The rising-rate environment has thrown the whole stock market into a tailspin, and the housing industry, in particular, is especially sensitive to the impact that higher interest rates have on home affordability. Housing is just one step removed from the business that mortgage-software platform specialist Ellie Mae (NYSE:ELLI) does, and despite having an impressive platform that clients really like, some investors have questioned how long Ellie Mae can stay insulated from a weakening mortgage market.
Coming into Thursday's third-quarter financial report, Ellie Mae investors still were hopeful that the company would post impressive gains in revenue and manage to eke out modest profit growth. Ellie Mae's income came in even stronger than that, but top-line growth suffered, and the company believes that headwinds will keep hurting its sales results at least for the immediate future.
Ellie Mae's mixed quarter
Ellie Mae's third-quarter results finally showed that the company is vulnerable to changing conditions in the mortgage market. Revenue was higher by 15%, to $123 million, but that wasn't quite as strong as the 20% growth rate that most of those following the stock were hoping to see. Yet after accounting for one-time items, adjusted net income jumped 22%, to $24.2 million, and the resulting adjusted earnings of $0.67 per share easily topped the consensus forecast among investors for $0.54 per share.
Much of Ellie Mae's business seemed reasonably strong, but beneath the surface, some adverse trends started to appear. The number of active users on Ellie Mae's Encompass platform hit 192,300, which was up about 9,000 from year-ago levels. But the number was down sequentially from the second quarter. Similarly, loan volume of 699,000 was up 7,000 compared to the third quarter of 2017, but fell 22,000 from three months ago. Revenue per closed loan of $176 was consistent with recent results.
Ellie Mae's cost controls weren't as successful as some investors had hoped. Although general overhead costs rose only 4%, the jump in research and development costs and sales and marketing expenses far outpaced the rate of growth in revenue.
CEO Jonathan Corr explained some of the challenges that the company faces. "Rising rates, low housing inventory, and overall home affordability are serving as significant headwinds to the overall mortgage market," Corr said, and "while we believe these headwinds are temporary, they are prompting us to reset our assumptions for the year." The CEO noted that interest in the Encompass platform remained strong.
Can Ellie Mae avoid a bigger slowdown?
In the long run, Ellie Mae has few doubts that it can sustain its growth trajectory. Mortgage lenders are turning to the Encompass platform to improve productivity and efficiency, and Ellie Mae's newest upgrades to the platform have gotten a positive reception from clients. As Corr put it, "Over the long-term, we expect the mortgage industry to trend to a sustained purchase-driven market, and we believe we are well-positioned to drive further market share gains and technology adoption across our large customer base."
However, that didn't mean that Ellie Mae could avoid acknowledging the extent of the near-term consequences of the industry's slowdown. For the fourth quarter, Ellie Mae expects revenue of $113 million to $116 million and adjusted earnings of $0.34 to $0.39 per share, both of which are considerably below the consensus forecast among investors. Similarly, full-year guidance for 2018 was reduced to a revenue range of $477 million to $480 million, down more than $20 million from the previous projections, and adjusted earnings of $1.84 to $1.88 per share fell pretty squarely in the middle of Ellie Mae's prior guidance.
Shareholders weren't happy about that downgraded guidance from Ellie Mae, and the stock fell more than 13% in after-hours trading following the announcement. The mortgage-software specialist will have to convince its investors that its challenges will be short term in nature. It will be interesting to see how the company reacts to future moves from the Federal Reserve that will have an impact on rates going forward.