Stewart Information Services Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; financial statements are unaudited. Stewart provides title insurance and real-estate settlement services, with ancillary search and valuation operations. Comparisons are with Q1 2017 unless otherwise noted. Amounts below are in millions except per-share data.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Operating revenues | $434.2 | $438.1 |
| Total revenues, including investment income and investment/other gains or losses | $437.2 | $443.0 |
| Pretax income (loss) | $(3.3) | $5.9 |
| Net income (loss) attributable to Stewart | $(3.8) | $4.1 |
| Diluted EPS | $(0.16) | $0.17 |
| Cash used by operating activities | $(28.9) | $(19.2) |
- Margins and costs: Title-segment pretax income was $5.1 million versus $12.3 million; pretax margin fell to 1.2% from 2.9%. Agency retention costs were 82.4% of agency revenues versus 81.9%; employee costs were 32.0% of operating revenues versus 31.9%; other operating expenses were 18.5% versus 17.9%. Title-loss provisions declined to $19.0 million from $20.7 million, or 4.5% of title revenues versus 4.9%.
- Cash and debt: Cash and cash equivalents were $103.5 million at quarter-end, down from $150.1 million at December 31, 2017. Notes payable were $108.6 million versus $109.3 million. The company reported $656.2 million of stockholders’ equity and a debt-to-equity ratio excluding Section 1031 notes of approximately 16.5%.
- Investments and statutory reserves: Cash and investments totaled $807.3 million, including statutory reserves; management reported $309.6 million net of statutory reserves. Statutory reserve funds of approximately $476.0 million in investments and $21.6 million in cash are not available for other purposes. The filing reports $257.5 million of cash and investments, excluding equity-method investments, available for underwriter operations, including claims payments.
- Cash flows and capital allocation: Investing cash use was $1.5 million and financing cash use was $15.9 million. Cash decreased by $46.6 million during the quarter. Financing included $5.0 million of debt repayments, $7.1 million of dividends and $0.6 million of share repurchases for tax withholding. Acquisitions used $12.0 million of cash.
- Other comprehensive loss: Comprehensive loss attributable to Stewart was $13.6 million, including $8.3 million of after-tax unrealized losses on available-for-sale investments and $1.6 million of foreign-currency translation losses.
Material changes and operating drivers
- Total revenues declined 1%. Direct title revenues were down 1%, while agency gross revenues increased 2%; lower agency remittance rates by geographic mix meant net agency revenues declined 1%.
- Title-segment pretax income fell 58%, principally reflecting $2.2 million of unrealized equity-investment losses recognized in earnings under newly adopted accounting guidance, higher employee costs including the effect of the 2017 Title365 acquisition, and lower agency remittance rates. Lower title-loss expenses partly offset these factors.
- Ancillary services and corporate revenue declined 31% to $11.8 million, primarily because valuation-services customers placed fewer orders. The segment’s pretax loss widened to $8.4 million from $6.4 million; it included $2.3 million of advisory expenses for the strategic alternatives review. Excluding those expenses, management said the segment’s pretax result would have improved 5%.
- Operating conditions were weaker in several residential and refinance measures: existing home sales declined about 2%, closed purchase orders fell 9%, closed refinance orders fell 23%, and centralized title revenues declined 40%. Domestic commercial title revenues rose 14%, primarily on higher-dollar transactions.
- Operating cash use increased year over year, mainly due to the net loss and higher payments on accounts payable and other liabilities, partly offset by lower claim payments.
Merger, outlook, risks and other notable items
- Pending merger: On March 18, 2018, Stewart agreed to be acquired by Fidelity National Financial (FNF), with closing expected in Q1 or Q2 2019, subject to shareholder, regulatory and other customary approvals. The standard consideration is $25 cash plus 0.6425 FNF shares per Stewart share; shareholders may elect $50 cash, 1.2850 FNF shares, or the 50/50 mix, subject to proration. Regulatory-required divestitures above $75 million of 2017 revenue could reduce consideration, with a maximum stated reduction of $4.50 per share at $225 million of divested revenue. Stewart may owe a $33 million termination fee in specified circumstances; FNF may owe Stewart a $50 million reverse termination fee for certain regulatory failures.
- Management outlook: No numerical earnings or revenue guidance is provided. Management said it believes liquidity and capital resources are sufficient for ongoing operations and claims, subject to regulatory restrictions on subsidiary funds. It is pursuing cost management, automation, technology investment and operational consolidation to improve margins.
- Key business and transaction risks: Results depend on real-estate activity, mortgage rates and availability, home prices, refinancing, commercial transactions, agency remittance rates, claims experience, foreign exchange and seasonality. Merger risks include approval delays or failure, potential divestitures, market-price fluctuation in FNF shares, proration and tax outcomes, employee/customer uncertainty, transaction costs and restrictions on Stewart’s pre-closing business. Failure to complete the deal could adversely affect the business and stock price.
- Claims, legal and regulatory matters: Estimated title-loss reserves were $479.8 million, including $412.1 million for incurred-but-not-reported claims. Management said ordinary-course litigation, industry class actions and regulatory inquiries are adequately reserved and are not expected to materially affect financial condition or results; actual claim liabilities may differ materially from estimates. Unused letters of credit totaled $5.4 million.
- Accounting and leases: Revenue-recognition adoption did not materially affect accounting or reporting. The company early-adopted guidance permitting reclassification of certain tax effects from AOCI to retained earnings. It expected the new lease standard, planned for adoption January 1, 2019, to materially increase balance-sheet assets and liabilities; disclosed undiscounted lease payments with terms over 12 months were approximately $167.1 million as of December 31, 2017.
- Management reported disclosure controls and procedures were effective as of March 31, 2018, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Stewart shareholders approve the merger and whether required antitrust and insurance-regulatory approvals are obtained, including any divestiture conditions or consideration adjustments.
- How the merger’s election and proration mechanics, FNF share-price changes, timing and potential tax consequences affect the value shareholders ultimately receive.
- Whether title volumes, especially purchase and refinance activity, recover, and whether commercial strength offsets weaker residential activity and agency-retention pressure.
- Whether title-loss reserve estimates and claim development remain adequate, and whether statutory liquidity and reserve requirements constrain cash available to the parent.
- Whether operating cash flow improves and the company achieves planned cost savings while funding technology, acquisitions and merger-related costs.