Stewart Information Services Corp (STC) 2017 Q3 法說會逐字稿

Good day, and welcome to the Stewart Information (inaudible) Quarter 2017 Earnings Conference Call and Webcast. Today's call is being recorded. (Operator Instructions) I would like now to turn the call over to Nat Otis, Director of Investor Relations. Please go ahead.

Thank you, Keith, good morning. Thank you for joining us for our third quarter 2017 earnings conference call. We will be discussing results that we released earlier this morning. Joining me today, our CEO, Matt Morris; and CFO, David Hisey. To listen online please go to the Stewart.com website to access the link for this conference call. I would 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, actual results may differ materially from those projected. 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.

Thank you, Nat, and good morning, everyone. We appreciate you taking the time to join us today. First of all I'd like to extend a special welcome to David Hisey, our new CFO, who joined us in August, and also on behalf of everyone at Stewart. I'd like to take the time to thank Allen Berryman for his many years of exemplary service to the company and congratulate him on his retirement.

Finally, before we go into the quarter, I'd like to recognize our employees in the Southeastern United States, and specifically, the Houston area, for the perseverance they have shown in the ongoing recovery from the impact of hurricanes, Harvey and Irma. Every one of us here at Stewart has seen the hardships that people have faced and continue to face as well as the kindness, generosity and humanity that followed. It's truly been amazing to witness. With (inaudible) and while the impact has not been extensive in purely financial terms (inaudible) greater had it not been for the tireless efforts of our team, particularly, here in Houston, and I want to thank them personally for their leadership during the storms. This isn't just about the impact of delayed closings and higher expenses, Stewart employees worked throughout the time in Houston, our headquarters here, they were closed for several days during the storm and many employees were displaced in their homes for weeks, and in some cases still haven't moved back into their homes. And I sincerely thank them for their incredible effort during this time.

So now to matters of the quarter. So this morning we reported pretax income of $19 million and a net income of $11 million or $0.46 per share for the third quarter of 2017. We also reported operating revenues of $498 million. Our results were impacted by declining market trends, particularly, refinancing orders. The impact of hurricanes, Harvey and Irma, that I mentioned earlier, as well as the departures of certain retail staff that we previously discussed.

On the second earnings -- second quarter earnings call, we noted retail staff departures in several specific regions, the departed revenues represented approximately $70 million in annual revenues. Stewart has taken swift, aggressive actions to address these disruptions. Our employees work tirelessly after the hurricanes to quickly restore full operations. We have successfully recruited new revenue-generating associates and stabilized staff attrition. At quarter end we had hired new revenue-generating associates with expected annualized revenues -- revenue generation of $20 million to $25 million. Additionally, our second quarter acquisition of Title365 generated new business, which we expect to result in $40 million to $50 million in annual revenue. These combined actions are expected to fully replace all of the departed revenue by 2018 selling season and ongoing recruiting efforts and targeted acquisitions should further bolster our top line.

I also want to provide an update on the Title and Escrow production deployment and the timing of any expense savings benefit from it. On last quarter earnings call we noted that the staff departures had put those benefits at risk, given the priority of rebuilding revenue in the impacted areas and refining our technology deployment to ensure the continued delivery of great service to our customers. As a result, we now expect to achieve a full $10 million run rate benefit by the end of 2018 and another $10 million by the end of 2019. It's also important to highlight the recently announced change to our leadership structure, our Chief Legal Officer and Chief Compliance Officer, John Killea, has been appointed to the additional role of President of Stewart Information Services. John's expertise and experience has been invaluable to the Stewart organization, since he joined the company in 2000. In this capacity, president John will help drive execution of Stewart's strategic priorities. Additionally, we announced that John Magness has recently joined the company as Chief Corporate Development Officer. John is a seasoned and well respected industry veteran with over 35 years in the title and real estate business. Most recently he served as President of Old Republic Title Companies. In his role as Chief Corporate Development Officer, John will play a key role in ensuring Stewart continues to provide the high quality services our customers have come to expect while we increase our revenue going forward.

Finally, as you saw in today's release, our board is exploring the full range of strategic alternatives available to Stewart. We have retained financial and legal advisors to assist us with the strategic review process and all options are on the table, including business combinations, the sale of the company and continued execution of our standalone business plan. At the same time, I assure you that we will remain focused on executing our current operating plans and continue to provide comprehensive service and solutions to our customers.

We do not intend to provide updates on the strategic review until further disclosure is deemed appropriate or required, and therefore, will not be in a position to address any questions regarding the review, during today's call.

So at this point I'll turn it over to David for more detail on our financial results.

Thank you, Matt, and good morning, everyone. As Matt discussed, our revenue and margins were impacted by the departures of certain retail staff, the impacts of hurricanes, Harvey and Irma, as well as market trends, particularly, refinancing orders.

The Title segment generated pretax income of $25 million or a 5% margin compared to a pretax income of $50 million or 9.5% margin in the third quarter of 2016. The margin impact of revenue departures, as everyone knows, in the hurricanes is very high because what ends up happening is you lose the small cost of the producers themselves, you're keeping the support in those areas as you're rebuilding those markets. You've got the hiring cost of new people and as all that normalizes the margins return as the revenue production occurs.

Let me provide a bit more context on the revenues. On the positive side, the residential fee profile increased 8% to $2,000 as the business mix shifted to a higher portion of purchase of orders. International operations revenue improved 7% as Canada and the United Kingdom continue to perform well. The commercial business continues to perform well and entered Q4 with a strong pipeline. However, we saw revenues decline in Q3 due to several transactions being pushed into the fourth quarter. In addition, while there was a good breadth in transaction type and geography this quarter, we didn't have any large deals close like we did in the third quarter 2016.

On the agency side, we continue to sign new agents and are excited (inaudible) bring forward the new technology we are implementing that will provide our agents with enhanced connectivity and user experience.

Gross agency revenues were down 5% and net revenues were down 7%. The independent agency remittance rate was 17.5% compared to 18% last year due to a shift in geographic mix.

In short, the average remittance rate was almost 20% in those states where we experienced gross revenue declines whereas the average remittance rate was 15% in those states where we experienced gross revenue increases.

Given our current agent footprint, we expect the remittance rate to remain in the mid-to-high 17% range over the near term.

Title losses as a percent of revenues were approximately 5% this quarter. Our total balance sheet policy loss reserves were $476 million at quarter end and remained above the actuarial midpoint of total estimated policy loss reserves.

Moving onto Ancillary Services and Corporate segment. Revenues decreased 45%, primarily due to our divestiture of the default loan servicing business in 2016. Expenses declined 46% more than offsetting the revenue decline during the quarter. As a result, excluding $6 million of parent company and corporate expenses, the search and valuation services business was slightly positive from a pretax standpoint.

With respect to overall expenses, employee costs in the third quarter of 2017 decreased 9%, even with the effect of elevated hiring costs as we look to replace the revenue producers. The decrease is due to a combination of volume related (inaudible) primarily in ancillary services, the previously described staff departures and ongoing operational efficiency gains in corporate operations.

As a percent of total operating expenses, employee costs for the third quarter of 2017 were 28.1% versus 28.3% last year.

Other operating expenses for third quarter 2017 decreased 6% due to reduced outside search fees, driven primarily by lower search revenues from the ancillary services and centralized Title operations. Of note, other operating costs in the quarter included $1.4 million of Title365 integration costs. As a percentage of total operating revenues, other operating expenses were 17.8% versus 17.2% in the third quarter of 2016.

On an ongoing basis, we expect that our other operating costs will average approximately 18% to 20% of total operating revenues in any given quarter, recognizing the seasonality of revenues.

Finally, our debt-to-capital ratio at quarter's end was 17.1%.

I will now turn it back to Matt for a few concluding comments.

Thank you, David. Just before we move into the Q&A, I wanted to take a moment and reiterate the positive steps we have taken to position us well for the remainder of this year as well as we move into 2018. Again, to summarize, we have successfully recruited new revenue-generating associates and stabilized staff attrition. We've also strengthened our executive team with the promotion of John Killea and the addition of John Magness. The acquisition of Title365 has been successful and we expect it to have strong positive contribution to our results. We have largely mitigated the impact of the hurricanes at this point and we've refined the deployment of our Title and Escrow production technology and are experiencing a positive feedback on the improved (inaudible). In addition to the system that David referenced of deploying (inaudible) integrate with our Title agencies, making it easier to do business with us and we expect to see that enable our share to expand next year. And as a result, we remain optimistic about the future of Stewart.

And so, we will now take your questions. Again, as a reminder, we're not going to take questions regarding the strategic review. So operator, please open the lines.

(Operator Instructions) We'll take our first question from John Campbell with Stephens Inc.

So nice work stabilizing the attrition. I know that was something you guys were focused on. But on the new recruitment rev, I guess just the run rate of rev, could you guys talk about what regions that is mostly geared towards. And then, if there's any 1 or 2, maybe particular competitors where you're seeing those agents come from?

So the regions we talked about, large part of that is in the West as well as some in Arizona as well as Texas. So I think those revenue producers are in those areas. I'd say that the West and Northwest have a large percentage of those. In the terms of where they are coming from, we -- I'm not sure we can disclose that information going forward. But again, we are encouraged not only by, yes, the revenue but also, kind of, how people are coming on board with Stewart and the opportunity that they see. So in my mind, these are all experienced producers, some leading our new offices as well that are coming from established companies. And we have high expectations on their ability to drive our revenue and efficiencies going forward.

Okay. And then, on just the -- on the reserve ratio, if I look at that year-to-date, that's running, I think, about 30 bps-or-so higher, relative to last year. Any thoughts on where that goes, maybe a good range to think about for 4Q and then maybe for next year?

Yes, I think as we mentioned, John, it's David Hisey, it's really -- we should really be thinking about it in the 5% range. I think there's always some little things here and there. I think we may have had little bit in our Canadian operations this period, but I think 5% is probably the number to keep them on going forward.

Okay. And then last one for me. What's the comfortable debt range or leverage ratio for you guys?

Well, I think we probably want to stay -- I think we had said about 17% currently. I think maybe we can go up a little bit from there, maybe in the 20% to 25% range without a lot of [adjective] from the rating agencies. But I think that's a number to think about, but we can always go back and speak to them as needed.

We'll take our next question from Bose George with KBW.

Just a follow-up on the staff hiring. Are they, generally, in the same geographies where you lost staff or are they in different areas?

No, they are generally new in the geographies where we have lost staff. Yes, and we have the normal hiring but I think where our more aggressive recruiting has been in areas where we have lost. I mean, that the markets where we did lose staff are strong markets and strong title markets for us that we made the commitment to go back and invest in. And so that's where the bulk of our hiring is coming back in through.

Okay, great. And then, the -- just the ongoing hiring and the acquisition pipeline, it seems that's independent of the strategic review, both -- they both continue.

Correct.

Okay, great. And then, just on the Mortgage Services segment, is that $6 million loss or I guess that the corporate segment is at $6 million loss at good run rate or after the breakeven now on the Mortgage Services, do you think you could start seeing the earnings there is trending up?

Yes, but as I stated, I think it's -- for now it's a good run rate. I think as we continue to look at that business, we may see some things moving forward. But I think that's a good run rate for now.

Okay, and then, I should just sneak in one more. On the -- in the commercial segment, what are the margins in that business? Are those margins sort of the levels where you want them?

Yes, we think they are. We don't see those changing significantly from what they have been. But I'd say, our commercial margins are pretty much in line with what our expectations are, they have been and should be going forward.

We'll take our next question from Kevin Kaczmarek with Zelman & Associates.

Can you give us a rough break out of the impact of the storms between commercial and residential purchase and refi?

A lot -- really, all of that would be residential, purchase and refi. Yes, I think any commercial transactions would be a shorter delay, where we're seeing that the bigger impact would be in the residential and residential resale, to be honest with you, would be a majority of that impact.

Okay. And on the Title365 revenue and the annualized revenue from the new employees (inaudible). How much of those annualized numbers was in the third quarter and how much should we be expecting in the fourth quarter?

Yes. I mean, I think -- hey, Kevin, it's David Hisey here. So I think we the -- keeping in mind the seasonality of the business, right, and the time it takes for people to ramp up their books, we're really expecting the producers to start to hit their stride, really as we start to come into next year. I think -- and similarly with respect to 365, right, the third quarter is pretty much an integration quarter, so we got high expenses and still trying to get the revenue transition, we'll see some benefit of that. But again, you're really not going to be hitting that $40 million to $45 million run rate until we start to get into early to mid-next year just because of the cyclicality of the business. And 365 has done higher revenues, historically. I think it's just a function of how we hit the ground running and get that business going.

Okay. And I guess last one on the -- I guess I got 2 more. On the Title production technology, where are you guys in the rollout? Can you give us a sense of like what percent of markets you rolled out in or what percent of your business has the production platform?

Yes, so -- I mean, I don't think we've given a percentage of where we are on the rollout per say, but I would say we're well underway. We've done some major states in terms of our deployment and are receiving good feedback. I think, on Q2, we talked about pausing that, revising our deployment, we have methodology and I will confirm that the more recent reports as we continue to deploy, gotten good feedback. So I'd say we're well (inaudible) process and a product that we have much more confidence in.

Great. And a last one, on the -- looking at the fourth quarter, obviously, there is -- you mentioned the $4 million of pretax profit shortfall this quarter. I assume some amount of revenue is going to be pushed to the fourth quarter, and shouldn't that come in at a pretty high incremental margin? How should we think about the revenue and pretax profit being shifted from 3Q to 4Q?

I'm not sure -- we continue to look at that, and valid question. What you also saw, kind of, is that it relates to the hurricanes, as while the closings didn't occur and you had all the cost. Obviously, in these affected market, you really did not have any orders and you've seen a pullback, just overall activity in those markets. So there's no, probably, high expectation that basically these are just delayed closings and your, kind of, run rate of orders, you've maintained through that process. So I think it's going to be a little bit of a loss going in Q4 because you do have some that are closing, that were scheduled for Q3. But offsetting that, you have orders that really didn't occur in Q3 because of the damage in those markets.

(Operator Instructions) We'll go next to Geoffrey Dunn with Dowling & Partners.

Matt, can you talk a little bit more about the integration of Title365? You bought the company in mid to late July. Did the revenues come on as expected in the third quarter? How did the transition from, kind of, agency revenues over to direct revenues move along in the integration? And I guess what I'm trying to get out of this, did you get the type of revenue and margin you were expecting off the acquisition, or was it more delayed than you expected in 3Q?

So I (inaudible) revenue was as expected. I think on bottom line performance, it was within expectations. But I think as David I think referenced, we did have some integration cost. And driving some of those efficiencies just on their systems, and again, some contractor provisions, et cetera. You're definitely not seeing kind of the bottom line impact in Q3 that we would expect going into next year. So still some integration cost and some opportunities as we consolidate systems, some of that's in procurement, some of it is in, yes, the technology platforms, some much of that should be done toward the end of this year and then we should see the margin improvement that we should expect in the next year.

So when we think about the commentary from last quarter trying to replace that revenue hole that developed, it sounds like we wouldn't have expected new hires to really kick in until towards the end of the year and going into '18. Sounds like the bottom line impact of 365 ran a bit slower. Is that a fair categorization for third quarter at least, and then in fourth quarter, do you think we're on the same trajectory that you expected last quarter or are we a bit behind that?

No, I think we're on the same trajectory. Obviously, fourth quarter from a residential -- so you've got the seasonality that comes into play and so you don't see as significant impact on Q4, we're really looking at the commercial transactions which usually drive our Q4 performance. But I don't think any of those estimations have changed in terms of the efficiency of Title365 or these revenue producers coming on board.

And it appears we have no further questions at this time. I'll return the floor to our presenters for closing remarks.

Just want to say (inaudible) joining us for this quarter's conference call, and appreciate your interest in Stewart and look forward to hearing from you next time. Thank you.

And this will conclude today's program. Thanks for your participation. You may now disconnect. Have a great day.