Fidelity National Financial Inc (FNF) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the FNF first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Mr. Dan Murphy. Please go ahead.

Thank you. Good morning, everyone, and thanks for joining us for our first-quarter 2007 earnings conference call. Joining me today are Bill Foley, our Chairman and Chief Executive Officer; Al Stinson and Randy Quirk, Co-chief Operating Officers; and Tony Park, our CFO. On the call this morning, Bill Foley will begin with a brief review of our businesses. Randy Quirk will provide an overview of the title business, and Tony Park will finish with a review of the financial highlights.

This conference call may contain forward-looking statements that involve a number of risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Forward-looking statements are based on management's beliefs as well as assumptions made by and information currently available to management. Because such statements are based on expectations as to future economic performance and are not statements of fact, actual results may differ materially from those projected.

We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. The risks and uncertainties which forward-looking statements are subject to include but are not limited to changes in general, economic, business and political conditions, including changes in the financial markets; adverse changes in the level of real estate activity, which may be caused by, among other things, high or increasing interest rates, a limited supply of mortgage funding or a weak U.S. economy; our potential inability to find suitable acquisition candidates; acquisitions in lines of business that will not necessarily be limited to our traditional areas of focus or difficulties in integrating acquisitions; our dependence on operating subsidiaries as a source of cash flow; significant competition that our operating subsidiaries face; compliance with extensive government regulation over operating subsidiaries; and other risks detailed in the statement regarding forward-looking information, risk factors and other sections of the Company Form 10-K and other filings with the SEC.

This conference call will be available for replay via our website at FNF.com and will also be available through phone replay beginning at 1:30 PM Eastern time today through next Thursday, May 3. The replay number is 800-475-6701, with an access code of 869684.

And we now turn the call over to Bill Foley, our Chairman and Chief Executive Officer.

Thanks, Dan. The first quarter of 2007 was a period in which we were primarily focused on managing our existing businesses as efficiently and profitably as possible. This includes the title insurance business, the specialty insurance operations and the 40% owned Sedgwick claims management business.

The first quarter is normally the most difficult quarter in the title business. January and February closed order volumes usually suffer from the seasonal slowdown in open order activity between Thanksgiving and Christmas, and the traditional slow start to the year for the real estate markets. March usually brings a pickup in order volumes as you enter the seasonally stronger spring and summer months.

Even with this seasonal lull, we were able to generate a 9.2% pretax margin in the title business in the first quarter by remaining focused on employee counts and efficiency metrics. This was nearly equal to the pretax margin in the first quarter of 2006, despite a 10.5% decline in the title segment revenue from the prior year. Randy Quirk will go into more detail on our title business in a few minutes.

The title business is what really allows FNF to pay a significant $1.20 annual cash dividend, which equates to more than a 4.5% yield. Our specialty insurance operations are made up of three distinct businesses -- flood, personal lines and the home warranty insurance business. All three specialty insurance businesses had successful quarters on a number of fronts.

Flood insurance generated $34 million in revenue in the first quarter, with 655,000 flood policies in force as of March 31, 2007. We receive approximately $0.30 of each premium dollar per new and renewal policies, and a 3.3% override based on the face amount of the claims that we process. We take no underwriting risk in the flood business as the underwriting risk is assumed by the federal government. We are simply paid to manage the program, process new and renewal policies, and process the related flood insurance claims.

Personal lines produced $46 million in revenue in the first quarter, with 217,000 policies in force as of March 31, 2007. We are primarily underwriting traditional homeowners insurance, both through leads generated via our title insurance operations, and through an independent agent network, as well as auto insurance and other personal lines products. We had a loss ratio of 68% in the personal lines business for the first quarter, down from 85% in the fourth quarter of 2006.

Home warranty generated $19 million in revenue in the first quarter. Home warranty insurance is a one year renewable policy that covers the major mechanical household systems and appliances such as electric, central heating, interior plumbing and dishwashers. Home warranty is a higher incidence, very low severity insurance business that produced a 21% pretax margin in the first quarter.

Sedgwick is our 40% owned third party administrator or TPA. Sedgwick designs, implements and manages outsourced TPA programs for Workers' Compensation, liability and disability claims management for approximately 1,200 clients, including 28 of the Fortune 100, and 86 of the Fortune 500. Sedgwick generated approximately $160 million in revenue during the first quarter, with an EBITDA margin of 15%. We remain committed to the goal of ultimately maximizing the value of Sedgwick for our shareholders.

Finally, on our last call, we discussed the FNRES investment in the development of the Cyberhomes portal. That development continued in the first quarter as major content on schools, parent reviews and neighborhoods was added to the site. Three major real estate firms have signed on to provide real estate listings through Cyberhomes, bringing more than 400 new broker signups.

Finally, a cobranding relationship with the Wall Street Journal has gone live as Cyberhomes is now the valuation tool utilized by realestatejournal.com. While it is early, we remain excited about FNRES and its potential to become a leading provider of real estate content, products and services to consumers, lenders and other real estate industry professionals.

Let me now ask Randy Quirk to comment on the title business in more detail.

Thank you, Bill. Total open order volumes were relatively strong in the first quarter and followed a traditional seasonal pattern, increasing each month during the quarter. For the entire quarter, we opened just over 650,000 total orders for a quarterly average of 10,500 open orders per business day. In January, we opened 212,900 orders or just over 10,100 openings per day.

In February, we opened 202,000 orders, an improvement to 10,600 orders per day, and in March we opened 237,500 orders or 10,800 open orders per day. When compared to the prior year first quarter, total open orders and open orders per day declined by approximately 5%. However, the closure percentage for the first quarter declined to approximately 60% compared to 64% in the first quarter of 2006, and 69% in the fourth quarter of 2006. This is not uncommon in a more refinance-driven market as refi orders fall through more frequently than resale orders. Refinancial orders comprised more than 60% of open order volumes for the first quarter. Those refinance orders ultimately generate, on average, about half the premium and half the absolute profit of the resale order.

Finally, April order counts have declined from the first quarter levels and we have been averaging approximately 10,200 open orders per day.

Another important metrics that we monitor is employee count. We ended the first quarter with approximately 12,400 employees in our title field operations, roughly even where we ended 2006. However, this is a decline of nearly 1,100 positions from the end of the first quarter of 2006, which has allowed our employee metrics to show an improvement of nearly one open order per employee per month for the prior year.

We opened approximately 18 orders per employee per month this quarter versus 17 orders per employee in the prior year quarter. On the closed orders side, our 11 closed orders per employee per month were equal to the first quarter of 2006.

If you summarized the business in one sentence, you could say that open order volumes remain relatively solid, the closure percentage is down due to the higher mix of refinance orders, and our efficiency metrics remain strong due to the significant staff reductions over the past twelve months. We believe that we are doing a good job with the headcount and efficiency factors that we can't control, particularly given the business mix in the market. We will continue to closely monitor the direction of open order counts and are prepared to adjust headcount as appropriate.

From an expense standpoint, title personnel expenses decreased by $42 million or 9% over the first quarter of 2007 -- for the first quarter of 2007 over the first quarter of 2006. As a percentage of title segment operating revenue, personnel expenses were 34% for the first quarter of 2007, roughly equal to the just-under 34% for the first quarter of 2006. Other operating expenses decreased by $11 million or 5%, for the first quarter of 2007 versus the first quarter of 2006.

As a percentage of title segment operating revenue, other operating expenses were 16.5% for the first quarter of 2007 versus 15.6% for the first quarter of 2006. Combined personnel and other operating expenses were approximately 50.7% of title segment operating revenue for the first quarter of 2007 versus 49.5% for the first quarter of 2006, despite an 11% decline in closed orders and a 10.5% decline in title segment revenue from the prior year.

Additionally, the first quarter again was strong in our commercial title business. We opened more than 15,000 commercial orders in our national commercial divisions and closed approximately 7,200 commercial orders, generating nearly $75 million in revenue. This was a 14% increase over the first quarter of 2006 and commercial revenue accounted for nearly 18% of total direct title premiums in the first quarter.

Let me now turn the call over to Tony Park to review the financial highlights.

Thank you, Randy. FNF generated $1.4 billion in revenue for the first quarter, with pretax earnings of $127 million, net earnings of $83 million and cash flow from operations of $85 million. This compares to prior year pro forma revenue of $1.5 billion, pretax earnings of $155 million and net earnings of $99 million.

The title segment generated $1.25 billion in total revenue for the first quarter. This was a 10.5% decline from the first quarter of 2006. Pretax margin for the title segment was 9.2%, nearly equal to the prior year pretax margin of 9.5%, despite the double-digit percentage decline in title revenue.

Personnel costs of $411 million were down $42 million or 9.3% versus the first quarter of 2006. We continued to provide for title claim losses at 7.5% of gross title premiums in the first quarter of 2007. Actual title claims paid during the quarter were $55 million, resulting in a $17 million increase to balance sheet reserves.

In 2005, we identified some adverse development in the 2004 and 2005 policy years and increased our provision rate accordingly. The 2006 policy year is developing as expected, and we have not seen further adverse development on the 2004 and 2005 policy years in the past few quarters.

Specialty insurance revenue was $99 million in the first quarter, including $4 million in investment income. Flood insurance generated $34 million in revenue, a decrease from the $49 million in revenue recognized in the first quarter of 2006. The prior year quarter had the benefit of $20 million of revenue from the processing of hurricane flood claims. We expect a seasonal increase in flood revenue as we enter the spring and summer. New flood policy activity is strongest in the spring and summer, as is renewal activity, and we recognize our commission revenue when the policy is originated or renewed.

Personal line insurance contributed $46 million in revenue, growing 12% over the first quarter of 2006 and produced a loss ratio of 68% for the first quarter; a significant decline from the 85% loss ratio in the fourth quarter of 2006. Home warranty produced $19 million in revenue during the first quarter and generated a pretax margin of 21%. The overall pretax margin for specialty insurance was 25.7% for the first quarter, producing pretax earnings of $25 million.

As we noted in our release, the specialty insurance results include a $12.2 million pretax benefit from an adjustment related to the deferral and amortization of certain costs over the life of a policy consistent with the recognition of the premiums. The adjustment represents costs that should have been deferred as of March 31, 2007, on policies issued over the prior twelve months.

The ongoing operations produced $13.2 million in pretax earnings for a 13.4% pretax margin. The specialty insurance loss provision was $39 million in the first quarter, a $5 million sequential decline from the fourth quarter of 2006.

Our share of Sedgwick's net earnings was approximately $1 million for the first quarter. While we do not consolidate the results, Sedgwick had revenue of $160 million and EBITDA of approximately $24 million for the first quarter. Our debt primarily consists of the $491 million face value in senior notes due in 2011 and 2013. The debt to total capital ratio was 12.4%.

Finally, our investment portfolio totaled $4.5 billion at March 31. There are approximately $2.7 billion of legal, regulatory and other restrictions on some of those investments, including secured trust deposits of approximately $750 million and statutory premium reserve for underwriters of approximately $1.4 billion. There are also some other restrictions including less liquid investments, like our ownership stake in Sedgwick, cash held as collateral in our security funding program, and working capital needs at some underwritten title companies, all of which total approximately $500 million. And we backed this out as another category of restrictions.

So of the gross $4.5 billion, approximately $1.8 billion was theoretically available for use, with about $1.55 billion held at regulated underwriters and approximately $222 million in nonregulated entities. The cash at the holding company declined from year end, primarily due to the payment of our cash dividend in March. We also have $234 million of dividend capacity from our underwriters for the remainder of 2007.

Let me now turn the call back to our operator Cynthia to allow for any questions.

(OPERATOR INSTRUCTIONS). Geoffrey Dunn.

I wanted to ask you about how you are thinking about capital deployment. I am guessing at the level of the stock, the reason we are not hearing about buyback is the economics are not overly appealing when you consider the debt funding cost. So when you consider that and the fact it looks like you are doing a lot of little acquisitions, nothing material, are you thinking of other alternatives for capital return, or are you happy running underlevered for the moment until a better return opportunity develops?

The last conference call that we had, we talked about a significant buyback program. And we just weren't able to execute during the first quarter. So what we've actually -- we had our Board meeting yesterday, and we have a $25 million share buyback authorized at this time. And we are going to start buying shares back in the open market from time to time.

And our goal is to repurchase those 25 million shares, assuming cash flow supports it, sometime during 2007. So you're going to start seeing pretty significant buyback start to occur. And we held off earlier because frankly, a couple of different acquisition opportunities that we were looking at that just didn't work out.

I'll give you -- we have several other large ones we are involved in, but I will give you an example of the type of acquisition that we were reviewing in the first quarter that has now gone a given direction. And we had partnered with a financial sponsor to take a hard look at ServiceMaster. And we felt that ServiceMaster would have been interesting from an FNF standpoint to have owned perhaps 51% of the Company, 60% of the Company or 45% of the Company. As we felt we could sell some of products and some of the products that ServiceMaster offers through our escrow branch operation, particularly the Terminix Pest Control Solution and there were some lawn care products.

So that was the kind of thing we were looking at; it's the kind of situation we continue to search out. But as you know, with the private equity game today, things have become very, very expensive. It requires a lot of leverage; it's just been kind of contrary to the way we like to think about how we do our business.

So we have moved a little different direction, and that is we're going to start executing against the buyback. Additionally, we are taking a look at, in terms of capital generation, of doing a recap of Sedgwick, which will return a significant amount of our investment back to us. So I hope that answers the question.

Yes, so just to be clear, at these levels, you're a buyer of your stock and you think you can complete the $25 million this year, again, at these levels of valuation?

Yes, that's correct.

And then as a follow-up for Randy, I was impressed with how well you maintained your margins this quarter. How much more flexibility do you have on the expense front if the current projections for originations come through, and we're looking at a further decline of $2.2 trillion next year?

Just as you know, we watch our order count. We watch our staffing levels every week. We are firmly committed to these metrics. So if the orders do slip as MBA has projected, we'll make the necessary adjustments. So I think we can still get better at this. We are looking at ways to improve our productivity through our work process, through consolidation of operations, particularly over in the west where we have the most volume. So we are confident we can maintain our margins and in fact improve them as we go through the second and third quarter.

[Dan Peller].

Can you just expand a little bit on what you're seeing in California on a regulatory basis? Any update from [Quasner], or anything along those lines would be great.

Well, as you know, the regulations were rejected by the Office of Administrative Law. Commissioner Poizner has committed to make the corrected inadequacies in the original filing and resubmit. We as well as the California Land and Title Association and the rest of the industry continue to meet with the Department and Commissioner Poizner. The dialogue is open. The meetings have been, I think, productive. And it is still work in progress, and we have additional meetings scheduled. That's really the only update right now. Other than that, we're still working on this and the Commissioner seemed to be open to hearing our positions.

So you guys are kind of working together. It doesn't necessarily -- I mean, do you expect that it will be resubmitted to the OAL or --?

I couldn't speculate on that. But I do know that, again, the CLTA and the rest of the industry continue to meet with Commissioner Poizner, and he has been very cordial and forthright.

Bob Napoli.

I'd like maybe a little more clarity on the industry conditions that as we move into the spring home selling season. Generally, revenues and earnings pick up materially as you go into the second and third quarters of the year. And you have mentioned that the order volume had dropped in April. Now, I would expect more of that, even though the home building market is weak, that maybe a higher percentage is for home purchases and commercial property remain strong. But do you expect that the trends that you have seen in the past, a significant increase in earnings in the second and third quarter improved revenues should hold or not, given what you're seeing so far in April?

In terms of the open order count, in a traditional year you'll see orders really pick up dramatically at the end of April into May. That does not seem to be the case this year. The orders have softened a bit in the last few weeks. We think it to some degree could be the effect of the subprime, where some of the orders that have opened are not closing.

On the other hand, we did have a run-up of orders at the end of February into the beginning of March, and some of those orders will close in the second quarter. The record inventory building on the housing side, almost 4 million properties ready to go. Our commercial groups are ahead of their plan. They came out stronger this year in terms of order volume than they did last year. So we are looking for a good commercial year. So I think the second and third quarter should be strong, but perhaps -- and solid, but perhaps a little more stable than seeing a huge run-up in volume.

But I mean is it enough volume that you get the earnings leverage that you typically get? I mean, obviously --

Yes, I believe so, because actually, as some of these refi's, if they don't close, it will improve our fee per file with the resale closings. And then we will manage our expenses accordingly. So I believe we'll be good in the second and third quarter.

And then with regards to capital management, the discussion on looking at acquisitions and executing on the buyback, I think that you did say that there are other acquisitions that you're looking at. So if we don't see buybacks happening in this current quarter, that would suggest to us that some other significant deal came up and that's what is delaying the buyback. Is that fair?

That's a fair statement, but you're going to start seeing the buyback happen. It will be -- start being executed almost as we speak.

And I guess just on the acquisition front and development of FNF, I guess outside of the title business, which I know is your goal over time, to once again rebuild other businesses within this Company, ServiceMaster as one thing -- anything that is more closely related to the core business? And what outside of the core business is close enough that -- what intriguing items outside of title are you spending your time on?

Again, we like businesses that are heavily involved in some sort of processing, workflow systems; businesses that have recurring revenue. And we maintain our goal, which is to create another business over the next couple of years, that will evolve and become an FIS. And so buy the base business and start doing add-on acquisitions that will grow that business and again change what FNF is all about once again. And then hopefully, give our shareholders the benefit of those acquisitions through some kind of spinoff or sale of the Company and either additional stock repurchases or onetime dividends.

So we're on track. We have been a little bit sidelined because of the private equity involvement and the acquisition -- in the acquisition arena, and they have just really bid up properties. So we are trying to find properties that maybe are a little more under the radar screen, and so that's what we're working on. And there are acquisitions in the title arena that will help supplement Randy's business in terms of national footprint and ancillary business activities that will support what he -- what his business plan is.

So we're looking all the time, and -- but pending that, we really felt like there were a few too many shares outstanding in FNF and we need to retire some shares. Maybe at some point in the future we would actually issue shares in conjunction with an acquisition. So we really want to take some shares off the table.

And last question -- how much debt capacity do you have? How much excess capacity does -- can you maybe quantify that in some way?

The rating agencies have really indicated to us that we can lever up to a 35% debt to cap ratio. And when we did the [Skiba] title acquisition, we have actually levered up to about 45% debt to cap ratio. So we have a lot of leverage capability. We have great cash flow. The cash flow -- I was looking back at this year in their first quarter, and 15 years ago we would have lost money in the first quarter. In the first-quarter this year, we maintained nice margins. So we have terrific cash flow. We have a lot of leverage that is available to us. I believe -- our goal is going to be to put leverage on the subsidiary being acquired and not have FNF -- and not have the leverage be recoursed to FNF. So those are the kind of things we've been looking at, the kind of acquisitions.

(OPERATOR INSTRUCTIONS). Nik Fisken.

Bill, how are we going to execute the buyback -- open market versus Dutch versus one of these ASR's?

Open market, and we are going to be taking on that, doing an analysis of the number of shares traded. And of course, as you know, you can buy back a certain percentage of those shares traded in a given day. You can't trade in the first half hour, can't trade in the last half hour. But we are going to start buying some shares back, and our goal is to buy that -- to fulfill that 25 million share commitment this year.

What is driving the recap of Sedgwick?

Really, distribution of a portion of our investment. And we have talked to our financial sponsor partners. As you know, we don't consolidate that balance sheet. It's not a significant earner for us, so it's not adding on to our 40% of the net earnings, is not really doing anything for FNF. And so if we can recover 70% or 75% of our investment, and lower that investment profile in Sedgwick, that's good for us and good for the Company, and we'd recover $80 million or $90 million of cash. And Sedgwick in its current financial structure can easily support the additional leverage.

What happened with the corporate and other? I saw it was about $24 million in the quarter.

That was the acquisition of FNRES that we closed at the end of the fourth quarter. So that was -- their revenue runs about $50 million. So a big part of that is FNRES.

Mike Vinciquerra.

We talked a little bit about California. Can you talk about any other noise, maybe on a national basis, pricing concerns from other states or anything on a national level that might be of concern?

We're not hearing a lot of other noise in the other states. Florida continues to review rates. They've been in that process for awhile. Washington, the state of Washington, is forming a panel to look at the title industry. New York is, we believe, behind us. So we're not really hearing any additional noise. California is the one that's on our screen, and we seem to be working well with the people in California.

Very good. And then on the commercial business, there's a meaningful decline, maybe it's 10, 12%, I guess year over year in terms of commercial orders for the quarter. But the fee per file increased pretty dramatically. Is this just the ebbs and flows of the business? Is there anything specific you can point to as to why those numbers kind of shifted the way they did?

Yes, I believe it is. Actually, the orders opened in the first quarter of 2007 increased over the first quarter of 2006. There was some large closings in the first quarter up in the Northeast, up in New York. So it really is the ebbs and flows. These will open up in -- and some of these are long-term closing, so they'll open up in one quarter and close maybe in the third or fourth quarter. So you can't really push them into a specific quarter other than perhaps towards the end of the year. So more of the ebbs and flows, and certainly some large properties that are being moved.

And just a minor question -- just a state tax rate expectation for the rest of the year, Tony?

Yes, it's still 35.5%. We get the benefit of two things, the tax-free portfolio that we carry, and also with being more of a pure title company, we get more of our earnings now from the insurance companies. And as you know, insurance companies don't pay state income tax. They pay premium taxes. So that's kept our tax rate down to 35.5%.

And at this time, we have no further questions. Please continue.

Thank you. The first quarter was a good start to the year for FNF. We remain focused on maximizing the profitability of all of our businesses through continued growth and strict underwriting, and especially insurance operations, organic and potential acquisition growth, and Sedgwick, and strict cost controls and efficiency metrics in the title business. Thanks again for joining us this morning.

And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference service. You may now disconnect.