Real Matters Inc. (REAL) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by and welcome to the Real Matters Third Quarter 2020 Conference Call. [Operator Instructions] I would now like to hand the conference over to one of your speakers today, Lyne Beauregard Fisher. Thank you. Please go ahead, madam.

Thank you, operator, and good morning, everyone. Welcome to Real Matters Financial Results conference call for the third quarter ended June 30, 2020. With me today are Real Matters' Chief Executive Officer, Jason Smith; President and Chief Operating Officer, Brian Lang; and Chief Financial Officer, Bill Herman. This morning, before market opened, we issued a news release announcing our Q3 results for the 3 and 9 months ended June 30, 2020. The release, accompanying slide presentation as well as the financial statements and MD&A are posted to the Investor Relations section of our website at realmatters.com. During the call, we may make certain forward-looking statements, which reflect the current expectations of management with respect to our business and the industry in which we operate. These forward-looking statements are based on management's experience and perception of historical trends, current conditions and expected future developments as well as other factors that we believe to be appropriate and reasonable in these circumstances. The forward-looking statements reflect management's beliefs based on information currently available and should not be read as a guarantee of the occurrence or timing of any future events, performance or results. Forward-looking information is subject to risks, uncertainties and other factors that are difficult to predict, and that could cause actual results to differ materially from historical results or results anticipated by the forward-looking information. A comprehensive discussion of the factors which could cause results or events to differ from current expectations can be found in the Risk Factors section of the company's annual information form for the year ended September 30, 2019, and under the heading COVID-19 impact on risk factors in our MD&A for the 3 and 9 months ended June 30, 2020, each of which is available on SEDAR and on our website. As a reminder, we refer to non-GAAP measures in our slide presentation, including net revenue, net revenue margins, adjusted EBITDA and adjusted EBITDA margins. Non-GAAP measures are described in our MD&A for the 3 and 9 months ended June 30, 2020, where you will also find reconciliations to the nearest IFRS measures. With that, I'll now turn the call over to Jason.

Thank you, Lyne. Good morning, everyone, and thank you for joining us on the call today. I will kick things off by discussing some of the highlights of our third quarter and our view of the market. I'll then hand it off to Brian, who will provide his remarks regarding the performance of our operations in Q3. Bill will then take a deeper dive into our segment financials, and I'll wrap up the call with some brief remarks prior to taking your questions. Turning to Slide 3. We were very pleased with our third quarter results. As we outlined in the news release, both our U.S. Appraisal and U.S. Title segments posted record adjusted EBITDA. And the performance of our U.S. Title segment eclipsed U.S. Appraisal for the first time. We generated consolidated adjusted EBITDA of $20.9 million, up from $10.4 million in the third quarter of 2019. To put this in perspective, our third quarter alone generated more than 2/3 of the consolidated adjusted EBITDA we reported in fiscal 2019. Our third quarter results continued to demonstrate the impact higher volumes have on our financial performance. Consolidated revenues increased 29.2% to $118.1 million, and we generated consolidated net revenue of $43.9 million, up 52.7% from $28.8 million in the third quarter of 2019. Our strong top line growth was driven by the performance of our U.S. segments, offset in part by a 13.1% decline in our Canadian segment due to insurance inspection services being temporarily placed on hold by our clients as a result of COVID-19. We continue to outpace the U.S. mortgage market in terms of growth in the third quarter, recording market-adjusted growth of 6.1% in U.S. Appraisal and 159.7% in U.S. Title, as a result of significant year-over-year increases in market share and new client additions. We also benefited from a very robust U.S. mortgage refinance origination market due to lower interest rates. We estimate that U.S. market volumes were up 2% in the third quarter of 2020 relative to the same quarter last year. Our estimate of the market change includes growth in the U.S. mortgage origination market of 10%, comprised of the decline in purchase volumes of 20%, while refinance volumes increased 68%. Our estimate of market volumes also include home equity and default activity, which we estimate declined a combined 40%. Home equity and default volumes comprised about 1/4 of our total volume in the third quarter. And so the impact of changes in these volumes on our total market-adjusted growth calculation are not insignificant. As we continue to grow with new clients in the larger origination channel, we expect to see a continued decline in the proportion of our volumes that are derived from home equity and default. The impact of these volume declines are also reflected in the increase of our average U.S. Appraisal transaction revenue for the period as these transactions are priced materially lower than the large origination channel. U.S. Appraisal market-adjusted volume growth for origination only volume was 14.9% in the third quarter, and we estimate that average loan sizes for purchase and refinance transactions increased about 30% year-over-year. Our estimate of loan sizes is based on internal data, which reflects the composition of our customer base and will vary from external data points because of this as large regulated lenders have the balance sheet to fund larger nonconforming mortgages. If we were to wait market-adjusted volume growth to reflect our actual third quarter volumes across origination, home equity and default, our U.S. Appraisal segment delivered market-adjusted growth of 20.1%. Third quarter U.S. Title segment revenues rose 70.9% year-over-year, and we recorded market-adjusted volume growth of 159.7%. As you know, we calculate market-adjusted volume growth based on our estimate of the total market. However, our U.S. Title segment almost exclusively services refinance activity. U.S. Title market adjusted volume growth for refinance only volume was 57.2% in the third quarter. In line with the expectations we laid out during our last quarterly conference call, the effect of volumes carried over from March applications drove U.S. Title closed volumes higher in the third quarter, buoyed by a very strong market share growth, even factoring in constrained underwriting capacity. Sequential growth in U.S. Appraisal volumes were slightly higher than our expectations as volume began to trend up toward the end of the third quarter, in line with what was reported in the industry mortgage application data as well as the steady downward trajectory of mortgage rates. Given that appraisal orders are placed at the start of the origination process, our revenues in this segment typically track applications more closely than the title business, which is more closely linked to closed or funded loans. With that, I'll turn it over to Brian. Brian?

Thank you, Jason. Sustained strengths in the U.S. refinance mortgage origination market continued to provide a healthy backdrop for our growth in the third quarter, particularly in our U.S. title business. Our results were also bolstered by significant year-over-year market share increases with our clients across both U.S. segments, including share gains across our Tier 1 lenders in U.S. Appraisal. We launched 3 new clients during the third quarter in U.S. Appraisal. We also set a new record for transaction volumes, topping the record we set in the second quarter this year. On a year-over-year basis, U.S. Appraisal net revenue was up 21.5% and net revenue margins increased 50 basis points to 24.4% as we service more higher-margin mortgage origination volumes and fewer lower-margin home equity volumes. As Jason indicated earlier, we had very strong year-over-year market share growth in our U.S. title business in the third quarter. We went live with 4 new lenders, and we set a record for transaction volumes in U.S. Title, surpassing last quarter's record by a healthy margin. On a year-over-year basis, U.S. Title net revenue was up 98.8%, and net revenue margins increased to 64.9% from 55.8% in the third quarter of 2019. The increase in net revenue margin was a result of the early March surge in volumes that benefited our U.S. Appraisal segment in the second quarter that translated into higher closings for our U.S. Title segment in this quarter, in line with what we highlighted during our last quarterly conference call. Our U.S. Title sales pipeline is stronger than ever. The team continues to advance discussions with current and new potential clients as the heightened level of refinance activity is highlighting the need for lenders to add new vendors. Today's lower interest rate environment has caused lenders to experience scalability and performance challenges with their existing vendors, and we are starting to see the opportunity to accelerate the sales cycle with top 100 lender targets. There's also a consensus building that the interest rate environment will result in a sustained level of higher refinance activity over the next several quarters and lenders are shoring up their operations ahead of this cycle. In our Canadian segment, third quarter net revenue was down 36.5%, and net revenue margins decreased to 14.1% from 19.3% on a year-over-year basis. Canadian appraisal market slowed in April and May due to COVID, but had a meaningful recovery in June. Our Canadian segment results were also impacted by a decline in insurance inspection revenues due to our clients temporarily placing these transactions on hold during the quarter due to the pandemic. At this juncture, if regions throughout Canada continue to reopen, we expect to see a return to more normal markets by August. Overall, our team delivered an outstanding performance in the third quarter, with the vast majority of our employees still working from home. We onboard and trained 56 new employees during the third quarter, the majority of whom are dedicated to supporting the growth in our U.S. title business. From a network perspective, operations continue to run smoothly. The appraisers, notaries, abstractors and other closing agents on our network are performing well despite having to navigate through this ongoing pandemic. We remain thankful for both the contribution of our employees and that of the independent professionals on our network. And with that, I'll turn it over to Bill. Bill?

Thank you, Brian. Turning to Slides 4 and 5 for a closer look at our financial results. Consolidated revenues were up 29.2% in the third quarter of fiscal 2020 compared to the same quarter last year due to significant revenue growth for both our U.S. Appraisal and U.S. Title segments, which was partially offset by a modest decline in Canadian segment revenues. As Jason mentioned earlier, our Canadian insurance inspection business was challenged by COVID-19 as our clients temporarily place their orders on hold during the pandemic. Revenues in our U.S. Appraisal segment were up 18.8% year-over-year, while revenues in our U.S. Title segment increased 70.9%. As previously mentioned, Canadian segment revenues were down 13.1% comparatively. In our U.S. Appraisal segment, we service higher origination volumes due to market share gains, new client additions, and modestly higher market volumes compared to the third quarter of fiscal 2019. Our average revenue per unit increased in the third quarter as we continue to serve a greater proportion of higher-priced origination volumes compared to lower-priced on equity volumes. Transaction costs in our U.S. Appraisal segment increased 18% year-over-year, a reflection of the increased -- increase in volume service. Net revenue of $17.7 million was up 21.5% in this segment, and net revenue margins were up 50 basis points to 24.4%, consistent with the second quarter of fiscal 2020. Operating expenses in our U.S. Appraisal segment increased 13.7% to $6.9 million, up from $6.1 million in the third quarter of fiscal 2019, the result of higher payroll and related costs due to higher volume service. This increase in payroll and related costs partially offset the increase in net revenue, resulting in a 27.1% improvement in adjusted EBITDA year-over-year. In addition, adjusted EBITDA margins in our U.S. Appraisal segment increased to 61% in the third quarter of fiscal 2020, up from the 58.3% we posted in the same quarter last year. Compared to the third quarter of fiscal 2019, we converted each incremental dollar of net revenue to adjusted EBITDA at a rate of 73% in our U.S. Appraisal segment. Third quarter revenues in our U.S. Title segment increased 70.9% year-over-year, while transaction costs increased 35.6%, leading to an expansion in net revenue margins of 910 basis points. The increase in net revenue margins was due to higher closings in the quarter, which carried over from a surge in volumes that occurred in March that Brian discussed earlier. Additionally, net revenue margins for diversified revenues expanded due to service mix. U.S. Title revenues attributable to reported volumes for this segment, meaning revenues generated from our mortgage origination clients, increased 161.2% to $31.7 million, up $19.6 million from the third quarter of fiscal 2019, and our average revenue decreased $11 per transaction with a geographic mix. Diversified revenues declined to $5.2 million from $7.8 million in the third quarter of fiscal 2019 due to lower commercial, search and capital markets activity. Operating expenses in this segment increased to $12 million, which is up from $8.5 million in the third quarter of fiscal 2019, and adjusted EBITDA increased to $13.3 million from the $4.3 million we posted in the same quarter last year. Consistent with our performance over the last several quarters, the scalability of our U.S. Title operations was once again on display this quarter, and delivered a significant improvement to adjusted EBITDA year-over-year. Compared to the third quarter of fiscal 2019, we converted each incremental dollar of net revenue to adjusted EBITDA at a rate of 72%. In Canada, revenues decreased 13.1% to $6.6 million, and net revenue margins contracted by 520 basis points due to lower insurance inspection services performed as a result of COVID-19. Canadian segment operating expenses were $0.4 million in the third quarter this year, down 38.4% from the third quarter of fiscal 2019. And adjusted EBITDA margins increased to 59.8% from 58.6% in the same quarter last year as we temporarily redeployed certain employees from our insurance inspection business to support our growing U.S. title business. Putting this all together, third quarter consolidated net revenue increased 52.7% to $43.9 million, up from the $28.8 million we reported in the third quarter of fiscal 2019, on strong contributions from both our U.S. Appraisal and U.S. Title segments, as previously noted. Consolidated revenue -- net revenue margins increased 37.2% in the third quarter of fiscal 2020, up from 31.4% in the third quarter of fiscal 2019, due in large part to a greater proportion of consolidated net revenue coming from our higher-margin U.S. Title operation. As a result of our strong performance, consolidated adjusted EBITDA rose to $20.9 million in the third quarter of fiscal 2020, up from $10.4 million in the same quarter last year. And consolidated adjusted EBITDA margins increased to 47.6% in the third quarter of fiscal 2020 versus the 36.1% mark we posted in the third quarter of fiscal 2019. Turning to the balance sheet. We ended the quarter with cash and cash equivalents of $109.5 million, an increase of $20.4 million from the second quarter of fiscal 2020, which means we placed 97% of each adjusted EBITDA dollar on our balance sheet. And while we continue to purchase shares under our normal course issuer bid, our purchase activity was modest this quarter. We bought approximately 64,000 shares at a cost of about $432,000 in the quarter. We continue to be measured and disciplined in our purchase of shares under our NCIB, focusing on the opportunity to create shareholder value over a longer period of time. And in the meantime, we're comfortable holding cash on our balance sheet. With that, I'll turn it back over to Jason. Jason?

Thanks, Bill. We delivered exceptional financial results in the third quarter, setting new records for Real Matters in terms of transaction volumes and in terms of adjusted EBITDA. We continue to grow market share with our clients, and we added new clients, which allowed us to outperform the market, a long-standing operating principle for our company. Looking ahead, we continue to believe that lender underwriting capacity remains the largest hurdle to industry growth. Once industry underwriting capacity grows, even if U.S. 10-year treasury rates increased to 1% to 1.2% and remain at those levels for the next few years, we believe this will translate into 30-year mortgage rates of no higher than 3% as spreads normalize. We believe this will create a large multiyear market opportunity for Real Matters and provide a tailwind to our market share growth strategy. Longer term, through our annual planning process, we have already begun to set our sights on the next leg of growth for Real Matters, which will unlock opportunities on the data side of the business and on the purchase title side of the business. And we look forward to sharing those plans at an Investor Day this fall. With that, operator, we'd like to open it up for questions soon.

[Operator Instructions] Your first question comes from the line of Richard Tse of National Bank Financial.

Yes. So obviously, you guys are seeing quite a bit of momentum in title and closing. I'm kind of curious to get your impression in terms of when you think we'll start seeing upscale in the Tier 1 tier.

Yes. Richard, it's Jason. The -- our title operations are, as you can see, performing very well. Market share gains with the clients, we'd already launched, launching additional clients. But what's incredible in this environment is the industry doesn't have -- or the banks don't have enough vendors to manage all their volumes. So it's actually accelerating our sales cycle and including with our Tier 1 prospects, and we all have its clients on appraisal. So I would say that, that's going very well. But when I look out to 2021, even if we were to launch 1 today, they typically ramp up with smaller market share in the earlier quarter. So I really think of the Tier 1s as very important for our longer-term strategy. And this is the perfect environment to close them and launch them. But really, it's these lenders that we've launched, that we've been continuing to launch that can move market share faster that I think are really going to impact 2021, so -- and our Q4. So I think it's going very well. This is a perfect market for us to be moving forward with our Tier 1s, and we'll keep you updated as that progresses.

Okay. When it comes to the title and closing business, so far, a lot of discussion, I guess, in the past few years has really been on appraisals, and yet title and closing is certainly gaining its momentum. Just wondering if you can maybe sort of share with us what the relative size of the title and closing segment would be when it's compared to appraisal?

Yes. It's because the number of mortgages that can be refinanced or purchased changes based on what rates are at, really, the TAM is moving around. But if we were to go back and look at a 2019 level, the way that we like to think about it is -- think of appraisal in the sort of the $2.50 to $3 billion range. And then think of title in the $10 billion range. So now that we're in a multiyear refi opportunity, that dramatically increases the title side of the operation and at higher average dollar transaction volumes that just keeps -- it will out-proportion the growth in appraisal. So we're going to take a -- at the Investor Day this fall, we're going to do a sort of longer-term view of average TAM, TAM where we're at, so that investors can see where we are relative to appraisal opportunities going forward and title opportunities going forward. We've got lots of runway.

Okay. And just one last one for me. You referred to this in your filing as well as your comments today in terms of the impact on COVID and the lockdowns. Like had it not been for them, I'm kind of curious to see what the incremental revenue would have been to what you reported here. Would it be an extra $5 million, $10 million, like just kind of maybe give us an order of magnitude of what that potential could have been.

Well, I think, really, the difference is that the banks would have been able to hire up faster and build their capacity. And so the highest level that we've been able to see them grow historically is sort of the 20% per year. So I think if you think about the banks having a productivity drag within COVID, right, I mean we had some lenders that were less successful sort of work from home. So if we called it an industry-wide 5% drag on productivity, and then we took a quarter's share of the 20% annualized hiring growth, I think that would give you an idea in terms of what revenue would have otherwise been without the COVID affecting capacity.

Your next question comes from the line of Dan Chan of TD Securities.

You mentioned that the lenders' ability to increase capacity is probably the biggest limiter to your growth here. So what has been the lender's ability to grow? Is it in line with the 20% you assume in your multiyear opportunity forecast?

Yes. So I'll attack your question, Dan, in a couple of ways. So when I look at Q3, Q3 is very difficult to take any trend lines from. And why I say that is you could take 2 very large tier 1 banks. For all reasonable markets and all reasonable markets, they would have very similar rates, very similar sort of growth in originations, and yet, we saw 2 very large Tier 1 banks have their refi rates 100 basis points apart. If we went down to Tier 2 banks, we actually saw some lenders that didn't even have laptops for their employees. So they really had an outside reduction in the productivity. And then yet another Tier 2 lender would have been absolutely fine. So when I sum all that up, really, when you look under the data, it doesn't matter if it's a large bank or a small bank, a regulated bank or a nonbank, it was very difficult to take that streamlined approach. When we look at the MBA application index, I think it's indicative of sort of single-digit growth within the overall industry in the quarter. Purchase was down significantly. Obviously, refi was up significantly, but those app numbers don't include significant declines in HELOC and default. So some banks were able to move origination, underwriting staff from their HELOC business over to bolster that. Others, if they didn't have it, weren't able to do that. So -- and then you had some monoline lenders that are more focused on refi, who were able to just crank up staff within this environment because they were perfectly prepared for it. So it's very difficult to sort of say that there was a standardized trend across the industry. But I think we're -- COVID definitely played on the productivity and didn't allow the banks to hire and expand their staff as a whole as much as we would have liked. So I still think we need to see out of COVID here. I think we're then looking for an unwind of that productivity drop and then a return to strong hiring. So your -- really, it's difficult to project. We've had parts of the U.S. sort of revert back more into lockdown stage. So we're being cautious in terms of the capacity growth within the short term, the next couple of quarters, but we absolutely believe that once we're out this and into 2021, we're going to see that 20% annual sort of capacity growth come back into play.

And what has the pricing environment been like, given the supply constraints here? And what's your ability to increase net revenue margins in this high demand environment?

Yes. So typically, as we get more volume, we're able to drive enhanced net revenue margins in our appraisal and our title business, it's sort of how scale works in the platform. But when we have busier markets, you have a number of things moving around. You have pricing that the lenders are willing to pay for, an appraisal will go up. We -- obviously, that sort of pressure or that price inflation comes down to the appraisers as well. And I wouldn't say that it translates into an improvement of our net revenue margins because we're very focused on that sort of market share over the long run. But we can move our pricing through to the lenders. We're thoughtful in terms of how we do it with the lenders. So I'd say it's very mutual. I think that our ability to -- when we look at appraisal net revenue margins, I think that they'll be steady in the zone. And then as we get into 2021, we'll continue to see that increase in net revenue margins on track with our view of doubling volumes from 2018 levels.

Okay. And then last one for me. You now have over $100 million of cash. I know you're doing share buybacks, but your cash flow far exceeds those. Any thoughts on how you'd like to deploy that capital?

Yes. So we do like share buybacks as a way to return cash to shareholders. We're very disciplined in our approach there, and we take a longer-term view of executing on that. And in the interim, we're happy to hold cash. We will always maintain a strong balance sheet, given who our clients are. And that is a -- being national, being strong, being very, very strong financially, is very appealing to the big regulated banks, and there's very few players who are in that -- our position. So I think as we think through the next 5 years and we think about our growth and our move into some other areas, that will alter our capital allocation strategy, and we're going to lay that out more fully this fall at our Investor Day.

Your next question comes from the line of Thanos Moschopoulos of BMO Capital Markets.