Stewart Information Services (NYSE:STC)
Q3 2016 Earnings Conference Call
October 19, 2016 08:00 AM ET
Nat Otis - Director of IR
Matt Morris - CEO
Allen Berryman - CFO
Bose George - KBW
Geoffry Dunn - Dowling & Partners
John Campbell - Stephens Inc.
Ryan Byrnes - Janney
Kevin Kaczmarek - Zelman & Associates
Good day and welcome to the Stewart Information Services third quarter 2016 earnings conference call and webcast. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation.
I would like now to turn the call over to Nat Otis, Director of Investor Relations. Please go ahead.
Good morning. Thank you for joining us for our third quarter 2016 earnings conference call. We will be discussing results that were released earlier this morning. Joining me today are CEO, Matt Morris and CFO, Allen Berryman. To listen online, please go to the stewart.com website to access the link for this conference call.
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 expectation of future financial operating results and are not statements of facts, 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 to everyone. We appreciate you joining us today. Listen, before we begin discussing operating results, I do want to briefly address the agreement we announced earlier this week. It was made with two of our shareholders related to board composition and corporate governance. We do believe the agreement demonstrates Stewart's commitment to promoting best practices in both operations and governance structure. Whether through greater board independence, the consolidation of multiple share classes or a more disciplined approach to capital allocation, such as the increased common dividend, we remain focused on strengthening each aspect of the business model, while acting in the best interest of all Stewart’s shareholders.
With that said, the purpose of today's call is to discuss our financial results. So with that behind us, this morning, we reported our third quarter 2016 earnings, where at a consolidated level, we generated pre-tax income of 39 million, an improvement of about 44 million from the $6 million pre-tax loss reported in the third quarter of last year. Total third quarter 2016 revenues were essentially unchanged from third quarter 2015, while operating revenues fell just over 1%, primarily due to declines in our ancillary services operations.
We did report net income of 26.4 million, or $1.12 per diluted share for the third quarter 2016, compared to a net loss of 13.5 million or $0.58 per diluted share for the prior year quarter. Comparisons of our current quarter’s pre-tax and net income to last year's quarter are influenced by charges totaling 43.7 million incurred in third-quarter of 2015 as well as an atypical effective income tax rate in this year's quarter. Allen will provide more color on both of those items in a moment.
Total title revenues were comparable to the prior year quarter, as the impact of lower centralized revenues was offset by higher independent agency revenues. The title segment margins improved modestly from 9.3% to 9.5%. Our ancillary services operations generated essentially the same results as the prior year quarter after moving last year's charges with operating revenues declining 26% due to the strategic exit of our delinquent loan servicing business in the first quarter of 2016. We do continue to benefit from the cost management program completed in 2015, as well as enhanced financial discipline within our core operations, resulting in total employee and other operating expenses excluding the prior year charges, decreasing almost 4% for the quarter, more than offsetting the decline in operating revenues.
As shown in appendix A of our earnings release, our adjusted EBITDA improved almost 2% over the prior year quarter, while adjusted revenues declined just over 1%. Comparing third quarter 2016 sequentially to second quarter 2016, employee and other operating costs, increased approximately 4% compared to the 13% increase in total operating revenues. As we enter into the final stretch of 2016, we remain focused on strengthening our core title operations. We are encouraged by the work that's been done to prepare us for a strong 2017, and are continuing investments to improve the customer experience, drive revenue growth in select markets, lower our unit production costs and enhance margins.
We've established targeted marketing programs to take advantage of geographic opportunities, which we believe gives the best combination of growth and profitability. In addition to our revenue growth initiatives, we expect to continue realizing improving margins through further outsourcing, technology rationalization and title and escrow synchronization and automation, moving us toward our long-term goal of a 10% pre-tax margin. While we remain positive on our prospects going forward, both from an operational and a macroeconomic standpoint, it's important to underscore that the marketplace has been increasingly competitive in all channels and product lines. We will allocate resources necessary to further grow and improve performance in 2017 and beyond.
Now, I’ll turn it over to Allen for more detail on the financials results.
Thank you, Matt and good morning, everyone. The title segment generated pre-tax income of $50 million or 9.5% margin compared to third quarter 2015 pre-tax income of $49 million, or a 9.3% margin. Our title segment revenues were 530 million for the third quarter 2016, an increase of approximately 1% from third quarter 2015. With respect to our direct title operations, overall revenues decreased 1% from third quarter 2015, as a slight increase in purchase revenues was offset by lower centralized title revenues, primarily due to declines in refinancings and default activity. We are working diligently to expand our customer base as more regional lenders are capturing share in this market, while remaining cautious of an inevitable slowdown.
Domestic residential fee profile in the quarter was approximately $1900, comparable to third quarter 2015. Total commercial revenues for the quarter decreased 4% to 50 million. We’ve seen a softening in larger commercial transactions, especially in the northeast. In addition to the general interest rate uncertainty, new construction lending has slowed and so we are being - we are targeted in where we can capture commercial market share. Title orders opened in the third quarter were about the same as the prior year quarter, although the composition of those orders shifted somewhat with slight increases in open refinancing and commercial orders offsetting the decline in open to purchase orders.
Title orders closed declined 2% from third quarter 2015, primarily driven by a 1% decline in purchase and a 2% decline in closed refinancing orders. Third quarter 2016 total international revenues increased 12% due to increased volumes on a local currency basis, especially in Canada, partially offset by the impact of a stronger US dollar against the British pound. Revenues from independent agency operations increased 1% in the third quarter 2016, however, revenues, net of retention, decreased 3% as a result of relatively more revenues generated in states with lower remittance rates.
For instance, we saw revenue declines in states with average remittance rates higher than 18%, such as Illinois as well as revenue increases in states with average remittance rates less than 18%, such as Texas and Michigan. Quarterly fluctuations in the average remittance rates are not unusual and on a year-to-date basis, which is more indicative of our ongoing expectation. The average remittance rate is 18.2% in 2016 versus 18.1% in 2015. We anticipate our ongoing average annual remittance ratio to be in the low to mid 18% range.
Title losses, as a percentage of title revenues, were 5% in both third quarters of 2016 and 2015. We expect to maintain an accrual rate at the lower end of the 5% to 5.5% range on a full-year basis going forward. Our total balance sheet policy loss reserves were 461 million at quarter end and remained above the actuarial midpoint of total estimated policy loss reserves.
Looking at our ancillary services and corporate segment, revenues for the segment decreased 18% to 23 million, compared to the year ago quarter, primarily due to our strategic decision to exit the delinquent loan servicing operations. The segment reported a pre-tax loss of 11 million in the third quarter 2016, compared to a pre-tax loss of 54 million in the prior year quarter. Excluding the 2015 non-operating and non-recurring charges I’ll describe in a moment, the segment’s pre-tax loss for the third quarter 2015 was 12 million. Both year’s third quarters included approximately 7 million of expense attributable to parent company and corporate operations. Third quarter 2016 includes just over 1 million of costs associated with shareholder activism recorded as a corporate expense.
During our second quarter earnings call, we acknowledged that it’s taking longer than expected to restore the business lines within this segment to acceptable margins. On a year over year basis, we were able to reduce costs, commensurate with decline in revenues, largely through employee reductions. In addition, we are actively considering all options for certain of those operations. Our overall margin goal for the combined businesses within this segment, excluding the cost of corporate operations, remains in the mid to high single digit range with EBITDA margins in the low double digits.
With respect to operating expenses, remember that as I am reviewing, remember that the third quarter 2015 included a number of non-operating and non-recurring charges that were detailed in the press release, which totaled approximately $44 million. The discussion that follows excludes those charges. Employee costs for the third quarter 2016 decreased 6% from third quarter 2015, while average employee counts decreased approximately 10% from third quarter 2015, due to our cost management program, as well as reductions in employee counts tied to volume decline. Other operating expenses for the third quarter 2016 increased less than 1% and include just over 1 million of costs related to shareholder activism recorded as corporate expense. As a percentage of total operating revenues, other operating costs fell 90 basis points to 17.2% in the third quarter 2016.
Lastly, a couple of comments on other matters. The effective tax rate for the third quarter 2016 was 25% and was lower than normal due to recording adjustments between the tax return as filed and the related tax provision and recognition of certain available tax credits. Cash provided by operations was $46 million in the third quarter 2016, compared to $60 million for the same period in 2015. The decrease in cash provided by operations was primarily due to higher payments of claims and accounts payable and lower collections of accounts receivable, partially offset by the higher net income for the third quarter 2016.As of quarter end, $1 million of cash was held at the parent holding company.
As we've discussed on these calls before, we are focused on initiatives that will lower unit cost of production, thus furthering improving margins. Our plans to improve margins also include further outsourcing, additional automation and manual processes and continued consolidation of our various systems and production operations. We are currently investing in the technology necessary to accomplish these goals and have piloted new production technology on a test case basis, with the next stage being a pilot on a larger market state. As this multi-year effort is deployed, we can expect to begin achieving a lower cost profile beginning in 2017, with further improvement through 2019. We anticipate providing additional information during our next quarterly earnings call.
And with that, I will turn it over to the operator to take questions.
[Operator Instructions] And we can take our first question from Bose George with KBW. Please go ahead. Your line is open.
Yeah. Good morning. Actually, A couple of questions. First, just on the tax rate. What drove the tax rate lower this quarter, and just can you remind us what the run rate for that should be?
Yeah. The run rate for that is probably going to be around 38% and what drove it lower this quarter, every year, we kind of go through a process as we’re completing the federal income tax return of reviewing some of the tax positions that we took in making decisions on effective tax rate and sometimes those decisions that we make, once we finalize the return, we can alter a little bit. So what happened in this quarter that drove some of the lower effective tax rate is that we determined as we were completing the income tax return that some charges that we had taken previously were actually deductibles when we were preparing the effective tax rate we assumed they were not deductibles. So effectively we kind of understated - overstated I’m sorry overstated the effective tax rate earlier by treating those items as non-deductibles. So that's kind of one aspect of it and it's really kind of one-time thing. The second aspect of it is really just capturing some available tax credit. We haven't really been that aggressive in looking for those kind of credits until we become more of a cash taxpayer and now that we are, we are being more aggressive in looking for some of those credits. We took some in the third quarter and may be a then little bit less in the fourth quarter. But overall I would say our effective tax rate going forward is probably going to be around 38%.
Great, thanks that's helpful. In terms of the expenses on shareholder activism, are those done in the third quarter? Is there anything there also in the fourth?
There will probably be some lag over in the fourth quarter although I'm not sure it would be that material.
And our next question comes from Geoffry Dunn with Dowling & Partners. Please go ahead.
Matt, last quarter we talked about the performance of the mortgage service segment, and I think you gave yourself six months to kind of review what you wanted to do with that. Halfway through that period, can you give us a strategic update? In particular given that it remains a pretty big drag on the operating results?
And unfortunately I can’t give as you said, we’re looking at it closely and I can’t give too much granularity other than to say that any business within this segment that doesn't have a clear tie to our core title operation to the roadmaps and meeting the profitability metric is being actively accessed. So, we'll have more to update on the next earnings call.
Can you talk about how you think your market share and production is developing, both with respect to conscious decisions to pull back from certain agency markets, but also, we are hearing reports that you are seeing some employee attrition related to the uncertainty around the company. So can you talk a little bit about the impacts of both of those on your top line?
Sure, well I do, I know this call isn't really related to employees but we have been very pleased with the loyalty of many of our employees and the attachment to the Stewart brand. And so while it's tough to say since we are also refocusing our operations internally as you mentioned, I think several agency deals by our competitors have been impactful, some acquisitions of key agents that have been out there and it is true that our competitors have been very active in the pursuit of our employees especially given the recent market and all of it. And so we are hopeful what this week's announcement gives our employees greater comfort, the management and the board is aligned looking forward on strengthening and growing the Stewart franchise and if we can get the noise behind us and move forward. So, it has been difficult to attract and retain talent as well as new customers with the noise that we've had so we’re hopeful that this is behind us and we can drive things forward.
Thank you. We will take our next question from John Campbell will Stephens Inc. Please go ahead.
It sounds like you guys are positioning, from further cost, say, programs next year; I think you mentioned outsourcing, consolidation, and some initiatives around the geographical shifts. I know you guys said that you kind of pushed that out a little bit next quarter, but could you guys help size that up? Or is it just too early?
Yes, we’ve yet to make a public statement on the specific amount given we are early in probably the larger parts of the beta testing phase for where most of those cost should come out. We anticipate having a better idea of a data on our next call which will give more clarity on expected results but as we’ve stated before there are sensitivity around the customer facing activities in this project and so we want to make sure we have empirical data before assessing the size of the opportunity.
Okay. And then I think Allen you said that maybe 82%, 82.5% for the agent retention rates over the near-term, that's a good bit higher over the last two years. Is part of the geographical shift strategy; is part of that aimed at maybe bringing that back down to the 81%, 81.5% level?
I think, if I just look at it quarter to quarter like the last eight quarters it’s kind of bounced around from you know call it and I will use the reverse I'll use remittance rate, it's probably bounced around from around 18.5% to 18.1%. So it is a little unusual to see it bounce down the way it did this quarter to an 18% rate. But I’d also point out that it's not unusual, several quarters ago, I don't remember exactly which one, we saw the remittance rate bounce up to well north of 20%. So it did - it does periodically bounce around a little bit but over the longer term it probably should stay in that kind of 18.5 to hopefully a little better remittance rate.
Okay last one from me, I might have missed this. But the agency rev mix, I think it was 49% last quarter, 54% this quarter. Was that mix shift or is that more the kind of refi lift running through agency channel?
Hard to say honestly John, I think there is probably a little of all the above and as you look at the ratio of agent versus direct revenue obviously our direct revenue didn't grow a lot this quarter but I don't see that as indicative of kind of a new trend for us.
And our next question comes from Ryan Byrnes with Janney. Please go ahead.
Great thanks. Good morning everybody. Can you just remind us of the goodwill currently held at the mortgage services segment? And then also maybe just remind us as to what the pretax return margins you are looking for that business, in a go forward run rate scenario.
I mean remember that the segment have kind of been reconstituted from what the old mortgage services was. So a lot of topline ahead I couldn't quote as a goodwill number associated with the new segment but it will probably be in our 10-Q. What I can’t - and to your second point of the question, I mean, within that what’s now called ancillary services are several different product lines if you will with different customer bases and different production systems. So there is going to be a mix of margins associated with that and as Matt alluded to earlier we are always assessing those that aren't meeting our targets and prospects aren't that great for meeting the targets. But as I said a few minutes ago as we were going through the remarks we would like to see a sort of a high-single digit margin on those on an ongoing basis.
And then just wanted to parse out a little bit on your comments, on the softening of the commercial, I think you guys cited the Northeast is being a bit of a pressure. And your other competitor that reported, looks like they had some soft commercial orders as well. Just want to see any color on what is going on there.
I mean through the first two months of the quarter, real capital analytics estimated overall commercial transaction being down about 20%. So I’m pleased that we still outperform the broader market, as we also commercial can fluctuate on a quarterly basis depending on timing of deal closings and last year at this time wasn't really strong quarter. So, going forward we will continue to monitor the commercial trends, areas seeing the most pressure, our new construction some of the portfolio and mega deals and as you mentioned particularly New England we are seeing some softening there.
[Operator Instructions] We will go to Kevin Kaczmarek with Zelman & Associates. Please go ahead.
Good morning guys. I guess I had a question on the pilot program you mentioned. Can you give us some detail on the operations? I know you don't want to disclose numbers but is this a new set of processes or are you putting in a new production software system? Can you give us a sense of what you are doing?
Well, to answer your question, it’s yes. It’s processes, it's production systems. And what we're doing there and the pilot that I referred to is, think of it as a kind of shakedown cruise, when you’re doing a completely new system, you want to test it pretty thoroughly because this kind of goes to the heart of what we do prior to the actual issuance of the title policy and if you don't get it right then you can end up with some pretty big clients in a few years coming through on that policy. So what we're doing initially this year was kind of putting it through its paces in some of our smaller market states where the transaction volume isn't that great. We just rolling it out now in a larger market, stress tested if you will with higher transaction volumes. And as we go along we’re learning what tweaks we need to make to either a process or a system. So it is a little all of the above, it is sort of a completely new way of doing title production for us so obviously we want to be cautious in our approach on that.
And when did you finish putting it in and a smaller market? How big is the line between putting it in a smaller market and moving to the bigger one?
I want to say it’s probably late second quarter when we kind of were assessing the results of that initial small market test.
And on the impact of the increased competitiveness. Should we expect maybe some pressure on comp or overall expense trends? Does that mean you will be trying to balance revenue and market share with increased expenses or how should we think about trade-off between those going forward?
I think Kevin it’s something we watch closely and we want to make sure we’re aligned. What we're definitely focused on moving forward, I think some of the noise has been, has caused some of the competitive nature that we've seen, the rapid increase in the past several months and so we are hopeful with that noise that goes away, things get back to normal and maybe some of the competitive pressures are abnormal competitive pressures going forward.
And it appears we have no further questions at the time, I will return the floor to management for closing or additional marks.
Great that concludes this quarter's conference call, thank you for joining us today and your interest in Stewart, good bye.
And this will conclude today's program, thanks for your participation, you may now disconnect.
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