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SelectQuote, Inc. (NYSE:SLQT) Q2 2024 Earnings Call Transcript

SelectQuote, Inc. (NYSE:SLQT) Q2 2024 Earnings Call Transcript February 7, 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: Welcome to SelectQuote's Second Quarter Earnings Conference Call. [Operator Instructions] It is now my pleasure to introduce Matt Gunter, SelectQuote's Investor Relations. Mr. Gunter, you may now begin the conference.

Matt Gunter: Thank you and good morning, everyone and welcome to SelectQuote's fiscal second 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 on our earnings release and investor presentation on our website.

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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, annual report on Form 10-K for the period ended December 31, 2023 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 thank you all for joining. SelectQuote produced another very strong quarter in 2Q which marks our fourth consecutive quarter of performance ahead of expectations across both our core senior and health care services businesses. Before getting to the quarter, I'd like to begin by reiterating our conviction and the value creation strategy we have executed against since 2022. For those that are new to the story, SelectQuote seeks to generate stable and attractive EBITDA margins and a range of selling environments with an emphasis on returns to invested capital and growing cash flow. We've optimized our sales force of tenured agents to focus on the best leads to generate the highest possible unit economics for Medicare Advantage policy.

Our rapidly growing health care service business led by Select Rx, has significantly scaled the return and cash flow generation of our holistic marketing spend. And as a result, our revenue to CAC is now over 4x, more than double what it was 2 years ago. Additionally, we delivered a third consecutive quarter of positive profitability in our Healthcare Services division which will accelerate the overall earnings power and cash flow of SelectQuote. Our strategic goal of building a truly unique and diversified platform, featuring information and service-driven insurance distribution as well as value-added health care services is increasingly becoming a reality. With this quarter, we have now produced positive operating cash flow in 2 consecutive quarters on an LTM basis which is noteworthy given the first half of the fiscal year is our highest seasonal use of cash with the ramp to AEP and OEP for Medicare Advantage.

As a result of this progress, we now expect SelectQuote to approach breakeven free cash flow for fiscal 2024 and expect cash flow generation to expand as health care services continues to scale. From our vantage point, SelectQuote is not just healthier than it was 2 years ago but it's thriving with a strong foundation to realize the significant intrinsic value for shareholders that we see in our unique model. With that confidence, we are pleased to say that we have increased the midpoints for both our revenue and adjusted EBITDA outlook for fiscal 2024 which we will detail later in the call. Now let me turn to Slide 3 to provide highlights of our 2Q results. Consolidated revenue grew by 27% year-over-year, driven by both policy and LTV growth in our Senior division and an increasing contribution from health care services which more than doubled revenue year-over-year at $112 million for the quarter.

Our consolidated adjusted EBITDA also beat expectations growing by 6% compared to a year ago. As you will recall, our expectation for fiscal '24 was for EBITDA margins to moderate compared to a highly favorable Medicare Advantage season experienced by the industry in fiscal 2023. We -- it is important to call out the significant mix shift we've experienced given that EBITDA generation lags member growth in our Healthcare Services business. We'll speak to the drivers of each segment in a moment but we want to emphasize the embedded EBITDA scale that exists across all of Select quote. In our Senior segment, we continued to achieve strong efficiency of our tenured agent force in 2Q, even when comparing to a very favorable market backdrop in fiscal 2023.

As a result, we generated strong EBITDA margins of 32% despite expected marketing cost increases primarily due to the implementation of new CMS marketing roles, including the 48-hour role. Lastly, observed persistency remains stable and healthy. In total, we take great pride in the tailored and unbiased service our highly trained agents provide to seniors every day, many of whom live in areas with limited access in many cases, suffer from multiple chronic conditions or are below national averages for income. Turning to our Healthcare Services segment. In 2Q, we posted our third consecutive quarter of positive adjusted EBITDA and despite elevated investment in new member growth that occurs concurrent with AEP. Select Rx has now nearly 63,000 members which is well ahead of our original expectation for all of fiscal '24.

In our view, the growth serves as an overwhelming endorsement of the value our service delivers to customers. With a much higher base of members and the continued growth in the operating leverage of the business, we are meaningfully increasing our outlook for revenue within health care services for fiscal '24, while maintaining our expectations for adjusted EBITDA margins as we make investments to capture increased market share at highly attractive economics. If we turn to Slide 4, let me briefly elaborate on what we have observed in our senior segment in the second quarter and more broadly what we saw in AEP this year compared to last. First, our refocused strategy has resulted in outsized efficiency gains for our tenured agent sales force.

As you can see, our close rates and agent productivity have increased by 54% and 97%, respectively, compared to 2022. More impressive, though, is the resilience we've seen in these metrics compared to the fiscal 2023 season which you will recall, was very strong industry-wide. We credit this performance to our strategy to overweight tenured agents as well as the introduction of our latest agent desktop tools which further enhance efficiency, plan fit and the value to the policyholder and our carrier partners. Now, let me provide our high-level observations of this season to AEP compared to last -- first, at the industry level. Competition from other distribution platforms continues to be much more rational than a few years ago. For our model specifically, we shifted certain processes to incorporate the new CMS marketing roles and are very pleased to have mitigated higher marketing cost per policy with stable agent efficiency.

Lastly, the bigger impact to Cycle Senior segment was a 7% increase in LTV to $934 per policy. Ryan will expand on our LTV but to summarize, we continue to see stable policyholder persistency and the business we write. If we turn to Slide 5, let me speak to the efficiency from a cost and return perspective. We have shown these KPIs in the past but wanted to highlight the power and operating leverage, like what has created both from an Asian productivity and scaling perspective. First, our overall operating cost per policy for the past year remains highly attractive and is now over 30% lower compared to 2 years ago. Similarly, we have seen a 38% decrease in our marketing expense per policy compared to 2 years ago. We'll speak more about marketing costs for this AEP but the important takeaway here is the interplay between an efficient tenured agent workforce and how a focus on quality leads can drive unit profitability and cash flow.

Finally, we would marry that concept with how powerful SECI is as a holistic health care information hub for more than just Medicare Advantage customers. As we've noted before, the customer acquisition spend, we invest to drive returns and cash flow has synergy across more than just senior shopping for Medicare Advantage policies. As you can see in the last set of bars, our revenue to CAC has more than doubled from 2 years ago and is now at 4.2x. And which is remarkable from a return on invested capital perspective, especially considering that the timing of these cash flows are becoming increasingly front loaded as Select Rx continues to grow as a mix of our overall business. To summarize, we're very pleased with the foundation we have built to drive stable unit economics and operating leverage in our senior segment.

More importantly, we're reaping the benefits of our unique ability to scale the same variable cost to create significant revenue streams within other large market needs in the health care ecosystem. As we've said before, our infrastructure and approach gives Select both the unique opportunity to be the connective tissue for a very large population of Americans, carriers and caregivers. Best of all, as we've done with Select Rx, we believe there are a range of ways to capture market share by leveraging our existing expense structure. If we turn to Slide 6, let's talk in more detail about Select Rx and health care services. As I noted up top, our growth in the segment year-to-date has significantly surpassed expectations. As you will recall, our original full year 2024 outlook, anticipated SelectRx membership at the end of this year, at just over 60,000 members.

At the end of 2Q, we are nearing 63,000 members. It's worth noting that the growth in members has been nearly all through our Medicare Advantage lead set as we highlighted last quarter, we believe Select Rx compelling value proposition has the opportunity to be more broadly adopted through targeted marketing outside of our core Medicare Advantage platform. To be very clear, we do not plan to grow members just for the sake of growth but rather see significant EBITDA opportunity which is underpinned by what we are seeing and the attractive economics of our in-place membership. In fact, the increase that we are showing in our outlook for the business on the right side of this page now includes growth from selective lead targeting as well as through our existing Medicare Advantage funnel.

An insurance agent with a tablet device accessing a technology-enabled platform.
An insurance agent with a tablet device accessing a technology-enabled platform.

This investment is the primary driver of the stable margin expectations we now forecast for the year. We now expect member growth in the range of 40% to 50% compared to our original expectation of 25%. The -- we expect the larger base of maturing members to drive revenue growth of 80% to 100% year-over-year which is nearly double our original expectation. We believe this rapid growth in members clearly demonstrates significant value SelectRx provides to customers. We also remain excited about the embedded EBITDA we expect from these sticky revenue streams. As mentioned previously, SelectRx EBITDA generation lags member growth as members slow through the onboarding process. So with such rapid growth, we will be onboarding a large population of new members in 2024 which impacts the pace of our adjusted EBITDA margin progression.

Given our strategic decision to lean into member growth, Healthcare Services EBITDA margins are now forecasted to exit 4Q and the low single-digit range but on a much higher base of revenue than previously expected. Take a step back, we'll exit 2024 with a business that will have annualized and growing run rate revenues and the $550 million to $600 million range with positive EBITDA margins that will continue to improve as the business matures. To be clear, we aren't guiding for 2025 or beyond but we do believe SelectQuote market valuation fails to recognize the embedded value being scaled in health care services and the strong improved fundamentals exhibited over the past 2 years and our distribution businesses. As we've said since 2022, only measure us based on what we accomplished but it's clear we have accomplished quite a bit across the organization, most notably in health care services.

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 start with a quick overview of our consolidated financials for the quarter on Slide 7. SelectQuote outperformed internal expectations again with a strong AEP and senior coupled with continued outsized growth in SelectRx. Consolidated revenue of $405 million grew 27% year-over-year and adjusted EBITDA totaled $67 million compared to $64 million a year ago. As Tim noted, our adjusted EBITDA margin declined compared to a very strong year in fiscal 2023 but the largest driver in the margin difference with a higher mix of health care services revenue. Healthcare Services profitability will ramp as we lap the initial investment in new member onboarding and those members mature in the quarters ahead.

As you will see with our updated outlook, we have a lot to be excited about as profitability scales to select Rx. As you know, SelectRx is cash accretive and enhances SelectRx's overall return on invested capital and ultimately, will drive higher free cash flow and incremental shareholder value. If we flip to Slide 8 and 9, let's turn to the senior segment results which were excellent when compared to the very strong fiscal 2023 AEP season. Senior revenue of $248 million grew 11% year-over-year and was principally driven by MA policy growth. LTV also improved to 934 which was 7% higher than a year ago. As you can see on Slide 9, our total policy sales beat expectations during the second quarter. This was driven by our continued strategy to match targeted quality leads with tenured agents.

As noted in past quarters, our core focus is on Medicare Advantage versus other Medicare plan types which are represented in orange here. Looking at just approved MA policies in blue, we grew by more than 7% from our observations, was broadly in line with industry growth. We are very pleased with the operating results from our Senior division as our strategy continues to deliver stable growth and attractive returns in a range of Medicare selling environments, including the changes associated with the new CMS marketing rules. As Tim noted, the new rule modestly impacted marketing costs per approved policy and dampened the outsized strength we had in senior EBITDA margins in 2023. In 2Q '24, our EBITDA of $79 million produced an attractive margin of 32% which, as anticipated, moderated from the 37% produced a year ago.

Tim highlighted the efficiency gains we have realized with a higher mix of tenured agents compared to years past which drove stability and senior profitability. Also worth noting, we continue to see stabilization in policyholder persistency. As you'll recall, our LTV includes a 3-year look-back provision and has also incorporated a 15% constraint since 2022 which lowered our booked LTV. We feel really good about the durability of the LTVs we have been recognizing since adopting that 15% constraint and implementing our strategic redesign. I point this out as the vast majority of our receivables include this higher constraint. Additionally, we believe our strategy to focus on the highest quality lead sources and carrier partnerships has built significant resilience into our LTVs. There are multiple factors that drive our LTVs, including carrier mix, so we have made significant progress towards our goal of reducing volatility in our results with more focused growth and lead targeting.

We believe the stability we are seeing in persistency indicators creates a solid foundation for more stable and improving LTVs in the long term. Turning to Slide 10; let me give additional context on the standout growth we have driven in our Healthcare Services segment year-to-date. As Tim noted, we surpassed our original full year outlook for member growth during the second quarter. This was driven by continued demand from consumers for our convenience and tailored pharmacy service. To be clear, the AEP period is the seasonal peak for SelectRx member growth given the connectivity we have through our Medicare Advantage sales channel. This is highlighted by the 19% sequential growth in members compared to last quarter. For frame of reference, that 19% growth was nearly 10,000 members or more than 2x the total membership of the original pharmacy businesses we bought in 2021.

This is an impressive statistic and is representative of how powerful this energy is in our overall model. The step function in growth for the quarter explains why we have increased our member and revenue outlook for 2024. But I also call out that the growth in concurrent onboarding muted the blended EBITDA margin for Q2 which we expect to continue in the back half of the year. However, this is a great problem to have given those margins will scale as new members mature. So while our full year outlook for Healthcare Services margins remains in the low single digits, we'll be achieving profitability on a base of revenues that is significantly higher than what we anticipated when the fiscal year began. To echo Tim's point, the number of SelectRx is producing at a scaled base of members and profitability get very compelling very quickly.

Even more exciting is the positive impact SelectQuote's experience in cash efficiency which we believe is durable given the value we provide our members for their critical prescription drug needs month in and month out. To provide additional context on how members mature and margins for the business progress, we have created the views you see on Slide 11. Beginning at left, we highlight the number of prescription shipped per day which equipped 17,000 this past quarter. The growth of 76% year-over-year is largely a function of new member additions but we believe it also highlights the scale we are creating over the fixed cost of distribution within the business. Moving to the chart at right, we displayed the average prescription per member. Typically, it takes a new member of several months to reach what we call a full box, including all of their various medications.

You can see this maturation dynamic in the year-over-year growth rate of 12% despite the nearly 10,000 new members onboarded this quarter who are ramping to full boxes. These views of the SelectRx unit economics are compelling enough on their own but to Tim's point, when combined with the pace of new member growth against a very large addressable market and the cash efficiency we realized in the model, we see significant unrecognized equity value in SelectRx. Next, I'll touch on our Life and Auto and Home division which also produced a strong quarter with combined revenue growth of 14% and EBITDA growth of 14%. The -- as we mentioned last quarter, the P&C insurance market has been able to recognize increased premiums given replacement cost inflation for homes and cars.

This was the primary driver of improved results in that division. Our term life business increased revenues more than 10% year-over-year, primarily due to improved conversion of policy sales to in-force premium as we continue to expand our accelerated underwriting product, Swift Term Select. Let me now turn to Slide 12 to review our revised financial guidance for fiscal 2024. On the strength of both health care services and senior, we are increasing our revenue and adjusted EBITDA ranges which now represent growth of 26% and 31% year-over-year at the respective midpoint. As you can see, the overall model is driving operating leverage given EBITDA growth is projected to outpace revenue growth. Our full year revenue expectation is now $1.23 billion to $1.3 billion, primarily driven by growth in health care services.

This compares to our previous range of $1.05 billion to $1.2 billion. The bottom end of our adjusted EBITDA ranges increases from $80 million to $90 million, driven by strong EBITDA results in Senior. We are maintaining the top end of the range at $105 million as Healthcare Services margins continue to scale. Finally, on the balance sheet. Our term loan is granted SelectQuote a short-term extension on the current credit agreement which you will see in our forthcoming 10-Q. On restructuring, after evaluating various refinancing options, we are confident that securitization presents the best opportunity for a more permanent capital structure. We remain in active negotiations are still working to resolve certain deal points but we've made tangible progress and are optimistic we're approaching a deal.

It is worth noting that SelectQuote's underlying business is set to produce roughly $100 million of unlevered operating cash flow in fiscal 2024. Restructuring the balance sheet to significantly improve our earnings profile and operating flexibility and would drive meaningful additional value to shareholders. With that, let me turn the call back over to the operator to take your questions.

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