Fennec Pharmaceuticals Inc.

Good day and thank you for standing by. Welcome to the Altisource fourth quarter 2022 earnings conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising that your hand is raised. To withdraw your question, please press star one one again. 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.

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.althysource.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 impacts 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 gap to non-gap measures is included in the appendix to the quarterly slides. Joining me for today's call is Bill Shepard, our chairman and chief executive officer. I'll now turn the call over to Bill.

Thanks, Michelle. Good morning. We will begin with slide four. 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 five. 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 PIC interest rate and the number of warrants granted to the term loan lenders based on certain aggregate paydowns made prior to February 14, 2024. We can also extend the maturity date of the term loan facility and 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 pick 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 six. 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 counter cyclical 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 seven 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 Slide 8 demonstrates what Altasource'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, Altasource could generate $42 million of adjusted EBITDA on $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. First, the number of foreclosure starts. Second, the timing from foreclosure starts to foreclosure auctions and REO sales. And third, the percentage of foreclosure starts that ultimately convert to foreclosure auctions. Beginning with slide nine and foreclosure starts. For 2022, foreclosure starts were 368% higher than 2021. This increase is primarily driving the growth of our pre-foreclosure solutions, including title, valuation, trustee, and field services. Despite the 2022 increase in foreclosure starts, they were still 45% below 2019 levels. We believe this is due to the timing for servicers to initiate foreclosures on delinquent loans following the expiration of the moratoriums and certain limited 2022 GSE foreclosure suspension directives, and represents a significant opportunity for revenue growth should the market return to pre-pandemic foreclosure start levels. The second market factor driving Altisource's default revenue growth is the timing from foreclosure start to foreclosure auction and REO sale. We estimate that in today's environment, it typically takes an average of two years to convert foreclosure starts to foreclosure sales, and another six months to market and sell the resulting REO. Due to this timing, we anticipate that our later stage and higher margin foreclosure auction and REO asset management services will not fully benefit from the higher level of foreclosure starts that began in the first quarter of 2022 until early 2024. Turning to slide 10 and the third market factor, the conversion rate of foreclosure inventory to foreclosure sales. For 2022, foreclosure sales were 39% higher than 2021, but significantly lower than the 368% growth in foreclosure starts over the same period. We believe foreclosure sales haven't grown at the same rate as foreclosure starts for two reasons. First, foreclosure starts are still in the earlier stages of the process and have not had sufficient time to reach historical norms. Second, over the past couple of years, we believe a greater percentage of distressed homeowners have been able to sell their homes or modify or refinance their loans before any foreclosure sale due to the strong home price appreciation from the historically low interest rate environment. Today, 30-year fixed mortgage interest rates are approximately 6.5%, or more than double the pandemic low interest rates. This has reduced affordability to levels not seen since October 1985. Because affordability is directly correlated to home values, we share the view of many industry experts that home values are going to decline, leaving distressed homeowners with fewer options, which could be exacerbated if unemployment rises or the cost of living remains high. As newer foreclosures age and rising interest rates reduce home values, we believe foreclosure sale conversion rates should return to 2019 levels or higher. This should drive further growth for our later stage solutions that support foreclosure auctions and REO asset management, including valuation, title, field services, and our higher unit revenue and margin brokerage and auction business. Should mortgage rates and cost of living remain high or unemployment increase, we would expect foreclosure starts, foreclosure sales, and REO volumes to exceed 2019 pre-pandemic levels and support further growth for our servicer and real estate segment. Turning to slide 11, there are several leading indicators that consumers are becoming increasingly financially stressed, which could be precursors to a rise in mortgage delinquency rates. In today's higher interest rate and inflationary environment, early stage delinquencies are rising across consumer lending products. While mortgage delinquency rates remain low, the number of borrowers that are 30 to 59 days past due has grown by 78% from the low in March of 2021. In addition, as you can see on slide 12, high inflation is eroding the American consumer's purchasing power. Average personal savings rates were 4.5% in December 2022, a significant decline from over 26% in March of 2021. The housing market also is beginning to show some weakness. Annual home sales are slowing, home builder contract cancellation rates are rising, and in February, the medium home sales price declined over the prior year for the first time in more than a decade. In this environment, Moody's Analytics is forecasting national REO to rise sharply from current lows. Moving to slide 13 in our service earned real estate sales pipeline and wins. Here we provide a summary of our sales pipeline, sales wins, and revenue generated from sales wins. As you can see from our growing weighted average sales pipeline and wins, We are not waiting for the default market to recover to drive growth, and I could not be more excited about our progress. There are two transactions that I would like to expand on, given their potential to generate over $20 million in combined annual revenue on a stabilized basis. The first, which is reflected in the sales pipeline category on the slide, is related to a teaming agreement we have with one of the two winners of a large government contract to provide REO asset management, REO disposition, field services, title and valuation services on at least 30% of the portfolio assigned to that winning bidder. We are currently negotiating the services agreement and anticipate receiving referrals beginning in the third quarter. While there can be no assurance we will reach an agreement or the timing of an agreement, I'm optimistic about this business opportunity. The second, which is reflected in the sales win category on the slide, is to provide construction risk mitigation and title services to one of the largest lenders in the country. We commenced construction risk mitigation services for this customer in February and are planning to launch the related title work by the end of the second quarter. We anticipate that the volume of referrals will ramp as the year progresses. Each of these wins could stabilize in 2024 and should generate margins consistent with similar services in our servicer and real estate segment. In addition to our sales wins, we are maintaining a strong weighted sales pipeline. As you can see on this slide, our probability-weighted servicer and real estate segment sales pipeline is over $41 million today. Turning to slide 14 and our origination segment. The origination market continues to face challenges with the latest MBA report estimating that for the full year 2022, origination volume declined by 49% compared to 2021. Our origination segment's year-over-year revenue decline was modestly better than the market-wide decline in origination volume for the same period. This reflects significantly better than marked performance for the LendersOne business as we gain traction with our solutions that are designed to help our members save money. This was partially offset by performance in most of our other origination businesses. Based upon our progress we are making with our late 2021 and early 2022 product launches, converting sales wins to revenue, and 2022 and early 2023 cost reductions, we anticipate sequential revenue growth in the first quarter and both sequential and year-over-year revenue and adjusted EBITDA growth for the year. For 2023, the MBA is forecasting origination volume to decline by 18% compared to 2022. With the decline in origination volume and margins, originators continue to focus on lowering their costs and are increasingly looking to purchase our solutions that help them do so. Slide 15 provides a summary of our sales pipeline, sales wins, and revenue generated from sales wins. We are making good progress translating our $21.6 million in estimated 2022 sales wins into revenue. For the first quarter of this year, we estimate that we will generate $2.3 million in revenue from the $21.6 million in wins or $9.3 million of revenue on an annualized basis. Turning to our corporate segment, we continue to maintain cost discipline with corporate and other costs down by $31 million or 32% over 2021 from the sale of the pointless business, cost savings initiatives, and the assignment of our sales and marketing employees to the business segments. In conclusion, we are encouraged by our 2022 results and believe we are well positioned in 2023 to return to year-over-year revenue growth and generate positive adjusted EBITDA. In our servicer and real estate business, we anticipate revenue and adjusted EBITDA growth from market tailwinds, sales pipeline and wins, and scale. In our origination business, we are building an exciting and innovative business that we anticipate will return to revenue growth and improved adjusted EBITDA in what is forecasted to be a very difficult origination market. The stronger performance of our segments, combined with cost discipline and corporate, and the steps we took to strengthen our balance sheet should help us return to a growth company and create substantial value for our shareholders. I'll now open up the call for questions. Operator?

Certainly. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster.

One moment for our first question. And our first question will come from Raj Shama of B Reilly.

Your line is open.

Yeah, hi, thank you. Thank you for taking my question. I just, Bill or Michelle, I just want 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 massive, vast improvements Is that level representative of the SG&A and the gross margin just going forward, or were there any one-off savings in both in Q4?

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'll 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 that in the fourth quarter. So 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.

Got it. Thank you. And then just on the cadence of just pickup in the default service revenue, when when do you see you know have have reo sales started to see a pickup already or is that is that still too early i mean from from the business that you that was that was the revival you know early 22. yeah so the the increase in foreclosures that started in early 22 look there's a there's a standard deviation around the the mean if you will but uh so we're not we don't anticipate

you know, if it takes two years for a foreclosure, on average, some states are much faster, some states are much slower, 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 six months later, the sale. So I think you see our foreclosure inventory, I'm 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.

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 that business.

So 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're going to launch that government contract in the third quarter. From the perspective of that government contract, I would think of that as, you know, in today's environment, you know, the government estimates that to be a very large contract to our teaming partner that we're 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're thinking about it today.

Great. Thank you for answering my questions. I'll take it offline again. Thank you. Thank you, Rush.

One moment for our next question. And if you do have a question, please press star 11 on your telephone. Again, for any questions, please press star 11.

And our next question. We'll come from Mike Grondel of Northern Capital Markets.

Your line is open.

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'll transition into or support some title work and whatnot. I guess just describe what you're doing and providing there and how it ends up with title work.

Great. Yeah, thanks, Mike. So we're 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 lender's 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'll be providing the title insurance associated with the construction loan and draw requests.

Got it. The initial work started in February, and you're approving contractors. Then once they get approved, they go out and start building homes and selling them, and you get involved. There's more upside when you provide the title work, I would imagine, but you're filling the funnel with contractors now. Yeah.

So, Mike, I would look at it this way. The contractor review is still, you know, we get paid fairly well for doing that. But the juicier 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're providing the title, we would make sure the title is clean and free of liens at the time 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'll have a higher take rate.

Got it. And, hey, can you market this to other originators other than this big, large originator?

Yeah, absolutely. This is inside of our granite business, which is in our servicer and real estate segment. And we do work for many, you know, we have many customers, many bank customers, and we're looking to take sort of the same, a similar program that we established here to others. But we're pretty excited about this large lender that we're doing work with today because as they roll the program out to their employees, Mortgage brokers, there's a large opportunity to grow it. And so we are pretty excited about this one.

Got it. And, you know, 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've been doing the last couple of years?

Yeah, I think they were primarily in the origination segment. We're 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.

Got it, got it. And then I think you've said we can expect some sequential revenue growth in one Q. And then for the full year, you expect some revenue growth in slight positive EBITDA. Is that the right way to think how 23 is kind of setting up?

Yeah, 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'm wrong, I think we're 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.

Got it, got it. And hey, 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 You know, waiting. I mean, you have two plus years now. Are you sort of in a wait and see mode to see how this recovery plays out? Or, you know, do you expect to take other actions in 23?

Yeah, I mean, I think just, you know, from a starting perspective, you know, we feel very good about, you know, where our balance sheet is today. And I think we were sitting today on forty seven and a half million dollars of cash, something like that. Don't hold me to the exact exact number. By raising that equity, we were able to reduce the PIC interest rate and using that money to pay down the loan to 4.5% from 5. We reduced the warrants from 3.2 million to 2.6. If we raise another $10 million between now and February of next year, so we've 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 PIC 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, you know, from a cash and liquidity perspective, we're in a good position right now. We, you know, have some flexibility in terms of the timing to think about when we would want to raise that additional $10 million to get those benefits I just described.

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

That's right. It has to be from either a junior equity or, you know, a traditional equity raise.

Got it. Okay. Hey, thanks and good luck in 23.

Thanks, Mike. I should just clarify, junior debt or an equity raise, not junior equity.

Okay. All right. Again, if you'd like to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again.

And I'm showing no further questions.

I would now like to turn the conference back to Bill for closing remarks.

Thank you, Operator, and we appreciate everyone's support and look forward to talking to you again soon.

This concludes today's conference. Thank you for participating. You may now disconnect.