Earnings Transcript for ASPS - Q4 Fiscal Year 2022

Operator: Good day and thank you for standing by. Welcome to the Altisource Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker, Michelle Esterman, Chief Financial Officer. Please go ahead.

Michelle Esterman: Thank you, operator. We first want to remind you that the earnings release, Form 10-K and quarterly slides are available on our website at www.altisource.com. These provide additional information investors may find useful. Our remarks today include forward-looking statements, which involve a number of risks and uncertainties that could cause actual results to differ. In addition to the usual uncertainty associated with forward-looking statements, the continuing impact of government and servicer responses to the COVID-19 pandemic, together with the current economic environment, make it extremely difficult to predict the future state of the economy and the industries in which we operate as well as the potential impact on Altisource. Please review the forward-looking statements section in the company’s earnings release and quarterly slides as well as the risk factors contained in our 2022 Form 10-K, which describe factors that may lead to different results. We undertake no obligation to update statements, financial scenarios and projections previously provided or provided herein as a result of a change in circumstances, new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. In our earnings release and quarterly slides, you will find additional disclosures regarding the non-GAAP measures. A reconciliation of GAAP to non-GAAP measures is included in the appendix to the quarterly slides. Joining me for today’s call is Bill Shepro, our Chairman and Chief Executive Officer. I’ll now turn the call over to Bill.

Bill Shepro: Thanks, Michelle. Good morning. We will begin with Slide 4. I am encouraged by our progress in 2022 and early 2023 as we execute on our plan to recover from the impact of the COVID-19 pandemic. In 2022, we grew revenue and adjusted EBITDA in our countercyclical servicer and real estate segment as we began to benefit from the restart of the default market, product mix and cost savings. In both of our segments, we grew our sales pipeline and won significant new business that should contribute to revenue and earnings growth in the coming quarters. We also reduced our cost structure and improved our operating efficiency. As a result, gross profit and margins improved to 15% from 4% in 2021 and 2022 adjusted EBITDA loss was $15 million better than 2021. In February of this year, we also took substantial steps to strengthen our balance sheet by extending the maturity dates of our term loan and revolver and raising equity. Turning to Slide 5. In February, we amended and extended the terms of our existing senior secured term loan facility and revolver to April 2025. Under the terms of the amended credit term loan facility, we can reduce the payment in kind or PIK interest rate and the number of warrants granted to the term loan lenders based on certain aggregate pay-downs made prior to February 14, 2024. We can also extend the maturity date of the term loan facility and a revolver by an additional year to April 30, 2026, with $30 million of aggregate pay-down on the term loans as more fully described in our 10-K filing. In February, we also generated approximately $21 million in net proceeds from the sale of common stock and used $20 million to reduce the principal balance of our term loans. As a result of this par pay-down, we reduced the PIK interest component of the term loans to 4.5% from 5% and the number of warrants granted to the term loan lenders to approximately $2.6 million from $3.2 million. Moving to Slide 6. As we look to 2023, we anticipate revenue growth, margin expansion and positive adjusted EBITDA, driven by a continuing recovery of the default market, sales pipeline growth and wins, a lower cost base and scale. Our financial performance through February 2023 and our current cash balance are in line with our expectations. Furthermore, there is potential revenue and adjusted EBITDA upside in our countercyclical default business from a softening of the broader economy and the significant number of servicing portfolios reported to be in the market for sale, if acquired by our customers. Turning to Slide 7 and our countercyclical servicer and real estate segment, 2022 marked the beginning of the recovery of the default market. In 2022, we grew service revenue by 4% to $112 million and adjusted EBITDA by 40% to $31 million compared to 2021. We also improved our gross profit margins to 34% from 24% and our adjusted EBITDA margins to 28% from 21%. Our revenue growth reflects the beginning of the recovery of the default market and adjusted EBITDA and margin improvements reflect scale, product mix and cost savings. We anticipate the default market to continue its recovery through 2023 and reach a stabilized environment in the middle of 2024. While it’s difficult to predict the manner and timing of the recovery of the default market, Slide 8 demonstrates what Altisource’s run rate revenue and adjusted EBITDA could look like should the market recover to a normal pre-pandemic default operating environment. This slide is similar to the one that we shared with you last quarter and illustrates that in a normal pre-pandemic default market, Altisource could generate $42 million of adjusted EBITDA and $247 million of service revenue with upside from sales wins and a deteriorating economic environment. Slide 23 in the appendix summarizes the assumptions we used in arriving at the run-rate scenario. The time it will take to reach a stabilized default environment is driven by three market factors

Operator: [Operator Instructions] And our first question will come from Raj Sharma of B. Riley. Your line is open.

Raj Sharma: Yes. Hi, thank you for taking my questions. I just – Bill or Michelle, I just wanted to understand – I know you remarked on this during your prepared remarks, but is the Q4 expense and gross margin level that you just saw vast improvement. Is that a level representative of the SG&A and the gross margin just going forward? Or were there any one-off savings in both in Q4?

Bill Shepro: Raj, I’ll start and I’ll let Michelle fill in some of the details. So we improved in the fourth quarter, but there were a couple of items where we pulled three quarters of savings into the fourth quarter. One was related to bonus reversals and the second was a technology where we were able to renegotiate the pricing. I think the technology savings was about $1.9 million that we took in the fourth quarter, and we will benefit from that savings in 2023. And then there was a bonus reversal of a little bit over $4 million as my recollection, and we took all of that in the fourth quarter. So when you – if you normalize for that, we anticipate our first quarter will be better than the fourth quarter. But typically, our first quarter is seasonally slower like the fourth quarter, and then you start to see seasonal improvements in the second and third quarters.

Raj Sharma: Got it. Thank you. And then just on the cadence of just pick up in the default service revenue, when do you – have REO sales started to see a pickup already? Or is that still too early? I mean, from the business that you – that was the revival early in 2022?

Bill Shepro: Yes. So the increase in foreclosures that started in early ‘22, look, there is a standard deviation around the mean, if you will. So we’re not – we don’t anticipate if it takes 2 years for a foreclosure on average, some states are much faster, some states are much lower, you wouldn’t expect those to get through the process on average until the first quarter of ‘24, and that’s when you start to have the foreclosure auctions and then 6 months later, the sale. So, I think our – you see our foreclosure inventory – I am sorry, our REO inventory and foreclosure auction inventory in the presentation, in the appendix is holding up and maybe up a little bit from last quarter, but not nearly as much as we would expect as more time goes by and the market normalizes.

Raj Sharma: Thank you. Very helpful. And then just finally, I wanted to understand these new sales wins in the Default Services segment. Do they represent an incremental volume from sort of a return to normal pre-pandemic conditions? If you went back to 2019, the revenue levels that you were seeing there, these sales wins are incremental to those – to that business.

Bill Shepro: So, in our – sort of in our plan for the year, if you will, Raj, we always assume a modest amount of revenue growth from sales wins. And so these would contribute toward those sales wins. And of course, we don’t expect them to be stabilized this year given the timing of when we are going to launch that government contract in the third quarter. From the perspective of that government contract, I would think of that as in today’s environment, the government estimates that to be a very large contract to our teaming partner that we are working with. And then we have a teaming agreement that’s in place today where we would receive a minimum of 30% of their volume for the services that we provide. So, of course should the default market or delinquency rates increase that opportunity could increase compared to how we are thinking about it today.

Raj Sharma: Great. Thank you for answering my questions. I will take it offline again. Thank you.

Bill Shepro: Thank you, Raj.

Operator: [Operator Instructions] And our next question will come from Mike Grondahl of Northland Capital Markets. Your line is open.

Mike Grondahl: Hey guys. Hey Bill, could you describe that second large win you talked about, I think you said you were going to provide construction risk mitigation, which started in February, and then that will transition into or support some title work and whatnot. I guess, just describe what you are doing in providing there and how it ends up with title work?

Bill Shepro: Great. Yes. Thanks Mike. So, we are working with one of the largest originators in the country and help them basically stand up a construction lending to permanent loan program. And so the first step in that program is to essentially approve the contractors that are going to be providing the construction work for this lenders, borrowers, if you will. And then the second step is if that contractor is approved and the loan is approved, we manage all the construction draws related to that residential construction loan. And in some cases, not all cases, we will be providing the title insurance associated with those – with the construction loan and draw request.

Mike Grondahl: Got it. And so what the initial work started in February and you are approving contractors, then once they get approved, they go out and start building homes and selling them and you get involved, there is more upside when you provide the title work, I would imagine. But you are filling the funnel with contractors now.

Bill Shepro: So, Mike, I would look at it this way. The contractor review is still – we get paid fairly well for doing that. But the juicer work is doing the draw request. So, we basically confirm the work was done on the home before the contractor has paid their draw. And also to the extent we are providing the title, we would make sure that title is clean and free of liens at the time that the draw request is paid. We won’t get the title work on all the business, because in some cases, the borrower may choose the title policy. It really depends on the state. And in some cases, where the lender determines the title company, we anticipate we will have a higher take rate.

Mike Grondahl: Got it. And can you market this to other originators other than this big large originator?

Bill Shepro: Yes, absolutely. This is inside of our Granite business, which is in our Servicer and Real Estate segment. And we do work for many. We have many customers, many bank customers, and we are looking to take sort of the same – a similar program that we established here to others. But we are pretty excited about this large lender that we are doing work with today because as they roll the program out to their mortgage brokers there is a large opportunity to grow it. And so we are pretty excited about this one.

Mike Grondahl: Got it. And on the cost front, I think you mentioned some initiatives that took place in early ‘23, any update on those or are those just kind of a continuation of what you have been doing in the last couple of years?

Bill Shepro: Yes. I think they were primarily in the Origination segment. We are very focused on making sure each of those businesses are profitable or close to profitable. And so we made some changes inside of one of those business units to improve its profitability in the fourth quarter and continued some of that into the first quarter.

Mike Grondahl: Got it. And then I think you have said, we can expect some sequential revenue growth in 1Q and then for the full year, you expect some revenue growth and slight positive EBITDA. Is that the right way to think how ‘23 is kind of setting up?

Bill Shepro: Yes. So, I think in our Origination segment, we anticipate sequential revenue growth in the first quarter. Company-wide, I think – Michelle, correct me if I am wrong, I think we are anticipating some modest – flat to modest sequential revenue growth in the first quarter, but it will be lower. We anticipate it will be lower than the first quarter of last year. The first quarter of last year was a very strong origination market, and then it basically fell off the cliff in the second quarter. So, it’s a difficult comp overall because the company’s revenue in the first quarter of last year was higher from that market from the origination market. For the full year, we anticipate positive adjusted EBITDA, and we also anticipate revenue – year-over-year revenue growth compared to the prior year company-wide.

Mike Grondahl: Got it. And last question for me. On the balance sheet and the debt, after you restructured the debt, extended it and issued some equity, are you sort of in a wait and – I mean you have 2 plus years now, are you sort of in a wait-and-see mode to see how this recovery plays out, or do you expect to take other actions in ‘23?

Bill Shepro: Yes. I mean I think just from a starting perspective, we feel very good about where our balance sheet is today. And I think we are sitting today on $47.5 million of cash, something like that. But don’t hold me to the exact number. By raising that equity, we were able to reduce the PIK interest rate and using that money to pay down the loan to 4.5% from 5%. We have reduced the warrants from $3.2 million to $2.6 million, if we raise another $10 million between now and February of next year. So, we have got plenty of time in terms of thinking about it. But an additional $10 million pay-down on our debt from an equity raise would lower the warrants from $2.6 million to $1.6 million and it lowers the PIK interest rate by another 75 basis points to 3.75%. That also gives us the option to extend that loan out to April of ‘26. So, I think from a cash and liquidity perspective, we are in a good position right now. And we have some flexibility in terms of the timing to think about when we would want to raise that that additional $10 million to get those benefits I have just described.

Mike Grondahl: Got it. But it does have to be raised from external sources. You can’t use any of your existing cash?

Bill Shepro: That’s right. It has to be from either a junior equity or a traditional equity raise.

Mike Grondahl: Got it. Okay. Thanks and good luck in ‘23.

Bill Shepro: Yes. Thanks Mike. I should just clarify, junior debt or an equity raise, not junior equity.

Mike Grondahl: Okay.

Operator: [Operator Instructions] And I am showing no further questions. I would now like to turn the conference back to Bill for closing remarks.

Bill Shepro: Thank you, operator and we appreciate everyone’s support and look forward to talking to you again soon.

Operator: This concludes today’s conference. Thank you for participating. You may now disconnect.