Altisource Portfolio Solutions S.A.
Q2 2013 Earnings Call Transcript

Published: 25 Jul 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Altisource Portfolio Solutions Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Chief Financial Officer, Michelle Esterman. Ms. Esterman, please go ahead.

[Michelle D. Esterman:]

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 facts, are forward-looking statements. Factors that might cause actual results to differ materially are discussed in our earnings release, as well as our public filings. 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 today 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.

[William Charles Erbey:]

Good morning, and thank you for joining today's call. We're pleased with Altisource's strong second quarter performance. We achieved record revenue and earnings per share. The growth in revenue and earnings is primarily from the initial Homeward non-GSE loan referrals that were boarded onto our servicing system in the first quarter and the expansion of the Financial Services business, which is gaining traction. We recognized virtually no benefit from the ResCap portfolio in our Mortgage and Technology Services segments. Last quarter, I shared with you our perspective on the mortgage default and origination markets and Altisource's future growth opportunities. This morning, I'll provide a progress update on those growth opportunities, Michelle will discuss our financial results for the quarter and Bill will describe our second quarter operations and growth initiatives in greater detail. We're encouraged by Ocwen's recently announced agreement to purchase $78 billion of mortgage servicing rights from OneWest. As you can see on Slide 7, between 25% and 30% of the non-GSE loans and between 20% and 25% of the GSE loans in the portfolio are delinquent. This acquisition will drive meaningful default- and technology-related revenue and earnings growth to Altisource. As we have discussed with you in the past, Altisource's strategy is to grow its long-term earnings by 15% per year as a capital-light company, generating substantial operating cash flow, irrespective of the economic cycle we're in. As you can see on Slide 4, even with virtually no benefit from Ocwen's acquisition of the ResCap servicing platform, we grew servicing revenue by 27% in the second quarter of 2013 compared to the first quarter of 2013. Turning to Slide 8. We updated the revenue growth scenario graphs we shared with you last quarter to include Ocwen's announced OneWest servicing rights acquisition. The key revenue driver assumptions used for the 2 scenarios and the actual performance for each of these drivers for the first half of 2013 are set forth on Slide 9. In order to provide a conservative approach, we continue to assume that delinquency rates decline at the same rate as Moody's estimates. Additionally, we have not assumed that any of the cash generated by Altisource is reinvested in the business. The only difference between the 2 scenarios presented is the assumed servicing acquisitions by Ocwen. In scenario 1, we assumed that Ocwen does not acquire any additional private-label servicing rights beyond those that they have already -- that have already been announced. And in scenario 2, we assume that Ocwen acquires $100 billion of private-label servicing rights per year for the next 3 years. Each of these scenarios generates meaningful service revenue growth and substantial operating cash flow for Altisource. Further, given Ocwen's belief that $1 trillion of additional servicing will be sold, we believe those scenarios are conservative. As you can see in these 2 scenarios, with the 65% expected increase in the number of non-GSE loans within Ocwen's servicing portfolio in the fourth quarter of 2013 compared to the second quarter of 2013, we anticipate that we will experience substantial revenue and earnings growth in 2014. We intend to use cash flow to buy back shares and to make acquisitions that meet our strategic growth and return objectives. As you can see from the graph on Slide 8, we're primarily focused on 3 revenue initiatives beyond default-related services

[Michelle D. Esterman:]

Thank you, Bill. This morning, we reported second quarter 2013 service revenue of $161.7 million, net income attributable to shareholders of $30.9 million and diluted earnings per share of $1.25. Slides 4 through 6 provide highlights of our results for the current quarter compared to the prior period. We're very pleased with our operating results, given virtually no benefit in the Mortgage and Technology Services segment from Ocwen's acquisition of the ResCap servicing platform and the excess staff we're carrying in the Mortgage Services segment to support the 65% increase in the number of non-GSE loans on REALServicing by the fourth quarter of 2013 compared to the second quarter of 2013. Service revenue increased 27% from the first quarter of 2013, primarily due to Ocwen's Homeward acquisition, along with the expansion of the Financial Services segment. Generally, we begin receiving referrals once loans are boarded on REALServicing, although we do work with Ocwen to capture referrals in advance of boarding when it makes business sense. The Homeward non-GSE portfolio was boarded on REALServicing during the first quarter, and we anticipate that Ocwen will board the ResCap and OneWest non-GSE portfolios in the second half of 2013. As you can see on Slide 10, service revenue per delinquent loan for non-GSE loans, the primary driver of our default-related services revenue, increased from $354 in the first quarter of 2013 to $371 in the second quarter of 2013. The increase was due to the heightened volume of property inspection and preservation referrals on the Homeward portfolio. Net income attributable to shareholders in the second quarter of 2013 was 12% higher than the first quarter of 2013, primarily from revenue growth, partially offset by higher interest expense from the additional $200 million of debt obtained in May. If net interest expense were the same as the first quarter, second quarter earnings per share would have been $1.34 or 22% higher than the first quarter. From a cash perspective, we generated $67.5 million in operating cash flow in the first half of 2013, representing $0.23 for every $1 of service revenue. During the second quarter, we borrowed $200 million and amended the senior secured term loan agreement to provide additional share buyback capacity. We used cash during the quarter to purchase the ResCap fee-based business for $128.8 million; to repurchase $29.6 million of Altisource common stock, representing 313,000 shares at an average purchase price of $94.49 per share; and to invest $6.4 million in facilities and technology to support our growth. At the end of the quarter, our cash balance was $177.8 million. We intend to use this cash to repurchase shares and to support general corporate purposes, including potential acquisitions. With very limited exceptions, our strategy for the ResCap acquisition is to manage the business through Altisource's existing platform. We're in the process of finalizing the purchase price allocation of the ResCap acquisition. We currently estimate that all of the $128.8 million purchase price will be attributable to intangible assets that will be amortized over the expected life of the ResCap mortgage servicing pool, in proportion to the anticipated revenue recognized on the ResCap portfolio. We currently estimate that approximately 90% of the intangible assets will be amortized over the next 7 years. With regard to share repurchases, we believe the purchase of our shares provides a tax-efficient way to return value to our shareholders. Slide 11 provides a summary of our share buyback restrictions, including the senior secured term loan agreement, Luxembourg law and shareholder authorization. As of June 30, 2013, we estimate that we have the ability under these restrictions to repurchase approximately $40 million of shares should we choose to do so. I will now turn the call over to Bill for a discussion of the progress we've made on our growth initiatives. Bill?

[William B. Shepro:]

Thanks, Michelle. Our 2013 strategic growth initiatives are

[Operator:]

[Operator Instructions] Our first question comes from the line of Mike Hughes [ph] from Exane.

[Unknown Analyst:]

Just wanted to check in with you on share repurchase. Is there anything specific -- what's the Luxembourg law constraint that you have that limits you to $80 million? And is that something that can be revisited or reopened at some point?

[Michelle D. Esterman:]

Sure. In Luxembourg, we're limited generally by our level of retained earnings, and this is dictated by Luxembourg law. So as we earn more money, we have more capacity to repurchase shares.

[Unknown Analyst:]

Okay. And second question. There's a lot of rumblings in the industry about substantial additional portfolios of loans that may be coming up for sale later this year. I presume, Bill, that that's something that you guys are acutely interested in. And maybe you could confirm that you're seeing some of these portfolios?

[William Charles Erbey:]

I have to be a little careful because this is an Altisource call. But yes -- I mean, I think that's -- there is a very target-rich environment in terms of portfolios available today. And the trend that we've identified that made -- the large banks are in fact focusing their portfolios on their core client base. I think it will continue, and I think that provides some significant opportunities for all the participants in this space.

[Operator:]

And our next question comes from the line of Carter Malloy from Stephens.

[Carter Malloy:]

So first, just to follow up on the buyback question there. Given that you do have at least a pretty good sized capacity right now, what's the reason for not buying back more shares in the 2Q or 3Q periods? And are you guys doing that opportunistically, or is that more of a measured approach, sort of daily buyback?

[William B. Shepro:]

Yes. Carter, it's Bill. Yes, our plan is to continue to buy back shares going into the third quarter, and we do it on a daily basis.

[Carter Malloy:]

Okay. And then on the default margins being up 7%, I know that's the biggest chunk of the bottom line. But overall margins, is it safe to say that that's probably at least like a 5% bump to overall operating margins?

[William B. Shepro:]

Yes. I'm not sure we're prepared to give that guidance, Carter, but we're very -- the default margins, just to give you a sense, we're only going to add a couple hundred employees between now and the end of the year and we're adding a large number of loans in the default space. So that's going to help us quite a bit toward achieving the 7% increase by the end of the year. And our origination business, today, we're very focused on growing that business. As you know, in the appraisal management business, the margins are a little bit lower, so that brings down the overall margins on the origination side. But the balance of the origination business has very attractive margins.

[Carter Malloy:]

Okay, And actually so on that origination business as well, outpacing the market currently without a doubt. But looking into next year, a much, much more difficult operating environment, and you guys expect to continue to grow that. So what's the primary driver of that confidence in terms of is it product adoption, or is it new customers -- or new members, rather?

[William B. Shepro:]

We're signing service agreements with the membership at a very rapid clip. And when we do provide services to the members, they're very happy with the results. And we're also growing our relationship with Ocwen and their origination platform. And we're providing, for example, title insurance on their new loan originations. And that program is going very well as well.

[Carter Malloy:]

Okay. So you would expect Ocwen to be a meaningful portion of that origination services, say, in 2014?

[William B. Shepro:]

I expect them both to be.

[Carter Malloy:]

Okay. Great. That's helpful. And then, one last one is just there's a pretty big spike in Financial Services. One, is that good profitable revenue? And, two, what's the major driver there?

[William B. Shepro:]

Sure. I think, 2 things

[Operator:]

And our next question comes from the line of Mike Grondahl from Piper.

[Michael J. Grondahl:]

The first one, last quarter, on kind of your 5-year forward-look chart, I think you also referenced, in scenario 1, $950 million of service revenue and, in scenario 2, $1.45 billion in 2017? Have you updated those numbers by adding in OneWest?

[William B. Shepro:]

Yes. Mike, the -- both scenarios now include the OneWest loans.

[Michael J. Grondahl:]

Okay. But have those numbers changed, the $950 million and the $1.45 billion?

[William B. Shepro:]

Michelle, jump in. But of -- I would -- of course, they've changed, right?

[Michelle D. Esterman:]

Yes, they have changed.

[Michael J. Grondahl:]

Are you providing those new numbers?

[William B. Shepro:]

Mike, we didn't include it on the slide this quarter. We can take a look at that.

[Michael J. Grondahl:]

Okay. Great. And then, just a couple modeling questions. Do you have the non-GSE ending loan account at June 30? And also, for the GSE, the ending loan account?

[William B. Shepro:]

Michelle, I think you have that number.

[Michelle D. Esterman:]

Yes. I mean, we have the average loan count for the delinquency on Slide 10.

[William B. Shepro:]

And then ending count was pretty close to that, wasn't it, Michelle?

[Michelle D. Esterman:]

That's right. Because the majority of your boardings happened in the first quarter.

[Michael J. Grondahl:]

Okay, okay. And then, as it relates -- I think I read in the Q that you had $9 million of intangible amortization in 2Q. What will that run rate be in 3Q and 4Q?

[Michelle D. Esterman:]

We'll recognize our amortization in proportion to the revenue that we recognize on the Homeward and ResCap portfolios. So as we see the revenue from those portfolios increase, you'll also see the amortization...

[William B. Shepro:]

So do you have a rough estimate to what you think that could be? Just rough?

[Michelle D. Esterman:]

Yes, it's a little bit higher than where it is this quarter.

[Michael J. Grondahl:]

Okay.

[Michelle D. Esterman:]

Well...

[Michael J. Grondahl:]

Go ahead, Michelle.

[Michelle D. Esterman:]

It'll be higher than this quarter.

[William B. Shepro:]

Yes. But I think it will be – right, Michelle given we're adding all the ResCap loans...

[Michelle D. Esterman:]

That's right.

[Michael J. Grondahl:]

Okay. And then, with Hubzu, how should we think about that over the next year? I mean, is the main push there still getting the direct-to-broker signed up and this -- a third-party or 2?

[William B. Shepro:]

Yes. Mike, we're in very active dialogues with other asset managers and servicers about providing Hubzu to them on the distressed space. But at the same time, I'd say we've made very, very good progress in July on the rollout of our direct-to-broker program. I mean I think we added over 700 properties in July that were listed directly by brokers, the majority of which are non-distressed. And we're in very active dialogues to add substantially more properties to that program. So the reception we're getting on the direct-to-broker has been really positive.

[William Charles Erbey:]

And the growth rate we're expecting there has even exceeded what it was this past year. I mean, it's -- there's a lot of extremely positive momentum in that space.

[Michael J. Grondahl:]

Great. And then, last question. If your SG&A was $29.8 million. But I think, to be fair, I got to back out $9 million for intangible amortization. So am I understanding this right? I mean, basically, your SG&A was up $1 million from 1Q and, yet, you added all of those loans?

[Michelle D. Esterman:]

That's correct. And as we talked to you last quarter, we are adding some costs in our corporate and technology segments. As we project, we will be growing and we're doing that in order to support that growth.

[William B. Shepro:]

Yes. And, Mike, that's going to contribute also to our margin improvement because SG&A is primarily a fixed cost for us. And so, it is going to grow to some degree as we have some corporate staff, for example. But it's not going to grow nearly at the pace we're growing our revenue.

[Operator:]

And our next question comes from the line of Steven Eisman from Emrys Partners.

[Eduardo Cabral:]

This is Eduardo in for Steve. I guess on trying to pinpoint, like, the 65% increase in non-GSE. Is it safe to assume that you can multiply the $371,000 times the 285,000 to get about $100 million of non-GSE revenue and gross that up at 65%?

[Michelle D. Esterman:]

Sure. So if we look at the 65% and what that could mean, if you look at Slide 7 and take the midpoint of that range, that would tell you that there are about 123,000 delinquent non-GSE loans that will be coming onboard. And our revenue per non-GSE loan for the last 12 months, from Slide 10, if you add those up, gives you $1,433 per non-GSE loan. So that results in $176.3 million of revenue. And we've told you we're increasing our margins by 7 percentage points. Mortgage Services had a margin of 40%. So if we take that to 47%, that gives you $82.8 million of operating income.

[William B. Shepro:]

And just to be clear, that's only related to non-performing, non-GSE loans. That doesn't include the technology revenue we generate and some of the infrastructure and other fees we generate or the charge-off business.

[William Charles Erbey:]

Nor does it account for the 7 point pickup on the existing business. Correct.

[Eduardo Cabral:]

Got it. Got it. Okay, okay. So said a different way, margins going -- total margins at around 43% could be going closer to -- could be closer to 50%?

[William B. Shepro:]

Yes, I think what we said is, in the Mortgage Services business, you're going to see last year, our full year operating margins were about 40%, I think. And that's going to grow up to about 47%. It'll be brought down a little bit by the origination-related work, which is lower margin. But that's a rough proxy.

[Operator:]

[Operator Instructions] Our next question comes from the line of David Haas from Moore Capital.

[David Haas:]

I just had a quick question on, Bill Erbey, something you said on the last call. You gave us a good sensitivity of operating cash flow based on the current market cap back on April 25, based on the 1 and 2 scenarios. In the first one, you suggested that 59 -- that operating cash flow over the course of the next 5 years would, sort of, generate 59% to 83% of market cap in scenario 1. In scenario 2, it was 82% to 114%. Now the market cap is obviously a lot higher. But you've also done the OneWest deal. I was wondering if you can update us on those numbers.

[William Charles Erbey:]

I don't have that. Michelle, do you have any estimate or is that something we've got to follow up with?

[Michelle D. Esterman:]

We can follow up. I don't have it at my fingertips right now.

[David Haas:]

Okay. I guess, maybe just food for thought and if you could -- I'm not sure if you can confirm my numbers, but we were coming out with, based on the market cap back on April 25, it suggested that the 59% to 82% range back then was roughly $9 per share on average over 5 years of operating cash flow to $12.25 at the 82% level if you just averaged it on a per share basis over 5 years. I would assume that those numbers also rise with the OneWest transaction.

[William B. Shepro:]

Yes. David, I'm not sure we can -- I'm not sure we're prepared to give that kind of guidance on this call. But I think the one way to look at it is once you get your new revenue -- your service revenue number, you can estimate how much operating cash flow we're going to generate off of that service revenue. And we give you that each quarter. And that will give -- you pretty quickly could run the math to see, under both scenarios, how much cash we'll generate compared to our market cap.

[Operator:]

And our next question comes from the line of Lee Cooperman from Omega Advisors.

[Leon G. Cooperman:]

This is much more of a top-down kind of question. The great Warren Buffett says that stock repurchase makes sense only under 1 condition and 1 condition only, that is if you're buying something back that's significantly undervalued. I think we've learned over the last decade that more often than not, companies are making a mistake. You obviously would be more diligent than most because I think about 30% of the equity or thereabouts is owned by insiders led by Bill. So I'm just curious, this willingness to buy back stock, I think stock is up tenfold from the initial spinout from Ocwen. What metrics are you looking at in terms of growth and earnings that lead you to believe that it's a good thing for all the shareholders to do the repurchase?

[William Charles Erbey:]

What we've looked at, Lee, in this business is that we try to keep it as a very non-capital-intensive business. So we generate -- as we generate excess cash flow, what our strategy has been is to -- and I wouldn't say dollar cost averaging, but on a consistent basis, use that cash to repurchase shares and have debt capacity, if you will, for acquisition opportunities as they become available. So in this environment with -- just leaving cash sitting around is very expensive. Our core business will really never require much cash, much investment, if you will, to achieve those returns. And so, the really -- the one-off types of requirements for cash, we won't have enough debt capacity to do acquisitions that will fit in with and extend our business mix. So it's -- I'm well aware also of the fact that most companies buy stock back at the wrong time. So we're trying to do it on a consistent basis over time as an overall strategy for the business.

[Leon G. Cooperman:]

I assume, central to that view is that you guys believe the stock is undervalued, whether to have a price objective is reasonable or not, who knows? We think it's worth 120 based upon our earnings estimates for this year or next year, year after and longer-term growth. But I'm assuming, forgetting the number that you guys are doing this because you think you're enhancing the shareholder -- returns to the shareholder that are not selling?

[William Charles Erbey:]

Absolutely. And the management team is not -- are not sellers. You look into different scenarios on Slide 8. We think those scenarios are conservative in terms of what we can generate. So we look at our current multiple in the market as being low compared to where we think it should be. We have a challenge, I think, in terms of more effectively communicating exactly where our -- what our business model is and where we're going. And we've been -- Bill Shepro and the management team and I have been spending quite a good time looking at that in terms of what is the position -- not only the marketing positioning of it, but actually how do we take the intellectual property that we have and extend that into markets that people don't think are going to be declining in terms of opportunities. So we're -- I'm very positive about the company and its prospects to continue to perform as it has over the past 4-or-so years since it -- we went public.

[Operator:]

Well, at this time, I'm not showing any further questions. I would like to turn the call back over to Michelle Esterman.

[Michelle D. Esterman:]

Thank you, everyone, for joining today's call, and we look forward to talking with you next quarter.

[William B. Shepro:]

Thanks.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.