Real Matters Inc

TSX:REAL

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Real Matters Q3 2018 Results Conference Call. [Operator Instructions]Lyne Fisher, Vice President of Investor Relations, you may begin your conference.

[Lyne Beauregard Fisher]

Thank you, operator, and good morning, everyone. Welcome to Real Matters Financial Results Conference Call for Third Quarter of 2018. With me today are Real Matters' Chief Executive Officer, Jason Smith; and Chief Financial Officer, Bill Herman.This morning before market opened, we issued a news release announcing our Q3 2018 results for the period ending June 30, 2018. The release, accompanying slide presentation as well as the financial statements and MD&A are posted in the Investor Relations section of our website at realmatters.com.During the call, we may make certain forward-looking statements that relates to our current expectations and views of future events, including but not limited to, future market share and future results. We have based these forward-looking statements on our current expectations and projections about future events and financial trends that we believe might affect our financial condition, results of operation, business strategy and financial needs. A comprehensive discussion of the risks that impact Real Matters can be found in the company's annual information form dated December 27, 2017, which is available on SEDAR and on our website. Actual results may differ materially from those indicated or underlying forward-looking statements as a result of various factors, including those described under the heading Important Factors Affecting Results from Operations, outlined in the Strategy and Outlook section of the company's MD&A for the 3- and 9-month periods ending June 30, 2018.As a reminder, we refer to non-GAAP measures and key performance indicators in our slide presentation, including market share, net revenue, net revenue margins, adjusted EBITDA, adjusted EBITDA margins, adjusted net income and adjusted net income per share. Non-GAAP measures are described in our MD&A, where you will also see reconciliations to the nearest IFRS measures.With that, I'll turn the call over to Jason.

[Jason Smith, Founder, President, CEO & Director]

Thank you, Lyne, and good morning, everyone, and thank you for joining us on the call. I'll kick things off today by discussing some of the key highlights of our third quarter performance. And we'll then hand it over to Bill for a deeper dive into the numbers.Our appraisal business delivered steady performance in the third quarter, as our market share continued to trend higher despite some persistent market headwinds. As we noted in our release this morning, this year's spring market did not deliver the increase in origination volumes we've seen in the past, making it a lackluster quarter for mortgage origination activity. In fact, all of the Tier 1 banks we are live with today reported double-digit percentage declines in originations this quarter compared to the same quarter last year, which ultimately affected our appraisal volumes. That said, we believe that the volume will revert to the Tier 1 banks over the long run. Outside of market factors, we maintained top ranking on Tier 1 scorecards, and we went live in new channels with several top 100 lenders in Q3. Based on today's pipeline, we expect continued channel expansion in Q4 and into fiscal 2019 with several others.Looking at the title and closing business, revenues were down 23%, in line with what we telegraphed during our last conference call. The decline in our consolidated revenues for Q3 was due to lower title and closing revenues. This also had a pronounced impact on net revenue and net revenue margins for the period. The core portion of our title business was impacted by the continued year-over-year slowdown in refi activity. And on the diversified side of the business, which accounted for approximately half of title and closing revenues in Q3, revenues in margins were down in the period.As we said in the past, this part of our business does not follow any particular cycle or seasonality. It's project-based work. While we're not investing further in diversified, we've segregated our diversified operations from our core title business so that each team can focus on their own goals and performance. On the core side, we have moved the business to our platform, and we are focused on enhancing our key performance metrics like clear to close, which is what we believe will attract new clients. We added one top 100 customer in our U.S. title business in the quarter and continue to work on the pipeline.With that, I'll hand it over to Bill. Bill?

[William P. M. Herman, Executive VP & CFO]

Thank you, Jason, and good morning, everyone. Turning to Slide 4 for a look at some of the financial highlights. Consolidated revenues for the quarter decreased 4% to $73.5 million from $76.7 million in 2017 as a result of lower title and closing revenues.Based on the MBA's estimates expressed on a unit volume basis, U.S. mortgage originations market was down 3%, which comprised of 3% increase in the purchase market and a 16% decline in refinance compared to the prior year quarter. On a market adjusted basis, our consolidated revenues increased 0.5%. And while we use the MBA to estimate market-adjusted growth, as Jason referenced in his earlier remarks, other external data points lead us to believe that the MBA's estimate of the market for the period are likely too high. In other words, we would estimate that the market was likely down closer to 10%.Turning to the U.S. segment. We reported 2 -- total U.S. segment revenues of $65.1 million, down from $67.7 million in the third quarter of 2017. Our appraisal revenues were $52.6 million and grew organically by over 5%, after taking into account the estimated market decline using available MBA data. Higher appraisal volumes from new clients and market share gains with existing clients drove this performance. Title and closing and other revenues declined $12.5 million from $16.2 million in the third quarter of 2017. Based on the MBA forecast, the unit volume of refinance mortgage originations declined 16% compared to the third quarter of 2017, which clearly impacted our title and closing revenues due to their high correlation to changes in refinance market activity. As Jason mentioned earlier, our title and closing revenues were also impacted by lower diversified revenues during the period. On a market-adjusted basis, we estimate our title and closing revenues were down 16%.Taking a look at the Canadian segment. Revenues were $8.4 million compared to $9 million in the prior year period, as lower appraisal revenues were offset in part by the positive impact of FX. And on a consolidated basis, we reported net revenue of $20.2 million, down 13% from $23.3 million in 2017, largely due to a significant decline in U.S. title and closing revenues, which, as you know, generate higher margins than appraisal, coupled with the change in the mix of the U.S. title and closing revenues we serviced in the quarter.Working our way down the income statement, consolidated operating expenses were down $3.6 million in the third quarter of fiscal 2018 compared to the same quarter last year. We reduced operating expenses in our U.S. segment by $1.9 million by trimming headcount to align with lower transaction volumes, primarily in the title and closing business, and from the integration of certain operations earlier this year. Corporate operating expenses declined $1.7 million on lower stock-based compensation expense, which was partially offset by higher developer salaries and FX. Adjusted EBITDA decreased to $0.9 million from $2.8 million in the third quarter of 2017 as a result of lower U.S. title and closing revenues and net revenue, and was offset in part by lower operating expenses. As we continue to ramp market share with lenders in the appraisal business, we expect to see increasing operating leverage.Turning to the balance sheet. We had cash and cash equivalents of $66 million at the end of the quarter, and we initiated our normal-course issuer bid in the quarter and repurchased 232,000 shares at a cost of about $1 million. We want to maintain a strong balance sheet, so we'll be thoughtful in our investment decisions, including acquisitions, strategic investment in our own business and share repurchases.With that, I'll turn it back to Jason. Jason?

[Jason Smith, Founder, President, CEO & Director]

Thanks, Bill. And so to recap our results for the third quarter, the appraisal business delivered steady performance despite a soft spring market. Our appraisal market share continued to increase. We maintained top ranking on Tier 1 scorecards. And we went live in new channels with top 100 lenders, expect to continue a channel expansion in Q4 and fiscal 2019 with several others. Title and closing revenues were down significantly, which led to the decline in our consolidated revenues, net revenue and net revenue margins. In title, we added one top 100 customer in the quarter and continue to work on the pipeline.Taking stock of our performance to date in fiscal 2018, U.S. appraisal revenues are up 4% or 15% on a market-adjusted basis using the MBA's current numbers. The number would be greater with our own estimates. We've increased our appraisal market share consistently over the course of the last 3 quarters working towards our long-term goal. Title and closing revenues were down 21% or 8% on a market-adjusted basis and facing strong market headwinds this year. As such, the appraisal business will continue to be the main driver of our near-term results. We will be reporting on our market share for both businesses at the end of fiscal 2018.There is no question, our results this year have been impacted by where we are in the U.S. mortgage originations cycle. It's why we take a long-term view and focus on growing market share. As we look to the fourth quarter of 2018, we provided an outlook in our release and MD&A. We expect fourth quarter consolidated revenues and net revenue will decline compared to the third quarter of fiscal 2018, reflecting our expectations from mortgage origination volumes, net of market share gains and new client additions. We anticipate consolidated net revenue margins will improve compared to the third quarter of fiscal 2018 due to revenue mix.With that, operator, we'd like to open it up for questions now.

[Operator]

[Operator Instructions] And our first question comes from the line of Thanos Moschopoulos from BMO Capital Markets.

[Thanos Moschopoulos, VP & Analyst]

With respect to the Tier 1 lenders losing market share, you've talked about the dynamic previously. What's your perspective on if and when that trend might start to reverse itself? And in light of the trend, are you placing more focus on penetrating some of the other lenders, like the nonbanks? Or is your focus remaining on the Tier 1s primarily?

[Jason Smith, Founder, President, CEO & Director]

We're focused -- this is Jason speaking. We're focused on good quality lenders that have a long-term market strategy and growing share with them, so we continue to target new lenders and widen our -- the breadth of customers that we have within the marketplace. With respect to the Tier 1s, in a raising interest rate environment, the sediment is that they will regain share. They are at a very low-level, regulated banks relative to -- or I should say the big Tier 1s relative to their historical norms. And so the feedback we get is that they're committed to the mortgage business and are looking forward to regaining share.

[Thanos Moschopoulos, VP & Analyst]

Great. And then in terms of the appraisal business, can you remind us the margin dynamic in a slower market assuming there is greater availability of appraisers, lower volumes. Does that in and of itself have a margin effect or are margins on the appraisal business just more a function of where you are in the ramp cycle of a new region?

[Jason Smith, Founder, President, CEO & Director]

Yes, it's more a function of a ramp cycle either in a region or what we're anticipating in terms of market growth in the next quarter. So in a declining or in a flat market, we're able to improve margins and drive that dynamic competition.

[Thanos Moschopoulos, VP & Analyst]

Okay. And maybe one last one on the title and closing business. Where do we maybe start to see the inflection point as far as the decline of diversified being offset by the growth in the new platform? I guess maybe hard to pin down, you mentioned that you have a new customer, but I guess, safe to say that we're still a few months away from that inflection point?

[Jason Smith, Founder, President, CEO & Director]

Well, I'll take the customer pipeline component of that, and then I'll let Bill speak to it in terms of the overall balance. We continue to build a strong pipeline with these customers and do anticipate growth in 2019 in terms of that market share with those customers. And then I'll let Bill reference diversified and the market declines in 2019.

[William P. M. Herman, Executive VP & CFO]

Yes, thanks, Jason. So with respect to when are we looking to rationalize into the growth, I think the short answer would be, obviously, at the right moment. Clearly, today is not the right moment. We continue to foster and support that business to continue performing as it has in the past and continue to steward those assets. So I think from a timing perspective, Thanos, it is certainly not within the next several months. I think the market dynamic, as predicted by the MBA for the rate -- for the refinance mortgage origination activity declining north of 20%, is probably not the right time to be thinking about rationalizing our core refinance activity into the growth. So with that, I think that you're probably at least a good year away before you see any activity in respect to that.

[Jason Smith, Founder, President, CEO & Director]

Yes. I think what I would add is, I think we've done the hard work in that we separated it from -- we segregated the 2 businesses, and so we've really got that focus on the organic and building the pipeline such that the diversified business won't have an impact on it. So it's good margin business, and we'll continue to focus on it and grow it.

[Operator]

Our next question comes from the line of Gavin Fairweather from Cormark.

[Gavin Fairweather, Analyst of Institutional Equity Research]

You just talked about the lower net revenue margins in appraisals, you built up capacity. How should we think about the margins specific in appraisal as we enter into your fiscal Q4 and Q1, which are the slower times of the year?

[Jason Smith, Founder, President, CEO & Director]

Yes, absolutely. Thanks, Gavin, great question. The -- I think the short -- as it relates to Q4, in particular, around appraisal margins, obviously, we're building capacity in Q3 in advance of the expectation of a spring market that, frankly, the volumes didn't spring as high as or as significantly as we would have expected. So I think you can -- we're expecting a return to a higher margin -- margins in appraisal, in particular. In light of that circumstance, in this particular quarter, on a quarter-over-quarter compared basis, the U.S. segment margin degradation, 40% or 40 basis points rather of that decline was attributable to appraisals. So we expect to get that back in Q4. And thinking forward into 2019, the plan, as laid out, frankly, some time ago, is to continue to drive additional margin expansion from the network effect in the appraisal line of business. So we continue to expect that to be paramount en route to our 2019 plan.

[Gavin Fairweather, Analyst of Institutional Equity Research]

Okay, that's helpful. And then just secondly, you talked about some of the mix within title. Can you just elaborate on some of the mix there that caused the margins to be a bit lower?

[William P. M. Herman, Executive VP & CFO]

Absolutely. So when we think of the mix, in particular, in U.S. title and closing-related services, the refinance core side of the business, frankly, the margins were as expected, they're steady and they continue to be. The diversified side of the house, which is really project-based, revenue is lumpy and is project-based. It doesn't behave like the refinance mortgage origination market, and as a consequence, it's difficult to time and understand. So really, when you look through it, it was just a composition of that revenue in this particular quarter. We serviced some lower-margin revenues in the diversified side of the house in this quarter. As we think forward into Q4, we don't expect to service that level of volumes that we serviced in Q3, and we expect a little bit of margin expansion coming out of the title and close business for that reason.

[Operator]

Our next question comes from the line of Paul Steep from Scotia Capital.

[Paul Steep, Analyst]

Could you talk a little bit on the title business as to where you are in terms of maybe the realignment that we talked about, I guess, last quarter in terms of running off some noncore business?

[Jason Smith, Founder, President, CEO & Director]

Well, this is Jason. We -- I think we're steady as we go through 2019. We do not expect any runoff in the diversified business.

[Paul Steep, Analyst]

Okay. So basically, whatever adjustments, all done and behind you. And now it's just focus on Title 2.0, right?

[Jason Smith, Founder, President, CEO & Director]

[Audio Gap]Segregated the businesses. They have separate leadership. We've done the platform work on the core. We launched one new top 100 lender on that -- on the core in the quarter. And so it's just build up pipeline and build up the market share.

[Paul Steep, Analyst]

Great. And last one for me. How should we think about share buyback here. You're sitting on a fair amount of cash. Is there a thought at the board level maybe given to looking -- or management level looking at maybe a more substantive repurchase of the shares?

[William P. M. Herman, Executive VP & CFO]

Yes. Thanks, Paul. It's Bill. As you know, we have approval to purchase up to 4 million shares, and really, we don't intend to exceed USD 30 million of purchases under the current NCIB, the sole purpose of which is to maintain a strong balance sheet. To date, as you might be aware, we've purchased 426,000 shares at a cost of about $2.4 million, and I think, strategically, what I would tell you is that we're going to be thoughtful around our share repurchase strategy weighing share repurchases against reinvestment in the business, and of course, potential acquisition opportunities as well in my view.

[Operator]

Our next question comes from the line of Daniel Chan from TD Securities.

[Daniel Chan, Research Analyst]

Just wondering if you guys can give us an update on the Tier 2 that you're beta testing on the Title 2.0 platform?

[Jason Smith, Founder, President, CEO & Director]

Yes, so the beta testing is on the purchase side of the business. It's going well. We've actually got 3 lenders that we're working with. We've been building up sort of the base case KPIs around that. And we'll continue to work through that into next quarter and into 2019.

[Daniel Chan, Research Analyst]

And is there any update on the Tier 1 pipeline in terms of title and closing?

[Jason Smith, Founder, President, CEO & Director]

Yes, look, we continue to work with our entire client base, both Tier 2s and Tier 1s. And we anticipate that we will be successful as we think forward. But we'll update on those specific clients when we actually get them live, it's just so difficult to time the live dates with these clients. So we'll update when we're actually doing transactions.

[Daniel Chan, Research Analyst]

Okay. And then last one for me. Bill, the OpEx came down sequentially this quarter. How should we be thinking about OpEx over the next year as you look at some of the origination volumes kind of come off here?

[William P. M. Herman, Executive VP & CFO]

Yes, absolutely. So from an OpEx perspective, I think I'd tell you a couple of things. Certainly, we've made some moves this year. Most notable would be the integration of our Cincinnati operations into our Buffalo and into our Rhode Island operation. So we incurred an integration charge in Q2 of this year and that really was really our realignment in reduction of headcount to better service our client base. Second to that is a charge we took in the current quarter. It really was just an alignment in the Rhode Island office, which services the title and closing business. Really, a reflection of lower mortgage origination volumes from a refinance perspective. So I think those 2 things coming into Q4 will play nicely into our Q4 OpEx. I would expect some decline on that basis for those reasons. Thinking through to 2019, I guess, I would say this. It really depends on how the mortgage market behaves. How our clients' share of the mortgage market plays through. And I don't see any significant investments, currently, in operating expenses shining through in 2019 in order to service hopefully higher order volumes through to 2019.

[Operator]

[Operator Instructions] Our next question comes from the line of David Ridley-Lane from Bank of America.

[David Emerson Ridley-Lane]

[Audio Gap]the number of U.S. appraisers on the platform has trended over the last 12 or 24 months?

[Jason Smith, Founder, President, CEO & Director]

We missed the front part of your question.

[David Emerson Ridley-Lane]

Oh, sure, I wanted to ask how the number of U.S. appraisers on your platform has trended over the last 12 or 24 months?

[Jason Smith, Founder, President, CEO & Director]

We don't have a specific stat on that, but we published, David, it's -- as volumes move around in different regions, we're really focused on having sufficient capacity to handle current volume, and then any anticipated volume. And so it flexes up and down. Obviously, we need a very long tail of -- in terms of appraiser coverage, to handle all the real markets. So the vast majority of our tens of thousands network is for coverage and that's consistent. So it's really around major urban areas where the volume is and how that shifts based on what we're seeing from our clients and as market volumes move throughout the U.S.

[David Emerson Ridley-Lane]

And I guess, tying that in to the commentary that onboarding appraisers here in the third quarter was a bit of a higher cost issue. How significant is the quarter-to-quarter movements on the number of appraisers on the platform?

[Jason Smith, Founder, President, CEO & Director]

So the real driver there is -- I mean, I think the total dollar impact in that revenue margins was 40 basis points.

[William P. M. Herman, Executive VP & CFO]

That's correct.

[Jason Smith, Founder, President, CEO & Director]

And so really, the driver is if we've got the strong base of competing appraisers on the market, and because we have volume with them, they're competing and we get better pricing. They've got better loads, but they're really focused on how we work with our appraiser partners such that they're making more in a week versus per transaction. But if we're growing share or anticipating growing share in a coming quarter, and so in terms of volume, not sure, I should say, volume is based on seasonality, then what we're doing is we're bringing in capacity with new appraisers and there -- where we don't have that volume contribution with and we don't get that network effect with those new appraisers. So that's really the dynamic, and because we didn't see the volume there, that impacted the margins in the quarter. And with our current view of the marketplace, we don't have that challenge of that issue. And so we're -- I believe that we'll see a net revenue margin increase next quarter.

[Operator]

There are no further questions at this time. Mr. Smith, I'll turn the call back over to you.

[Jason Smith, Founder, President, CEO & Director]

Well, that wraps up things for today. Thank you for joining our call. Have a great day.

[Operator]

This concludes today's conference call. You may now disconnect.