Altisource Portfolio Solutions S.A. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Altisource provides mortgage, real estate, consumer-debt and technology services through Mortgage Services, Financial Services and Technology Services. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $252.7 | $272.8 | $758.7 | $781.6 |
| Service revenue | $239.8 | $245.5 | $715.4 | $689.9 |
| Gross profit | $78.7 | $98.9 | $241.4 | $266.7 |
| Operating income | $24.9 | $47.6 | $79.7 | $119.0 |
| Net income attributable to Altisource | $10.6 | $37.0 | $49.1 | $86.7 |
| Diluted EPS | $0.54 | $1.82 | $2.49 | $4.19 |
| Operating cash flow | Not separately stated | Not separately stated | $106.0 | $109.2 |
Q3 total revenue declined 7% year over year; service revenue declined 2%. For the nine-month period, total revenue fell 3%, while service revenue rose 4%. Reimbursable expenses, which are passed through without margin, fell 54% year over year in both periods. Gross profit as a share of service revenue was 33% in Q3 and 34% year to date, versus 40% and 39%, respectively, a year earlier. Operating income as a share of service revenue fell to 10% in Q3 and 11% year to date, from 19% and 17%.
- Segment trends, nine months: Mortgage Services service revenue increased 16% to $569.0 million; Financial Services declined 14% to $57.4 million; Technology Services declined 25% to $120.3 million.
- Mortgage Services growth reflected property preservation referrals, Hubzu auction activity and origination services, but margins weakened with a greater mix of lower-margin preservation work and increased compensation and technology costs.
- Financial Services revenue fell mainly because the company reduced or ended work for certain unprofitable clients and volumes shifted between customers. Technology Services revenue fell with lower Ocwen infrastructure work, lower pricing for certain software services and fewer loans on REALServicing.
Cash, debt and liquidity
- At September 30, cash and cash equivalents were $134.9 million, available-for-sale securities were $45.2 million, and current assets and current liabilities were $313.6 million and $132.1 million, respectively.
- Long-term debt had $481.1 million principal outstanding ($474.6 million net carrying amount); the stated interest rate was 4.50%, with maturity on December 9, 2020. Debt principal declined from $536.6 million at December 31, 2015. The company repurchased $51.0 million par value at a 13.2% average discount and recognized a $5.5 million gain during the first nine months.
- Nine-month operating cash flow was $106.0 million. Investing used $74.1 million, including $48.2 million for Residential common shares and $9.6 million for the Granite acquisition. Financing used $76.3 million, including $49.2 million for debt repayments and repurchases and $34.3 million for share repurchases. Cash declined $44.4 million to $134.9 million.
- Management said it expects operating cash flow to cover capital expenditures and required debt and interest payments over the next 12 months. It also reported $4.0 million of shares remaining under the repurchase authorization; repurchases are subject to debt-covenant restrictions.
Changes, outlook and risks
- Q3 net income attributable to Altisource fell 71% year over year, and nine-month net income fell 43%. Lower gross profit, higher SG&A and the absence of a $7.6 million Equator earn-out gain recorded in 2015 contributed to the decline. The nine-month 2016 results also included a $5.5 million gain on debt extinguishment and $3.4 million of expenses related to the Residential-share investment.
- The effective tax rate was 39.0% in Q3 and 20.1% for the nine months; management cited a higher expected 2016 rate and prior-quarter true-ups. It anticipated an approximately 20% annual effective tax rate.
- Ocwen accounted for 56% of consolidated revenue in both Q3 and the first nine months of 2016. A further 19% of revenue in each period related to Ocwen-serviced portfolios where another party selected Altisource. Ocwen’s regulatory, servicing-rights and licensing risks could reduce Altisource’s business or affect pricing. Management cited diversification initiatives and the variable nature of costs as mitigants, but gave no assurance of success.
- Management identified seasonality in property sales and lawn maintenance, generally weaker in fall and winter, and in Financial Services collections, typically stronger in Q1.
- Litigation includes a securities class action and shareholder derivative matters. The parties in one derivative action reached a settlement at an October 13, 2016 conference, subject to a proposed stipulation and court approval. The company said it could not estimate potential losses for the lawsuits. It is also responding to government inquiries whose outcomes and financial effects were not yet estimable.
- Management reported an unresolved material weakness in internal controls concerning review of long-lived-asset impairment indicators and indefinite-lived-asset impairment analyses, primarily goodwill. Remediation was underway, with completion targeted by December 31, 2016; the weakness was not yet considered remediated.
- No specific revenue or earnings guidance was provided. The filing describes growth and customer-diversification initiatives, but cautions that they may not succeed.
Important facts for investors to verify
- Whether Ocwen-related regulatory developments, servicing transfers or pricing changes affect revenue, receivables or asset values, given the high customer concentration.
- Whether margin declines stabilize, particularly in Mortgage Services and Technology Services, and whether diversification initiatives generate profitable growth.
- Progress in remediating the material weakness and whether controls operate effectively for a sufficient period.
- Terms, potential financial exposure and court approval status of the derivative-action settlement, as well as developments in other litigation and government inquiries.
- Debt covenant headroom and cash needs alongside planned debt repayments, acquisitions and share repurchases; also monitor the value and accounting treatment of the Residential-share investment.