In late May, I wrote two pieces on Lender Processing Services (NYSE:LPS) that reflected my increasingly bearish opinion on the company: “Rethinking Lender Processing Services Amidst New Allegations and Surging Put Activity” and “Shorts Close In On LPS.” On Friday, LPS delivered the bad news that the bearish trading activity seemed to anticipate. The company significantly lowered earnings guidance and demonstrated that legal, regulatory and market uncertainty have all increased. LPS announced at least a 29% reduction in its previous Q2 2011 earnings guidance of 79-82 cents:
“(LPS) now expects second quarter 2011 adjusted earnings to be in the range of 54-56 cents per diluted share. This updated outlook reflects further weakness in default volumes and continued sluggish origination activity, in particular, in the refinancing marketplace. Lower default volumes will in turn impact related revenues in LPS’ Other TD&A sub-segment. Also, results are expected to be impacted by higher than expected regulatory and legal-related expenses in the quarter.”
LPS also projected second quarter revenue to decline 8% from the first quarter; previous guidance was for a 5% decline. Overall corporate expenses will be at the upper-end of previous guidance but could increase further depending on the outcome of regulatory and legal proceedings. LPS refrained from providing revised full-year guidance.
In response, the stock closed down 12.6% for a fresh 2 1/2 year low. Short interest has steadily increased on LPS since March 15th. Put activity has also surged and Friday’s options action shows that put holders are in no rush to lock in profits (the massive open interest on September puts keeps creeping higher). This behavior suggests that the company expects even more significant downside to come. (My puts expired on Friday, so I sold them. Still holding shares ... for now). The charts below provide an update on the short interest numbers and juxtapose key turning points in short interest with the stock price.
Click to enlarge
(Chart created using TeleChart)
I decided to listen to the conference call to gauge the mood of analysts, many of whom must feel very burned now. I highly doubt LPS’ expansion of its repurchase plan to a new $100M authorization will turn negative sentiment around any time soon. Given the brevity of the earnings announcement, I also knew I would get more insight from the question and answer period.
In summary, LPS previously under-estimated the growing regulatory weight being applied to the foreclosure process. The company is now admitting that even more uncertainty lies ahead. While management expects to provide more clarity in six weeks at its regularly scheduled earnings conference call, they acknowledged that they are prepared to get even more cautious on guidance at that time.
Here are the notes I jotted down as I heard particular items of interest during the Q&A period:
- No major customer has dropped LPS.
- For Q2, now expect default revenue to be down 6% sequentially. Default volumes will remain artificially low for the remainder of 2011.
- Blamed for the miss: Regulation, expansion of the consent order, and a drop in foreclosure volume that went beyond what was expected. Customers have also been caught by surprise.
- The remainder of 2011 should remain difficult.
- LPS is taking a restructuring charge to get costs down – not reflected in EPS guidance.
- LPS will be in a better position to determine whether (increasing) legal expenses are recurring/operational in next earnings statement. Expenses could go up. About half of the year-over-year increase in expenses will be recurring.
- There is not much LPS can do in the short-term to offset increasing costs given the company is locked into contracts.
- Foreclosure revenues are being deferred – they must happen at some point. Timing is difficult now.
- One analyst directly challenged management by asking how they could provide guidance that went below the worst case scenario described at the last conference call (see my notes from that conference call). Management responded that they had expected some meaningful uplift in the second half. Instead, default volume is actually down in the second quarter and business all but dried up in May. At the time of the last conference call, it just “didn’t make sense” that volumes would go even lower than they were.
- Pretty dramatic drop-off in LFS (Loan Facilitation Services?) – expect it to be down 19-20%. Industry volumes are down. MBA last predicted refinance activity will be down 10% for the second quarter. Essentially this revenue dried up in the month of May. Another surprise was the mix (no specifics on the mix).
- Default business is causing the revenue miss. LFS is causing the margin miss.
- The regulatory environment for the industry is changing rapidly.
- In the next six weeks, LPS expects it will get more clarity on the consent order for themselves and their customers and a better idea about discussions with state attorney generals (me: this is a MUST for monitoring).
- A Goldman Sachs analyst referenced the 4 million foreclosures that are “just stuck there” and asked whether it is possible these foreclosures just get ignored and never go through the pipeline (like a pig just rotting in there). LPS answered that banks are forced to keep foreclosures on the books until they are absolutely clear what the new rules will be going forward.
- Until LPS gets more clarity, the company will not make significant decisions on the share buyback although it got an additional $100M authorization through the end of 2012.
- When pressed, management admitted that they are not certain much more clarity will materialize in the next six weeks. Without more clarity, LPS will get even more cautious with guidance.
- Management insists that its business model is intact given continued success in technology implementations.
Be careful out there!
Disclosure: I am long LPS.