Nat Otis – Director-Investor Relations Matt Morris – Chief Executive Officer Allen Berryman – Chief Financial Officer.

John Campbell – Stephens Bose George – KBW Kevin Kaczmarek – Zelman & Associates Geoffrey Dunn – Dowling & Partners.

Good day, and welcome to the Stewart Information Services Second Quarter 2017 Earnings Conference Call and Webcast. Today’s call is being recorded. At this time, all participants have been placed on 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. Thanks, Erika. Thank you for joining us for our second 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 will contain forward-looking statements and 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..

Thank you, Nat, and again, we appreciate everyone joining us today. This morning, as you saw in the press release, we reported pretax income of $33 million for the second quarter 2017 compared to $42 million from the second quarter of 2016. Stewart generated net income of $19 million compared to net income of $24 million for the prior year quarter.

As mentioned in the earnings release, we are very pleased to announce that on June 2, Stewart acquired the retail branch division of Title365, which operates primarily in Southern California.

We are excited to have these associates join the Stewart family as this acquisition affirms our commitment to targeted growth and scale efficiencies in our direct operations, particularly, in the Western U.S.

Our retail team gains experienced leadership and market penetration in several high-growth target markets, while the Title365 associates benefit from our global reach, financial strength and extensive resources.

Second quarter 2017 operating revenues decreased 1% to $481 million from $484 million in the second quarter of 2016, while gross title revenues increased 1% from last year. We are pleased to see our commercial and international operations posting revenue growth of 14% and 7%, respectively.

These increases were contracted by expected declines in refinancing transactions and ancillary services revenues as well as certain employee losses in our direct business, which I’ll discuss further in a moment.

Total employee and other operating cost decreased by $11 million or 5%, validating the continued diligence to manage our cost as well as the benefit from our actions in 2016 to focus on core title operations. On our first quarter earnings call on April 20, we noted that we have seen some management and staff departures in our retail operations.

We did see those departures continuing during May and June. As you know, we have focused relentlessly on margin improvement and financial discipline for many quarters now.

The pace and scope of these initiatives intensified in early 2017, which, coupled with assertive timelines, culminated in these departures, most of whom chose to work for smaller underwriters and independent agencies. The markets most impacted were Texas, Arizona and the Pacific Northwest.

We have, and do expect, our requisite recruiting and hiring of strong industry players to rebuild these markets will not only recapture lost revenue but lay a very strong foundation for our long-term growth objectives.

In addition to rebuilding, we are refining the deployment of the new Title and Escrow production technology and process we described on our last earnings call to ensure that our customer-facing staff can continue delivering exceptional customer service.

This revision does place some risk around our previous expectation of $10 million of annualized savings by the end of 2017, with another $10 million realized by the end of 2018, assuming orders stay comparable year-over-year.

We will provide further updates in future earnings calls, but do remain committed to the initiative and its ability to drive efficiency into our production while providing an enhanced platform for our valued associates to improve service to their customers.

Again, we believe the new additions to our team, along with the changes to our deployment, have brought a renewed stability to our offices, improving our opportunities going forward. With respect to our revenue for the second half of year, we estimate the gross impact of revenue of tax to the departures to be approximately $40 million to $45 million.

Open orders on a per work-day basis declined relative to the prior year during the second quarter, with the decline becoming more pronounced in May and June. The new hires previously mentioned will yield new orders; however, there is an obvious lag time before those orders’ resulting revenue being recognized.

While Title365 will help offset the lower order count and revenue decline, we anticipate that the biggest impact from the departures will be in Q3 as a result of timing. I’ll now turn it over to Allen for more detail on our financial results..

Thank you, Matt, and good morning, everyone. The Title segment generated pretax income of $40 million or an 8% margin compared to pretax income of $51 million or an 11% margin in the second quarter of 2016. Our Title segment revenues were $470 million for the second quarter of 2017, an increase of 1% from the last year’s second quarter.

With respect to our direct title operations, the overall revenues decreased 2% from the prior year quarter, with revenue increases in our commercial and international operations offset by decline in centralized title revenues, which was in line with industry trends.

Revenues from purchase transactions also declined primarily due to the staff departures noted by Matt a moment ago.

Total commercial revenues for the quarter were up 14% over the prior year quarter, as domestic commercial revenues increased to $47 million from $40 million in the second quarter of 2016, despite a 5% decrease in commercial orders closed.

Total title orders closed decreased 13% from second quarter 2016, primarily driven by a 36% decrease in refinancing transactions closed. Domestic commercial fee per file was $6,300 and domestic residential fee per file was approximately $2,100. Revenues from independent agency operations increased 4% or $9 million in the second quarter of 2017.

Net-of-retention agency revenues were similar to that of the prior year quarter. The independent agent remittance rate was 17.9% in the second quarter of 2017 as compared to 18.6% in the prior year quarter due to increases in revenues from lower remitting states.

We experienced relatively more of our agency revenues coming from states with more agent-friendly splits like Texas, New York, Michigan and California. Consistent with our previous expectations, 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 5.2% in the second quarter of 2017 as compared to 3.7% in the prior year quarter, or 4.9% when adjusted for the policy loss reserve reduction we mentioned earlier. We anticipate maintaining a loss accrual rate of approximately 5% during 2017.

Our total balance sheet policy loss reserves were $465 million at quarter end and remained above the actuarial midpoint of total estimated policy losses.

Looking at our Ancillary Services and Corporate segment, which now consist almost exclusively of search and valuation services, total revenues for the segment decreased 32% to $15 million compared to the year ago quarter, primarily due to our divestitures of several lines of businesses at the end of 2016.

This resulted in a pretax operating loss of $6 million in the second quarter of 2017 compared to the pretax loss of $9 million in the prior year quarter. After factoring in $6 million of parent company and corporate operations expenses, the segment was close to breakeven in the quarter.

Of note, total employee and other operating cost for the segment in the second quarter declined by $9 million or 32%, more than offsetting the revenue decline from last year’s quarter.

With respect to operating expenses, on a consolidated basis, employee cost for the second quarter of 2017 decreased 9% from the second quarter of 2016, and average employee counts also decreased approximately 9%.

The decline is attributable to reductions in employee counts tied to volume declines, primarily in ancillary services, the previously described staff departures in direct operations and ongoing operational efficiency gains in corporate operations. We also incurred lower contract labor cost compared to second quarter 2016.

As a percentage of total operating revenues, employee costs for the second quarter of 2017 were 29%, an improvement of 250 basis points compared to 31.5% in the prior year quarter. Other operating expenses for the second quarter of 2017 increased 3% from second quarter of 2016, primarily because of increased outside search fees.

Our commercial and international operations are the principal users of outside search services and so the increased revenues noted earlier resulted in higher cost for these services. As a percentage of total operating revenues, other operating expenses were 18.5% versus 17.9% in the second quarter 2016.

On an ongoing basis, we expect that other operating cost will average approximately 18% to 20% of total operating revenues in any given quarter, recognizing the seasonality of revenues and the fixed cost component of these expenses.

Depreciation and amortization expenses decreased 12% from the second quarter of 2016, primarily because of the disposal of certain intangible assets in connection with ancillary services divestitures I mentioned earlier. Lastly, a couple of comments on other matters.

The effective tax rate for the second quarter of 2017 was comparable to the prior year quarter. Cash flows from operations decreased to $36 million compared to $50 million in the second quarter of 2016. The decline was primarily due to the lower net income generated during the second quarter 2017 and the lower collections on accounts receivable.

As of quarter end, approximately $4 million of cash was held at the parent holding company. And with that, I will turn the call back over to the operator to take questions..

Thank you. [Operator Instructions] We’ll take our first question from John Campbell with Stephens. Please go ahead..

Hey guys. Good morning..

Good morning..

Good morning, John..

So on the other expense line, it did sound like that grew a little bit faster than revenue growth, that’s – it looks like the first time over the last few quarters, but Allen, I think you mentioned that’s higher cost from the search services, is that right?.

That’s correct. So if you think about the components of variable or the pieces of that other operating expense line item that are variable, they don’t all vary in direct proportion to revenues. There are certain types of revenues that move or cause the variable cost component of that line to move differently.

So in particular, commercial and international tend to use outside search services much more extensively than the other operations that we have. And so you have a higher variable cost when you have that type of revenue increased.

So it really was that sort of outside search services that drove the increase from last year because you saw those very nice increases in revenues from commercial and international..

Okay. That makes sense.

So I guess, the trending of that cost versus revenues should be based on commercial trends from here out?.

Yes. Like I said a minute ago, I think that if you think about just how the trend has run over the last, call it, 8 to 10 quarters, they’ve run about – other operating cost have run about 18% to 20% of total operating revenue. Just thinking about seasonality of revenues and with due regard for the fixed cost component of that expense..

Okay.

And then on the commercial business, anything you can provide as far as geographic trends or maybe how that looked on the national versus local level?.

It was a pretty balanced quarter. We did have one larger transaction that closed. Energy and multifamily continued to be areas of strength. Geographically, we’re seeing little more input from our Western markets. So again, a pretty well balanced quarter.

Going forward, we obviously remain cautiously optimistic in our ability to continue to outperform the market, so although we’re – where – uncertainty remains on the macro environment..

Okay.

And then does Title365 have any type of footprint in commercial?.

No. Nothing meaningful on a national basis. All those are really retail operations, local operations..

Okay. Then last one for me. On the attrition that you guys called out, it sounds like that’s obviously mostly in the direct business.

How does that balance between residential and commercial direct?.

That would be largely residential..

Okay, great. Thank you guys..

Absolutely..

Thank you. And we’ll go next to the line of Bose George with KBW. Please go head..

Hey guys, good morning..

Good morning..

Just first on the $40 million to $45 million of annual revenues lost that you referred to, is some of that already reflected in the 2Q 2017 numbers? Or is that all kind of incremental going forward?.

That’s really the expectation for the back half of the year, Bose. So that’s really where – and as we said a minute ago, we think that’s skewing more towards the third quarter..

Okay.

And just when I think about how that comes in, is that $40 million to $45 million sort of a reduction off the baseline off the back half of 2016? Or is that in annualized, so basically will be half that number in the back half of 2017?.

No, it’s not an annualized number. I mean that is a fixed number specific to 2017..

And then you noted – sorry with the hires and Title365, et cetera, by year-end, you feel like a lot of that will be recovered?.

Yes. So just – the $45 million is gross when we look at the total number of departures we had and revenue attached to those individuals. So the hire moves we have made to date, the hiring is ongoing as well as Title365 as we discussed, should largely make up for that as we get into the fourth quarter..

Okay. Great. And then actually on the commercial side, I mean the fee profile is up very nicely. It looks like you’re getting more big-ticket perk deals.

Do you think that trend continues? I mean, could we see that number grow? And obviously, your peers have much higher numbers, I mean, could we see it kind of drift towards that ball park overtime?.

I mean, it certainly – the emphasis that we placed on building our underwriters’ balance sheet, both from a surplus perspective and from a liquidity perspective, have helped in regard to us being able to handle higher liability transactions. I don’t want to make a prediction as to what the future may bring, but the trends have been positive.

As Matt mentioned a moment ago, we are aware of some of the macroeconomic trends – or expectations going into 2018 particularly..

Okay, great. Thanks..

[Operator Instructions] We’ll take our next question from Kevin Kaczmarek from Zelman & Associates. Please go ahead..

Hey guys. Can you give a little more color around the Title365 acquisition? You mentioned the 250 employees.

I mean, is that like $50 million to $70 million of revenue annually or something like that?.

Well, we won’t give guidance on that revenue number, Kevin. I mean, it’s – as we said, it’s an important acquisition for us from a – particularly, a little larger than your normal kind of tuck-in acquisition, it certainly does help us out in California, which is an important market, not only for us, but just a big market for the industry.

So it’s very positive for us from that perspective. But as we said earlier, we really look to that to help backfill some of the revenue loss from the attrition that we’ve had in the second half.

All right.

Is that a primarily a residential purchase, isn’t it refi, a meaningful amount of refi volume close to those offices?.

Yes. I mean, it’s a California market. It has inherently more refi business than what you might experience nationwide. So Title365 is certainly going to mirror that Californian market on a – from a refi perspective..

Yes. From a mix, it’s probably pretty consistent with our existing California operations. But Kevin, just to emphasize, this is a good – top line revenue goes along with our growth initiatives that we have been talking about, I think, this is validation of that, but strategically, I mean, I don’t want to lose sight of that.

We’ve been talking about growth in our western operations and we really think this is a catalyst for continued growth going forward. So great acquisition for us, but is that integrated some strong leaders, and I think will start to change our presence from our direct operations in the West, which is something we’ve been pursuing for a while now..

Are you disclosing a purchase price on that? Or do you – can you give us a sense of valuation, like was it a competitive bidding process?.

No, we are precluded from disclosing purchase price..

Okay. That’s helpful. And on the production system upgrade, I caught some of your comments but not all of them in the prepared remarks.

Just sorry if you mentioned this, but which geographies are on new system already and which ones are still migrating?.

Yes, I don’t think we said which markets are on the new system and which ones are migrating. I think in the comments, what we alluded to was that we have – definitely took a step.

I mentioned some of the speed and scope that we were deploying and we have – we were concerned that we were inhibiting some of our customer experiences and so we have definitely – looking at that deployment and making sure that we are taking care of our customers and providing a system that encourages our associates to take care of our customers.

So we’ll keep you apprised of that. This was the quarter where we really had to dig in and look at a lot of that. And again, we’re absolutely committed to the process and direction of where we are headed, but we did change some of our deployment just to make sure we’re taking care of our customers and that our associates can do so going forward.

So we’ll provide continued information as that deploys..

Okay. And one last one for me.

Can you talk about some of the qualitative aspects of the departures? For instance, are people leaving in teams? Are the defections primarily in areas where they are migrating production systems? Is it mid-management level or more production employees? Just a sense of why people are leaving? And when it might kind of trail off?.

Yes. I mean I don’t know that I want to get into specifics. I think probably from an industry perspective, the departures occur like you would expect. I mean, I think the important thing to note here is that we think we have stabilized in these markets. And as we said, we – they were targeted Texas, Arizona, Pacific Northwest.

We think we’ve stabilized, brought in new management in those markets and brought some business in and so we’ll continue to move on from that stabilization to grow in those areas..

Pleased, overall, with the quality of the folks that we brought on board, as we rebuild..

Okay. And I guess you’re still looking at other M&A opportunities.

Are you going to work on integrating this for now, what’s the pipeline look like?.

I mean, we’re always keeping our eyes open. Like I said earlier, the tuck-in acquisitions are important to us. Title365 might have been a little larger than the normal, but it wasn’t the only one in the quarter and it was just the one that rose to the level of discussing, just given its importance to us on the California market..

I mean, there is integration there. But again, it’s core business and so we think that, that integration will go well so – toward that end. I don’t think we’re precluded from looking at other opportunities while we integrate those assets..

Okay. Thanks a lot..

Thank you. And we’ll go next to Geoffrey Dunn with Dowling & Partners. Please go ahead..

Thanks, good morning guys..

Good morning..

Good morning..

Matt, it seems to me that the departures are motivated more because of an evolving culture here. You’ve been talking a lot more about expenses over the last two years. You got a lot more eyes on you to make sure you deliver on profitability.

So can you talk more at a high level, how are you conveying the changes that you talk to us about each quarter to your broad employee base and make sure everybody’s onboard and focused on that transition of the company to whatever Stewart becomes going forward?.

Right. I think that’s a long discussion, obviously. I mean, we have lots of discussions on our game plan. We talk about what winning looks like overall. We talk about the importance of margins. We talk about being most admired by our associates, by our customers and by our shareholders.

And I think, obviously, there is transition and we have had some cultural transition and we’re deliberate in keeping the aspects of our culture of trust and integrity and customer service and understanding our industry – at the same time, continue to drive and understand accountability and what teamwork looks like in terms of the game plan.

So like I said, in these changes – and we probably have been more deliberate in seeing some of these departures – that we do have people out and effectively communicating what that game plan is and what’s in it for our associates. At the end of the day, they succeed and win in their markets..

Okay. We have seen these kind of transitions before at other companies.

Can you talk about at a regional level, or regional office level, I mean, have you changed compensation structures? Have you aligned comps with performance? What kind of changes are you making to entice people to embrace this?.

No, we have done both of those. Again, this goes further back but as you mentioned, we’ve been talking about this for a while now, moving everyone, consolidating legal entities, moving everyone to an ERP system, standardizing your allocations. I mean, these are all significant changes for our direct operations.

And so keeping that communication flow strong is important, aligning that compensation pay per performance has been something that we have definitely driven, understanding again how it fits into the overall whole and what profitability looks like, what those expectations are, are all part of the transition that we drive forward..

Are all your retail branches now on a pay per profitability basis effectively?.

Yes..

Okay. Great, thanks..

Yes, absolutely..

At this time, we have no further questions. I’d like to turn back over to our speakers for any closing or final remarks..

So now that concludes our quarter’s conference call. Thank you for joining us today and your interest in Stewart, and we look forward to hearing from you again next quarter. Thank you..

We’d like to thank everybody for their participation. Please feel free to disconnect at any time..