Altisource Portfolio Solutions S.A. (ASPS) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Altisource third quarter earnings conference call. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Michelle Esterman, Chief Financial Officer. Please go ahead.

Thank you, operator. We first want to remind you that the earnings release, Form 10-Q and quarterly slides are available on our website at www.altisource.com. These provide additional information investors may find useful. Our presentation today contains forward-looking statements made pursuant to the Safe Harbor provisions of the federal securities law. Statements in this conference call and in our press release issued earlier today, which are other than historical fact, are forward-looking statements. Factors that may cause actual results to differ materially are discussed in our earnings release. The company disclaims any intent or obligation to publicly update or revise any forward-looking statements regardless of whether new information becomes available, future developments occur or otherwise. Joining me for today's call are Bill Erbey, our Chairman; and Bill Shepro, our Chief Executive Officer. I would now like to turn the call over to Bill Erbey.

Good morning, and thank you for joining today's call. This morning, I'd like to spend a few minutes discussing Altisource's capital allocation strategy, Michelle will provide an overview of our financial performance, and Bill will discuss Altisource's strategic initiatives. Our capital allocation strategy is central to our commitment of enhancing and increasing shareholder value. We do this by, one, repurchasing Altisource shares when we believe the stock is attractively priced; and two, diversifying Altisource's revenue and customer base by making acquisitions and investing in organic development of new and next-generation products and services that support our vision to become the premier real estate and mortgage marketplace. Our business generated significant cash to fund these initiatives. As of September 30, 2014, we had $176.6 million of cash. During the third quarter of 2014, we executed on all fronts. From July 1, 2014 through today, we repurchased 1.7 million shares of our common stock at an average price of $101.39 per share. As of today, there are 20.3 million Altisource shares outstanding, a 7.6% reduction from June 30, 2014. Turning to acquisitions, we completed the acquisition of Mortgage Builder in the third quarter. Mortgage Builder expands our technology and marketplace offerings to include a loan origination system with the marketplace. With the financial strength of Altisource as its parent, we believe Mortgage Builder will succeed in attracting new customers and expanding its relationship with its 200 existing customers, 52 of which are also Lenders One members. Finally, we continue to invest in the organic development of new and next-generation products and services to support our marketplace vision. Unlike many others in the industry, we do not capitalize internal software development costs. This investment is reflected in the change in the technology services operating margin which has declined from 35% in 2010 to 3% in the third quarter of 2014. We believe the new and next-generation technologies are an integral component of our marketplace vision. Bill will discuss some of these initiatives in greater detail. In the future, we plan to continue repurchasing shares, making acquisitions and investing in the organic development of new and next-generation products. Today, we have an active acquisition pipeline, and we're quite excited about some of these opportunities to further diversify our revenue and customer base. I would now turn the call over to Michelle for a financial update. Michelle?

Thank you, Bill. This morning, we reported third quarter 2014 service revenue of $247.7 million, net income attributable to shareholders of $42.3 million and diluted earnings per share of $1.79. Slides 4 through 6 provide highlights of our results for the current quarter compared to prior periods. Service revenue declined 6% in the third quarter of 2014 compared to the second quarter of 2014, with the entire decline occurring in the higher-margin Mortgage Services segment. We believe a portion of this revenue is not lost, but has been shifted to future periods, primarily as a result of the slowdown in foreclosure initiations and the seasonality of REO sales. Despite the fact that operating margins in the Mortgage Services and Financial Services remained relatively consistent, the more pronounced 17% decline in operating income was driven by the revenue decline in the higher-margin Mortgage Services segment and by higher costs in the development of our next-generation technology. Net income attributable to shareholders in the third quarter of 2014 was 22% lower than the second quarter of 2014, driven by the decline in operating income and from $1.7 million more interest expense from the additional $200 million of debt we borrowed during the third quarter of 2014. From a cash perspective, we generated $14.2 million in operating cash flow in the third quarter of 2014, representing $0.06 for every $1 of service revenue. The decline in operating cash flow per dollar of service revenue was driven by timing differences in the collection of accounts receivable, and to a lesser extent, other timing differences in converting working capital to cash. We expect the fourth quarter operating cash flow to be much higher. Our accounts receivables collections have been strong through the first 3 weeks of the quarter. On August 1, 2014, we increased our debt by $200 million, which carries the same interest rate as our existing debt. We used cash during the quarter to repurchase $128.1 million of Altisource's common stock, representing 1.3 million shares at an average purchase price of $102.45 per share, invested $17.6 million in facilities and technology to support our growth, and $14.9 million to acquire Mortgage Builder. We ended the quarter with $176.6 million of cash and an unused accordion feature of our senior secured term loan of $200 million. With regard to share repurchases, we believe the purchase of our shares provides a tax efficient way to return value to our shareholders when the stock is attractively priced. Slide 7 provides a summary of our share buyback restrictions, including the senior secured term loan agreement and shareholder authorization. In the fourth quarter of 2014, we intend to seek shareholder approval to increase the buyback authorization. I will now turn the call over to Bill. Bill?

Thanks, Michelle. I'm pleased to be here today to talk about the business, our exciting growth strategy and areas of investment and focus. Before we get into that discussion, I know many of you may have questions relating to the letter Ocwen received earlier this week from the New York Department of Financial Services. Since this letter was addressed to Ocwen, we do not believe it is appropriate for us to respond to questions related to the letter during the Q&A session of today's call. Turning to our strategic objectives, there are 3 on which Altisource's leadership team is very focused. First, Altisource is committed to helping Ocwen maintain its leadership position in providing sensible loan modifications and helping it run a profitable, efficient and compliant operation. Ocwen is a very large and important customer and represents a long-term profitable income stream for us. In fact, Ocwen's $2.6 million loan portfolio accounts for approximately 4.5% of all outstanding residential mortgage loans in the United States. Our second objective is executing on our strategy to diversify our revenue stream and customer base to support long-term growth. Our diversification strategy is well underway, and Altisource is building a bigger and broader range of clients. This morning, I'll discuss the progress we are making on 4 of these initiatives. The first initiative is growing our origination-related services revenue, leveraging, a, Lenders One; b, Wholesale One, our newly created mortgage broker cooperative; and c, Mortgage Builder. Lenders One has grown to 275 members, and collectively accounts for approximately 16% of the U.S. origination market. As we work to develop the technology solution that will allow the Lenders One members to order and receive our services in a seamless fashion, we are focused on continuing to strengthen our value proposition to the members. The Wholesale One cooperative is still in its infancy and we are just beginning to implement our go-to-market strategy. Additionally, in the third quarter of 2014, we acquired Mortgage Builder, and are pleased to include Mortgage Builder as the newest member of the Altisource family of companies. Mortgage Builder enhances our technology offerings to include a loan origination system with the marketplace. Through Mortgage Builder's marketplace, we plan to offer origination-related services to its 200 customers. We are also developing other non-mortgage cooperatives and expect to launch at least one of these cooperatives by the end of the year. Our second strategic initiative is the development of our next-generation technology. We expect to begin offering our REALAnalytics technology to the broader market in late 2015. REALAnalytics provides advanced analytical models as a service, combining consumer behavior sciences, sophisticated data models and web services technologies to help clients achieve better outcomes without the time or cost of major technology upgrades. Our third initiative is providing rental property management services to Altisource Residential. RESI is a valuable and growing customer of Altisource. RESI accounted for $9.9 million of service revenue to Altisource in the third quarter of 2014, an increase of 90% from the first quarter of 2014. We continue to build and develop our team to provide high-quality services to RESI as its rental portfolio grows. The fourth strategic initiative is growing Hubzu in the distressed and nondistressed real estate market. As we shared with you last quarter, we began receiving REO referrals from our new top 10 commercial bank customer in July of 2014. We are now managing over 2,000 homes for this customer. While we have only sold a few homes so far, we expect sales from these referrals to start growing in the fourth quarter of 2014 and reach a steady state by Q2 2015. Further, as we discussed with you last quarter, Hubzu recently commenced development of a retail technology platform that will enable the flexibility, functionality and velocity needed to capture value in the nondistressed or retail real estate market. We expect an initial release in mid-2015 and are making good progress. We are also evaluating potential bolt-on acquisitions that we believe will enhance our offering and accelerate our capture of nondistressed real estate revenues. Our last strategic objective is to provide compliant services and enhance our compliance management system. Compliance is an essential point of focus for our leadership team, business managers and operations personnel, all of whom are evaluated on compliance. While not an exhaustive list, some of the compliance items we are focused on include: maintaining strong compliance and legal organizations; remaining current on all the applicable and evolving rules and regulations; providing timely and effective training to our employees and ensuring that they can easily access our policies, procedures and training materials; evaluating business unit compliance and escalation practices; leveraging our compliance, quality control and internal audit organizations; and holding regular compliance oversight council meetings for each business unit to track performance, understand root cause and recommend operational improvements to strengthen compliance and reduce, if not eliminate, complaints. Of course, it goes without saying that progress on our objectives and growth initiatives would not be possible without the talented employees of Altisource. I am proud of Altisource's employees who provide high-quality services to our customers, develop new and next-generation products and drive the initiatives to support our growth. In closing, we are executing well against our strategic plan which focuses on developing a diversified revenue stream and customer base to support long-term growth and strong cash flow generation, driven by the delivery of high-quality compliant services. At this time, we would like to open up the call for questions. Operator?

[Operator Instructions] And our first question comes from the line of Mike Grondahl from Piper Jaffray.

Guys, could you talk just a little bit more about the slowdown at Hubzu? Sort of was that more internal issues or market issues that are external? Could you just talk about the trends you saw there and sort of what caused the slowdown?

Mike, this is Bill. Yes, historically, the third quarter for real asset sales for both distressed and nondistressed is slower than the second quarter, which is seasonally the strongest quarter, so I would say the slowdown is just primarily related to that.

Okay, and I saw it in part of the explanation, Michelle said something about some foreclosure initiatives. Was she just meaning they're taking longer?

No, Mike, that's a separate point. There's a slowdown in foreclosure initiations, primarily as a result of the National Mortgage Settlement. And as a result of that, that settlement, the collateral material from the custodians are required to be delivered at the front of the process so that the change in the procedures that the custodians are following, and it's just taking some time to get all the materials necessary to start the foreclosure. So as a result, there's fewer foreclosure referrals than we would have expected.

Okay. And maybe just one more. I mean, I think you guys made the point on continuing the buy back and whatnot, but you did mention sort of a strong acquisition pipeline. What's kind of an ideal acquisition for you that you're looking at? And kind of help us think about size of acquisition.

So Mike, we're generally looking at acquisitions that are in line with the marketplace strategy. During my prepared remarks, I mentioned related to Hubzu, there's a couple of interesting acquisitions that we think can help accelerate our ability to get into the retail space. We also look for acquisitions that generally have a strategic component where we can do more with it beyond just what the business was doing historically. Now take Mortgage Builder as an example, we think with Altisource as the owner, we'll be able to incrementally add additional customers, but we'll also be able to provide additional services to their existing customer base. So we look for other acquisitions like that.

Okay. And I'm sorry, one more. The 2,000 REOs that you're managing that you got from that top 10 financial institution, is that all of them or are more still coming?

No, that's what we've received so far and that's just a monthly flow. I think we've said in the past 200 to 400 per month. So we've now taken over the ...

Okay. So there's still more coming after the 2,000?

That's right. We've now taken over the legacy portfolio. We've received the monthly flow since we signed the contract, and a few weeks ago, we took over their legacy portfolio.

[Operator Instructions] And our next question comes from the line of Fred Small from Compass Point Research. Fred Small - Compass Point Research & Trading, LLC, Research Division: Maybe a little additional color on the margin in the Mortgage Services segment and sort of what drove the sequential decline there, if it's all related to just Hubzu and sales from Hubzu having a higher margin or -- the revenue, I guess, the revenue declines were there in the asset management segment where I think Hubzu flows through, you've said before, and in the insurance segment. So any additional color there is helpful.

Yes, Fred, our margins in the second quarter to the third quarter in the Mortgage Services segment were relatively the same. I think they were down 1%, and that's mix primarily, mix of services provided. Fred Small - Compass Point Research & Trading, LLC, Research Division: So do you mean the mix being less? Is Hubzu the driver of the higher-margin there?

Yes, Hubzu is certainly part of it, yes. That's probably the lion's share. Fred Small - Compass Point Research & Trading, LLC, Research Division: Okay, got it.

So in terms of margins, we're pretty flat. Fred Small - Compass Point Research & Trading, LLC, Research Division: Okay. In terms of the change in the process from the custodian with regard to foreclosure initiations, can -- how should we think about quantifying the slowdown there? Is this sort of, once the processes are all in place, the volumes -- the volumes pick back up? Because, I guess, if you're -- the Hubzu is sort of the -- or the Hubzu revenue recognition is the end of the process. Is that correct? That's sort of the actual sale, whereas you're saying that the process changes on the front end in terms of the initiation of the foreclosure process?

Yes, so, exactly. And so when foreclosures, as they pick up, as all the collateral materials are obtained, we provide some nonlegal processing work in the foreclosure space and then ultimately, those homes become REOs. That increases the inventory of REO we're managing. That ultimately gets sold. Fred Small - Compass Point Research & Trading, LLC, Research Division: Right, and so I guess it's -- is it a permanent change that slows down the inflow which will slow down the outflow?

No, no. I think over time, you're going to see the inflow increase.

Yes, Fred, what it is, is that when you have to get all the -- to initiate foreclosure today, that's initiate, not when the actual foreclosure actually occurs, it used to be at day 90, it's now at day 120. What you're also required -- it's the later of 120 or the day when you have all the documents that are required to effectuate foreclosure. So that put a large increase in demand on the custodians to provide documents to initiate the foreclosure. What it will do is it basically will then mean that once that has occurred, those process can flow through without having to collect those documents once again. So it has not been a -- it hasn't been a permanent change of the, if you will, of the resolution process. It's been more of a onetime pushing it out and then once they get caught up, that should return to more normal timelines. Fred Small - Compass Point Research & Trading, LLC, Research Division: Okay, understood. And in this case, who is the custodian?

They're big, they're large -- they're banks. Fred Small - Compass Point Research & Trading, LLC, Research Division: And so it's sort of the custodian for the trust?

Yes, yes, they're the ones who hold the documents, the note, the mortgage, et cetera.

Our next question comes from the line of Jade Rahmani from KBW. Jade J. Rahmani - Keefe, Bruyette, & Woods, Inc., Research Division: On the rental platform, I was wondering if you could indicate how many people were working on the platform, either directly employed or subcontracted, and perhaps how the headcount splits out by function, including construction, renovation, repair and maintenance as well as leasing.

Jade, we don't break those statistics out separately.

[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Michelle Esterman for any further remarks.

Thank you for joining the call today. We'll talk to you next quarter.