. And this is Pat again on it. The thing I would say is that generally, across our health vertical in general and probably Medicare in particular, carrier spend has been quite a bit stronger than broker spend for us. And I think that some of the challenges the broker industry is having are well known. And as we look forward, we think that is a trend that will probably continue in that carriers are looking to Medicare Advantage to be a big growth area for them, I think as I get reports from you and some of your peers, that’s always one of the four or five bullet points in the summary is Medicare Advantage growth. So, clearly, they are focused on it. And they want to have direct relationships with their end customers. And I think the benefit of the carrier is kind of gating an importance is that we have this playbook, and we have executed it before in P&C where P&C was the space where brokers were relatively penetrated. And you have seen the customer acquisition efforts skew very, very heavily to carriers over time. And we expect that carriers will continue to rise in importance in the health channel, although we believe that over time, brokers will continue to be very valuable to consumers that want to carriers.
Daniel Grosslight
Got it. Appreciate the color. Thanks guys.
Steven Yi
Thanks Daniel.
Operator
We will hear now from Meyer Shields with KBW.
Meyer Shields
Thanks. Good afternoon. I guess if we listen to most of the auto carriers over the course of the third quarter, it sounds like there was this recognition that things are worse than they thought. And I am wondering how that corresponds with what you are seeing from them in other words sequentially the interest from demand partners going from the second quarter into the third quarter?
Steven Yi
Yes. Hey Meyer, it’s Steve. Yes, I think that generally resonates with us and what we are hearing from our carrier partners. Referring back to my earlier comment, I mean there are some carriers who feel that they achieved rate adequacy. But I think that the majority of the carriers that we are working with, I think are still working through it. And we have seen some positive news on that front, used car prices coming down, California proving its first rate increase, I believe in 2 years. I mean certainly, we see those as positive signs. And then we see the continuing progress that the carriers are making in getting state-by-state approvals. But I think overall, it’s fair to say that the comments you made about the auto insurance carriers and how difficult this market environment has been. It certainly resonates with us and matches what we are hearing from them directly.
Meyer Shields
Okay. Perfect. Second, this is sort of an abstract question, but it looks like Hurricane Ian may force a return to a more actuarial basis for pricing homeowners in Florida. And I am just wondering what – is it your sense that competition for Florida business was lower before all of the COVID impact on supply chain? Was Florida sort of an underperformer in your marketplace?
Steven Yi
I think it’s safe to say that.
Meyer Shields
Okay. Perfect. I guess we will have that. And just one last question, the $8.6 million impairment of cost method investments, does that have anything to do with the other verticals closing?
Pat Thompson
Sorry, Meyer, it was the cost basis impairment?
Meyer Shields
Yes.
Pat Thompson
Yes. The – we have an equity investment that we made several years ago, and it’s a company kind of in the space, and we were holding that investment at book value. And given kind of some of the challenges in the P&C industry, we went through an exercise and we had a partial impairment of that investment. So, we kind of wrote it down and something resembling a mark-to-market on that. So, it’s a minority investment. No, nothing to do with interest.
Meyer Shields
Thank you.
Steven Yi
Hey. Thanks, Meyer.
Operator
[Operator Instructions] We will hear now from Ben Hendrix with RBC.
Ben Hendrix
Yes. Hi guys. Thanks. Just a quick question going back to the under 65 market on the healthcare side. This past quarter, we have heard one of our coverage companies, Bright Health get out of the of the ACA exchange market altogether. And we have heard other larger carriers kind of expand their footprint. Has that changed in all your trajectory, your client mix and your outlook overall for that market? Thanks.
Steven Yi
Hey Ben, it’s Steve. It hasn’t. I mean we have seen some of that. I think that the transition within the under 65 space to having carriers go direct-to-consumer, invest in marketplaces like ours, we have seen a steady upward trajectory there. I think we have seen more of that within the Medicare Advantage space, certainly with major carriers. Again, based on earlier comments really leaning into this space and building a good balance of distribution through brokers, agents as well as building direct capabilities. And so with respect to our overall sentiment with regard to health insurance, I mean we continue to see just the broad trends there with health insurance companies overall, really increasingly going direct-to-consumers, having an interest in doing that and building those capabilities. And over the long-term, I think we will continue to see benefit from that because, as Pat mentioned earlier, that’s really within our way house the ability to work with major insurance carriers to help them deploy their performance marketing dollars in a transparent and a super-efficient way.
Ben Hendrix
Thanks. And then just last question with regards to your – with your term loan to 2026. Just can you remind us kind of how that’s positioned for increased interest rates? Do you guys have hedges in place on that?
Pat Thompson
Yes. It’s floating rate debt. So, it’s effectively a LIBOR spread that presumably will be transferring to SOFR in the near future. And so as rates go up – the rates on the floating rate debt go up, we typically kind of lock in the rates quarter-by-quarter is what we have been doing thus far this year. So, of course, interest expense has been going up, and we don’t have any long-term hedges in place.
Ben Hendrix
Thank you, guys.
Steven Yi
Thank you, Ben.
End of Q&A
Operator
And with no other questions at this time, that will conclude today’s conference. We do thank you all for your participation. And you may now disconnect.
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