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Edited Transcript of STC earnings conference call or presentation 20-Apr-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Stewart Information Services Corp Earnings Call

Houston Apr 21, 2017 (Thomson StreetEvents) -- Edited Transcript of Stewart Information Services Corp earnings conference call or presentation Thursday, April 20, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Allen Berryman

Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary

* Matthew W. Morris

Stewart Information Services Corporation - CEO and Director

* Nat Otis

Stewart Information Services Corporation - SVP of Finance and Director of IR

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Conference Call Participants

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* Bose T. George

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Geoffrey Murray Dunn

Dowling & Partners Securities, LLC - Partner

* Hayden Blair

Stephens Inc., Research Division - Research Associate

* Kevin Michael Kaczmarek

Zelman & Associates LLC - Director

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Presentation

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Operator [1]

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Good day, and welcome to the Stewart Information Services First 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 Regulations. Please go ahead.

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Nat Otis, Stewart Information Services Corporation - SVP of Finance and Director of IR [2]

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Good morning. Thank you for joining us for our first quarter 2017 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 an expectation of future financial operating results and are not statements of fact, actual results may differ materially from those projected.

The risks 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.

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [3]

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Thank you, Nat, and Good morning, everyone. We appreciate you joining us today. This morning, we reported pretax income of $6 million for the quarter, which is a meaningful improvement of $22 million compared to the first quarter of 2016. Stewart generated net income of $4 million or $0.17 per diluted share compared to a net loss of $11 million or $0.48 per diluted share for the prior year quarter.

The comparison does include certain realized losses and other charges during the first quarter of 2016 as well as an atypical effective income tax rate for the first quarter of 2017, which Allen will speak to you in a moment.

We saw total first quarter 2017 revenues increased 1% to $443 million with operating revenues improving to $438 million from $433 million. Growth in core nontitle revenues was offset by expected declines in ancillary services revenue. Our focus around ongoing cost discipline efforts as well as the divestiture in the fourth quarter enabled employee and other operating costs to decline almost $20 million or 8%, relative to that 1% increase in revenues.

As shown in appendix A of our earnings release, our adjusted EBITDA improved to $13 million from a loss of $1 million in the prior year quarter on a 1% adjusted revenue increase, demonstrating the leverage inherent in our transformed operating model.

First quarters are traditionally weakest of the year for the title industry, so we are encouraged to see the results of our initiatives and to start the year off strong. Gains in operational efficiency were achieved in both the Title segment and the Ancillary Services and Corporate segment with pretax margins improving solidly from prior year's first quarter.

With the revisions to our corporate governance structure fully in place, our attention and focus going forward is maintaining cost discipline while generating core title revenue growth in specific markets through internal investment and targeted acquisitions.

Smart revenue growth coupled with continuation of our previously announced production cost efficiency project, we hope sustainable margin improvement in both the mid and long term.

From the macroenvironment perspective, we currently anticipate a slight decline in 2017 overall title industry revenue due to much lower refinancing activity. We do anticipate transaction volume increases in existing new home sales, driven largely by demographics in the emerging millennial homebuyer.

This increase in purchase transactions coupled with the continued increase in home prices will largely offset the impact of lower refinancing transactions on industry premium revenue. We are mindful, however, that rising interest rate and an increasingly low inventory of homes available for purchase may impact the affordability and available transaction volume this upcoming summer season.

We're closely following the evolving forecast of commercial purchase activity as well, as we anticipate an expected decline in commercial refinance volume later this year.

So now, I'll turn it over to Allen for more detail on our financial results.

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [4]

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Thank you, Matt, and good morning, everyone. The Title segment generated pretax income of $12 million or a 3% margin compared to the first quarter of 2016's breakeven results. Our Title segment revenues were $426 million for first quarter of 2017, which was an increase of 3% from last year's quarter.

With respect to our direct title operations, the overall revenues increased 1% from first quarter of 2016 with revenue increases in our commercial and international operations offset by a decrease in centralized title ops, which experienced expected decline in both refinancing and default title revenues.

Total commercial revenues for the quarter were up 8% over the prior year quarter as domestic commercial revenues increased to $42 million from $39 million in the first quarter of 2016. Total title orders closed to decrease 6% from the first quarter of 2016, driven by a 22% decrease in refinancing transactions closed, partially offset by a 4% increase in purchase transactions closed.

Of note, we did see a jump in other orders opened, which primarily resented -- represented increased HELOC activity to start the year.

Revenues from independent agency operations increased 4% or $9 million in the first quarter of 2017. Net of retention, revenues increased by 3% or $1 million. The independent agency remittance rate was 18.1% in the first quarter 2017 as compared to 18.2% in the prior year quarter.

We continue to expect our ongoing average annual remittance ratio to be in the low- to mid-18% range. Title loses of the percentage of title revenues were 4.9% in the first quarter of 2017 as compared to 5.6% in the prior year quarter. We anticipate maintaining a loss accrual ratio of approximately 5% during 2017. Our total balance sheet policy loss reserves were $460 million at quarter end.

Looking at our ancillary services and corporate segment, which now consist almost exclusively of search and valuation services. Operating revenues for the segment decreased 22%, $17 million compared to the year ago quarter, primarily due to exiting our delinquent loan servicing operations, a process completed in first quarter of 2016 and our divestitures of the loan file review, quality control services and government services lines of business at the end of 2016.

The segment reported a pretax loss of $6 million in the first quarter 2017 compared to a pretax loss of $10 million in the prior year quarter excluding the nonoperating and nonrecurring charges described in the earnings release. The segment's results include approximately $6 million of expenses attributable to parent company and corporate operations compared to $9 million in the first quarter of 2016, which include $2 million of charges.

Excluding the $6 million of corporate expenses per quarter, our 2017 goal is for the search and valuations business to be profitable. And our longer-term objective is to achieve mid-to-high single-digit annual margins.

With respect to operating expenses, my review excludes the first quarter 2016 charges of $7 million in the ancillary services and corporate segment that were detailed in the earnings release.

So employee costs for the first quarter of 2017 decreased 7% from first quarter of 2016, while average annual -- or average employee count decreased almost 10% from the prior year quarter. The decline is attributable to reductions in employee counts tied to volume declines, primarily in ancillary services and ongoing operational efficiency gains in title and corporate operations.

We also incurred considerably lower contract labor cost compared to first quarter 2016. As a percentage of total operating revenues, employee costs for the first quarter of 2017 were 31.9%, an improvement of 280 basis points compared to 34.7% in the prior year quarter.

Other operating expenses for the first quarter 2017 decreased 4% from first quarter of 2016 with professional fees and third-party service provider costs being the primary driver of the decline. As a percentage of total operating revenues, other operating expenses decreased by 100 basis points to 18% in the first quarter 2017 compared to 19% in the first quarter of 2016.

Depreciation and amortization expenses decreased 12% from the first quarter of 2016, primarily as a result of the disposal of certain amortizable, intangible assets at the end of 2016 in connection with ancillary services divestitures I mentioned earlier.

Lastly, a couple of comments on other matters. The effective tax rate for the first quarter of 2017 was lower than normal due to the tax benefits from previously unrecognized research and development tax credits.

Cash flows from operations improved in the first quarter of 2017 to net cash used of $19 million compared to the $32 million cash used in the first quarter of 2016.

The improvement was primarily due to the large increase in net income generated, offset by higher payment to clients. As of quarter end, approximately $4 million of cash was held at the parent holding company.

As we've discussed on these calls, we've seen the results of not only specific programs to lower cost in targeted areas but also in the vigilance we exercise every day in seeking opportunities to be more efficient. Our total employee and other operating costs have declined in each of the last 6 quarters when compared to the year ago quarter.

We will, of course, continue to exercise this vigilance and minding the details while continuing to pursue large-scale, longer-term initiatives, including the new title and escrow production technology we described on our last earnings call.

We continue to roll this new technology out during the first quarter. And based on current transaction volume and mix, our total expected $10 million of annualized savings by the end of 2017, with an additional $10 million realized by the end of 2018, remain unchanged.

While we were pleased with the first quarter performance that flowed in part from our cost discipline, we have seen some management and staff departures within certain offices as we focus on achieving margin gains. We are managing through any related revenue disruptions as we move forward in 2017.

And with that, I'll turn the call back over to the operator to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Bose George with KBW.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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Just trying to -- Just with the expenses, when we think about the expenses going forward, should we look at kind of the run rate benefits you had year-over-year this year, kind of run that going forward and then kind of add in the $10 million of -- sort of, total benefit kicking in at the end of this year and $10 million next year? Or are there other sort of investment expenses we should think about as well that could reduce that -- the benefits?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [3]

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So just to make sure I understand the question. From a run rate perspective, if you think about first quarter and running forward in the second, third, fourth quarters, employee cost are going to have some natural seasonal fluctuations as you go under the higher volume transaction lines. But fundamentally, there's no structural change other than the title production and technology that we talked about that will kind of lower those employee cost structurally.

So I think, what I said was, we're really trying to just mind our details. And in doing so, we find opportunities to lower cost, whether it's an employee cost or elsewhere. So that's kind of how I would think of the run rate going forward.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay. Yes, I guess, when I was thinking of the run rate, your employee costs were down 7% year-over-year. So just thinking of it, obviously, in that -- in those terms that, that's kind of a sustainable run rate, is that fair?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [5]

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Going forward, sure. I would think that's fair, just being mindful of kind of the seasonal variations you may get as your demand picks up.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [6]

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Okay, sure. And then in terms of the $10 million and the $10 million that kicks in at the end of this year and next year. Are there any offsets to that or should we just kind of think that there's this benefit and that will kind of drop to the bottom line as well over that time period that you mentioned?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [7]

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I mean, as we're rolling it out, of course, we're going to incur some expenses. But our expectation is those expenses are, kind of, largely offset by ongoing savings. So it's really you have a rollout period that you're incurring some duplicative cost while you're saving money, and then once you're done with the rollout, those duplicative costs go away.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [8]

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Okay. So, say, by the back of '18 whatever that total $20 million benefit is something we should be able to see?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [9]

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'18 and kind of going forward.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [10]

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Okay. And then shake up with other little things. The purchase order count was up by, I guess, north of 4%, but the purchase revenue was down a little over 2%. Can you just talk about the drivers in that market?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [11]

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Well, our premium revenue was up, roughly concurrent with the purchase orders closed. There were some other categories of revenue that offset that a little bit in terms of declines. So it's the premium revenue, which you'll see when the Form 9 comes out, was up, more consistent with the purchase orders closed.

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Bose T. George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [12]

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Okay. And then actually 1 other unrelated question. I mean, a couple of months ago, a company called OneTitle, they filed for a 25% price reduction in New York. I'm just curious if you have any thoughts about them. Is that a company that you ever run into?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [13]

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No. I mean, we're obviously aware of what went through the market. But no, I don't think it has an impact.

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Operator [14]

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We'll take our next question from John Campbell with Stephens Inc.

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Hayden Blair, Stephens Inc., Research Division - Research Associate [15]

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It's Hayden stepping in for John here. Just a quick piggyback on Bose's question here. I guess, another way to ask it would be, how much, if any, of the $10 million cost savings goal for 2017 is being reflected in these 1Q results?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [16]

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None, right? I mean, because we're rolling it out now, so the savings occur as we're sort of rolling it out. So that by the end of 2017, you're starting to incur the meaningful savings.

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [17]

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I think there's some related to, again, some employee reductions that we're enabled to take place, right? And when we talk about the announcement we made end of last year, we're kind of looking at things rolling out through '17 and '18. But really, it's intended to be back ended.

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Hayden Blair, Stephens Inc., Research Division - Research Associate [18]

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And the bulk of those savings are to come on the other operating expense line?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [19]

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No. No, it's really what we call...

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [20]

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It should be combined -- combine them both.

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [21]

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Yes, yes. Some of both.

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Hayden Blair, Stephens Inc., Research Division - Research Associate [22]

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Got you. And then, I guess, year-over-year, open orders on the refis were down a little bit on the quarter relative to what we were expecting. But looks they reaccelerated a little bit into March and I think rates have now finally ticked down a little bit, closer to their lowest point of the year. So can you talk a little bit about trends to date here, both purchase and refi, if you can, and whether or not that reacceleration in refis is kind of ticked back up here in the 2Q? Or that's something that we should kind of expect, kind of, moving forward?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [23]

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Yes, I mean, I think we're cautious. Obviously, you see -- yes, consumer confidence, where rates are, what the general activities is. Refinance just, obviously, a bit bounces around, significantly if that volume changes. So there was a little uptick, I think, mortgage jobs for refi were up a little bit beginning of the year. But it's hard to say that, that's sustainable going forward.

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Operator [24]

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We'll take our next question from Geoffrey Dunn with Dowling & Partners.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [25]

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Just to get on the expense bandwagon. Outside looking in, it's very difficult to determine if you achieved your expense savings or not just because of the volatile nature of title expenses. So are there any other metrics or goals or margin range you could provide to try to give us more of a framework for judging whether or not the expense savings come through? Or how to try to incorporate that into our outlooks? I know it's a tough question, it's just the reality of the business.

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [26]

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Yes. I mean, I think internally we sort of set some objectives for spend ratios, if you will, which is employee cost and other operating cost, and we do that through our budgeting process. And so embedded in the budgeting process, we target some spend ratios that then become our internal metric that we don't really talk about externally.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [27]

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Okay. So, really, there's not much we can, really, do other than ...

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [28]

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The thing is it's a little easier -- you know, obviously, we're -- the primary focus is just driving that improvement on the margin until -- our measure of success is how well are we doing kind of driving that margin up through not only cost savings but generating some more top line revenue growth, which is going to have a pretty powerful impact on the bottom line.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [29]

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Okay. On the commercial business, there has been a general trend here of fee profile climbing, which I assume is traction in the larger deals. Can you talk a little bit about the success you've had there in terms of Stewart's improving profiles are in the larger transactions and what has driven that? And there's obviously a lot of room to move as you look at other competitors. So what are the factors that have been moving you up the deal size?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [30]

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I think we've talked several years, I think, just going -- the ongoing stability and financial strength has aided our representation in the market as we continue to invest there. We did benefit in the first quarter from several deals that got pushed from the fourth quarter that were some larger deals including a portfolio transaction.

We also benefit from some energy-related transactions. So going forward, we remain cautiously optimistic on our ability to continue to outperform the market, while we're certainly aware of some uncertainty that remains in the macroenvironment.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [31]

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Okay. Last question I have is the focus from a lot of the noise around your stock has been on whether you're not -- you're for sale. I'm curious how you've been looking at M&A. I mean you have a, kind of, an unusually strong P/E multiple on your stock right now. Obviously, you're doing a better job with expenses and scale can only help that. Rather than talk about whether you're for sale, I'm interested in whether or not you're looking at any meaningful acquisitions, particularly on the -- to bump up your direct operation? And if you would ever consider a deal that could even more require equity?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [32]

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Yes, I mean, I would say that, that is an ongoing board discussion. Obviously, we have new board members, but that's definitely a conversation that we are undertaking. And, again, if you look at the positive, benefit of additional revenue and incremental margins we gain, there are some things that can be meaningful. And I don't think right now all of the board would be opposed to using equity if the right opportunity came about.

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Operator [33]

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(Operator Instructions) We'll go next to Kevin Kaczmarek with Zelman & Associates.

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Kevin Michael Kaczmarek, Zelman & Associates LLC - Director [34]

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Back to the purchase premiums and order counts. You mentioned that premiums were up similar to the transaction, but does that mean maybe some escrow revenue wasn't coming in that you were getting before? Is that due to a mix shift? I guess, what went away and should we expect it to come back or is that kind of gone?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [35]

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Well, I can't say that I think it's gone. I mean the escrow revenue was all from the prior year first quarter, but it was more of a geographic specific. So I don't want to declare that it's gone forever because it does -- it -- I have seen quarter like this quarter, where the escrow revenue doesn't necessarily move in concert with the premium revenue, but then I've seen it come back in a following quarter. So hard to say that it's gone forever.

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Kevin Michael Kaczmarek, Zelman & Associates LLC - Director [36]

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Okay. And I guess one approaching the expense issues on the deal production system in a different way. You guys break out fixed versus variable cost in your Qs and Ks. And I guess, if I'm thinking about the expenses, would that fall more under the variable category? Or maybe you're saving certain amount of hours per file or something like that, per person? Or would it be more under the fixed category?

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [37]

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You know, honestly, I think it'll influence both to some degree. I mean, from a variable perspective, then the new production technology would mean you use the less -- you need fewer heads to accomplish the same production volume. But you would also have less of the underlying systems and sales, if you will, that need maintaining. And so you're cutting your fixed cost base to some degree because you're not maintaining the -- to the same degree, a technology platform that you are today. So I think there's going to be some influence on both fixed and variable.

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [38]

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And yet, the other piece I'd point out is that part of what this exercise does is shift what is more highly fixed cost right now to variable. So that's why it's definitely going to be both. Because we're in the efforts of consolidation and some centralization. You're actually moving certain fixed expenses we have now to be a more variable, which although, are thus more controllable and we can effect to that cost per file more.

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J. Allen Berryman, Stewart Information Services Corporation - CFO, EVP, Treasurer and Secretary [39]

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Yes, it gives us a lot more flexibility, in other words, and how an order is processed.

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Kevin Michael Kaczmarek, Zelman & Associates LLC - Director [40]

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And with the offices that have the new system, do you have a sense of how much less time it takes each order to get done? Or how many fewer people are needed to process a given order, for given number of orders?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [41]

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No, not right now. I mean, I think we do have that. We obviously -- your time to close is coming back down, there's still some hang there if we look at closing forms and just the closing timeline. But we are seeing efficiencies, but not ready to put specific employee counts around that.

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Kevin Michael Kaczmarek, Zelman & Associates LLC - Director [42]

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Okay. And then 1 question on competition. I know seems like some outsiders have been looking at this space and I know there's quicken loans, they start running volumes to an underwriter. And in Texas, where you guys have a lot of share, I guess, maybe you can comment on things like that specifically. But in general, in big states like this, can you give us a sense of the competitive environment? And what you can do to maybe counteract some of the new entrants in some of the bigger states?

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [43]

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I mean, it's always highly competitive. I think what you're seeing is probably increased competition at the lower end of the market. So I think for our take, we've had the stability of being here since 1893 and maintaining integrity in the process. And I think having people care about the process and the customer experience and the value of the policy is what we're focused on. And so -- we always see new entrants, and -- but I think we're well positioned to play a meaningful role in the market. Not only do we have the global reach that we can handle any transaction anywhere in the world, but we think we're well poised with more of a local touch to understand the communities that we're involved in.

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Operator [44]

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And it does appear we have no further questions. I'll return the floor to our presenters for any additional or closing remarks.

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Matthew W. Morris, Stewart Information Services Corporation - CEO and Director [45]

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Just want to say thank you, again, for joining us today. We appreciate you're interested in Stewart, and good day. Thank you.

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Operator [46]

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