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Executives

Nancy Murphy – VP, IR

Hugh Harris – President and CEO

Tom Schilling – EVP and CFO

Analysts

Darrin Peller – Barclays

Julio Quinteros – Goldman Sachs

Carter Malloy – Stephens

Glenn Greene – Oppenheimer

Kevin McVeigh – Macquarie

John Kraft – DA Davidson

Greg Smith – Sterne Agee

Ty Lilja – Feltl & Company

Lender Processing Services, Inc. (LPS) Q2 2012 Earnings Call August 3, 2012 10:00 AM ET

Operator

Welcome to the Lender Processing Services Second Quarter 2012 Earnings Conference Call. Today’s conference is being recorded. Your participation on this call is implied consent. If you do not wish to be recorded, then please disconnect at this time.

I would now like to turn the conference over to Nancy Murphy, Vice President, Investor Relations. Please go ahead.

Nancy Murphy

Thank you, Jerica. Good morning and welcome to Lender Processing Services second quarter 2012 earnings conference call. With us today are Hugh Harris, President and CEO; and Tom Schilling, CFO, to review the second quarter results and answer your questions. To allow time to field questions from participants, we ask that you please limit yourself to two questions and then reenter the queue if you would like to follow up.

Before we get started, I would like to remind you that our earnings release and the slide presentation we will use to facilitate today’s discussion are available on the Investor Relations section of our website.

I would also like to remind you that we may make forward-looking statements during today’s call, and those statements are subject to various risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings, including our 10-K, most recent 10-Q and our earnings release. We do not undertake any duty to update or revise those forward-looking statements, including quarterly guidance.

In addition, our discussion today will contain references to non-GAAP results in an attempt to provide a more meaningful presentation in comparison to prior periods. Reconciliations between GAAP and non-GAAP results have been provided in the earnings release.

Now, I’ll turn the call over to Hugh.

Hugh Harris

Thank you, Nancy. Good morning and thank you for joining our call today. I’m going to start with an overview of the second quarter and then Tom Schilling, our CFO, will walk you through our financial performance. Finally, we’ll open the call up to questions.

First, let me just say we are very pleased to report strong second-quarter operating performance, including a 7% increase in revenue to $533 million and a year-over-year 36% increase in adjusted earnings per share to $0.76. Both the TD&A and Transaction Services segments generated positive performance in the second quarter.

Our GAAP net earnings were obviously impacted by the increase in our reserve of the legal contingencies. We increased this reserve because we’ve gained greater clarity over the potential resolution of legal and regulatory issues related to the past practices. We continue to make progress toward resolving these matters, and I’d like to highlight a few of the most significant.

First, we announced yesterday, we’ve settled all our legal issues with the Missouri Attorney General’s office. This settlement includes a dismissal of all criminal charges filed against DocX. Second, an motion to dismiss in the Nevada Attorney General’s case was granted in part which resulted in the scope of the suit being significantly narrowed. In addition, as it relates to the consent order, the independent third-party we have engaged has begun work on the final document execution phase.

These items combined with greater clarity on other legal and regulatory matters have resulted in our ability to better estimate the cost of resolving these issues. As a result, we have increased our legal reserve by $145 million in the quarter. Tom will offer additional commentary on this in his prepared remarks. It continues to be one of our top priorities to resolve issues around these past practices in a way that is in the best interest of our company, our customers, our shareholders, and our employees.

Today, LPS is an improved company with an ongoing commitment to achieve the gold standard for compliance in our industry and a support of our customers. We have made and continue to make investments in our people and infrastructure to ensure best in class compliance, risk management, and business processes. We’re also taking what we’ve learned through this process and using this knowledge as we build new solutions and work with our customers.

I continue to spend a significant amount of my time with our customers, with employees and other industry participants. These meetings consistently reinforce for me the importance of LPS technology solutions to help our clients address operational challenges, compliance requirements, and efficiency needs. I’m more confident now than ever that our core technologies will continue to drive for LPS – drive growth for LPS over the long term.

We continue to have many opportunities to grow our servicing technology businesses. While MSP already processes over 50% of the nation’s first mortgages, we are striving to create deeper relationships with these existing clients by expanding our offerings. Another opportunity for us with existing clients is adding home equity loans to MSP. Home equity today represents an addressable market of approximately 18 million loans. We’re currently in the process of converting two customers with approximate 240,000 home equity loans from competitive platforms. We expect this to be an attractive longer-term opportunity as services move forward business process enhancements.

Increasingly, services of all sizes are looking for the scale and best-in-class capabilities MSP delivers. We completed the conversion of three customers to MSP in the first half of 2012, representing about 55,000 loans. Over the past several months, we have had meaningful discussions with non-traditional and specialty servicers looking to enter the servicing markets. Our MSP platform allows clients to strengthen their business processes, support the regulatory compliance and reduce complexity by consolidating loans onto a single robust servicing system, recognized clearly as the industry standard.

Origination technology is another example of how we’re positioning the company for long-term growth. One of the primary drivers today is LPS’s loan quality gateway, which are platformed to connect over 17,000 participants in the origination process and provide loan transparency for lenders and investors. We now have 17 of the top 20 servicers either using or in the process of converting to the gateway.

Additionally, there’s increasing customer demand for loan origination systems that can support changing compliance, loan quality requirements, the need for enhanced efficiency and evolving distribution networks. This is an under-served market and we’re positioning LPS to capture increased purchase originations as the housing market ultimately recovers.

As we’ve previously mentioned, we have been investing in the development of a comprehensive solution to address compliance, loan quality, transparency and operational performance. Our recent acquisition of Lending Space is a key step to delivering this solution. Lending Space provides proven, scalable technology and a strong and talented employee base, which will enable LPS to expand our capabilities in the broker and correspondent lending markets.

It also accelerates our development timeline for this comprehensive solution, which we expect to complete over the next 12 to 18 months as. This wide range of offerings includes various delivery options depending on client need, which allows us to serve multiple origination channels from wholesale to correspondent. Both of these channels are vital to the feature of the housing and mortgage industry.

Additionally, because LPS is the largest provider of centralized settlement services in the U.S. we will also benefit as correspondent and wholesale lenders move towards a centralized model for the purchase market.

In our Transaction Services segment, lenders and servicers are increasingly relying on LPS origination and default services. Our origination services capitalized on higher than expected refinance volumes in the second quarter, which generated a 42% increase in revenue year-over-year. Lenders rely on our origination services, because we provide the strength and stability of centralized appraisal management, title and closing offerings that have significant quality control and quality assurance brought into the process. And these services can be integrated directly into MSP, so lenders clearly benefit from increased efficiencies as well.

During the quarter, we also made progress in expanding the breadth and depths of products with key customers. Origination services won new business including HARP 2 title and close with a top five originator.

On the Default Services front, new wins included REO title and desktop professional services with three of the top five servicers in the industry. Despite continuing industry-wide delays in the total foreclosure activity, Default Services revenue and margins improved sequentially. These improvements were the result of management, process, and efficiency changes we made over the past several quarters. These changes have not only resulted in a reduced risk profile for the company, but also in greater opportunities for the future.

As reported by the LPS Mortgage Monitor, the backlog of seriously delinquent loans remains extremely elevated at about 3.7 million loans that are on average about 600 days past due. We continue to believe that the foreclosure process is the likely path for the majority of these loans. Our market leading position, regulatory compliance services, and employee expertise make LPS a trusted partner for servicers who are moving forward with processing this backlog. We remain cautious about the near-term outlook as servicers continue to adjust to new standards, but we still expect this backlog will be processed over the next three to four years.

In summary, our positive performance reflects the successful execution of our customer and technology focused strategies, to strengthen returns and position LPS for long-term growth as the industry moves forward. These strategies include expanding our technology leadership, increasing product penetration with new and existing customers, managing our cost structure to improve efficiency and enhance margins, making strategic acquisitions, and as we have said from the beginning, achieving the gold standard for regulatory compliance and operational excellence in our industry and in support of our clients.

Now, I’ll turn the call over to Tom, who will review the financial results in detail. Tom?

Tom Schilling

Thanks Hugh, and good afternoon. As I review our second quarter operating results including the reserve for legal contingencies and our guidance for the third quarter, I’ll be referring to the supplemental slides to facilitate the review.

As Hugh mentioned, we’re pleased with the strength of our second quarter operating performance on all fronts. We delivered adjusted EPS of $0.76 per share, up 36% over last year and well above our guidance range of $0.58 to $0.62 per share.

Adjusted EBITDA margin increased to 27%, up almost four percentage points sequentially driven by higher transactional volumes and discipline in managing our costs. We generated strong adjusted free cash flow of $115 million, up 41% year-over-year, and again we further strengthened our balance sheet by reducing debt and increasing cash.

The favorability to our guidance was a result of better performance across the board. Origination Services revenue and margin declined as we capitalized on stronger than expected refinance volumes. Default Services revenue and margin increased sequentially, despite a continuing difficult operating environment. And Technology, Data and Analytics had another strong quarter of revenue and profits.

Before covering our results in more detail, I want to touch on our reserve for legal and regulatory matters. As you will recall, we established our loss contingency in the fourth quarter of 2011 with a reserve of $78 million. As Hugh discussed earlier, we’ve recently gained greater clarity into the cost to resolve the various legal and regulatory matters, including the announcement yesterday regarding our settlement with the Attorney General of Missouri. As a result, in the second quarter, we increased the reserve by $145 million or $1.19 per share.

While the estimated cost to resolve these matters has increased, we’re pleased that the recent progress we’ve made has allowed us to further refine our estimate of the contingent liability. We’re also confident that our strong cash flow and liquidity allow us to continue to execute our capital allocation strategy while addressing these estimated legal costs. As a reminder, the legal reserve represents our best estimate at this point in time, and we will continue to assess our loss contingency for these matters each quarter and will adjust as appropriate.

Including this incremental reserve, on a GAAP basis we reported second quarter net loss of $38 million or $0.45 per diluted share compared to net income of $21 million or $0.25 per diluted share in the same quarter last year.

My remaining comments regarding second quarter of financial performance excludes the impact of the charge and the adjustments as outlined in the GAAP to non-GAAP reconciliation included in our earnings release as exhibit E.

Second quarter revenue increased to $533 million, up 7% year-over-year, driven by a 42% increase in Origination Services and a 9% increase in Technology, Data, and Analytics. Sequentially, revenue increased 5% with growth balanced between TD&A and Transaction Services.

Adjusted EBITDA increased to $145 million up 29% year-over-year and 23% sequentially, while EBITDA margin increased sequentially from 23% to 27%. The sequential improvement was driven primarily by higher contribution from default services.

As shown on slide 10, adjusted cash flow from operating activities increased from the prior year quarter by 26% to $141 million and adjusted free cash flow increased 41% to $115 million fueled by higher earnings and improvements in working capital. Capital expenditures which are primarily targeted at our core technology platforms totaled $26 million in the quarter.

During the quarter we continued to strengthen our balance sheet, reducing our debt by $54 million to less than $1.1 billion including prepaying the mandatory payments under our term loan A through the end of 2013.

Cash and cash equivalents were $138 million, an increase of $35 million from the first quarter. The average interest rate on our debt was 6.2% during the quarter. Our near-term capital allocation objectives are unchanged. We will maintain the investment necessary to grow our core business with capital expenditures running at about $100 million to $110 million for the year. We will continue to explore potential acquisitions that can strengthen our technology offerings to our customers and we plan to continue to pay our regular quarterly dividend. Finally, with the increase in the estimated legal contingency reserve, we plan to build and maintain a strong cash balance until these issues are ultimately resolved.

Now, I’ll review the performance within our two business segments. Referring to slides eight and nine, Technology, Data and Analytics revenue grew 9% year-over-year reflecting continued demand for LPS’s technology solutions. Servicing Technology revenue was up 7% driven by higher recurring revenue and increased data usage fees. Default Technology increased 17% fueled by market share gains and Origination Technology increased 17%, primarily due to higher origination volumes on our loan quality gateway platform.

EBITDA for the TD&A segment increased over the prior year quarter by $3 million to $76 million representing a strong 41% margin, up slightly from the prior quarter, but down on a year-over-year basis due to higher expenses in Data and Analytics and Origination Technology as we invest for future growth in these areas.

Moving on to the Transaction Services segment. Revenue increased 5% sequentially, driven by an 8% increase in Default Services revenue, reflecting higher title orders and a seasonal increase within field services. Origination Services revenue increased 3% due to higher refinance origination volumes.

EBITDA for Transaction Services increased 44% sequentially to $81 million, while the EBITDA margin increased 6 percentage points to 23%. The margin expansion was primarily driven by higher revenue and margins in Default Services and improved revenue mix and operating leverage in Origination Services.

Corporate expenses before depreciation were$11 million in the quarter compared to $10 million in the prior quarter, primarily due to a non-cash impairment charge for an administrative system.

Now, we’ll review our guidance for the third quarter as shown on slide 11. We expect consolidated revenue to be in the range of $500 million to $520 million and adjusted EPS in the range of $0.68 to $0.72. For TD&A we expect revenue to be roughly flat with second quarter. As it relates to Transaction Services, we expect another strong quarter in Origination Services with revenue on par with the second quarter, as interest rates remain at historic lows and HARP program continue to support elevated levels.

Within Default Services, we expect similar level of default activity as seen in the second quarter. However, as we discussed on past calls, as we continue to improve our risk profile, we are migrating away from certain contracts. As a result, we expect a decline in revenue versus prior quarter.

In summary, we’re pleased with the strong second-quarter operating results and we’ll continue to operate our business lines with a focus on both effectiveness and efficiency.

Now, I’ll turn the call over to the operator, so we can take a few questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll begin with Darrin Peller, Barclays.

Darrin Peller – Barclays

Thanks, guys. First, I have a couple of questions to ask, I’ll just try to keep it to two. One on the legal side and one on the fundamental side of the business, but starting off on the legal side. It’s great to see the Missouri case settled and obviously nice to hear that the Nevada case has narrowed. However, given the size of the reserve increase, I think it’d still be helpful to hear whatever you can provide a little more detail on it. In particular, was the majority of it associated with an extrapolation of the Missouri settlement or the Nevada case advances or was a big part of it related to the consent order? And then, maybe just, is there anything you can say to us to give us some comfort that this is not going to be the sort of an ongoing slippery slope of the multiple large reserve increases going forward?

Hugh Harris

Yeah. Let me address the legal reserve. I want to make sure that we get past practices behind us as this company tries to move forward. And as we’re going through time here over the last six months, we’ve spent a lot of time meeting with all of the groups on the legal front, whether it be the consent order related or the AGs, etc. We have much better clarity today than we did six months ago or nine months ago as to what it is going to take to resolve these issues.

Missouri was just part of it but something we’re glad to get behind us. It’s good to get one of these done. So that’s about all I could really say around the reserve at this point.

Darrin Peller – Barclays

Well, I guess just to – not to push too much, but you were saying you have that much more, that much greater clarity than you did probably when you took the $78 million reserve. Can we as analysts and investors have some comfort that this is I guess, majority at this point. I mean is there anymore you can say to give us, because $144 million versus $78 million a couple of quarters ago is obviously a big step up.

Hugh Harris

Yeah.

Darrin Peller – Barclays

And then I’ll just leave it at that.

Hugh Harris

Yeah. No, I appreciate your question and I would love to say everything’s over. But this is our best estimate today. A key that I think people need to focus on is, we’ve had no new issues. The issues that are there relate to DocX from 2008 to 2010, on a business that’s been closed for two years, and we’re just trying to continue to make progress and get this behind us.

Darrin Peller – Barclays

All right, thanks, Hugh. Just on the fundamental side real quickly, the Data and Analytics have showed very strong growth, well above what we had expected. Can you just help us understand maybe Tom you can give us a sense, what should we be really modeling in, what should we be expecting for that kind of growth rate, I mean, 9% or so is stronger than the sort of mid-to-high single digits, which is I think we even thought, is that sustainable?

Tom Schilling

Look, I think the 9% was very strong. We had a lot of things going our way this quarter. As I mentioned we had higher data access usage within our MSP platform, strong origination volume, which was helping the Origination Technology side on loan quality gateway, and you know I think like we’re guiding, we’re expecting that the third quarter TD&A will be more like roughly flat, as we’re starting to see more efficient and effective use of the system frankly on MSP, as the servicers start to work through some other issues, those are – volumes are always hard to predict, but we do expect to see some leveling out back to more normalized volumes starting in the third quarter.

Darrin Peller – Barclays

All right, that’s helpful and then last question for me. On the overall business on the transactional side of the business, obviously some of it is somewhat cyclical. Can you help us understand if you even believe that you’re somewhat right sized in that business for, let’s say, a normalization in the fall versus a normalization and Origination Services, such that you can maintain a certain level of free cash flow even if there was a maybe a bit of slowdown in the refi side or change on the Default side overall, I mean, because obviously you’re generating very, very strong free cash flow right now, and it’d be nice to see that’s sustainable even if the market were to change a bit.

Tom Schilling

I think, it matters of degree on that. Obviously as we know and we’ve seen in the past, we can have very significant changes in the volumes coming both in Default as well as in the Origination side, but I would say is – what we’re looking at particularly through the third quarter. I think we’re looking at relatively consistent volume levels, and so I think that our cost structure is – as you saw with the second quarter, our cost structure was certainly right sized for the volume levels we’re at now, and it’s something we manage everyday when we see order volumes going up or down. But, yeah, I mean I think we – for normal – kind of normal adjustments in the volumes, I think we’re well sized right now, and we’ll continue to make the changes we need to the cost structure to right size it for the volumes that we get on a daily basis.

Hugh Harris

Yeah, I would just add to that. Darrin. I think Tom’s point is a good one, and that is one of the strengths of this organization is the ability to manage for the volumes up and down. They have done a great job of this on all the different fronts over the years and continue to have a strong focus on that.

Darrin Peller – Barclays

All right. Thanks, guys. Thanks, Tom.

Operator

Julio Quinteros, Goldman Sachs.

Julio Quinteros – Goldman Sachs

Hey, guys. Good morning.

Tom Schilling

Good morning, Julio.

Julio Quinteros – Goldman Sachs

Just to come back to the right sizing commentary, just thinking about operating leverage in the business relative to the growth rates, and I know we’re not talking about 2013 specifically, but I wonder if there is a way to sort of think about the – this new right size level if you will in terms of the operating expense structure and what type of growth rates which you guys can support for sustained margin expansion as we start thinking beyond 2012 there?

Tom Schilling

Yeah, certainly. I mean, as we look ahead if we have strong transactional growth on the Transactional Services side – obviously, we can accommodate the upside of growth, generally speaking much easier with better margins than it is to absorb declines in the transactional volumes. On the TD&A side, we’re certainly – I think we’ve shown historically very well poised too. As revenues go up, we tend to drive very strong incremental profit on our TD&A segment. So, I think we feel very good as the market begins to recover and have a more normalized view that we’re well-positioned to be profitable in that.

Hugh Harris

Yeah. I think one of the points that Tom has made over and over in the last several months is there is a high variable cost in the Transaction businesses as opposed to fixed costs. Is that fair?

Tom Schilling

Yeah.

Hugh Harris

It does help with that.

Julio Quinteros – Goldman Sachs

And maybe just to go back to some of the legal issues in terms of what’s left to do. Can you just remind us the different AG states that you have to still deal with. So, the settlement in Missouri is one. You talked about the motion to dismiss in Nevada. What are the other states that are still left to be dealt with at this point?

Hugh Harris

Well, we have – we’re actually working with several states at this time and the one thing that I’ve said when we did the reserve before is, we’re having dialogue now, which we didn’t have a year ago. So, it was tough to begin to address some of these issues the way we needed to. But, just for a number, we’re talking with approximately 13 statesat this time, but the key to it is we’re talking, and I think that’s the important thing to note.

Julio Quinteros – Goldman Sachs

Okay. And then just lastly on the consent decree, talk a little bit about being in the final stages of that, can you just remind us what those final stages will entail and then ultimately what does that free you up to do going forward?

Hugh Harris

Yeah, the final phase is the document execution review, and there were three phases to the consent order; two of those have been completed. And the one thing that I would say and we continue to get questions around the timing of when this all will be done. I have a lot of confidence in the third party that is doing the work, and they’re totally independent, and it’s taken them longer than they had hoped, certainly longer than we had hoped, but I have a lot of respect for the people that are running that business, and I think they are doing a good job with it.

We’ve met all our targets. We’ve hit everything that we’ve been requested to do with the regulators. And it’s the final phase of a process as I’ve described it before. I think our working relationship with the regulators has been very, very good, and I would just say we will continue to work through this.

Julio Quinteros – Goldman Sachs

But it doesn’t preclude you from doing anything in the mean time until this things gets finalized?

Hugh Harris

No, we’ve had no restrictions on us, just like this acquisition. We do have conversations with the regulators to let them know what’s going on, what we’re doing, and what’s happening and I think they appreciate that and we have good dialog back and forth, but there are no restrictions.

Julio Quinteros – Goldman Sachs

Thanks guys. Good luck.

Hugh Harris

Thanks.

Operator

Carter Malloy, Stephens.

Carter Malloy – Stephens

Hey, guys, congratulations on great quarter.

Hugh Harris

Thanks, Carter.

Carter Malloy – Stephens

I’m definitely beating a dead horse here to ask about it, but it’s a big number, so I feel it’s warranted. In looking at the charges out this quarter, taking into account Missouri and Nevada and even the 13 other states, even though the Missouri, I think the accusations they had leveled and the aggression was a little stronger than some of the other states, that doesn’t seem to explain the magnitude of what you’ve set aside being a few hundred million dollars. So, that leads us to either make an assumption that it’s all related – or a lot of this is related to the consent order or I guess ultimately is there something external to the consent order that you guys may have working or maybe reserving against that is not – not well understood by us.

Tom Schilling

Carter, yeah it really is, as Hugh touched on, Hugh and our entire legal team have been very engaged over particularly the last 60 days. So this is the Missouri settlement, which was very good for us and we’re very happy to get that behind us, but that was just one component into all the various issues that are all included in that legal reserve.

And we’ve made progress on all them. So as a remainder, we now know that the consent order costs will be more, so that’s certainly one thing that has increased within the – within that legal reserve is the cost to complete that final phase, because it took longer to get started, and it’s probably going to take longer to finish. But it’s on every front getting more and more clarity as Hugh mentioned having dialogue with the parties brings more clarity. And so while – as we keep saying, it’s our best estimate at this point in time, I think we all collective feel very good that we have the kind of clarity we need to start estimating these kind of amounts and has made a lot of progress on many fronts.

Carter Malloy – Stephens

Okay. And the potential for that number to go up, slightly it’s understandable, the potential for that us to see another $140 million charge, even $100 million charge, you guys think is low or even extremely low?

Hugh Harris

Well, I would just say, Carter, if we thought the number was going up today, I would have taken a bigger number....

Carter Malloy – Stephens

Okay.

Hugh Harris

Our best estimate today is, this is what it’s going to take to resolve these issues.

Carter Malloy – Stephens

Okay. And then also you guys mentioned moving away from a few contracts on the Default side of the business. It seems like there is a lot – has been a lot of that going on in the market. So, can you give us more color on – was that field services or was that a competitive loss or an unreasonable customer, what’s driving those decisions and will we see more of it?

Tom Schilling

I think a combination of things. One, as we talked about this, I know earlier in the year, the business model in our Foreclosure Solutions group has been completely changed and we have many contracts that we are migrating away from and the timing of those as we mentioned at the beginning of the year are going to kind of happen throughout 2012, we expect some of that. We also continue to be very, very – just like we are very – we’re very focused on managing our cost structure, we’re very focused on managing on a day-to-day basis the kind of the transactions we accept.

So, if we have low-margin contracts that just don’t fit the profile, we are walking away from certain businesses where the margin profile is not where we need it to be. That may hurt us in the short-term, I think over the long-term it’s our belief that being the provider of gold standard compliance as well as the one who has a very strong balance sheet and the kind of reputation with our Technology Solutions that we have, we will continue to win more of that business in the future at the right kind of margins.

Carter Malloy – Stephens

And so, when you say moving away from because of low margins, is that – is this centered round things like admin services or is it across the board field services and the other things you’re doing in that...?

Tom Schilling

It’s not isolated to the admin services, but it’s certainly admin services as well as certain select contracts within field services.

Carter Malloy – Stephens

Okay. Thanks very much for the help.

Hugh Harris

Thanks, Carter.

Operator

Glenn Greene, Oppenheimer.

Glenn Greene – Oppenheimer

Thanks, good morning.

Hugh Harris

Good morning.

Glenn Greene – Oppenheimer

I’m going to beat a dead horse again. So going back to the litigation reserve, let me sort of try it at another angle. So, I was thinking about it this way, so there’s $203 million in the reserve, maybe you can help us understand the big components of that directionally without being specific, but how much directionally is the AG suit? How much is the consent decree; is the FDIC suit in there? What are the other big pieces that are missing, obviously it increased pretty significantly and it’s everyone sort of begging the question what kind of changed since January, I think is really the question?

Tom Schilling

Yeah, let me just – yeah, because this is – we’re not going to itemize what’s in there for every component for obvious reasons, but we’re – what we’ve said is it contains the cost to resolve the consent order, the cost to resolve all the various state AG matters, the cost of the U.S. Attorney investigation, the cost of the American Home Mortgage Arbitration suit, and the cost of the FDIC – so, the resolution of the FDIC suit. Those are the items that remain in that legal reserve and it is a comprehensive estimate for each of those, and as I mentioned to Carter, you can just imagine that many of those separate components had changes in this quarter, that resulted in the $145 million increase to the overall reserve.

Glenn Greene – Oppenheimer

Okay. Fundamental question, so, the Default revenue – in the Default revenue, the sequential increase of 7% and it sounded like the underlying metrics were kind of status quo, maybe, there is a little bit of seasonality in the field services, but I just wanted to get a little more color why that kind of stepped up as much as it did. And related to that, one of your peers called out pretty meaningful loss mitigation work related – I think might have been related to the big $25 billion settlement. I was wondering if you had received any benefit this quarter from that as well.

Tom Schilling

On Default, we saw a couple of things. One, we had as you recall, in the first quarter, we had talked about, we had some additional reserves that we had setup on accounts receivable for our Default Services group. We didn’t have those, those were absent in the second quarter, so that actually helped a bit on a quarter-over-quarter basis. But then, we also saw again the seasonality on field services, I mean, it’s the old – it’s spring time, so the grass needs cut, and those kind of things, so we see the revenue uplift there. And then, we also saw an increase in our title orders in the second quarter. So, we saw some expansion there and we saw obviously I think a much more – some of the management moves we made at the end of last – or the end of 2011 are starting to take a hold with the new leadership, we’ve installed at the Default Services Group we are starting to have our focus on our cost structure and managing it to the order volumes on a daily and weekly basis.

Glenn Greene – Oppenheimer

So, was there any sort of uptick from the big mortgage settlement, any incremental work you’ve got from any of the big five servicers?

Tom Schilling

Well, we get – obviously the vast majority of what we do is for the bigger – for the biggest lenders. So obviously we’re seeing some uptick from them. I don’t – I don’t know that you can pin it specifically to the back to the AG settlement, I mean, I think it’s more as they work through their issues not only at the consent orders and the things that they’re working through for the requirements of the state AG settlement. They still have a lot of issues at a state by state level that they’re working through, but as they continue to make progress in and release those volumes, we’re benefiting from that.

Glenn Greene – Oppenheimer

Okay. and then on...

Hugh Harris

And I would add to that, Glenn, just to say that, we’re fully engaged with all of these major servicers on a daily basis and they are finding things as part of their settlement and as part of their agreements, and really their ongoing monitoring of what they have to do over the next two to three years where we’re going to be able to help them significantly. And so, they are using our resources to address a lot of the issues they are going to face going forward.

Glenn Greene – Oppenheimer

Okay. And then the last question on the TS margins, kind of thinking Q-to-Q, the incremental profitability in Transaction Services was greater than the incremental revenue or another way to say that the margins were phenomenal? Was there any –

Hugh Harris

Was that bad?

Glenn Greene – Oppenheimer

No, not bad; just a question. Is there any specific cost takeout or how do we sort of rationalize the increase in the margins?

Tom Schilling

I think, it’s – again, we had absent a on-top reserve for certain accounts receivable that we had in the first quarter. So, when you look at that, that’s kind of a little bit of anomaly in the numbers, so you kind of have to look at...

Glenn Greene – Oppenheimer

How much was that?

Tom Schilling

About $5 million in the first quarter. So, that accounts for some of it, but a lot of it is these businesses scale fairly well because the fixed cost component is small; it’s the variable cost. We tend to manage it very well on the upside, so we make a higher incremental margin on the upside than a lot of times we can cut the incremental margin on the downside, because while it’s variable, it’s costs that have to be managed. And so, it tends to be a better management of that on the way up than there is on the way down sometimes. So, good margin expansion I’d say.

The other thing is just within Default Services, as we continue to transform those business models, it not a – per se a hatchet of taking a big glob of costs out. As the work that was started back in the end of 2011 is starting to manifest itself with higher margin products, better business models, and just better rigor around the staffing models and more discipline around costs in general.

Glenn Greene – Oppenheimer

Okay, great. Thanks a lot. Congratulations.

Hugh Harris

Thanks.

Operator

Kevin McVeigh, Macquarie.

Kevin McVeigh – Macquarie

Great. Thanks. Could you kind of talk to market opportunities for home equity loans around 18 million or so. Can you remind us today, what kind of the core market opportunities amongst the core kind of traditional business in terms of – from a loan perspective?

Hugh Harris

Well, you’re saying for first mortgages?

Kevin McVeigh – Macquarie

Yes.

Hugh Harris

Yeah. There is about 50 million first mortgages out there today, and we have about 26 million active loans on the system with about over a million home equity loans today with – I think I mentioned, we just added about 240,000 home equity loans. This is a real focus for lenders and the fact that what they’re finding is home equity loans are really the same as first mortgages and need to be treated the same. And the systems that they’re operating on today, can’t – don’t – do not have a lot of functionality that MSP has. So, the drive we think and the servicers are telling us is to move those loans onto a more robust system like MSP, so they can manage them exactly the way they would manage a first mortgage.

Kevin McVeigh – Macquarie

Got it. And then I just – I wanted to kind of – I know the reserve has been asked a lot but just in terms of that, Tom, at this point, are all 13 states factored into that reserve at some point, number one? And then number two, have any other component change, so you did a nice job framing out what the components of it were. Have they changed since December and I know kind of you talk in the best estimate today, but you also gave us your best estimate December. Can you just kind of help us kind of quantify just if you could?

Hugh Harris

Yeah. Let me just say on this, I mean clearly the key to all this in my mind is a fact that we have spent a significant amount of time with all of these parties on all of our litigation issues over the last six months. As we’ve spent time with them, talked to them, understood things better, it gave us the clarity we needed, we think, to set this reserve. And I will tell you, I had only been here when we took the first reserve for a short period of time, but now that I’ve been involved in a lot of these meetings with the legal team and with the folks that are working on this, it was clear we needed to increase the reserve.

Kevin McVeigh – Macquarie

Yeah, I know, it’s just – I was just trying to – because it seems like Missouri is $1.5 million and if that’s one of 13 states, are there any other – and I know there is a lot of different components to, but just trying to come up with the per incident, is it 11,000? Is there – is California in there, just – are all 13 states factored into to some aspect of that reserve at this point?

Hugh Harris

Yeah...

Tom Schilling

No, go ahead.

Hugh Harris

The one thing I would say to you is this is an ongoing process. And we’re talking to people on a regular basis. We have had no new issues, which is I think critical because if I – because if you’ll recall when I first got here we were once a month getting hit with a new problem. So, we now know that the AGs have talked to us, they’re engaged with us, the other legal and regulatory issues that we’re focused on, we’re having constant dialogues, so we just have more clarity. And I don’t know a better way to put it and it’s hard to get into particular states and all that kind of thing without causing a problem for ourselves, because everything is fluid at this point.

Tom Schilling

Yeah, the one thing I would just add though, yes I mean all the states that you talked about, everything that we’re trying to settle, so whether it’s a California issue or a Nevada issue, all those items are included within the legal loss contingency that we’ve recorded. So the original $78 million plus the additional $145 million that we booked this quarter – or in the second quarter contemplate settlement and resolution costs of all those open issues.

Kevin McVeigh – Macquarie

Got it. And then, Tom, is it a 12-month issue now that the reserves have been booked or is it just something, Tom, that can work out over – it could be a multi-year?

Tom Schilling

You’ll see in our balance sheet. I think, it’s all labeled as a current liability because it’s hard to predict exactly the timing, so we’re classifying it always as a current liability. But I would – I think it’s and you can comment on this too, I think it’s our hope that we would actually see that realized, that we would try to get these matters behind us within the next year frankly given the time that it’s taken to get ourselves to this point. I think – wouldn’t be surprised to see some of that bleed beyond the middle and next year, but we hope to get a substantial portion of these things settled, resolved behind us within the next 12 months.

Kevin McVeigh – Macquarie

Okay. Thank you.

Operator

John Kraft, D.A. Davidson.

John Kraft – DA Davidson

Good morning and congratulations on the Missouri settlement.

Hugh Harris

Thank you.

Tom Schilling

Thank you.

John Kraft – DA Davidson

I won’t ask any questions about the legal, but I want to talk about the industry trends overall. It looks like on the origination side you clearly are gaining share and continue to, I guess I wanted to look forward a bit and as you look into 2013, I know that you’re not providing guidance, but orders of magnitude the MBA at least is expecting call it a 20% decline, what are your internal estimates?

Tom Schilling

know we’re obviously not going to go there in terms of our internal estimates, but what I would say is it’s a very – the only prediction we’d make that is it’s going to be very hard to predict, right. We’ve got forecast out from the three leading forecasters of mortgage originations who predict refi markets ranging from down 35% in the third quarter to up 7%, and I think you probably find that same kind of disparate ranges as you go on out with these forecasts. Very difficult to predict. What we are seeing right now and based on what we’ve seen come through in the July timeframe. We feel pretty comfortable that the volumes for refi activity are going to be pretty similar in the third quarter to what they were in the second quarter, so continue to be very strong.

I’d say, we’re probably more bullish right now on the refi levels being sustainable given the HARP programs, the HARP 2 as well as the discussion that’s already starting to ensue around a version of HARP 3 that could potentially be a catalyst to continue to sustain the origination volumes into the 2013 timeframe. So I would say without getting specific, I’d say we’re a bit more bullish around 2013 volumes continuing to be a little stronger than maybe some of the sentiment out there.

Hugh Harris

Yeah, John, let me just add, I spent the day with a CEO that runs one of the largest origination shops and his comment to me was, there was no way to predict more than quarter-to-quarter right now, because everything is changing on the regulatory front, the new products that come out, etcetera. And his comment to me was, he said, you guys are doing a great job of staying ahead of this and staying up with it, but he said I can’t predict, and he said I run one of the best origination shops in the country. So, we’re trying at this point to stay quarter-to-quarter, give you guys the best guidance we can, and do everything we can to meet and exceed our objectives here.

John Kraft – DA Davidson

Okay. Well, assuming that we can’t predict, let’s just say that the industry is flat, what’s your – given that you can gain share here, proven to, and given in light I guess of the new purchase origination positioning that you’re doing, what sort of a growth rate is a good target for you, if the market is flat?

Tom Schilling

I’d probably say, look we probably – in a completely flat transactional market overall, then I’d say we’d be looking at somewhere in the mid single digits of growth, because we continue to take share, but we’re already a pretty big player, so we’re not going to get astronomical kind of growth rates in a static environment like that. So, I think it’s probably within our Transaction Services, probably similar to what we see in the TD&A market, which has been kind of that single-digit growth if it’s just completely stable volumes, because we do continue to get better penetration and take share.

John Kraft – DA Davidson

Sure. Great. Thanks, guys and congrats on the progress.

Operator

Greg Smith, Sterne Agee.

Greg Smith – Sterne Agee

Hi, guys. How should we think about the risks and opportunities with portfolios shifting around with the servicing shifting around and potentially impacting MSP either positively or negatively?

Hugh Harris

Well, I’d just say to you on that, Greg, we are fully engaged with all of the new entrants. We’re talking to them on a regular basis. We’re talking with the people that are buying these portfolios. The one thing that really helps us is the fact that we have a 50% market share and if you look at servicing employees and resources that are having to be hired by these new entrants, most of them are trained on MSP. So, it makes an easier transition for them to move to the MSP platform. So, we’re aware of new entrants, we’re aware of the fact that some of these portfolios are going to be moving around, and we’re constantly in dialogue with those folks.

Greg Smith – Sterne Agee

Okay. Great and then as we think about foreclosure volumes over the quarters ahead it sounded like you guys said you expect them to still be held back just from regulatory issues. Is there anything that could be a spark if just the housing market continues to improve. Do you think that would be a spark or is there anything we’re not really thinking about that, that could be spark to really ignite finally starting to really work through this big – all the delinquent loans out there?

Tom Schilling

I mean – I think it would have to be dozens of little sparks because the real issue is a state by state issue and a servicer by servicer issue. So, the best example is things like New York, I mean, you’ve got almost no foreclosures being completed in the state and a huge backlog. So it’s going to – I think, the sparks that will start ignited as the states come to terms with their processes, how quickly they’ll let these things go through, how they resolve the challenges that are out there today to some of the foreclosures, that what’s going to be really have to – have to happen before we’re going to start to see the recovery in the volumes. And those things are being worked through. I mean some servicers more successful than others and some states more successful than others, but those of the kind of things that are going to have to happen. And I don’t think there is going to be a catalyst one point in time that you’re going to see that’s going to change the dynamics in a fundamental way.

Operator

Ty Lilja, Feltl & Company.

Ty Lilja – Feltl & Company

Hi, guys just. Just two questions around Default Services. First, you were just talking about moving away from certain types of businesses. I was wondering if you could give a sense of historically in a year like 2010 and 2011, how much of your Default Services revenue that type of business accounted for? Also, you mentioned title – some title work improving rising in that business. I was wondering if that was all new customer wins or was there may be a component of people initiating a bit more foreclosure action relative to Q1.

Tom Schilling

Yeah, in terms of the – I mentioned that we saw some default title work orders increase in the second quarter versus first quarter. I’m not quite sure how it divides up between new customers and existing customers but the vast majority I would say is just coming from our existing client relationships and as their volume increased, we benefited from that. But we certainly are winning new customers on that as well. But I think the biggest majority there came from the existing customers.

And in terms of the market share – or the revenue mix, we’ll have to follow-up with you on kind of the range of revenue mix from these particular things because it’s not all just one line of business. In some cases, it’s just contracts within certain of our businesses where we’re kind of holding our standard to certain margin levels within each of our business lines and as those – as we find things that we think expose us to more risk and not enough profit in that equilibrium, we walk away from some of that business and that’s what we’re looking at.

Operator

Thank you and that concludes today’s question-and-answer session. Mr. Harris, I would now like to turn the conference over to you for closing remarks.

Hugh Harris

All right. As I said before, we are very pleased with our second quarter performance and with our outlook heading into the third quarter. While we expect the operating environment to remain challenging in 2012, we’re 100% focused on executing our strategies to deliver superior technology based solutions to our customers and value to our shareholders.

Through ongoing discussions with the appropriate parties, we’ve taken the positive step forward. Again, the information we needed to increase the reserve that will allow us to begin putting these legal issues related to past practices behind us.

With significant cash flow and liquidity, LPS has the continuing financial flexibility and resources to move forward and execute against our capital allocation plan and to capitalize on the momentum we continue to build as a new and improved LPS. Together with our senior management team and all of our employees I am excited about the future, our role in helping all of our clients and the leadership role we will take in helping to rebuild the mortgage industry.

We appreciate your interest today in LPS and we look forward to continuing our dialogue about the company’s progress. Thank you very much.

Operator

That concludes today’s conference call. You may now disconnect.

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