Description
Filed with the SEC from Sep 13 to Sep 19:
Altisource Portfolio Solutions (ASPS)
Investor Barry Wish decreased his holdings in the mortgage-services company to 1,268,387 shares (5.4%) by selling 94,789 shares from July 2 through Aug. 20 at prices in a range of $74.30 to $91.73.
BUSINESS OVERVIEW
The Company
Altisource Portfolio Solutions S.A., together with its subsidiaries, is a provider of services focused on high value, technology-enabled, knowledge-based functions principally related to real estate and mortgage portfolio management, asset recovery and customer relationship management. We enable our clients to achieve their goals by leveraging our process management, innovative technology, econometrics and consumer behavior practice and high-quality, cost effective global human resources.
We are publicly traded on the NASDAQ Global Select Market under the symbol ASPS. We were incorporated under the laws of Luxembourg on November 4, 1999 as Ocwen Luxembourg S.à r.l., renamed Altisource Portfolio Solutions S.à r.l. on May 12, 2009 and converted into Altisource Portfolio Solutions S.A. on June 5, 2009. On August 10, 2009, we became a stand-alone public company in connection with our separation from Ocwen Financial Corporation (“Ocwen ® ”) (the “Separation”). Prior to the date of Separation, our businesses were wholly-owned subsidiaries of Ocwen.
Mortgage Services
Our Mortgage Services segment continues to be the primary driver of growth. This segment generates revenue principally by providing services that loan originators and loan servicers typically outsource to third parties. Our services are provided using our national platform and span the lifecycle of a mortgage loan. Our services are primarily centered on our relationship with Ocwen, but we also have longstanding relationships with some of the leading capital market firms, commercial banks, hedge funds, insurance companies and lending institutions.
Our services typically begin with a default management referral from a customer which results in a pre-foreclosure title search, property inspection services and non-legal back-office support services in connection with managing foreclosures. Upon receipt of an asset management referral after a property has been foreclosed, we provide REO preservation, REO asset management, REO valuation, REO brokerage, REO closing and REO title insurance services.
While our initial focus has principally been related to default services, we are also committed to developing our services to support mortgage originators and correspondent lenders. In February 2010, we acquired the Mortgage Partnership of America, L.L.C. (“MPA™”). MPA is the manager of a national alliance of community mortgage bankers and correspondent lenders which does business as Lenders One. We believe MPA’s 210 plus member companies originated approximately 8% of the total U.S. residential mortgage originations in 2011. Further, in 2011, we co-formed Correspondent One which once fully operational will provide members of Lenders One additional avenues to sell their loans beyond Lenders One’s preferred investor arrangements and the members’ own network of loan buyers. We anticipate this will result in improved profitability for the members and facilitate the sale of our services to the members.
In 2011, we reorganized our reporting structure within this segment in that certain services originally part of Component Services and Other are now classified as part of Customer Relationship Management in our Financial Services segment. Following this change, Component Service and Other was renamed Origination Management Services. Prior periods have been recast to conform to the current year presentation.
Residential Property Valuation Services. We provide our customers with traditional appraisal products through our licensed appraisal management company, working with our network of experienced appraisers and our exclusive ordering system. Customers may also order alternative valuation products through our system and network of real estate professionals. We also offer customers the ability to outsource all or part of their appraisal and valuation management oversight functions to us.
Closing and Insurance Services . We provide an array of closing services (e.g., document preparation) and title services (e.g., pre-foreclosure title search, title insurance) applicable to the residential foreclosure process and the sale of residential property. During 2011, we focused on increasing our referral capture rate in our operational states and rolling out insured title services nationwide, similar to what we accomplished with our title search and asset management businesses in 2010.
Default Management Services. We provide non-legal back-office support for foreclosure, bankruptcy and eviction attorneys as well as foreclosure trustee services. We do not execute or notarize foreclosure affidavits of debt or lost note affidavits.
Financial Services
Our Financial Services segment provides collection and customer relationship management services primarily to debt originators (e.g., credit card, auto loans, retail credit, mortgages) and the utility and insurance industries. Our leadership team for this segment is focused on disciplined floor management, delivering more services over our global delivery platform, expanding our quality and analytical initiatives and investing in new technology. Our global delivery platform consists of highly trained specialists in various geographic regions.
Sales and Marketing
We have experienced sales personnel and relationship managers with subject matter expertise. These individuals maintain relationships throughout the industry sectors we serve and play an important role in generating new client leads as well as identifying opportunities to expand our services with existing clients. Additional leads are also generated through request for proposal processes from key industry participants. Our sales team works collaboratively and is compensated principally with a base salary and commission for sales generated.
From a sales and marketing perspective, our primary focus is supporting the growth of our largest customer, Ocwen, expanding relationships with existing MPA members and targeting new customers that could have a material positive impact on our results of operations. Given the highly concentrated nature of the industries that we serve, the time and effort spent in expanding relationships or winning new relationships is significant.
Intellectual Property
We rely on a combination of contractual restrictions, internal security practices, patents, trademarks, copyrights, trade secrets and other intellectual property to establish and protect our software, technology and expertise. We also own or, as necessary and appropriate, have obtained licenses from third parties to intellectual property relating to our services, processes and business. These intellectual property rights are important factors in the success of our businesses.
As of December 31, 2011, we have been awarded one patent that expires in 2023 and three patents that expire in 2024. The U.S. Patent Office has also notified us of the allowance of a pending U.S. Patent Application. In addition, Altisource has registered trademarks or recently filed applications for registration of trademarks in a number of countries or groups of countries including the United States, the European Community, India and in eleven other countries or groups of countries. These trademarks generally can be renewed indefinitely.
We actively protect our rights and intend to continue our policy of taking all measures we deem reasonable and necessary to develop and protect our patents, copyrights, trade secrets, trademarks and other intellectual property rights.
Industry and Competition
The industry verticals in which we engage are highly competitive and generally consist of a few national vendors as well as a large number of regional or in-house providers resulting in a fragmented market with disparate service offerings. From an overall perspective, we compete with the global business process outsourcing firms. Our Mortgage Services segment competes with national and regional third party service providers and in-house servicing operations of large mortgage lenders and servicers. Our Financial Services segment competes with other large receivables management companies as well as a fragmented group of smaller companies and law firms focused on collections. Our Technology Services segment competes with data processing and software development companies.
Given the diverse nature of services that we and our competitors offer, we cannot determine our position in the market with certainty, but we believe that we represent only a small portion of very large sized markets. Given our size, some of our competitors may offer more diversified services, operate in broader geographic markets or have greater financial resources than we do. In addition, some of our larger customers retain multiple providers and continuously evaluate our performance against our competitors.
Competitive factors in our Mortgage Services business include the quality and timeliness of our services, the size and competence of our network of vendors and the breadth of the services we offer. For Financial Services, competitive factors include the ability to achieve a collection rate comparable to our competitors; the quality and personal nature of the service; the consistency and professionalism of the service and the recruitment, training and retention of our workforce. Competitive factors in our Technology Services business include the quality of the technology-based application or service; application features and functions; ease of delivery and integration; our ability to maintain, enhance and support the applications or services and the cost of obtaining, maintaining and enforcing of our patents.
Seasonality
Our revenues are seasonal. More specifically, Financial Services revenue tends to be higher in the first quarter, as borrowers may utilize tax refunds and bonuses to pay debts, and generally declines throughout the rest of the year. Mortgage Services revenue is impacted by REO sales which tend to be at their lowest level during fall and winter months and highest during spring and summer months.
Government Regulation
Our businesses are subject to extensive laws and regulations by federal, state and local governmental authorities including the Federal Trade Commission, the state agencies that license our mortgage services, collection entities and the SEC. We also must comply with a number of federal, state and local consumer protection laws including, among others, the Gramm-Leach-Bliley Act, the Fair Debt Collection Practices Act, the Real Estate Settlement Procedures Act (“RESPA”), the Truth in Lending Act (“TILA”), the Fair Credit Reporting Act, the Homeowners Protection Act and the SAFE Act. These requirements can and do change as statutes and regulations are enacted, promulgated or amended. One such recently enacted regulation is the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The Dodd-Frank Act is extensive and includes reform of the regulation and supervision of financial institutions, as well as the regulation of derivatives, capital market activities and consumer financial services. Included in the Dodd Frank Act, among other things, is the creation of the Consumer Financial Protection Bureau, a new federal entity responsible for regulating consumer financial services and products. Title XIV of the Dodd-Frank Act contains the Mortgage Reform and Anti-Predatory Lending Act (“Mortgage Act”). The Mortgage Act imposes a number of additional requirements on lenders and servicers of residential mortgage loans by amending and expanding certain existing regulations. In some cases, penalties for noncompliance are significantly increased and could lead to settlements or consent orders on us or our customers that may curtail or restrict the business as it is currently conducted. The Mortgage Act generally requires that implementing regulations be issued before many of its provisions are effective. Therefore, many of these provisions in the Mortgage Act will not be effective until 2013 or early 2014.
We are subject to certain federal, state and local consumer protection provisions. We are also subject to licensing and regulation as a mortgage service provider and/or debt collector in a number of states. We are subject to audits and examinations that are conducted by the states. Our employees may be required to be licensed by various state commissions for the particular type of service delivered and to participate in regular continuing education programs. From time to time, we receive requests from state and other agencies for records, documents and information regarding our policies, procedures and practices regarding our mortgage services and debt collection business activities. We are also subject to the requirements of the Foreign Corrupt Practices Act and comparable foreign laws, due to our activities in foreign jurisdictions. We incur ongoing costs to comply with governmental laws and regulations.
Available Information
We file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other information with the Securities and Exchange Commission (“SEC”). These filings are available to the public over the Internet at the SEC’s web site at http://www.sec.gov . You may also read and copy any document we file at the SEC’s public reference room located at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1 800-SEC-0330 for further information on the public reference room.
Our principal Internet address is www.altisource.com and we encourage investors to use it as a way of easily finding information about us. We promptly make available on this website, free of charge, the reports that we file or furnish with the SEC, corporate governance information (including our Code of Business Conduct and Ethics) and select press releases. The contents of our website are available for informational purposes only and shall not be deemed incorporated by reference in this report.
CEO BACKGROUND
William C. Erbey. Mr. Erbey was appointed as the Chairman of the Board of Directors of Altisource in July 2009. He has served as the Chairman of the Board of Directors of Ocwen Financial Corporation (“Ocwen”), Altisource’s former parent company, since September 1996 and as the Chief Executive Officer of Ocwen from January 1988 to October 2010. He served as the President of Ocwen from January 1988 to May 1998. From 1983 to 1985, Mr. Erbey served as a Managing General Partner of The Oxford Financial Group, a private investment partnership that was the predecessor of Ocwen. He is also the founder and Chairman of Home Loan Servicing Solutions, Ltd., formed in December 2010 to acquire mortgage servicing assets. From 1975 to 1983, Mr. Erbey served at General Electric Capital Corporation in various capacities, including as President and Chief Operating Officer of General Electric Mortgage Insurance Corporation, Program and General Manager of the Commercial Financial Services Department and President of Acquisition Funding Corporation. He holds a Bachelor of Arts in Economics from Allegheny College and a Master of Business Administration from Harvard University.
Mr. Erbey’s extensive experience as the Chairman and Chief Executive Officer of Ocwen demonstrates his leadership capability and business acumen. His experience in the mortgage services industry brings valuable financial, operational and strategic expertise to our Board of Directors.
William B. Shepro . Mr. Shepro was appointed Chief Executive Officer and to the Board of Directors of Altisource in July 2009. Mr. Shepro previously served as the President and Chief Operating Officer of Ocwen Solutions at Ocwen. He previously served as President of Global Servicing Solutions, LLC, a joint venture between Ocwen and Merrill Lynch, from 2003 until 2009. Mr. Shepro also held the positions of Senior Vice President of Ocwen Recovery Group and Senior Vice President, Director and Senior Manager of Commercial Servicing at Ocwen. He joined Ocwen in 1997. Mr. Shepro serves on the Boards of Altisource and certain subsidiaries. He holds a Bachelor of Science in Business from Skidmore College and a Juris Doctorate from the Florida State University College of Law.
Mr. Shepro’s day-to-day leadership and intimate knowledge of our business and operations provides the Board of Directors with Company-specific experience and expertise. Furthermore, Mr. Shepro’s legal background and operational experience in the residential and commercial mortgage servicing industries provide the Board of Directors with valuable strategic and operational insights.
Roland MĂĽller-Ineichen. Mr. MĂĽller-Ineichen was appointed to the Board of Directors of Altisource in July 2009. He also serves on the Board of Directors of Bank Arner S.A., a provider of private banking services based in Lugano, Switzerland and on the Board of Directors of SWA Swiss Auditors AG, a private company based in Freienbach, Switzerland that provides auditing and consulting services for financial institutions in Switzerland. Mr. MĂĽller-Ineichen most recently served as a Partner with KPMG Switzerland and KPMG Europe LLP where he served as lead partner on the audits of national and international Banks, Security Dealers and Fund Management Companies. Mr. MĂĽller-Ineichen began working in the Zurich office of KPMG in June 1995 as a Senior Manager in the audit department banking and financial services and served as a Partner from January 1999 until his retirement in December 2008. Prior to KPMG, Mr. MĂĽller-Ineichen progressed through various audit and managerial roles with Switzerland-based financial institutions. In addition, from May 2010 until September 2011, Mr. MĂĽller-Ineichen served as a member of the Board of Directors of Absolute Private Equity AG, a Switzerland-based investment company. Mr. MĂĽller-Ineichen is a Swiss Certified Public Accountant. He completed a commercial and banking business apprenticeship with UBS in 1980. Mr. MĂĽller-Ineichen holds a Business Commerce degree.
Mr. Müller-Ineichen’s past employment experience provides the Board of Directors with accounting expertise, and his experience in the financial services industry provides the Board of Directors with valuable strategic and financial insights. Furthermore, Mr. Müller-Ineichen is financially literate and qualifies as a financial expert as required by SEC rules and The NASDAQ Stock Market (“NASDAQ”) listing standards.
Timo Vättö. Mr. Vättö was appointed to the Board of Directors of Altisource in August 2009. He is the founder and owner of Vättö Management Services AG, a provider of independent corporate advisory services to corporations, institutional investors and private families, which was founded in November 2008. Previously, Mr. Vättö was employed by Citigroup in Switzerland and the U.S. for almost twenty years in senior client coverage and business head roles within the client franchise management and business origination functions for Corporate and Investment Banking, most recently as Head of Swiss Investment Banking. In addition from 2004 to 2009, Mr. Vättö served as a member of the Board of Directors, including as a member of the Audit Committee of Citibank (Switzerland) AG, part of Citigroup’ s Wealth Management Business. Mr. Vättö holds a Master of Science, Economics and Business Administration from the University of Tampere (Finland).
Mr. Vättö’s experience with Vättö Management Services AG and Citigroup makes him financially literate as required pursuant to NASDAQ listing standards and his knowledge of the financial services industry provides the Board of Directors with subject matter expertise.
W. Michael Linn. Mr. Linn was appointed to the Board of Directors of Altisource in May 2011. Mr. Linn also serves on the Board of Directors and as President and Chief Executive Officer of Greensleeves LLC since July 2007 where he focuses on increasing the use of alternative energy to power buildings. In addition, he serves on the Board of Directors of National Lime & Stone and is a private investor in energy-related industries. Mr. Linn previously served on the Board of Directors of Ocwen from August 2002 to May 2008 and as the Executive Vice President of Sales and Marketing of Ocwen from February 2004 to May 2007. Prior to joining Ocwen, Mr. Linn served on the Board of Directors and as the Executive Vice President of Sales and Marketing of Solomon Software, Inc., a corporation now owned by Microsoft Corporation. He has also served on the Board of Directors and as President and Chief Executive Officer of Saunders, Inc., a venture backed, privately held financial services and technology solutions company. Mr. Linn graduated from Harvard College in 1970 with a Bachelor of Arts and earned a Master of Business Administration from Harvard Business School in 1973.
Mr. Linn’s experience evaluating and designing management information and control systems for Fortune 500 Corporations and for the U.S. Government and his service as a senior officer and member of the Board of Directors of a leading provider of accounting and management control software makes him financially literate as required pursuant to NASDAQ listing standards. His extensive management and prior Board of Directors experience as well as his expertise with emerging technologies and in the development of strategic relationships bring valuable operational sales and strategic expertise to our Board of Directors.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
Our Business
We are a provider of services focused on high value, technology-enabled, knowledge-based functions principally related to real estate and mortgage portfolio management, asset recovery and customer relationship management.
We classify our businesses into three reportable segments:
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Mortgage Services consists of mortgage portfolio management services that span the mortgage lifecycle from origination through REO asset management and sale;
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Financial Services principally consists of unsecured asset recovery and customer relationship management; and
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Technology Services consists of modular, comprehensive integrated technological solutions for loan servicing, vendor management and invoice presentment and payment as well as providing infrastructure support.
In addition, our Corporate Items and Eliminations segment includes eliminations of transactions between the reporting segments and also includes costs recognized by us related to corporate support functions such as executive, finance, legal, human resources, vendor management and six sigma.
In evaluating our performance, we utilize Service Revenue which consists of amounts attributable to our fee based services. Reimbursable Expenses and Cooperative Non-controlling Interests are pass-through items for which we earn no margin. Reimbursable Expenses consists of amounts that we incur on behalf of our customers in performing our fee based services, but we pass such costs directly on to our customers without any additional markup.
Further discussion regarding our business may be found under Part I, Item 1, “Business”.
Strategic Update
For 2011, we focused our efforts on strategically supporting Ocwen as its portfolio of loans serviced continued to grow at an accelerated pace. To support such growth, we invested significantly in hiring and training new personnel (increasing our global staffing by 66%), developed and expanded some of the newer services (primarily insurance related services) and continued to add to the geographic footprint for existing services where it made economic sense.
Through Ocwen’s growth and our focused efforts to capture more revenue per loan serviced by Ocwen, we recognized $334.8 million of Service Revenue, a 36% increase over the year-ended December 31, 2010. In addition, although we made significant investments in personnel and related costs months in advance of loans boarding, we achieved gross margins based on Service Revenue of 44%, comparable to 2010 levels, and improved income from operations as a percent of Service Revenue to 26%, up from 22% in 2010.
From a cash perspective, we generated $111.6 million in operating cash flow which represents $0.33 for every dollar of Service Revenue. We sought to strategically deploy cash principally in three ways. First, we returned $61.1 million to shareholders through the repurchase of 1.6 million shares under the stock repurchase program. Second, we invested $16.4 million in technology and facilities to support our rapid growth. Third, we continued to invest in mortgage origination services with our $15.0 million investment in Correspondent One and our acquisition of Springhouse.
Looking ahead to 2012, we expect to remain focused on a few key initiatives that we believe will allow us to continue to deliver superior results for our customers and shareholders:
Support Ocwen’s growth. Our primary focus for next year will be the continued support of Ocwen. Ocwen’s growth in loans serviced, including loans boarded in the second half of 2011 and the additional 0.2 million loans we expect Ocwen to board in early 2012, will be the principal driver of our expected growth in 2012. Furthermore, we believe Ocwen will remain a leader in the on-going consolidation of high touch residential loan servicers.
Improve operating effectiveness. We must deliver high quality, regulatory compliant services that meet or exceed customers’ performance expectations. This requires us to intelligently and persistently invest in an array of broad based competencies including technology, quality assurance, compliance, econometrics and behavioral science among others.
Service Offerings. We intend to capture additional revenue per loan from the loans boarded on our systems as well as develop a more balanced portfolio of service offerings that we believe will enable us to generate long-term consistent revenue and earnings growth, with faster growth in 2012. In 2012, we will expand our offering of mortgage origination services, principally to the members of Lenders One, as well as begin implementation of our next generation of REALSuite technologies.
Bring Financial Services to Profitability. Our Financial Services segment improved in 2011 posting $4.4 million in pre-tax income, which compares to $0.3 million in 2010, although revenue declined 8% to $71.2 million. We remain committed to this segment as we believe that significant market opportunities exist in assisting clients in the areas of customer relationship and asset recovery management services. We continue to believe that investments in areas such as optimal resolution models deployed through dynamic scripts will enable us to take advantage of these opportunities over an extended time period.
Basis of Presentation
We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). For periods prior to the Separation, our results include revenues and expenses directly attributable to our operations and allocations of expense from Ocwen which may not necessarily reflect what our consolidated results of operations, financial position and cash flows would have been had we operated as an independent company during that entire period.
Stock Repurchase Plan
In May 2010, our shareholders authorized us to purchase 15% of our outstanding share capital, or 3.8 million shares of common stock, in the open market. From authorization through December 31, 2011, we have purchased 2.3 million shares of common stock on the open market at an average price of $34.55 per share leaving 1.5 million shares available for purchase under the program.
Acquisitions
In April 2011, we acquired Springhouse, an appraisal management company that utilizes a nationwide panel of appraisers to provide real estate appraisals principally to mortgage originators, including the members of Lenders One, and real estate asset managers. In July 2011, we acquired the assembled workforce of a sub-contractor in India that performs asset recovery services. See Note 4 to the consolidated financial statements for additional information.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
We seek to deploy excess cash generated in a disciplined manner. Principally, we will continue to reinvest excess cash in developing compelling services that we believe will generate high margins. In addition, we may seek to acquire a limited number of complementary companies that fit our strategic objectives. Finally, given the tax inefficiency of dividends, the low returns earned on cash held and our current belief to pursue a limited number of acquisitions, we believe one of the best ways to return value to shareholders is through a share repurchase program.
On May 19, 2010, our shareholders authorized us to purchase up to 3.8 million shares of our common stock in the open market. Through December 31, 2011, we purchased 2.3 million shares of our common stock on the open market at an average price of $34.55 leaving 1.5 million shares still available for purchase under the program.
Liquidity Requirements after December 31, 2011
During the first quarter of 2012, we expect to distribute $2.4 million to the Lenders One members, representing non-controlling interests.
Management is not aware of any other trends or events, commitments or uncertainties which have not otherwise been disclosed that will or are likely to impact liquidity in a material way (see also Contractual Obligations, Commitments and Contingencies below).
Capital Resources
Given our ability to generate cash flow which is sufficient to fund both current operations as well as expansion activities, we require very limited capital. Were we to need additional capital, we believe we have adequate access to both debt and equity capital markets.
CRITICAL ACCOUNTING JUDGMENTS
The preparation of financial statements in conformity with generally accepted accounting principles of the United States (“GAAP”) requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results. For additional information, see Note 2 to the consolidated financial statements. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions.
Goodwill and Identifiable Intangible Assets
Goodwill . We evaluate goodwill for impairment annually during the fourth quarter or more frequently when an event occurs or circumstances change that indicates that the carrying value may not be recoverable. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting units. If the fair value is determined to be less than the book value, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value. We estimate the fair value of the reporting units using discounted cash flows. Forecasts of future cash flow are based on our best estimate of future net sales and operating expenses, based primarily on expected category expansion, pricing, market segment share and general economic conditions. Certain estimates of discounted cash flows involve businesses and geographies with limited financial history and developing revenue models.
Based on the fourth quarter 2011 analysis, management concluded no impairment was indicated given the fair value for the associated reporting units was substantially in excess of the book value.
In 2010, management determined it was prudent to impair $2.8 million of goodwill in the Financial Services segment. This determination was made after considering quantitative and qualitative factors including past performance and execution risk.
Identifiable Intangible Assets . Identified intangible assets consist primarily of customer lists, acquired trade names and trademarks. Indentified intangible assets that amortize are tested for impairment whenever events or changes in circumstances occur indicating that the carrying amount of the asset may not be recoverable. An impairment loss would be recognized for an intangible asset if its carrying value exceeds its fair value.
Given the performance of our Financial Services segment, we continue to monitor the performance of amortizing intangible assets, particularly those associated with customer lists. To date, we have not determined the need for any impairment charges for identified intangible assets.
Accounting for Income Taxes
We are subject to income taxes in Luxembourg, the United States, India and Uruguay. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and estimates for which the ultimate tax determination may vary from year to year. For example, our effective tax rates could be adversely affected by lower than anticipated earnings in countries where we have lower statutory rates and higher than anticipated earnings in countries where we have higher statutory rates, by changes in foreign currency exchange rates or by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations. We are subject to audit in various taxing jurisdictions, and such jurisdictions may assess additional income tax during an examination. Although we believe our tax balances are sufficient to support our future tax liabilities, the final determination of tax audits and any related litigation could differ from the balances we have accrued.
OTHER MATTERS
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist of escrow arrangements and operating leases.
We hold customers’ assets in escrow at various financial institutions pending completion of certain real estate and debt collection activities. These amounts are held in escrow for limited periods of time, generally consisting of a few days. To the extent these assets are not co-mingled with our fees and are maintained in segregated bank accounts, they are generally not included in the accompanying Consolidated Balance Sheets, the balance of which is $17.7 million at December 31, 2011.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
OVERVIEW
Our business
We are a global provider of services focused on high-value, technology-enabled, knowledge-based solutions principally related to mortgage and real estate portfolio management, asset recovery and customer relationship management.
We classify our business into the following three reportable segments:
Mortgage Services: Provides services that span the mortgage lifecycle and are typically outsourced by loan servicers and originators. We provide these services primarily for loan portfolios serviced by Ocwen. We also have longstanding relationships with some of the leading capital markets firms, commercial banks, hedge funds, insurance companies and mortgage bankers. Within the Mortgage Services segment, we provide the following services:
Asset management — Asset management services principally include property preservation, property inspection, real estate owned (“REO”) asset management, our consumer real estate portal and REO brokerage operations. We plan to provide asset management services for single-family rental properties in the future.
Residential property valuation — Residential property valuation services principally include traditional appraisal products through our licensed appraisal management company and alternative valuation products primarily through our network of real estate professionals. We generally provide these services for loan servicers and mortgage bankers.
Closing and insurance services — Closing and insurance services principally include an array of title search, closing and title agency services including document preparation, pre-foreclosure and REO title searches, escrow and title insurance, and other insurance related services applicable to residential loan servicers. We plan to provide closing and title agency services on newly originated loans in the future.
Default management services — Default management services principally provides foreclosure trustee services for loan servicers and non-legal processing and related services for and under the supervision of foreclosure, bankruptcy and eviction attorneys.
Origination management services - Origination management services principally includes MPA’s operations, our contract underwriting business and our developing loan fulfillment business. MPA serves as the manager of Lenders One, a national alliance of independent mortgage bankers that provides its members with education and training along with revenue enhancing, cost reducing and market share expanding opportunities. We provide other origination related services in the residential property valuation business. In addition, some of the origination related reseller businesses, including the flood certification business, are included in the Technology Services REALSuite business.
Financial Services: Provides collection and customer relationship management services primarily to debt originators and servicers (e.g., credit card, auto lending, retail credit, mortgages) and the utility and insurance industry. Within the Financial Services segment, we provide the following services:
Asset recovery management — Asset recovery management principally provides post-charge-off consumer debt collection services on a contingency fee basis.
Customer relationship management — Customer relationship management provides customer care and early stage collections services. In addition, customer relationship management provides insurance and claims processing, call center services and analytical support.
Technology Services : Comprises our REALSuite TM of applications as well as our information technology (“IT”) infrastructure services. We only provide our IT infrastructure services to Ocwen, Home Loan Servicing Solutions (“HLSS”), Correspondent One, our two recently formed subsidiaries, Altisource Residential and Altisource Asset Management, discussed below, and ourselves. The REALSuite platform provides a fully integrated set of software applications and technologies that manage the end-to-end lifecycle for residential and commercial mortgage loan servicing including the automated management and payment of a distributed network of vendors. A brief description of the key REALSuite software products is below:
REALServicing® — an enterprise residential mortgage loan servicing product that offers an efficient and effective platform for loan servicing including default administration. This technology solution features automated workflows, a dialogue engine and robust reporting capabilities. The solution spans the loan servicing lifecycle from loan boarding to satisfaction including all collections, payment processing and reporting. We also offer REALSynergy®, an enterprise commercial loan servicing system.
REALTrans® — a patented electronic business-to-business exchange that automates and simplifies the ordering, tracking and fulfilling of vendor provided services principally related to mortgages. This technology solution, whether web-based or integrated into a servicing system, connects multiple service providers through a single platform and forms an efficient method for managing a large scale network of vendors.
REALRemit® — a patented electronic invoicing and payment system that provides vendors with the ability to submit invoices electronically for payment and to have invoice payments deposited directly to their respective bank accounts.
With the deployment, beginning in the third quarter of 2012 and continuing through 2014, of our next generation technologies to support our mortgage services businesses, we believe we will be more cost efficient and more effective at providing higher quality mortgage related services for Ocwen, and for other customers. With deployment in the Financial Services business occurring through 2014, we believe it will also enable this segment to gain market share in its existing markets and develop higher margin platform business process outsourcing solutions, similar to what is being used by Ocwen. These solutions include a suite of technologies, including dialogue engines and customized customer self help programs to improve performance and reduce variability in outcomes. The tools applicable to our Financial Services segment include our optimal resolution model and our vendor, business process management, dialogue and invoice payment and presentment technologies. Through the use of these tools and technologies, we believe we can improve our customers’ profitability, reduce our hiring, training and compliance costs, scale our operations faster and, at the same time, create stickier customer relationships across higher valued services.
Corporate Items and Eliminations : Includes costs related to corporate support functions including executive, finance, legal, human resources, vendor management, risk and six sigma and also includes eliminations of transactions between the reporting segments.
We classify revenue in three categories: service revenue, revenue from reimbursable expenses and non-controlling interests. In evaluating our performance, we focus on service revenue which consists of amounts attributable to our fee based services. Reimbursable expenses and non-controlling interests are pass-through items for which we earn no margin. Reimbursable expenses consist of amounts that we incur on behalf of our customers in performing our fee based services, but we pass such costs directly on to our customers without any additional markup. Non-controlling interests represent the earnings of Lenders One, a consolidated entity that is not owned by Altisource. It is included in revenue and reduced from net income to arrive at net income attributable to Altisource.
Stock repurchase plan
In May 2012, our shareholders approved a new stock repurchase program, which replaces the previous stock repurchase program. Under the new plan, we are authorized to purchase up to 3.5 million shares of our common stock in the open market in addition to amounts previously purchased under the prior plan. From authorization of the prior plan in May 2010 through June 30, 2012, we have purchased approximately 2.5 million shares of our common stock in the open market at an average price of $37.49 per share. During the six months ended June 30, 2012, we purchased 0.3 million shares of common stock at an average price of $63.25 per share. Since no common stock was repurchased during the second quarter of 2012, 3.5 million shares of common stock remain available for repurchase under the plan.
Residential asset businesses — We are in the process of establishing residential asset related businesses to support the growing residential single-family rental market as we believe there is a significant opportunity that leverages our existing infrastructure and competencies. The single-family residential rental market in the United States is a $3 trillion industry, accounting for 52% of all residential rental units. With the continued displacement of homeowners related to foreclosure and other economic circumstances, we believe the demand for single-family rentals will significantly increase. Studies estimate that over four million distressed loans and REO will be converted to rental homes by 2015. Despite the size of the single-family residential rental market, it has received very little attention as most people have historically viewed the industry as extremely fragmented, localized and decentralized. We believe, on the other hand, that there are significant opportunities to consolidate the market by leveraging purchasing, technology and centralized operations and management. We know firsthand, as a result of establishing Altisource as one of the few nationwide single-family REO management and property inspection and preservation companies in the United States, that property management can be executed on a national scale. Unlike most property management firms, we are not constrained by the location of the home. We have existing nationwide single-family asset management, property inspection and preservation, real estate brokerage and settlement services operations, primarily performed from centralized lower cost locations.
Entering the residential rental market is a complementary extension of our existing service offerings, leveraging our significant economies of scale. As a result, we believe our per unit operating costs are substantially lower than others in the industry. With our operating cost advantage, we believe that we can manage a single-family home at a cost similar to an apartment unit managed by a multi-family REIT.
Because of the different capital considerations and the operating metrics associated with owning and renting single-family homes, we believe this business is best suited to operate separate and apart from Altisource. In this regard, we have created two companies that we intend to separate and distribute to our shareholders. The first, Altisource Residential will acquire residential related assets and, the second, Altisource Asset Management, will provide asset management and advisory services to Altisource Residential. It is intended that Altisource will provide construction management, rental property management and leasing brokerage services to Altisource Residential, creating a long-term, stable revenue stream for Altisource. Further, to the extent Altisource Residential acquires non-performing loans, it is intended that it will retain Ocwen to service the loans who, in turn, will retain us to provide default related and technology services.
Throughout the second quarter, we continued to broaden our internal capabilities and processes. When Altisource Residential begins acquiring homes, we will be instrumental in the efficient launch of their operations. Our preparations for the separation of Altisource Residential and Altisource Asset Management are ongoing, including preparation of required documents to file with the Securities and Exchange Commission. We continue to expect the separation to occur in the second half of the year.
Mortgage origination related services — With an objective of long-term growth in the origination services market, we acquired the manager of the Lenders One mortgage cooperative in February 2010. In 2011, the members of Lenders One originated approximately $107 billion of loans. We estimate that in excess of $1.5 billion was spent on origination related services in connection with these loans. The manager of the cooperative leverages the size of Lenders One, now 232 members strong, to obtain better execution on the sale of closed loans with third parties and to achieve lower costs on origination related services from third parties.
We are developing two channels to grow our origination related business and further increase the members’ profitability. First, we invested in Correspondent One to buy closed loans from the members of Lenders One. With the exit of several of the larger correspondent lenders from the market, there are fewer available avenues through which members can sell their loans. Our intent is for Correspondent One to become a competitive, attractively priced alternative for the members.
Second, leveraging our vendor network, technology, scale, global workforce and lower sales costs, we have begun offering origination related services directly to the members at a cost we believe is below market. Many of the services are in place and are similar to the services we provide in our default related business. We anticipate our growth in origination related service revenue will accelerate after our next generation technology is in place to support the ordering and delivery of these services. We are nearing the completion of the development phase of this technology and plan to pilot the portal with some of the members in the third quarter of 2012. Once the pilot and any resulting remediation are complete, we plan to offer a bundle of origination related services to the full membership of Lenders One.
While we are very early in the rollout of these two channels, there are encouraging signs that the strategy is working. Our service revenue from origination related services has grown to $8.3 million in the second quarter of 2012, a 73% increase from the second quarter of 2011. Lenders One net membership has grown by 18 members in 2012 with 7 net members added in the second quarter. Altisource has signed service agreements to provide origination services with 108 members, and we are negotiating 36 additional contracts. Correspondent one increased loans purchased from $5.7 million in the first quarter to $10.9 million in the second quarter of 2012. Further, Correspondent One increased its loan pipeline from $3.7 million at the end of the first quarter to $18.6 million at the end of the second quarter of 2012 with $31.6 million in the pipeline as of July 20, 2012. The number of approved sellers to Correspondent One also increased from 12 in the first quarter to 28 in the second quarter.
Consumer real estate portal — We are also continuing to fully develop our consumer real estate portal as we believe there are opportunities to benefit from a shifting consumer preference for on-line transacting. The consumer real estate portal provides an automated, transparent and integrated on-line solution for buying and selling real estate and related services. Like the residential rental business, the market for this business is immense. The 2012 forecast for home sales in the United States is approximately $780 billion. These sales will generate over $40 billion in brokerage commissions annually. Based on our observations, we believe the industry is beginning to see a shift in consumer behavior and attitudes toward on-line transacting for homes. In 2011, we sold approximately 20,000 homes through our consumer real estate portal, and our revenue has grown to $25.6 million in the first half of 2012, compared to $12.3 million in the first half of 2011 (the consumer real estate portal is part of our Mortgage Services segment).
Unlike some of the other public and private real estate related websites, our portal is not based on a marketing, informational model. Rather, we are centered on executing real estate transactions. Our objective is to become the premier end-to-end real estate transaction marketplace that seamlessly and efficiently connects home buyers, sellers and real estate service providers for distressed and non-distressed homes. We believe the real estate purchasing and sales market is underserved and consumers will welcome a new product offering transparency, simplicity and lower transaction costs. Using Altisource’s next generation technologies, we believe the consumer real estate portal will transform the way real estate services are delivered by providing a unique transaction processing platform that offers an automated, transparent and integrated solution to buy and sell homes and purchase the related services as part of a home buying experience.
We believe the key to selling homes quickly at an optimal sales price is generating a high volume of relevant prospective buyer traffic to each home. We generate, on average, more than eight offers per property. It takes us approximately 42 days from the date the home is listed on our portal until it is under contract for sale. Today, we sell all of Ocwen’s REO through the consumer real estate portal. Following our rebranding effort, we intend to provide this service to other mortgage servicers as well. Ultimately, our goal is to expand our offerings into the non-distressed home sale market.
In the medium to longer term, we also intend to explore the possibility of distributing our ownership interest in this business to our shareholders, creating a new public company. The consumer real estate portal has many of the same characteristics as some of the other publicly-traded real estate related technology companies. Similar to these companies, we believe that we can create greater shareholder value with the portal operating as a separate stand-alone business. As a stand-alone company, the portal would have a singularly focused management team, and the performance of the business would be easier to compare with like companies.
With regard to the residential asset businesses and the consumer real estate portal, there is no certainty at this time that the separations will actually occur. Further, the consummation of any spin-off or similar transactions will be subject to our reaching satisfactory conclusions with our financial, tax and legal advisors on all applicable issues and the receipt of any necessary approvals.
Financial Services segment — This segment includes our receivables management and customer care businesses. We believe the Financial Services segment has meaningful expansion opportunities however, at present, it has generated far lower margins than we believe should be achieved. Therefore, before turning our attention to revenue growth, we continue to build the foundation for higher margins. In 2012, we are simplifying the technology architecture, improving our borrower communication and implementing borrower self-help programs. Looking to 2013, we intend to pursue growth from existing customers and deeper penetration of the industries we currently serve. In 2014, with our next generation technology in place, we plan to provide higher margin platform business process outsourcing solutions, similar to what is being used by Ocwen. These solutions include a suite of technologies, including dialogue engines and customized customer self help programs to improve performance and reduce variability in outcomes.
Revenue
We recognized service revenue of $226.6 million for the six months ended June 30, 2012, a 57% increase when compared to the six months ended June 30, 2011 ($118.1 million for the second quarter of 2012, a 63% increase over the second quarter of 2011). The continued growth in service revenue in both periods is due to the increase in Ocwen’s residential loan portfolio, impacting Mortgage Services and Technology Services, coupled with our ongoing expansion of mortgage and real estate portfolio management services. Partially offsetting our service revenue growth in Mortgage Services and Technology Services was a decline in the Financial Services segment in both periods. This is primarily due to the shift of existing services to a lower cost geography with corresponding lower fees from our customers for these services and a modest decline in total placements as a result of lower credit card delinquencies.
The increase in revenue from reimbursable expenses in both periods is due to the increase in our asset management and default services businesses in our Mortgage Services segment.
Our revenues are seasonal. More specifically, Financial Services revenue tends to be higher in the first quarter and generally declines throughout the year. Mortgage Services revenue is impacted by REO sales which tend to be at their lowest level during the fall and winter months and highest during spring and summer months.
Cost of Revenue and Gross Profit
Cost of revenue principally includes payroll and employee benefits associated with personnel employed in customer service and operations roles, fees paid to external providers related to the provision of services, reimbursable expenses, technology and telephony expenses as well as depreciation and amortization of operating assets.
We recognized cost of revenue of $184.5 million for the six months ended June 30, 2012, a 56% increase when compared to the six months ended June 30, 2011 ($92.7 million for the second quarter of 2012, a 47% increase over the second quarter of 2011). Our gross margins can vary significantly from period to period. The most significant factors contributing to variability include seasonality, mix of services delivered, timing of investments in new services, hiring of staff in advance of new business and the timing of when loans are boarded by our customers. Gross profit margin as a percentage of service revenue remained flat for the six months ended June 30, 2012 compared to the six months ended June 30, 2011.
Selling, General and Administrative Expenses and Income from Operations
Selling, general and administrative expenses (“SG&A”) include payroll for personnel employed in executive, finance, legal, human resources, vendor management, risk and six sigma roles. This category also includes occupancy costs, professional fees, depreciation and amortization on non-operating assets.
We recognized SG&A of $36.0 million for the six months ended June 30, 2012, a 19% increase when compared to the six months ended June 30, 2011 ($19.0 million for the second quarter of 2012, a 37% increase over the second quarter of 2011). On a consolidated basis, SG&A is growing at a slower pace than service revenue. On an absolute basis, the increase in SG&A for the six months ended June 30, 2012 was primarily due to a $5.1 million increase in occupancy related costs ($2.1 million increase in the second quarter of 2012 compared to the second quarter of 2011) primarily from the addition of new leased facilities and equipment to support our growth. In addition, other SG&A in the first half of 2012 increased $1.5 million compared to six months ended June 30, 2011 from higher marketing costs related to the consumer real estate portal business, travel expenses primarily associated with the management of our global operations and business license fees in our growing REO brokerage business. Partially offsetting these increases were lower compensation expense of $1.0 million in the first half of 2012 primarily due to the reversal in the first quarter of share-based compensation and incentive compensation expense related to the departure of an Executive Officer in March 2012.
As a result of our stabilization of SG&A costs on higher service revenue, income from operations as a percentage of service revenue improved to 28% for the six months ended June 30, 2012 from 23% for the six months ended June 30, 2011 (27% for the second quarter of 2012 and 22% for the second quarter of 2011).
Income Tax Provision
The Company recognized an income tax provision of $5.6 million for the six months ended June 30, 2012. The income tax provision, computed by applying the Luxembourg statutory tax rate of 28.8%, differs from the effective tax rate primarily because of the effect of a favorable tax ruling in Luxembourg and the mix of income and losses in multiple taxing jurisdictions. Adjusting for the impact of net income attributable to non-controlling interests, the effective tax rate for the six months ended June 30, 2012 of 9.5% compared to 11.1% for the six months ended June 30, 2011. The lower tax effective tax rate in 2012 is due to higher relative taxable income in the current year in tax jurisdictions with a lower tax rate.
SEGMENT RESULTS OF OPERATIONS
The following section provides a discussion of pretax results of operations of our business segments for the three and six months ended June 30, 2012 and 2011. Transactions between segments are accounted for as third-party arrangements for purposes of presenting Segment Results of Operations. Intercompany transactions primarily consist of IT infrastructure services and charges for the use of certain REALSuite applications from our Technology Service segment to our other two segments. Generally, we reflect these charges within technology and communication in the segment receiving the services, except for consulting services, which we reflect in professional services.
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Fund Letters
