Ellie Mae (ELLI), which makes software used to simplify the mortgage loan origination process, is trading sharply lower (-20%) after reporting Q2 earnings results last night. ELLI missed on revenue and guided sharply lower for Q3 and 2017.
Originating a residential mortgage involves multiple parties and requires a complex series of transactions that must be handled accurately under tight time constraints. By the time a mortgage has been funded, the typical loan package contains over 1,000 pages of documents that come from over a dozen different entities, usually operating on disparate technology systems and databases.
Traditionally, much of the data used to prepare these documents has been gathered manually, rather than electronically, with documents exchanged among the many participants by fax, courier or mail. The entire process results in significant duplicative efforts, time delays, errors, costs and redundant paper documentation, and often exposes borrower data to privacy and security breaches. The company's goal is to be the industry standard platform for residential mortgage originations in the US. Ellie Mae's platform increases efficiency, facilitates regulatory compliance and reduces documentation errors.
In simple terms, Ellie Mae provides automation software and operates a network that facilitates the residential mortgage origination and funding process. Its cloud-based Encompass and DataTrac software suites combine loan origination with CRM (customer relationship management) to gather, review, and verify data from a single database.
As regulations have become more complex and burdensome (making compliance increasingly difficult), banks increasingly feel they can no longer rely on the traditional paper-based, error-prone way of doing things. The launch of RESPA-TILA in 2015 is a perfect example. ELLI has described RESPA-TILA as "by far the largest compliance challenge this industry has ever faced." The more rigorous compliance demands with RESPA-TILA are driving even more automation, as these vast new requirements make manual processes prohibitively costly for lenders to sustain. This is good news for ELLI and its mortgage platform which streamlines the whole process.
Finally, ELLI's software is particularly attractive to customers because of what the company calls its "Success-Based Pricing" model. With this model, customers do not have to purchase the technology. Instead, they pay a fee -- which may be passed to the borrower, to the extent permissible by law, as part of the lender's origination, document preparation and processing fees -- for each closed loan. As such, there are no upfront costs and the customer only pays when they close a loan and often they can charge the customer.
Q2 Results and Guidance
Non-GAAP EPS fell 5.6% YoY to $0.51, which was within prior guidance of $0.50-0.53. Revenues rose 15.5% year/year to $104.1 mln, which was a good bit below prior guidance of $109-111 mln. The guidance was pretty rough as ELLI now expects Q3 non-GAAP EPS of 0.38-0.41 and revenue of $104-106 mln, both of which are well below market expectations. In terms of full year guidance, ELLI lowered its non-GAAP EPS guidance pretty substantially to $1.47-1.50 from $1.79-1.92 and revenue guidance was lowered to $400-405 mln from prior guidance of $433-440 mln.
So what is going on? ELLI says the mortgage market is in the process of transitioning from a refi centric one to a purchase driven one. Some customers experienced closed loan volume lower than expected in Q2 as they dealt with declining refi volume, while the tight housing inventory held back purchase volume.
Also, ELLI saw some enterprise customers, which comprise an increasing portion of its customer base, take longer to ramp on ELLI's platform than planned. These factors led to a lower closed loan volume than expected, so ELLI is resetting assumptions for the year as the market completes this transition. Beyond this year, ELLI expects the market to normalize and for its business to resume stronger growth.
In sum, this was a tough quarter for ELLI as refi activity is finally slowing down. The stock has been having a nice run since early February when it was trading below $85, it hit a high of $114.95 recently. However, it's selling off sharply today on the Q2 revenue miss and substantial guide-down for Q3 and FY17. The strong refi market had been a nice tailwind for ELLI but it sounds like 2H17 will not be as robust as they initially expected. Hopefully, they will see some improvement in 2018.