Ellie Mae (ELLI) Q3 2018 Results - Earnings Call Transcript

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About: Ellie Mae, Inc. (ELLI)
by: SA Transcripts

Ellie Mae, Inc. (NYSEMKT:ELLI) Q3 2018 Earnings Call October 25, 2018 4:30 PM ET

Executives

Alex Hughes - Ellie Mae, Inc.

Jonathan H. Corr - Ellie Mae, Inc.

Popi Heron - Ellie Mae, Inc.

Analysts

Saket Kalia - Barclays Capital, Inc.

Sterling Auty - JPMorgan Securities LLC

Ross MacMillan - RBC Capital Markets LLC

Brian Essex - Morgan Stanley & Co. LLC

John Campbell - Stephens, Inc.

Brad Sills - Bank of America Merrill Lynch

Mayank Tandon - Needham & Co. LLC

Stephen Hardy Sheldon - William Blair & Co. LLC

Patrick Walravens - JMP Securities LLC

Brian Schwartz - Oppenheimer & Co., Inc.

Operator

Good day, and welcome to the Ellie Mae's 3Q 2018 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Alex Hughes, Vice President of Investor Relations. Please go ahead, sir.

Alex Hughes - Ellie Mae, Inc.

Thanks, Travis. Good afternoon, and thank you for joining us on today's conference call to discuss Ellie Mae's third quarter 2018 results. This call is being broadcast live over the web and can be accessed for 90 days in the Investor Relations section of Ellie Mae's website, www.elliemae.com. Joining me on today's call are Jonathan Corr, Chief Executive Officer; and Popi Heron, Interim Chief Financial Officer.

We would like to remind you that during the course of this conference call, Ellie Mae's management team will make projections and other forward-looking statements regarding future events or our future financial performance. Such statements include statements relating to the forecasted revenue, contracted revenue, net income, net income per share, adjusted net income, adjusted net income per share, adjusted EBITDA, free cash flow, capital expenditures, addition of contract receipts, growth of revenue per loan and the effective tax rate for the fourth quarter and full year 2018.

Additional forward-looking statements include those about the progress of rolling out Encompass Lending Platform, integration of Velocify's software solutions, expected efficiencies in cost reductions by our customers using our solutions, drivers of adoption of our platform, our long-term growth opportunities and trends in the broader mortgage market.

We wish to caution you that such statements are simply predictions, and actual events may differ materially. We refer you to the documents that we file from time-to-time with the Securities and Exchange Commission, specifically our filings on Form 10-K and 10-Q. These documents identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

I also want to inform our listeners that management will make some reference to non-GAAP financial measures during the call. You will find supplemental data in our press release, which includes reconciliations of the non-GAAP measures to the comparable GAAP results.

And with that, I'll turn it over to Jonathan.

Jonathan H. Corr - Ellie Mae, Inc.

Well, thanks, Alex. Good afternoon, everybody, and thanks for joining us. There are two key messages that I'd like to convey today. First, this year's mortgage market is proving to be more challenging than originally expected for a variety of reasons, which I'll discuss in a moment.

But second, our underlying business continues to strengthen with additional gains in market share, and important investments made in our platform to build on our leading position. We believe we're in a better position today that at any point in our history to deliver on our long-term vision to automate the mortgage origination process from end to end.

But let me start by addressing the mortgage market, a combination of particularly tight housing inventory and rising interest rates is fueling low home affordability, which is stalling the purchase market more than the industry or we anticipated. Although demand for housing is strong and growing, these elements on the supply side are creating a near-term challenge.

We see this reflected in pending home sales data, which is declined on an annual basis for nine consecutive months, while improving slightly on a sequential basis in September. And lenders tell us that many buyers are now waiting on the sidelines for home prices to come down, or at least settle, or some sellers are reluctant to lower their listing price, or choosing to stay in their current home longer rather than trade up into a higher cost mortgage based on unequal appreciation in many markets.

These dynamics appear across the board, but they seem to be the most acute at the entry level where the housing supply is the most constrained. In speaking with customers and prospects last week at the Annual Mortgage Bankers Association meeting in Washington, D.C., many expect to see the tight market ease as we approach next spring.

More inventories is expected to come on the market over time helping home prices to moderate and many interested buyers to re-engage. Lenders have said they've already seen homebuilders increased their new construction focus at the entry level. Moreover, the economy is strong, and this combined with demographic changes is encouraging and provides a positive view to the future.

Longer-term household formations are expected to continue to increase with millions of millennials reaching the average first-time home buying age, the early 30s. An entry level buyer is experiencing high levels of employment. And given that millennials consider home ownership a top priority, we're optimistic that over time these trends will become tailwinds to the market.

In the near term, however, as we experience in the third quarter, we see these headwinds constraining mortgage applications in closed loan volumes through Q4 and the first part of 2019. Therefore, we've chosen to take an even more cautious stance on industry dynamics in our outlook.

At the same time, although there is a significant high interest in innovation and technology to combat the margin and competitive pressures that lenders feel, some lenders are taking more of a wait-and-see approach with respect to the timing of enterprise, technology decisions, until they get better visibility into the 2019 market, which is causing some bookings to push into the first half of next year.

We now expect bookings of Encompass seats closed in 2018 to be between 27,000 and 29,000 for the year. The mortgage cycle side, we remain very confident in our underlying technology foundation and growing value proposition. While we believe these headwinds are temporary, potentially running through the first half of 2019 as the mortgage market transitions with the overall housing market, in some lender segments we're seeing increased interest to invest in technology and specifically in our platform.

Large lenders and correspondent investors continue to express strong interest in Encompass as they look to technology to tackle rising costs and to drive efficiency. The cost to close a loan in the first quarter passed $9,000 for the first time. And so, lenders understand that they need a strategy to bring down costs.

Despite overall industry declines, the continued adoption of Encompass as well as the improved efficiencies that many of our customers are experiencing resulted in loan volume growth on our platform. 699,000 loans closed for the quarter, up 1% percent year-over-year, despite industry volume down 9% year-over-year, and when translated to the number of loans, represents approximately a 13% decrease on a unit basis over the same time period.

Given the reception of our platform by the industry, we expect to continue to gain market share as customers gain further efficiencies and other lenders in the industry seek similar performance and embrace the Encompass Lending Platform.

At the same time, we're in a position to grow revenue per loan as we drive innovation and deliver greater value within Encompass, enabling the adoption of a broader set of solutions and improved business and operating efficiencies. In the third quarter, revenue per loan grew 14% year-over-year to $176, as customers adopted new product offerings.

We've also made tremendous strides in rolling out valuable new components to our Encompass Lending Platform. The latest release of Encompass enables improved efficiencies for lenders of all sizes through intelligent workflow automation, customizable third party originator workflow, new correspondent integrations and products and pricing enhancements, further enhancing the robust wholesale and correspondent channel capabilities throughout the platform.

The release of Consumer Connect, which is being very well received, we've also significantly enhanced the front end of Encompass for lenders who are focused on delivering the best experience they can for borrowers. In addition, we continue to make progress integrating Velocify's lead management and engagement capabilities and pulling that into our consumer engagement suite including CRM and Consumer Connect, which we believe will help drive greater efficiencies at the front end for our customers.

Our other offerings, including Data Connect and Investor Connect also continue to gain traction. We're seeing major correspondent investors adopt Investor Connect to be able to access the large share of high quality loan flow to the thousands of lenders that use Encompass, which also drives greater value for our lenders by making it easier for them to transact with these investors.

We currently have the majority of the top five investors signed for Investor Connect. Similarly, the interest in Data Connect has been robust and is laying the foundation for customers to use analytics, AI and machine learning to drive greater efficiency and performance across the entire mortgage process.

In summary, while the near-term mortgage market is experiencing headwinds due to low inventory and affordability, we believe these are temporary and we've laid the groundwork for continued long-term success. With more of the lending ecosystem embedded in our platform, we've created network effects that give us tremendous confidence about our long-term growth opportunities.

Based on our discussions with our customers and other industry participants, as well as the long-term increase in household formations, we believe the longer-term trends will lead to a sustained purchase market as we enter the second half of 2019 into 2020 and beyond. We remain laser focused on further expanding our value proposition as we drive toward our goal to automate everything automatable in the mortgage origination process. And we feel confident we can continue to drive market share gains and revenue per loan growth long-term.

With that, I'll hand it over to Popi for a discussion of the financials.

Popi Heron - Ellie Mae, Inc.

Thank you, Jonathan. Good afternoon, everyone, and thank you for joining us today. As you know, we adopted accounting standard ASC 606 as of January 1, 2018, utilizing the modified retrospective method. Unless otherwise indicated, all 2018 numbers are under the new standard, while third quarter of 2017 numbers are under the old standard ASC 605. I'd also like to note that all growth rates are compared to the prior year periods unless stated otherwise.

Before discussing our third quarter results, I would like to call your attention to the 8-K we have filed in conjunction with our earnings press release, informing readers of our intention to amend our financial statements previously reported in Form 10-Q for the first and second quarters of 2018.

As we've previously discussed, the new revenue standard ASC 606, requires us to estimate a portion of our Encompass closed loan fees. The standard requires that we constrain our estimates so that it is probable that a significant revenue reversal will not occur. During our review of those estimates in the third quarter, we determined that it was necessary to apply additional constraints to the estimate. This resulted in a change to our opening balances that we had recorded at adoption and has resulted in an estimated $1.7 million reduction to our six months' revenue numbers previously reported.

Now turning to our results of the third quarter. Our revenue performance in Q3 was impacted by lower-than-expected origination volumes. As Jonathan mentioned, a combination of tight housing inventory and rising rates has led to lower home affordability, which has resulted in lower closed loan volumes for the quarter.

We were able to outperform expectations on the bottom line or net income, adjusted net income and adjusted EBITDA, as we managed personnel and compensation expenses in light of the current industry outlook. Total revenue for the third quarter was $123 million, an increase of 15% against an industry volume drop of 9% on a dollar basis and a drop of approximately 13% on a unit basis as Jonathan mentioned.

While we were pleased with our significant outperformance of the market, revenue came in lower than expected. The largest factor was lower industry origination volumes which led to reduced variable revenue from Encompass and the Ellie Mae Network.

Contracted revenue increased 25% to $88.6 million and represented 72% of total revenue. Contracted revenue includes our subscription revenue streams that are fixed by the terms of a contract and our professional services revenues which represented approximately 7% of total revenue.

We are seeing customers take a wait-and-see approach during this time period, which has led to slightly lower contracted revenue than expected, mainly driven by lower professional services revenue. Our customers closed 699,000 loans on the Encompass platform in the quarter, up 1% year-over-year despite industry volumes declining significantly over the same period. This represents the expanding footprint of Encompass.

In the third quarter, we had 192,000 active users, an increase of 5% from Q3 of 2017, and approximately flat sequentially. For the first quarter, average monthly closed loans per active user was 1.21 compared to 1.27 in Q3 of last year and 1.25 last quarter. While closed loans per active user were down about 5% year-over-year, we're encouraged by the fact that it declined meaningfully less than the industry volume composite over the same period, particularly when you consider the industry unit decline. We believe this points to increased efficiencies by our customers.

Moving to gross margin, GAAP gross margin for the third quarter was 58.3%. On a non-GAAP basis, third quarter gross margin was 64.8%. GAAP net income for the third quarter was $12.4 million, or $0.35 per diluted share, compared to $14.5 million, or $0.41 per diluted share, in the third quarter of 2017.

Net income for the third quarter of 2018 includes the amortization of acquisition-related intangibles related to our Velocify acquisition. On a non-GAAP basis, adjusted net income for the third quarter was $24.2 million, or $0.67 per diluted share, compared to $19.9 million, or $0.56 per diluted share, in the third quarter of 2017.

The GAAP quarterly effective tax rate for Q3 was negative 1%, as the R&D tax credit benefit that we routinely recognize exceeded GAAP income tax expense before the credits in the quarter. On a non-GAAP basis, our third quarter effective tax rate was 16.7%. Adjusted EBITDA for the third quarter was $40.9 million compared to $38.7 million for the third quarter of 2017, and was 33.2% of revenue.

Now shifting to the balance sheet and cash flow. We finished the quarter with cash and investments of approximately $342 million, up from $324 million in the second quarter. Cash flow from operations was $37.1 million. Free cash flow was $12.2 million for the quarter and $6.8 million on a year-to-date basis. In line with our reduced revenue outlook for the year, we expect 2018 free cash flow in the range of $20 million to $25 million. We continue to expect CapEx of approximately $95 million.

Now turning to our guidance for the fourth quarter and full year 2018. Our 2018 annual guidance takes into consideration industry forecast for mortgage origination volumes. We use the composite estimate of mortgage origination volumes as published by Fannie Mae, Freddie Mac, and the Mortgage Bankers Association to forecast certain portions of our business.

For 2018, this composite shows an estimated 9% decline in origination volumes on a dollar basis from 2017. For the fourth quarter, it is expected to decrease 14% sequentially and 17% year-over-year. Since the time of our last guidance in August, the composite forecast for the fourth quarter has decreased by 3 percentage points.

Furthermore, as Jonathan said, we believe loan volume on a unit basis is declining more sharply. With this in mind for 2018, we now expect annual revenue to be in the range of $477 million to $480 million. Contracted revenue is now expected to be in the range of $347 million to $349 million. Net income on a GAAP basis is now expected to be in the range of $22 million to $24 million, or $0.61 to $0.67 per diluted share.

On a non-GAAP basis, adjusted net income for the year is now expected to be in the range of $65.8 million to $67.6 million, or $1.84 to (sic) $1.88 per diluted share. Adjusted EBITDA is now expected to be in the range of $125.3 million to $127.8 million.

For the full year 2018, we now expect that we will book between 27,000 and 29,000 Encompass seats. For the fourth quarter of 2018, we expect revenue to be in the range of $113 million to $116 million. Net income on a GAAP basis is expected to be in the range of $0.0 million to $2 million, or $0.00 to $0.06 per diluted share. On a non-GAAP basis, adjusted net income for the fourth quarter is expected to be in the range of $12.4 million to $14.2 million, or $0.34 to $0.39 per diluted share.

Adjusted EBITDA is expected to be in the range of $28.8 million to $31.3 million. For the fourth quarter of 2018, our income tax expense is expected to be between $500,000 and $1 million on a GAAP basis and between 15% and 20% on a non-GAAP basis.

With that, I'll turn it over to the operator for your questions.

Question-and-Answer Session

Operator

Thank you. The first question comes from Saket Kalia, Barclays Capital.

Saket Kalia - Barclays Capital, Inc.

Hey guys, thanks for taking my questions here. Jonathan, obviously a tough environment out there. The lower the seat additions for the year, I believe. I guess, the question is, can you talk about seat churn at all, and specifically, if the obviously tougher environment is driving layoffs at your customers as well?

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. Great, great question, Saket. We are not seeing any real change from our historical churn which is very low, obviously very high retention rates. It's still consistent with 1% to 1.5% per quarter. And that really is when we think about customers actually either going out of business or potentially being acquired or potentially leaving, it still remains even in this market quite consistent with history. What we are seeing is and I think it's what's affecting overall active users is, we're seeing kind of a combination of things happen which is we're seeing many of our customers work and do loans with less employees. So, maybe 5%, 10% less active users at a portion of our customers.

At the same time, we have other customers that actually are expanding and growing their teammates. And then at the same time, we're ramping new customers. And so, it's really that combination of things that we're seeing. But it's actually consistent with what we've talked about and expected, this happens to be a market that's a little bit tougher, but we expect that customers are going to figure out how to get more and more efficient and do more loans with fewer people. And we've talked about that in terms of focusing on the loan and revenue per loan metrics. And that's kind of what we're seeing, that's kind of the benefit for us of the Success-Based Pricing model.

Saket Kalia - Barclays Capital, Inc.

Got it. Got it. And for my follow-up also for you, Jonathan. I think we talked about loan mortgage volume being down about 13%, unit volume that is, down about 13%...

Jonathan H. Corr - Ellie Mae, Inc.

Yeah.

Saket Kalia - Barclays Capital, Inc.

...I think in the quarter and it looks like we outperformed that. I guess looking forward, I think you touched on this, but just to ask it expressly, looking forward how do you think about mortgage volume long-term and your ability to continue outperforming that?

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. So, what we're hearing and seeing and as I've talked to economists at the various constituencies out there, whether it'd be MBA, Fannie, Freddie, even NAR, is that the market is tight right now because of inventory and prices, but demand is strong. And the perspective is it's going to be a tough few quarters, but when you look at their estimates, especially the Mortgage Bankers Association, where I was at the annual last week and you see a steady uptick in their projections in the back half of 2019 into 2020, 2021 and beyond. And the fundamental drivers of that are overall demographics, the size of the millennial population, the aging of the millennial population; all is just creating this big demand curve that should have a steady set of demand that will drive the purchase side of the market. So, it's not going to soar, but we should see a steady modest growth rate as we go out beyond 2019, that's the expectation that we see there.

From our standpoint, we look at in a market that's growing modestly and where there's competition and folks need to figure out how to bring down the cost of lending, which in the first quarter was over $9,000 for the first time. Lenders know they need to embrace technology. They know they need to figure out how to be more competitive, how to deal with margin compression, and the way to do that is in technology investment.

And we're also seeing for the first time, I mean, not first time, that – last week, when I was at MBA, I saw the highest interest I've ever seen from some of the largest lenders and big correspondent investors in the history of Ellie Mae. And that is because we have gotten to a place of so much share coming from Encompass lenders that sell to other investors that those investors are now coming to the table and showing genuine interest, serious interest for Encompass.

So, when I kind of look at that, I just think we're in a great position and I think the market long-term is going to have a steady growth to it. We're just going through a short-term bump. But I think from our standpoint, our executions there were outperforming, whether we add share which we will continue to do. I think the biggest opportunity for us is continuing to drive more and more value for the industry which allows us to drive revenue per loan. And if you look at $9,000 to get a loan done, there is a lot of fat and inefficiency there.

Saket Kalia - Barclays Capital, Inc.

Got it. Very helpful, guys. Thanks very much.

Operator

Our next question comes from Sterling Auty, JPMorgan.

Sterling Auty - JPMorgan Securities LLC

Yeah, thanks. Hi, guys. I want to follow on Saket's first question. So, as you think about cycle here and as you bottom and begin to grow, when do you think we hit the bottom of the head count within your customer base? And it's always tough from the outside to correlate the number of contracted seats versus the head count. So, in other words, trying to figure out within the customer base, when that contracted revenue might bottom and begin to grow on a kind of same-store sales basis?

Jonathan H. Corr - Ellie Mae, Inc.

Well, again, I mean, contracted revenue is a component of it. Obviously, the model is Success-Based Pricing. So, contracted really remains the floor, right? And even in this market, the vast majority of our customers are above that subscription floor, right? And that is kind of the reason we, how we think about the business and why we really focus folks on the loan volume and the revenue per loan that we can deliver. And at a macro level, I think that we'll see folks tightening up and probably not changing their contracted seats right now because they can't, but rather maybe reducing the number of active users and trying to deliver more loans with fewer folks, which is what we expect to happen, and that will probably likely be the picture for the next few quarters, as people acclimate to a strictly purchase-driven market.

Now, we're getting that last bit of – I mean, we're at a point where refi is pretty much out of the system. If you look at year-over-year other than kind of a baseline of about $400 billion, so cashed out refi. So, one thing we are starting to see and I know if you saw our announcement around our latest version of Encompass and support for HELOC is we're seeing home equity lines of credit start to come back. And that's an opportunity that will start to kick in as refis have slowed down. So, I'd say the next couple of quarters is kind of from an employee standpoint, but we really just don't see a change in the actual revenue because it really at this point is tied to loans.

Sterling Auty - JPMorgan Securities LLC

That makes sense. And then, just one follow-up, the revenue per loan actually came in a bit below what we're expecting. So, within the closed loan volumes, what was impacting that revenue per loan?

Jonathan H. Corr - Ellie Mae, Inc.

Well, in the revenue per loan, a portion of why we weren't probably as high as we were, were some of the things that we've been cross-selling, folks are a little bit – taken a little bit more time to make some of those investments. And basically, that's what I would say. The other thing is probably if you think about our revenue per loan, pro services is part of that because we kind of look at overall revenue per loan and pro services came in a bit last again in conjunction with the bookings of seats going out a little further and people being a little bit more careful about their dollar spend as they finished 2018, because just as any business and any set of folks, people have their bonuses tied to their performance. So, if their revenue is down, they're going to spend a little less, but they're still looking and we're hearing that to make those commitments as we go into 2019.

Sterling Auty - JPMorgan Securities LLC

Got it. Thank you.

Operator

Our next question comes from Ross MacMillan, RBC Capital Markets.

Ross MacMillan - RBC Capital Markets LLC

Thanks so much. Jonathan, I wondered if you could cast it a little further lens here into next year, two things. One is, if customers do reduce the number of active users because they're trying to drive sort of head count down, but they can't come out of contract. Do you think you can still – under that scenario, do you think you can still with active users potentially coming down, can you still outgrow the market from a loan volume standpoint? It's not clear to me that that's going to be easy if you've got fewer users, even if they're becoming at the margin more efficient, that's an incremental headwind. So, I wonder if you could just talk to that for a minute.

Jonathan H. Corr - Ellie Mae, Inc.

Yeah, I mean, I think, think about it from a market share perspective, right? So, last year we had about 35% of the share and we've shared with you guys. Our projections this year based on the activity of folks that we're bringing on that we'll finish the year probably four to five points higher. And so, we've got a combination of things that are happening, you've got a big footprint. So, if the loan volume as an industry is going down 5%, yet we're picking up share by adding more entities that do lending even though a single entity may do less with, and they may have less active users, you've got to remember we have 2,400, 2,500 lenders, we are adding lenders, we've added lenders this year, we've got lenders that are ramping this year that we've talked about that we have yet to see the volume really come through.

Big lenders like TD Bank, big lenders like PenFed Credit Union that we signed last year that is still not fully ramped out, and others that we've sold. So, it's really that combination of things that I think you'll still see us outperform the industry loan volume by just continuing to pick up share. And at the same time we have a mix of customers, some of them are expanding, some are contracting, but we have a big footprint even as things move around, and you're adding more, you're invariably going to grow that, and we expect to see that happen.

Ross MacMillan - RBC Capital Markets LLC

And on revenue per loan, obviously, you're growing in the teens right now, there's still the inorganic component from Velocify. And I know we're not in 2019 yet, but just given the margin pressures in the industry and maybe the – as you commented on slightly lower appetite for additional products, cross-selling additional products, what's your – what's the framework that you think we should use as we think about revenue per loan beyond this year into next year?

Jonathan H. Corr - Ellie Mae, Inc.

I still think the revenue per loan is going to follow our – the trajectory would be laid out there in the long-term view earlier this year, I'm not giving guidance yet, for 2019 yet, but I still see along the lines of what we laid out, which was $15 to $20 per loan on an annualized basis as we keep going forward, I still think we're on that trajectory.

Many of the things that we have – that are brought to market, Data Connect, the beauty of things like Investor Connect which lenders don't pay for but the investors are paying for, some of the things we've done around mortgage insurance capabilities which is increasing value there, as well as there is built-in increases on a revenue per loan basis. And Velocify is still, it is gaining traction and we're seeing traction there, all of those are going to drive revenue per loan.

And again, lenders still, they know they need to compete, they know they need to deal with margin compression, they're taking a little longer to make decisions, but the dynamic is, in many ways, some of the things they may have invested in, like other consumer-facing solutions over the last year or some of these other LO-facing point-of-sales, where they're paying money out of pocket, they can really embrace what we're delivering across our platform at a much lower incremental cost per loan. And we're seeing that play out since we've released Consumer Connect, as we're rolling out capabilities around Loan Officer Connect, and those will be the elements that will drive that revenue per loan. So, I still believe you should be thinking about it the way we set out that long-term guidance or plan, or guidance.

Ross MacMillan - RBC Capital Markets LLC

Thanks. And Popi, can I ask one just quick to you to round out just on the ASC 606 modifications? Could you size that for Q3 and Q4 relative to where you had originally guided. So, how much of the revision down was this modification due to your assumptions on the ASC 606 shift that you've made?

Popi Heron - Ellie Mae, Inc.

Yeah. I can definitely address that. So, on a year-to-date basis, there's a difference between ASC 605 and ASC 606 of about $1.2 million in the third quarter, and we're expecting something in the neighborhood of $2 million to $4 million on the year, but pretty much (37:46).

Ross MacMillan - RBC Capital Markets LLC

I meant the modifications to what you had assumed that – the component that you have to estimate under ASC 606 in that revision, I wondered how much of the revision in the back half that was?

Popi Heron - Ellie Mae, Inc.

Oh, my apologies for that. So, on an annual basis it's about $5 million of revenue and then in terms of what we saw in the first half is about $1.7 million.

Ross MacMillan - RBC Capital Markets LLC

Great. Thank you.

Jonathan H. Corr - Ellie Mae, Inc.

So about $3 million...

Ross MacMillan - RBC Capital Markets LLC

Yes. Yeah, $3 million and change. Okay, thank you.

Operator

Our next question comes from Brian Essex of Morgan Stanley.

Brian Essex - Morgan Stanley & Co. LLC

Hi, good afternoon, and thank you for taking the question. I was wondering if maybe I could circle back to Saket, I guess, play off of Saket's question a little bit. Popi, in terms of your guidance, I was wondering what kind of fundamental assumptions were baked into that, is it purely volume or would you have head count reductions baked into that? How do we think about upside, downside to that number as we evaluate the news flow from the industry that we may hear in 4Q?

Popi Heron - Ellie Mae, Inc.

I assume you're referring to the revenue and so I can address that. Yeah. Okay. So, about $10 million relates to volume, volumes that we're seeing in – over the course of the year.

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. So, let me expand on that. So, you've got volumes which are the lion's share of that, we've kind of looked at it, added a little bit of further conservatism because we think there's an almost like a tendency to kind of potentially get worse on a unit basis. So, we've brought that into the mix. We are a third into the quarter, so we have some visibility there that we brought out into the mix. We've also made very modest assumptions.

So, we're kind of saying, we're still going to see that kind of dynamic around active users, so our assumptions of where we are at Q4 is modestly higher. And clearly that's because we're seeing some ramp but again I think we're going to see some erosion on the active user side of things, so that's kind of calculated into the total picture. And then, we're also looking at what we think is going to happen in terms of Q1, because some of the revenue in Q4 is tied to applications that that happened in Q4 going into Q1. So, we feel good about where the picture is right now. And we've got some cushion in there.

Brian Essex - Morgan Stanley & Co. LLC

Got it. And then maybe the follow-up. In terms of customer size and geography, is there anything about the mix of customers that you have or type of lending institution that makes you over or under indexed to the volatility in the market that you're seeing on the purchase side?

Jonathan H. Corr - Ellie Mae, Inc.

I would say that we're pretty diversified. I mean we're diversified across the country, we're diversified across the institution side, we have about 2,400, 2,500 lenders, about half are mortgage banks, about half are depositories, banks, regional banks, national banks, credit unions, so there really is, I mean it's a reflection of the market.

I would say on the downside in terms of lenders that actually can take advantage of the purchase market versus refi, our customers probably going to take advantage of the purchase market as it comes back more because of the local nature of their businesses, much more so there may be some of the national brands, I would say, so hopefully that's helpful.

Brian Essex - Morgan Stanley & Co. LLC

Yeah. Very helpful. Maybe if I could squeak one more in, what about the refinancing market? Is your share of the refinancing market maybe a little bit lighter now than it was in the past and are there substantial lenders that have the lion's share of that market outside of you?

Jonathan H. Corr - Ellie Mae, Inc.

Oh, I mean, on the refi side, I mean we've got a distribution and we've always been more shifted to the purchase side. But you're in a market that's not going to go (00:42:27) $400 billion.

Quicken is a big refi lender, right? That's almost all what they do. So, they've got a nice share of that market. We don't have Quicken's customer today. I think that what we're going to see though, as I mentioned earlier, as a backfill to refi because I think you're going to – you're not going to see people refi-ing for rate.

Brian Essex - Morgan Stanley & Co. LLC

Right.

Jonathan H. Corr - Ellie Mae, Inc.

You may find some cash out and see more home equity lines of credit so to happen. We're seeing it across the market, it's starting to expand, in that way we've rolled out a set of capabilities there and the folks that do HELOCs is a broad set of the credit unions and banks and regional banks that we have on the platform, so we feel really good about that.

Brian Essex - Morgan Stanley & Co. LLC

All right. That's very helpful. Thank you.

Operator

Our next question comes from John Campbell with Stephens, Inc.

John Campbell - Stephens, Inc.

Hey guys, good afternoon. On the new 27,000 to 29,000 bookings that you guys mentioned. Just curious, was that running behind earlier this year or is that something that started to slow a little bit this quarter and you expect it to slow more in the 4Q? Just kind of get an idea about timing there.

Jonathan H. Corr - Ellie Mae, Inc.

Yeah, I mean, we really just saw the slowing of the market in Q3 and we're projecting it into Q4. And we really see it as a function of folks slowing down, taking a little bit of a wait-and-see into 2019. We're still closing deals but not at the same pace we were doing in the first half of the year.

John Campbell - Stephens, Inc.

Okay and then earlier this month you guys, I think I saw that announcement, the bidirectional integration of Roostify. I was just – I was thinking that's a more of a competitor to Consumer Connect. So, just curious what you're doing there. That's a new strategy for you guys or just if you can walk through what you're doing there?

Jonathan H. Corr - Ellie Mae, Inc.

Yeah, it's not a new strategy. We've always had a – what I'll call a cooperative model which is – we have our own solutions, whether they be Consumer Connect or our Pricing solution or our Docs solution or Compliance solution, all of those we deliver to the marketplace. We also have partners in all of those categories and they're either on the Ellie Mae network or they are partners through our APIs. And in all of those cases we take a percentage transaction or percentage of the fees, and the model there is we want to give customers choice. We're driving to automate everything that we can across the industry and that way we monetize it either way. So, more than anything, Roostify probably really announced that because they wanted to make a point that they're out there. But the fact is we have partnerships with all the consumer-facing apps and we have our own, and if anybody is using the consumer-facing app we're getting compensation for it.

John Campbell - Stephens, Inc.

Oh, okay. That makes sense. Thanks, Jonathan.

Operator

Our next question comes from Brad Sills, Bank of America Merrill Lynch.

Brad Sills - Bank of America Merrill Lynch

Hey, guys. Thanks for taking my question. Just one on the volume growth lagging overall origination on a dollar basis, can you comment on that dynamic, and what you see that spread as being potentially next year to the forecast?

Jonathan H. Corr - Ellie Mae, Inc.

So, right now as I look at those projections in terms of dollar volume into 2020 – 2019. We're only going 2019 next year, okay. When I look across here the various folks, it looks roughly flat from a volume perspective, but as I had said earlier, in the purchase market you really have to think about units, right? And there's a very high correlation because it's tied to home prices, home price appreciation and the average loan size is following that. So, based on what we've seen and based on even some of the most recent anecdotes from National Association of Realtors and others, I think CoreLogic mentioned that the industry was off even 15% on a unit basis this quarter.

I would expect things to be off at least 5% next year in a flat volume market. So, prices have gone up, maybe that will slow down but we're still going to be at an average price point. That's 5-plus percent higher; that means the units for the most part are going to be affected on a 5% down. That's how we're thinking of the world. I think that could get a little tougher in the first half. So, I don't know what that ultimately will mean as we sit down and think about our guidance in Q1, but that's kind of what we're dealing with in the short-term.

Brad Sills - Bank of America Merrill Lynch

Great. Thanks, Jonathan. And can you remind us what types of terms customers are under for the contracted user fee? What is the average duration and are there some customers that you might give a concession to if they come to you and ask for reduced seats, given potential head count reduction?

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. So, we average on about four years right now. I mean, our contracts are between three and five, and so in any given year, we're renewing about a quarter of our customers. So, obviously, we did that this year, and obviously, adding on new customers. There is an ability to move things a very small percentage in the contract and existing contracts, but they can't come back and move the seats down materially while they're in contract. That being said, if a customer is massively distressed and maybe going out of business, we're going to help him out, right? That's kind of – it's not good for any of us if we don't do that. But the general scheme is, we don't make adjustments there. People are in contract. They're paying their subscriptions. And as I said earlier, we're just not seeing a real difference than what we've seen historically in terms of attrition and contracted seats and dynamics along those lines.

Brad Sills - Bank of America Merrill Lynch

Great. Thanks, Jonathan.

Operator

Our next question comes from Mayank Tandon, Needham & Company.

Mayank Tandon - Needham & Co. LLC

Jonathan and Popi, I was going to sort of shift gears to maybe more on the cost side, given some of the expected revenue headwinds, do you believe you may need to take maybe a stronger look at the cost structure and to protect the margins and earnings power of the company, and also wanted to get your thoughts on maybe a potential buyback in light of where the stock might trade tomorrow morning?

Jonathan H. Corr - Ellie Mae, Inc.

Yes. So, let me take the first one and then I'll take the second one. First one is, obviously, we've been – as we've seen what's going on in the market right now, we've been adjusting our growth investment from an expense standpoint knowing that there is this short-term bump, and you obviously have seen some of that come through in Q3. You've seen what we've implied in terms of Q4, obviously with a lower revenue line. So, we're absolutely going along those lines.

As we go into next year, we're going to look at, we want to continue to invest appropriately, but we're going to look at our expense lines and look at the resources that we have and make sure we're balancing between the two. I would say, in terms of high-level picture, and again, I'm not guiding right now, but when we laid out a margin plan that it talked about 30-plus percent next year, that was with an assumption of growth capability on the revenue side of where we were this year before they come down and before next year's down-market.

So, I expect we're going to be driving towards margin expansion and that's going to be our focus. But I don't expect that we're going to see 30-plus percent margins like we discussed in 2019, not giving guidance, but just expectation wise. We have a stock repurchase out there. And we've used it in the past, but we're also always looking at the best use of cash and that includes M&A that we're always considering. So, something we'll consider, we have a plan out there and we just got to balance the best use of proceeds.

Mayank Tandon - Needham & Co. LLC

Great. Thank you.

Operator

Our next question comes from Stephen Sheldon, William Blair.

Stephen Hardy Sheldon - William Blair & Co. LLC

Yeah. Thanks. I guess first here, anything to call out on why the margins were so much stronger this quarter than you'd expected? And then it also seems like the margins in the fourth quarter are going to come in a lot lower than you previously expected. I'm sure a lot of that's the flow-through from lower revenue. But were there any kind of expenses that shifted between quarters?

Popi Heron - Ellie Mae, Inc.

Yes. We definitely had a lower compensation cost in the third quarter as we adjusted our incentive comp plans in line with our revenue expectations. And we are also, as Jonathan mentioned, we're looking all of our cost structures and making sure we're in line with what we're seeing to remain – to retain our profitability in the next several quarters as we go through this industry shift. We, in terms of Q4, you're absolutely right, that revenue number is coming down about $7 million to $10 million based on our kind of quarter-over-quarter view in our guidance. So, that revenue is going to drop into the bottom line in terms of affecting profitability.

Stephen Hardy Sheldon - William Blair & Co. LLC

Okay. Thank you.

Operator

Our next question comes from Pat Walravens, JMP Securities.

Patrick Walravens - JMP Securities LLC

Great. Thank you and thanks for all the discussion so far. I just want to make sure we understand how the restatement stuff is going to play out. So, you need to file an amended Q1 and Q2, right?

Popi Heron - Ellie Mae, Inc.

Yes, that's correct.

Patrick Walravens - JMP Securities LLC

Yeah. When do you expect to file those?

Popi Heron - Ellie Mae, Inc.

Well, of course, as you know, there's a lot do in filing the two amendments and then the Q3 queue. Our goal is to file by the SEC deadline, November 9.

Patrick Walravens - JMP Securities LLC

Okay. How are you feeling about that?

Popi Heron - Ellie Mae, Inc.

We're feeling very confident. Yeah, we've got all our resources in place at our firm, yeah, we're very confident.

Patrick Walravens - JMP Securities LLC

Okay. Great. And Jonathan, is there still a CFO search going on, or is there still CFO search going? If so, how's that one?

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. There is still CFO search going. We've got a number of really strong candidates that we're well down the path with. And I expect that we'll still see us bringing someone on board by the end of the year, like I said.

Patrick Walravens - JMP Securities LLC

Okay. Great. And then last one, you've hit at this in a number of different ways, but I figured we might as well just get it out there. So, if we go back to more of a normalized environment, is the 20% growth rate in a flat market is still the way we should think about this or should we think about it as being something lower?

Jonathan H. Corr - Ellie Mae, Inc.

No, our long-term target growth rate is still 20%. I think going into 2019 and we'll not obviously give guidance in the beginning of next year. There's a lot of moving parts, there's a lot of friction in the market. We're going to have to look at what that picture looks like, but we are still driving the overall strategy with a long-term growth rate of 20%.

Patrick Walravens - JMP Securities LLC

All right. Thank you.

Operator

Our final question comes from Brian Schwartz, Oppenheimer.

Brian Schwartz - Oppenheimer & Co., Inc.

Yeah, hi. Thanks for taking my question. I just have one more to ask, Jonathan. Since it sounds like, well, clearly the business plan has changed here this quarter. Can you talk about, do you think that you need to make any changes here around the go-to-market strategy or the sales force, in general, as you think about your planning for 2019? Thanks.

Jonathan H. Corr - Ellie Mae, Inc.

Yeah. No, I think, I mean, the fact is the team is executing, right? I mean, we had 1% off in terms of volume expansion in a market that was down 13%. Our revenue per loan grew 14%. The team is executing on their cylinders. They're executing in an environment they have no control over, which is this mortgage market which we believe is a temporary bump to things. Now, we'll make tweaks as we always do to the sales force as we see more and more fantastic opportunity at the upper end of the market, especially with the large correspondent investors; as I said, there is real interest there for Encompass for the first time in our history. It's very exciting. And we'll obviously continue to hone our model to drive more penetration of our – of existing customer base and driving revenue per loan. But those would be tweaks rather than dramatic changes.

Again, I think the organization and the team are executing the long-term, mid- to long-term view here is as good as it's ever been, I feel great about it. We got to manage things effectively through the industry cycle and the short bump over the next few quarters.

Operator

Thank you. I will now turn the call back over to management.

Jonathan H. Corr - Ellie Mae, Inc.

Well, again, I want to thank everybody for joining us. Thanks for listening. I want to reiterate that although we're in a short-term market bump, we feel absolutely terrific about the long-term picture. And probably the most positive we felt about our ability to really drive continued automation and drive revenue per loan. So, again, thank you, I'm sure we'll see some of you guys out as we're out there doing some conferences over the next quarter, and I look forward to connecting with you again early in the year. Thanks.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.