Ellie Mae ( NYSE - ELLI ) -- Margins Remain High

Ellie Mae (ELLI $19.50) reported excellent better than expected Q2 results.  The company had indicated costs would rise sharply in the June period to lay the groundwork for further expansion.  Sales came in above target, though.  So those expenses were swallowed up with ease, enabling pretax margins to remain at superior levels (25%).  Earnings advanced 800% as a result to $.18 a share (fully taxed).  Sales climbed 106% to $23.6 million. 

Customer adoption of Ellie Mae's unique "success based" pricing model continued to rise.  The company charges a small amount to implement its technology at customer locations.  But most revenue is generated on a variable basis when mortgages are completed.  Lenders typically earn $750-$1,000 per loan and pay Ellie Mae a piece of that for the work performed.  The company still has a sizable installed base which uses licensed versions of the technology.  Those customers pay annual fees and don't participate in the recurring revenue scheme.  That group is transitioning to the pay as you go format.  That arrangement is more profitable for Ellie Mae because the ups and downs among its customers are averaged out.  Customers prefer it because the downside risk is reduced.  There's no potential for loss.

Revenues are being reinforced by Ellie Mae's service business.  The company operates a network that links mortgage originators with outside vendors that deliver services electronically.  Those include appraisals, title searches, income verification, and fraud detection.  The company charges for those transactions, but the price usually is far less than what it would cost to do manually.  The software checks the work, moreover, to ensure consistency and accuracy.  A recent stock offering raised $58 million in fresh capital.  Some of that might be deployed to purchase some of those providers, allowing the company to retain those incremental fees.

We are raising our full year earnings estimate by a dime to $.50 a share.  Our estimate assumes a modest decline in margins over the second half of the year due to moderating unit volume.  Refinancing activity has begun to slow.  While new mortgage activity is improving, the poor economy may inhibit its growth rate.  Our sales estimate has been lifted, too, by 12% to $90 million.  Next year $.65 a share represents a realistic target even if the economy remains in the doldrums.  Implementation of a broad-based Federal mortgage re-write program could provide substantial leverage.  Acquisitions might yield additional impetus.

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