Stewart Information Services Corp (STC) 2015 Q2 法說會逐字稿

Good day and welcome to the Stewart Information Services second-quarter 2015 earnings conference call and webcast. Today's call is being recorded.

The webcast is currently unavailable. We are taking all measures to remedy that during the call. We will continue with the call. At this time all participants are in a listen-only mode and the floor will be open for your questions following the presentation.

I would now like to turn the call over to Mr. Nat Otis, Director of Investor Relations.

Thank you, Keith. Good morning. Thank you for joining us for our second-quarter 2015 earnings conference call. We will be discussing results released earlier this morning. Joining me today are CEO, Matt Morris; CFO, Allen Berryman; and Group President for the Mortgage Services, Jason Nadeau.

I will remind participants that this conference call may contain forward-looking statements that involve a number of risks and uncertainties. Because such statements are based on an expectation of future financial operating results and are not statements of fact, the actual results may differ materially from those suggested. The risk and uncertainties with forward-looking statements are subject to include but are not limited to the risks and other factors detailed in our press release published this morning and in the statement regarding forward-looking information, risk factors and other sections of the Company's Form 10-K and other filings with the SEC.

Let me now turn the call over to Matt.

Thanks, Nat. We appreciate everyone joining us this morning. As you know, this morning we reported second quarterly 2015 earnings and while our title segment produced a quarter of solid results, our mortgage services segment did not meet expectations due to continued deterioration of the delinquent loan servicing business. The rapidly falling volume of defaulted and delinquent loans in the industry as well as the previously mentioned pricing pressures on existing contracts was sharper than expected.

So in assessing our ongoing smart growth in the mortgage services segment, we have made the decision, strategic decision, to exit our delinquent loan servicing business and focus on maximizing our profits from recent acquisitions in that segment. We do have Jason Nadeau here with us this morning to provide further color around our decision as well as some thoughts on our expectations going forward.

So as to overall revenues, we are pleased to report continued growth with total operating revenues increasing 19% over last year's second quarter. While a portion of that growth stems from the 2014 acquisitions which were finalized in August of last year, we saw strong growth in residential resell orders as well with closings up 17% over prior year quarter.

Opened orders thus far in July have held steady with June's rates and are still showing significant growth over the comparable prior year period.

We also remain on target with the strategic objectives described over the past several quarters including the value creation strategies announced in February of 2014. As of July 1, we completed a significant milestone in our cost management program with the first transition of certain back-office functions to a third-party service provider. The remaining functions identified for outsourcing will be transitioned by the end of August. At that point we will have essentially completed the cost management program announced in 2014 and will have achieved our revised target of $30 million of annualized savings, exceeding our original goal of $25 million.

Related to this program, we incurred nonoperating costs of $7.7 million this quarter which Allen will describe in more detail in a moment.

We also made significant progress on our capital return program buying back approximately 720,000 shares of stock and paying our first quarterly dividend on the previously announced $1.00 per share dividend.

I will now turn it over to Jason for some commentary regarding the changes in the mortgage services segment.

Thank you, Matt. Revenues in our market services segment were $58 million for the second quarter of 2015, up from $22 million second quarter 2014's $35.8 million with the increase both due to acquisitions completed in the second and third quarters of 2014 as well as increased refinancing volume in our centralized title operations that we acquired last year.

Revenues for the second quarter fell sequentially $5.7 million from first quarter's $63.7 million. Second quarter's 2015 operating revenue run rate was favorably impacted by growth in origination-based revenue due to increased refinancing volume. However, we experienced a much sharper than anticipated fall in delinquent loans servicing revenue with the drop off accelerating through the quarter, an industry trend we expect to continue.

Another contributor to the decline in revenue was the continued pricing pressure on existing delinquent loan servicing contracts. As a result of this declining revenue, pretax earnings for the quarter fell from $2.6 million in the first quarter to a loss of $3.3 million. With ongoing mortgage delinquencies and foreclosure inventory levels experiencing ongoing substantial declines, future demand for delinquent loan servicing related services are expected to diminish considerably from today's already depressed levels.

With these business lines having been profitable for many years in the past, but given this outlook, these service offerings which we collectively refer to as delinquent loan servicing no longer meet our profitability objectives and so we have made the decision to exit these operations. We are mindful of our clients' need for an orderly wind down that ensures minimal disruption to their operations. As such, we anticipate that we will continue to operate the delinquent loan servicing business line in a phased exit process. This will continue to impact the margin in this segment for the remainder of the year.

We believe this decision, while significant to historic segment revenues, will focus our capital and resources on our business units that have the strongest future for ongoing and stable growth. We will retain our capabilities to provide services to this segment.

Our remaining mortgage services operations constitute a core set of diversified offerings that satisfy the needs of lenders to manage vendor risk in a heightened regulatory environment. With the anticipated decline in refinancing volume, we expect the mortgage services segment to continue annualized revenues of $120 million to $140 million in 2016 down from 2014's year-end run rate of approximately $230 million. Given the percentage of revenues tied to centralized title and valuation services going forward, we expect EBITDA margins in the low teens.

I will turn it back over to Matt now for some comments on some of our consolidated results from operations.

Thanks, Jason. We are committed to improving our consolidated pretax margins and these actions will definitely support that objective.

So now to summarize our consolidated financial results, both total and operating revenues increased 19% over second quarter 2014. Pretax earnings for the second quarter of 2015 were $31 million compared to $11.5 million for the second quarter of 2014. Net income attributable to Stewart for the second quarter of 2015 was $17.1 million or $0.72 per diluted share as compared to net income of $6.3 million or $0.27 per diluted share for the second quarter of 2014.

As I noted earlier, both years second quarters include a number of nonoperating charges as well as litigation costs pertaining to legacy legal issues and title policy loss adjustments relating to prior policy years. We have included in the earnings release a table that details those items which presents a normalized view of both quarters' results of operations. As you can see on that basis, our pretax earnings increased 92% on a 19% increase in revenues. Further, given the increase in non-cash amortization attributable to the acquisitions, the table also presents a normalized view of EBITDA. On that measure, adjusted EBITDA improved 76.9%.

So now I will turn it over to Allen for more detail on the financial results.

Thank you, Matt. As was mentioned a moment ago, we reported several charges during the quarter which were partially offset by a net title loss reserve release and while I will provide more detail on the underlying drivers of these items as I discuss business unit results, I want to summarize them here and provide some context for the quarter's overall results.

We incurred $7.7 million of expense relating to the cost management program and CFPD readiness of which $2.6 million was severance and recorded as employee costs with the remainder recorded as other operating expense. $6.8 million of these costs were recorded in the corporate segment. We expect to incur costs under this program in the third quarter of this year as we finalize execution of the various project plans although the amount incurred will be less than in the second quarter as no further material severance is expected.

We completed our semiannual actuarial review of title policy loss reserves. Because of favorable experience on non-large losses, we lowered our estimate of total policy loss reserves and accordingly recorded a net $7.3 million reserve release in the quarter. A similar reserve release was recorded in the second quarter of 2014 of $6.5 million. We also accrued $4.5 million of litigation costs relating to the final trial of a previously disclosed matter dating back to 2005.

With that background, I will turn to our business unit results.

With respect to our direct title operations, revenues increased 17% in the second quarter of 2014. Our direct revenues include the acquired title operations revenues of DataQuick and LandSafe which we closed April 1 and June 1 respectively, in the second quarter of 2014. Excluding these revenues, the increase would have been approximately 15% driven by higher residential resale orders, increasing refinancing orders since acquisition date and growth in our commercial business.

Residential fee per file in the quarter was $1894, up from $1775 in the first quarter as increased purchase transactions led to a more favorable mix of closed orders.

US-only commercial revenues increased to 19.7% to $36.9 million compared to the second quarter 2014. Total worldwide commercial revenues for the quarter were $41.4 million, an increase of 3.3% from the second quarter of 2014.

For the second quarter of 2015, total international revenues were $28.4 million, down 13.5% from $32.8 million in the second quarter of 2014. While there were slightly fewer international closings than in the prior year period, the majority of the revenue decline was due to change in foreign currency exchange rates as a result of the strength in the US dollar.

Overall our direct operations had a solid quarter from a revenue perspective. Our offices reported strong revenue growth, our commercial business continues to show gains and our international business remains solid when viewed on a local currency basis. Direct revenues constituted 49% of our total title revenues, up from 47% in the first quarter.

Our independent agency operations also saw strong growth with revenues increasing 19.7% over second-quarter 2014. Our admittance rate of 18.6% was unchanged from the second quarter of 2014.

Title losses were $19.6 million in the second quarter 2015 or 4% of title revenues as compared to $18.2 million in the second quarter of 2014 or 4.4% of title revenues. As noted earlier, both second quarters of 2015 and 2014 including net reserve releases of $7.3 million and $6.5 million respectively. Excluding those releases, the core title loss rate for the second quarters of 2015 and 2014 was 5.5% and 5.9% respectively. Remember that quarter-to-quarter fluctuations in the overall title loss ratio are not unusual due to any new large claims incurred as well as adjustments to reserves for existing large claims on escrow losses.

Our total balance sheet policy loss reserves were $41.8 million at quarter end and remained above the actuarial midpoint of total estimated policy loss reserves.

With respect to operating expenses, employee costs for the second quarter including the acquisition, increased 13.1% from the second quarter of 2014. Employee costs for the second quarter 2015 included $2.6 million of severance related to the cost management program. Excluding severance, employee cost increased by 11.6% from the second quarter of 2014 as a result of increased transactional activity driving the increase in operating revenues.

As a percentage of total operating revenues, employee cost in the second quarter 2015 improved 170 basis points from 34.2% to 32.5% compared to the prior year quarter. Other operating expenses increased 9.9% in the second quarter of 2015 compared to the second quarter of 2014.

During the quarter, we incurred other operating expenses associated with cost management programs and CFPD readiness aggregating $5.1 million and a $4.5 million litigation charge as noted above. As a percentage of total operating revenue, other operating expenses were 18.6% and 20.1% in the second quarters 2015 and 2014 respectively.

Depreciation and amortization expense $7.3 million in the second quarter, an increase of $2.2 million compared to the second quarter of 2014. The increase is due to amortization expense on acquired intangibles in the mortgage services segment of $1.1 million and $1.1 million of amortization expense relating to an underwriter production system placed into service July 1, 2014.

Lastly, a few comments on other matters. Cash provided by operations was $32.4 million in the second quarter 2015 compared to $18.3 million for the same period in 2014, an improvement of 77%. The improvement is principally due to better results in our core operations, collections of receivables, a modest increase in payables and lower title loss statements. During the first quarter, we announced an increase in our dividend from $0.10 per share paid annually to $1.00 per share. We paid our first $0.25 per share quarterly dividend in June. During the second quarter, we acquired 719,756 shares of our common stock for an aggregate purchase price of $26.4 million.

With respect to our exiting the delinquent loan servicing business, we anticipate a charge relating to this restructuring totaling $5 million to $7 million in the third and fourth quarters. We will also conduct a review for potential goodwill and intangible asset impairment during the third quarter and any impairment charge will be recorded then.

With that I will turn the call back over to the operator for questions.

(Operator Instructions). John Campbell, Stephens Inc.

Good morning, congrats on a great quarter. Just want to clarify a few items related to the mortgage services segment. You guys said $120 million to $140 million run rate next year. That is on the segment basis and not what is reported on the P&L, is that right?

That is correct.

And then you said the low teens margin goal, is that on EBIT or did you say EBITDA?

We said EBITDA, John.

EBITDA, got it. And then by the end of this year just if I'm understanding this correctly, you are going to have zero default exposure in that segment?

You mean zero revenues or I didn't quite catch the question.

Just basically on an all-in basis no revenue is going to be tied to default exposure?

Well, I mean we will retain the expertise in providing services to the delinquent loan market. That is not to say we will eliminate our ability to provide services in that market going forward should the market come back.

And John, we still have REO title. There are some other services there provided. But again, the bulk of where those historic revenues have come pre-acquisitions on the distressed component servicing fees is going away. But obviously there are still some REO and other title related services that we handle for the default marketplace.

Got it. So the large contract that you guys just renewed at a little bit lower terms, is that going to be an annual type deal or is that part of what is rolling off at the end of this year?

That is part of what is rolling off this year.

Got it. Got it, okay, that is helpful. Allen, you said the 5.5% reserve ratio ex the release this quarter, is that a good range to think about going forward?

I think so. That is really sort of what we do as a core cool rate. It is right in the historic norms and it is notwithstanding some of the reserve strengthenings and/or relief as we have had over the last several quarters, it has sort of settled into that range.

Got it. Good job on the progress on the $30 million of cost saves you guys have outlined. Can you guys give us a little bit more color about what exactly is being outsourced and then if there is anything ex that that you guys are looking at that might put you above that outlying goal of $30 million?

I think what we are doing initially is sort of some of the traditional back office services whether it is in accounting or IT or some of the other shared services organizations that we have here. I mean certainly we won't stop as we move forward into 2016 looking for additional ways to remove costs out of the system.

The $30 million you will remember is an increase from the $25 million and that was just the increase was us continuing to look for ways to further streamline the cost structure and we didn't stop. So while I'm not really ready to publish any sort of number at the moment, remember that we will continue to look at these opportunities going forward.

Great. Nice work. Thanks, guys.

Ryan Byrnes, Janney.

Good morning. Thanks, guys. Just had a question just trying to parse out what the impact currently is from the delinquent business, the mortgage services segment. If you tried to exclude that -- is the current, the remaining part of the mortgage services segment -- is that currently running at low teens EBITDA margins or is there some expected improvement in 2016 in order to get to those low teens EBITDA margins?

No, we are not quite there yet, Ryan. We have got a little more work to do before we can get there or on sort of the business left behind or remaining for us. And with respect to trying to parse out the delinquent loan servicing business, just remember that in Q1, it was a contributor to earnings. In Q2, less so but it was really the outlook going forward that caused us to make the decision and that is really sort of the relevance to us. It is not so much what it did in the first half of this year it is what we expect it to do in the back half as well as going forward.

Ryan, so we do have -- obviously this revenue related to the acquisitions that came on and while they are integrated, there is further optimization of those operations from the acquired entities.

Okay, great. Thanks. And then just quickly on the commercial business, obviously another strong quarter there. Your competitor put another strong quarter as well. Just wanted to again see if there were again one-time items or anything involved there because again it was stronger than I think most of us were looking for.

Obviously commercial can be lumpy quarter to quarter and we haven't looked or analyzed where competitors landed itself but nothing in our revenues that we look at would say one significant transaction, so I think that was pretty steady for the quarter.

Okay, great. And then just within -- I realize international commercial could be lumpy and I think you guys noted some FX there too. But it kind of went down by over 50% there. Is that just lumpiness there? Again, we don't have too much historical details on that segment but just trying to figure out if anything was going on there?

It is primarily just the FX impact but there is some lumpiness in there particularly as you look at a year-over-year basis. International commercial was really strong for us in the first quarter, it could be subject to just closing dates on transactions had a really strong international core in 2014, so you also had that year-over-year growth consideration.

Continued strong pipeline. Again the FX issue seemed to be the dominant factor in explaining international this quarter.

Okay, great. Thanks for your answers, guys.

Kevin Kaczmarek, Zelman & Associates.

Good morning. Do you guys have a sense of what the EPS impact was on the delinquency business? So if you kind of excluded that from the quarter's operations, how much that would have contributed to EPS?

No, we haven't really broken it out that way. Like I said a moment ago, it is really less about what happened in Q1 or Q2 and more about the view out the windshield. The view in the rearview mirror if you go back a few years is exceptionally good. But the market changed very rapidly and we felt like we needed to get ahead of it. So we really haven't broken it out from a historic perspective.

Okay. On the residential purchase order growth, the midteens growth is like well above any metric I have seen from either a competitor or any other industry stat. Where's the strength coming from? I assume this is not some nuance in the way the purchase orders are counted or any sort of acquisition effect. Do you have a sense of where the strength is coming from?0

There was no one geography that really stuck out to us as we looked at the quarter revenue growth. We had solid revenue growth in pretty much all of our top 10, 15 states quarter over quarter. So I can't really pinpoint to a particular area that drove that sort of increase in orders.

It sounds like you guys are gaining share though within residential purchase.

We look and we gauge more of that -- probably more of the focus is on our direct offices to which we are gaining share in certain key markets that we are focused on. So again, we will analyze the data after we get into the quarter and see how share may or may not have played out.

But I think as we have discussed this last year, we have definitely moved from really looking at our core and our footprints and then implementing some growth strategies in certain segments and so anticipated that we are gaining share in the direct retail side of the house.

Okay. And at this point I may have missed this before, but do you know what the statutory liquidity ratio was as of the end of the second quarter?

No, we haven't completed that statutory balance sheet yet.

Okay, that is all I had. Thanks, guys.

John Campbell, Stephens.

Just one last quick question, out of the $12 million or so of one-time costs, how much was related to the title business? Was it just that $4.5 million due to the litigation?

I don't have that in front of me. Yes, the $4.5 million was clearly title segment and the severance was title segment -- or I am sorry -- the severance was corporate segment so it was principally that litigation charge.

So you are looking at probably closer to 16.5% margin on that business on an adjusted basis?

That sounds about right, yes.

400 and something basis points year-over-year; that is a good result. So last question would be at the corporate segment if I deduct some of those one timers, you are looking at about $31 million or so in corporate costs. Is that a pretty good run rate going forward?

Well, remember that the cost management program particularly the part relative to the outsourcing is going to influence that cost in Q3 and then fully baked into the Q4 number so I expected it to tick down in Q3 and then by Q4, you should have a more normalized run rate.

Got it. Thanks, guys.

(Operator Instructions). Geoffrey Dunn, Dowling & Partners.

Thanks, good morning. My first question was really a follow-up on John's question just now about the phase out of these one timers. When can we expect the severance, the cost management adjustments to be gone and get a real clean result on that basis?

The severance that we accrued in the quarter really relates to the actions that we are taking in June, July and August basically right now. So there is really no material. It is further severance expected with respect to the cost management program going forward.

Now I referred to earlier the $5 million to $7 million that we will incur over the back half of the year relative to this decision in mortgage services. There is obviously a severance component to that but that will flow through the mortgage services segment.

And on the cost management, that should be out of the numbers in 4Q?

Correct.

So barring the new delinquency business development, we should be looking at clean numbers fourth quarter?

That is the expectation, yes.

Okay. And then Matt, I had asked you before about your scorecard basically, what we could judge you in the MS business. And I think your previous comment had said a mid-teen pretax margin, now you are talking low teen EBITDA margin. So am I reading that correctly that on the same basis what was a mid-team pretax margin is now probably a low double-digit maybe 10% pretax margin expectation for that business going forward?

Yes, I think what is considered here, there is definitely -- I didn't hear the full question. But essentially you did have what again has been very strong business for us at various high margins. And as Jason alluded to, not only his -- have been declining but very rapidly toward the end of the quarter in our expectations and that has changed our expectations. And so essentially what you are left with is a lot of acquisitions that we have brought on -- brought on over and again amortization of that related to the expense is why we are talking about EBITDA at this point because again, a lot of that existing revenue going forward is tied to the acquisitions that came on board.

Okay, but in terms of the core business, that is still there which is basically acquisitions from last year, that is a core pretax margin of maybe 10%, 11%?

I think so, right. I think so. I think that is the kind of margin that we will drive it to as we get into 2016.

Thank you.

It appears we have no further questions at this time so I will return the floor back to Matt Morris for some closing remarks.

Thank you and again, thanks everyone for joining us. The second quarter of 2015 was a productive and positive quarter as we saw solid revenue growth, generated improved margins in our title segment and near finalization of our cost management value creation strategies.

The proactive decision involving our mortgage service operations will focus capital and resources on our business units that we believe have the strongest future for continued and stable growth and we appreciate your time with us today. Thank you very much.

This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day.