STEWART INFORMATION SERVICES CORP - FORM 10-Q

STEWART INFORMATION SERVICES CORP - FORM 10-Q - August 6, 2018

Attached files

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - STEWART INFORMATION SERVICES CORP	q2-18ex322.htm
EX-32.1 - EXHIBIT 32.1 - STEWART INFORMATION SERVICES CORP	q2-18ex321.htm
EX-31.2 - EXHIBIT 31.2 - STEWART INFORMATION SERVICES CORP	q2-18ex312.htm
EX-31.1 - EXHIBIT 31.1 - STEWART INFORMATION SERVICES CORP	q2-18ex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018


¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-02658

STEWART INFORMATION SERVICES CORPORATION

(Exact name of registrant as specified in its charter)



Delaware		74-1677330
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1980 Post Oak Blvd., Houston TX		77056
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (713) 625-8100

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No þ

On August 1, 2018, there were 23,744,381 outstanding shares of the issuer's Common Stock, $1 par value per share.

FORM 10-Q QUARTERLY REPORT

QUARTER ENDED JUNE 30, 2018

TABLE OF CONTENTS



Item		Page
	PART I – FINANCIAL INFORMATION

1.	Financial Statements	3

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

3.	Quantitative and Qualitative Disclosures About Market Risk	31

4.	Controls and Procedures	31
	PART II – OTHER INFORMATION
1.	Legal Proceedings	32

1A.	Risk Factors	32

2.	Unregistered Sales of Equity Securities and Use of Proceeds	36

5.	Other Information	36

6.	Exhibits	36

	Signature	37

As used in this report, “we,” “us,” “our,” "Registrant," the “Company” and “Stewart” mean Stewart Information Services Corporation and our subsidiaries, unless the context indicates otherwise.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	($000 omitted, except per share)
Revenues
Title revenues:
Direct operations	224,240		231,662		409,752		419,091
Agency operations	247,257		234,407		484,111		467,756
Ancillary services	13,732		15,118		25,563		32,422
Operating revenues	485,229		481,187		919,426		919,269
Investment income	5,247		4,941		9,951		9,613
Investment and other gains (losses) – net	2,393		(676	)	722		(389	)
	492,869		485,452		930,099		928,493
Expenses
Amounts retained by agencies	203,793		192,558		399,000		383,733
Employee costs	146,278		139,346		285,101		279,131
Other operating expenses	85,953		88,786		166,220		167,103
Title losses and related claims	18,697		24,462		37,678		45,163
Depreciation and amortization	6,154		6,441		12,388		12,819
Interest	673		712		1,646		1,529
	461,548		452,305		902,033		889,478

Income before taxes and noncontrolling interests	31,321		33,147		28,066		39,015
Income tax expense	5,602		10,993		4,307		10,850

Net income	25,719		22,154		23,759		28,165
Less net income attributable to noncontrolling interests	3,342		3,586		5,161		5,508
Net income attributable to Stewart	22,377		18,568		18,598		22,657

Net income	25,719		22,154		23,759		28,165
Other comprehensive (loss) income, net of taxes:
Foreign currency translation adjustments	(4,038	)	3,204		(5,630	)	4,529
Change in net unrealized gains and losses on investments	(2,428	)	355		(10,434	)	2,822
Reclassification adjustment for net gains included in net income	(231	)	(94	)	(480	)	(461	)
Other comprehensive (loss) income, net of taxes:	(6,697	)	3,465		(16,544	)	6,890

Comprehensive income	19,022		25,619		7,215		35,055
Less net income attributable to noncontrolling interests	3,342		3,586		5,161		5,508
Comprehensive income attributable to Stewart	15,680		22,033		2,054		29,547

Basic average shares outstanding (000)	23,546		23,444		23,527		23,438
Basic earnings per share attributable to Stewart	0.95		0.79		0.79		0.97

Diluted average shares outstanding (000)	23,625		23,620		23,607		23,613
Diluted earnings per share attributable to Stewart	0.95		0.79		0.79		0.96

See notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED BALANCE SHEETS



	As of June 30, 2018 (Unaudited)		As of December 31, 2017
	($000 omitted)
Assets
Cash and cash equivalents	121,128		150,079
Short-term investments	23,642		24,463
Investments in debt and equity securities, at fair value	673,333		709,355
Receivables:
Premiums from agencies	30,242		27,903
Trade and other	50,282		51,299
Income taxes	2,477		1,267
Notes	3,088		3,203
Allowance for uncollectible amounts	(4,842	)	(5,156	)
	81,247		78,516
Property and equipment, at cost:
Land	3,991		3,991
Buildings	22,806		22,849
Furniture and equipment	233,154		226,461
Accumulated depreciation	(193,128	)	(186,279	)
	66,823		67,022
Title plants, at cost	74,237		74,237
Investments on equity method basis	8,985		9,202
Goodwill	242,736		231,428
Intangible assets, net of amortization	11,138		9,734
Deferred tax assets	4,222		4,186
Other assets	50,408		47,664
	1,357,899		1,405,886
Liabilities
Notes payable	107,657		109,312
Accounts payable and accrued liabilities	94,057		117,740
Estimated title losses	475,460		480,990
Deferred tax liabilities	14,488		19,034
	691,662		727,076
Contingent liabilities and commitments
Stockholders’ equity
Common Stock and additional paid-in capital	184,301		184,026
Retained earnings	499,656		491,698
Accumulated other comprehensive (loss) income:
Net unrealized investment (losses) gains on investments available-for-sale	(6,336	)	7,526
Foreign currency translation adjustments	(14,647	)	(8,373	)
Treasury stock – 352,161 common shares, at cost	(2,666	)	(2,666	)
Stockholders’ equity attributable to Stewart	660,308		672,211
Noncontrolling interests	5,929		6,599
Total stockholders’ equity (23,744,939 and 23,719,522 shares outstanding)	666,237		678,810
	1,357,899		1,405,886

See notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)



	Six Months Ended June 30,
	2018		2017
	($000 omitted)
Reconciliation of net income to cash provided by operating activities:
Net income	23,759		28,165
Add (deduct):
Depreciation and amortization	12,388		12,819
Provision for bad debt	69		634
Investment and other (gains) losses – net	(722	)	389
Amortization of net premium on investments available-for-sale	3,116		3,421
Payments for title losses in excess of provisions	(1,175	)	(467	)
Adjustment for insurance recoveries of title losses	1,448		793
Increase in receivables – net	(4,363	)	(9,792	)
Increase in other assets – net	(2,626	)	(6,526	)
Decrease in payables and accrued liabilities – net	(26,326	)	(18,868	)
Change in net deferred income taxes	(457	)	2,329
Net income from equity investees	(768	)	(977	)
Dividends received from equity investees	985		1,237
Stock-based compensation expense	1,979		3,372
Other – net	60		2
Cash provided by operating activities	7,367		16,531

Investing activities:
Proceeds from sales of investments in securities	25,722		49,655
Proceeds from matured investments in debt securities	10,355		22,834
Purchases of investments in securities	(26,220	)	(88,381	)
Net sales (purchases) of short-term investments	221		(182	)
Purchases of property and equipment, and real estate – net	(5,690	)	(9,328	)
Cash paid for acquisition of businesses	(11,978	)	(18,080	)
Other – net	458		410
Cash used by investing activities	(7,132	)	(43,072	)

Financing activities:
Payments on notes payable	(5,993	)	(17,917	)
Proceeds from notes payable	26		25,897
Distributions to noncontrolling interests	(5,751	)	(5,300	)
Repurchases of common stock	(672	)	—
Cash dividends paid	(14,127	)	(14,065	)
Payment of contingent consideration related to an acquisition	—		(1,298	)
Purchase of remaining interest in consolidated subsidiary	(1,112	)	(1,013	)
Cash used by financing activities	(27,629	)	(13,696	)

Effects of changes in foreign currency exchange rates	(1,557	)	1,670
Decrease in cash and cash equivalents	(28,951	)	(38,567	)

Cash and cash equivalents at beginning of period	150,079		185,772
Cash and cash equivalents at end of period	121,128		147,205

See notes to condensed consolidated financial statements.

CONDENSED CONSOLIDATED STATEMENT OF EQUITY (UNAUDITED)



	Common Stock ($1 par value)		Additional paid-in capital		Retained earnings		Accumulated other comprehensive loss		Treasury stock		Noncontrolling interests		Total
	($000 omitted)
Balances at December 31, 2017	24,072		159,954		491,698		(847	)	(2,666	)	6,599		678,810
Cumulative effect adjustments on adoption of new accounting standards (Note 1-D)	—		—		3,592		(3,592	)	—		—		—
Net income attributable to Stewart	—		—		18,598		—		—		—		18,598
Dividends on Common Stock ($0.60 per share)	—		—		(14,232	)	—		—		—		(14,232	)
Stock-based compensation and other	42		1,937		—		—		—		—		1,979
Stock repurchases	(17	)	(655	)	—		—		—		—		(672	)
Purchase of remaining interest in consolidated subsidiary	—		(1,032	)	—		—		—		(80	)	(1,112	)
Net change in unrealized gains and losses on investments, net of taxes	—		—		—		(10,434	)	—		—		(10,434	)
Net realized gain reclassification, net of taxes	—		—		—		(480	)	—		—		(480	)
Foreign currency translation adjustments, net of taxes	—		—		—		(5,630	)	—		—		(5,630	)
Net income attributable to noncontrolling interests	—		—		—		—		—		5,161		5,161
Distributions to noncontrolling interests	—		—		—		—		—		(5,751	)	(5,751	)
Balances at June 30, 2018	24,097		160,204		499,656		(20,983	)	(2,666	)	5,929		666,237

See notes to condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1

Interim financial statements. The financial information contained in this report for the three and six months ended June 30, 2018 and 2017, and as of June 30, 2018, is unaudited. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

A. Management’s responsibility. The accompanying interim financial statements were prepared by management, who is responsible for their integrity and objectivity. These financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP), including management’s best judgments and estimates. In the opinion of management, all adjustments necessary for a fair presentation of this information for all interim periods, consisting only of normal recurring accruals, have been made. The Company’s results of operations for interim periods are not necessarily indicative of results for a full year and actual results could differ.

B. Consolidation. The condensed consolidated financial statements include all subsidiaries in which the Company owns more than 50% voting rights in electing directors. All significant intercompany amounts and transactions have been eliminated and provisions have been made for noncontrolling interests. Unconsolidated investees, in which the Company typically owns 20% through 50% of the equity, are accounted for by the equity method.

C. Restrictions on cash and investments. The Company maintains investments in accordance with certain statutory requirements for the funding of statutory premium reserves. Statutory reserve funds, which approximated $482.4 million and $490.8 million at June 30, 2018 and December 31, 2017, respectively, are required to be fully funded and invested in high-quality securities and short-term investments. Statutory reserve funds are not available for current claim payments, which must be funded from current operating cash flow. In addition, included within cash and cash equivalents are statutory reserve funds of approximately $13.6 million and $14.2 million at June 30, 2018 and December 31, 2017, respectively. Although these cash statutory reserve funds are not restricted or segregated in depository accounts, they are required to be held pursuant to state statutes. If the Company fails to maintain minimum investments or cash and cash equivalents sufficient to meet statutory requirements, the Company may be subject to fines or other penalties, including potential revocation of its business license. These funds are not available for any other purpose. In the event that insurance regulators adjust the determination of the statutory premium reserves of the Company’s title insurers, these restricted funds as well as statutory surplus would correspondingly increase or decrease.

D. Cumulative effect adjustments on adoption of new accounting standards. In February 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-02, Income Statement - Reporting Comprehensive Income, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which amended its standard on comprehensive income to provide a one-time option for an entity to reclassify the stranded tax effects of the Tax Cuts and Jobs Act (the 2017 Act) that was passed in December 2017 from accumulated other comprehensive income/loss (AOCI) directly to retained earnings. The stranded tax effects result from the remeasurement of deferred tax assets and liabilities which were originally recorded in comprehensive income but whose remeasurement is reflected in the income statement. The Company adopted ASU 2018-02 effective on January 1, 2018 and reclassified $1.0 million of net tax expense from AOCI to retained earnings in the consolidated statement of equity.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which, among others, (i) required equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplified the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminated the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and (iv) required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The Company adopted ASU 2016-01 effective on January 1, 2018, which resulted in a reclassification of the outstanding net unrealized investment gains, net of taxes, of $4.6 million relating to investments in equity securities previously carried in AOCI to retained earnings in the consolidated statement of equity.

E. Recent significant accounting pronouncement. In February 2016, the FASB issued ASU 2016-02, Leases, which updated the current guidance related to leases. The new guidance includes the requirement for the lessee to recognize in the balance sheet a liability equal to the present value of contractual lease payments with terms of more than twelve months and a right-of-use asset representing the right to use the underlying asset for the lease term. Disclosures will be required by lessees to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for annual and interim periods beginning after December 15, 2018 and early adoption is allowed. The Company expects to adopt ASU 2016-02 on January 1, 2019 using the modified retrospective method of adoption. The Company expects the adoption of ASU 2016-02 will result in material increases in the assets and liabilities reported on its consolidated balance sheets as indicated by the approximately $167.1 million of undiscounted future minimum lease payments with terms of more than twelve months as of December 31, 2017 (as disclosed in Note 16 of the Company's consolidated financial statements included in the Company's 2017 Annual Report on Form 10-K). The Company expects the new ASU will likely have an insignificant impact on its consolidated statements of operations and cash flows. The Company is currently in the process of system implementation and data migration and expects the transition to be completed during the fourth quarter 2018.

F. Merger Agreement. On March 18, 2018, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with Fidelity National Financial, Inc., a Delaware corporation (FNF), A Holdco Corp., a Delaware corporation and a wholly-owned direct subsidiary of FNF (Merger Sub I), and S Holdco LLC, a Delaware limited liability company and a wholly-owned direct subsidiary of FNF (Merger Sub II and, together with Merger Sub I, the Merger Subs). Upon the terms and subject to the conditions set forth in the Merger Agreement, at the Effective Time (as defined below), Merger Sub I will merge with and into the Company (Merger I), with the Company surviving Merger I as a direct wholly-owned subsidiary of FNF, and at the Subsequent Effective Time (as defined in the Merger Agreement), the Company will merge with and into Merger Sub II (Merger II and, together with Merger I, the Mergers), with Merger Sub II surviving Merger II as a direct wholly-owned subsidiary of FNF.

Subject to the terms and conditions of the Merger Agreement, at the effective time of Merger I (the Effective Time, each share of the Company's Common Stock outstanding immediately prior to the Effective Time (other than (i) shares owned by the Company, its subsidiaries, FNF or the Merger Subs and (ii) shares in respect of which appraisal rights have been properly exercised and perfected under Delaware law) will be converted into the right to receive cash consideration of $25.00 and 0.6425 shares of FNF common stock, par value $0.0001 per share (FNF Common Stock), subject to potential adjustment as described below. Pursuant to the terms of the Merger Agreement, the Company's stockholders have the option to elect to receive the merger consideration in all cash (the Cash Election Consideration), all FNF Common Stock (the Stock Election Consideration) or a mix of 50% cash and 50% FNF Common Stock (the Mixed Election Consideration), subject to pro-rata reductions to the extent either the election for the Cash Election Consideration or the election for the Stock Election Consideration is oversubscribed. Stockholders that elect to receive the Cash Election Consideration will receive is $50.00 per share, subject to potential adjustment as described below and proration to the extent the cash option is oversubscribed. The Stock Election Consideration and the stock portion of the Mixed Election Consideration will be calculated using a fixed exchange ratio that is based on the average of the volume weighted average prices of FNF Common Stock for each of the twenty (20) trading days prior to the signing of the Merger Agreement, or $38.91 (the Parent Share Price). The exchange ratio for the Stock Election Consideration will be equal to 1.2850 shares of FNF Common Stock per share of Common Stock (the Exchange Ratio), subject to potential adjustment described below and proration to the extent the stock option is oversubscribed.

Under the terms of the Merger Agreement, if the combined company is required to divest assets or businesses with 2017 annual revenues in excess of $75 million in order to receive required regulatory approvals (up to a cap of $225 million of 2017 annual revenues), the per share purchase price will be adjusted downwards on a sliding scale between such amounts of divestitures up to a maximum reduction of $4.50 in value in the event that businesses or assets with 2017 annual revenues of $225 million are divested, with such adjustment to consist of (i) in the case shares of Common Stock with respect to which Cash Election Consideration has been elected, a reduction of the amount of cash paid in respect of each share, (ii) in the case shares of Common Stock with respect to which Stock Election Consideration has been elected, a reduction in the Exchange Ratio based on the Parent Share Price, and (iii) in the case of shares of Common Stock with respect to which Mixed Election Consideration has been elected, a reduction in both the amount of cash and the Exchange Ratio to be paid to the holders of such shares, with 50% of the aggregate value of such reduction to consist of a reduction of the cash consideration and 50% of the aggregate value of such reduction to consist of a reduction in the Exchange Ratio based on the Parent Share Price.

The consummation of the Mergers, which is expected during the first or second quarter of 2019, is subject to the satisfaction or waiver of customary conditions, including, among other things, (i) the adoption of the Merger Agreement by the holders of a majority of the outstanding shares of Common Stock entitled to vote on the Mergers (the Company Stockholder Approval), (ii) the absence of any injunction or court or other governmental order (with respect to applicable antitrust or insurance laws, solely with respect to the Required Antitrust Regulatory Filings/Approvals and the Required Insurance Regulatory Filings/Approvals (each as defined in the Merger Agreement)) enjoining, prohibiting or rendering illegal the consummation of the Mergers, (iii) obtaining certain Required Antitrust Regulatory Filings/Approvals, (iv) obtaining certain Required Insurance Regulatory Filings/Approvals, (v) the Securities and Exchange Commission (SEC) declaring the Registration Statement (as defined in the Merger Agreement) on Form S-4 effective, (vi) the shares of FNF Common Stock to be issued in the Mergers having been approved for listing on the New York Stock Exchange, (vii) the representations and warranties made by each of the Company and FNF being true at and as of the Closing Date (as defined in the Merger Agreement), subject to the materiality standards contained in the Merger Agreement, (viii) the performance, in all material respects, by each of the Company, FNF and the Merger Subs of all of their respective obligations under the Merger Agreement and (ix) no Company Material Adverse Effect or Parent Material Adverse Effect (each as defined in the Merger Agreement) having occurred since the signing of the Merger Agreement.

The Merger Agreement contains certain customary representations, warranties and covenants made by the Company and FNF. The Merger Agreement also contains customary covenants for each of the parties, including the obligation for the parties to refrain from taking specified actions without the consent of the other party, and, in the case of the Company, conduct its business in the ordinary course and use commercially reasonable efforts to preserve intact its business organizations and relationships with third parties. Under the Merger Agreement, each of the Company and FNF has agreed to use its reasonable best efforts to take all actions and to do all things necessary or advisable under applicable law to consummate the Mergers, including preparing and filing as promptly as practicable with any governmental authority or other third party all documentation to effect all necessary filings, notices, petitions, statements, registrations, submissions of information, applications and other documents and obtaining and maintaining all approvals, consents, registrations, permits, authorizations and other confirmations required to be obtained from any governmental authority or other third party that are necessary, proper or advisable to consummate the transactions contemplated by this Agreement. Notwithstanding such obligation, in connection with obtaining any required regulatory approval, (a) FNF is not required to sell, divest, dispose of, license or hold separate (i) title plants and rights to title plants, businesses, product lines or assets to the extent that such title plants, rights to title plants, businesses, product lines or assets generated 2017 revenues in excess of $225 million in the aggregate, or (ii) any of its own brands in full and (b) FNF and its affiliates are not required to litigate in order to avoid or have terminated any legal restraint that would prevent the Mergers from being consummated.

The Merger Agreement contains certain customary termination rights in favor of either the Company or FNF, which are exercisable (i) by mutual consent, (ii) upon the failure to complete the Mergers by March 18, 2019 (the End Date), subject to certain exceptions and subject to up to two (2) extensions of up to three (3) months each upon the election of either the Company or FNF if, as of such date, all closing conditions (other than the receipt of the Required Antitrust Regulatory Filings/Approvals, the receipt of the Required Insurance Regulatory Filings/Approvals and the absence of any law or court or other governmental order relating thereto) having been met or being capable of being satisfied as of such time, (iii) in the event of a final and non-appealable law or order that prohibits the consummation of the Mergers or (iv) if the Company’s stockholders do not vote to approve the Mergers.

The Merger Agreement contains certain customary termination rights in favor of the Company, which are exercisable (i) for a breach of any representation, warranty, covenant or agreement made by FNF under the Merger Agreement that would result in failure to satisfy a closing condition (subject to certain cure periods) or (ii) if, prior to the Company Stockholder Approval being obtained, the Company’s board of directors authorizes the Company to enter into, and the Company enters into, an alternative acquisition agreement in connection with a superior proposal. Under the Merger Agreement, the Company will be obligated to pay a termination fee of $33 million to FNF if the Merger Agreement is terminated due to the Company’s board of directors changing its recommendation or if the Company terminates the Merger Agreement to enter into an agreement for a superior proposal.

The Merger Agreement also contains certain customary termination rights in favor of FNF. If the Merger Agreement is terminated due to (i) the failure to complete the Mergers by the End Date because of a failure to obtain the Required Antitrust Regulatory Filings/Approvals or Required Insurance Regulatory Filings/Approvals, and all other closing conditions have been or are capable of being satisfied at the time of such termination, or (ii) an injunction or governmental or other court order enjoining, prohibiting or rendering illegal the consummation of the Mergers that is based on the failure to obtain the Required Antitrust Regulatory Filings/Approvals or Required Insurance Regulatory Filings/Approvals, then FNF will be obligated to pay a reverse termination fee of $50 million to the Company.

The Merger Agreement was included as Exhibit 2.1 to the Form 8-K filed with the SEC on March 19, 2018.

NOTE 2

Revenues. The Company's operating revenues, summarized by type, are as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2018	2017	2018	2017
	($000 omitted)		($000 omitted)
Title insurance premiums:
Direct	158,947	159,488	291,708	290,489
Agency	247,257	234,407	484,111	467,756
Escrow fees	35,468	39,447	63,335	72,210
Search, abstract and valuation services	25,114	28,030	46,901	56,200
Other revenues	18,443	19,815	33,371	32,614
	485,229	481,187	919,426	919,269

Direct premiums - Premiums from title insurance policies directly issued or issued by affiliate offices are recognized at the time of the closing of the related real estate transaction.

Agency premiums - Premiums from title insurance policies written by independent agencies (agencies) are recognized when the policies are reported to the Company. In addition, where reasonable estimates can be made, the Company accrues for policies issued but not reported until after period end. The Company believes that reasonable estimates can be made when recent and consistent policy issuance information is available. Estimates are based on historical reporting patterns and other information obtained about agencies, as well as current trends in direct operations and in the title industry. In this accrual, future transactions are not being estimated. The Company is estimating revenues on policies that have already been issued by agencies but not yet reported to or received by the Company. The Company has consistently followed the same basic method of estimating unreported policy revenues for more than 10 years.

Escrow fees - An escrow is a transaction pursuant to an agreement of a buyer, seller, borrower, or lender wherein an impartial third party, such as the Company, acts in a fiduciary capacity on behalf of the parties in accordance with the terms of such agreement in order to accomplish the directions stated therein. Services provided include, among others, acting as escrow or other fiduciary agent, obtaining releases, and conducting the actual closing or settlement. Escrow fees are recognized upon closing of the escrow, which is generally at the same time of the closing of the related real estate transaction.

Search, abstract and valuation services - These services are primarily related to establishing the ownership, legal status and valuation of the property in a real estate transaction. In these cases, the Company does not issue a title insurance policy or perform duties of an escrow agent. Revenues from these services are recognized upon delivery of the service to the customer.

Other revenues - Other revenues consist primarily of fees related to tax-deferred property exchange services, information technology products related to real property records and closing settlement services, income from equity investees, and other services performed to facilitate the closing of real estate transactions. For those products and services that are delivered at a point in time, the related revenue is recognized upon delivery based on the unit price of the product or service. For those products and services where delivery occurs over time, the related revenue is recognized ratably over the duration of the contract.

NOTE 3

Investments in debt and equity securities. The total fair values of the Company's investments in debt and equity securities are detailed below:



	June 30, 2018	December 31, 2017
	($000 omitted)
Investments in:
Debt securities	637,883	671,441
Equity securities	35,450	37,914
	673,333	709,355

Investments in debt securities are classified as available-for-sale and the net unrealized gains and losses on such investments, net of applicable deferred taxes, are included as a component of AOCI within stockholders' equity. As a result of the Company's adoption of ASU 2016-01 (as discussed in Note 1-D), fair value changes relating to investments in equity securities are recognized as part of investment and other (losses) gains - net in the statement of operations beginning on January 1, 2018. Previously, the investments in equity securities, which consist of common stocks and master limited partnership interests, were accounted for similar to investments in debt securities.

As of June 30, 2018 and December 31, 2017, the net unrealized investment gains relating to investments in equity securities held were $4.9 million and $5.8 million, respectively.

The amortized costs and fair values of investments in debt securities are as follows:



	June 30, 2018		December 31, 2017
	Amortized costs	Fair values	Amortized costs	Fair values
	($000 omitted)
Municipal	62,837	62,831	71,581	72,669
Corporate	347,379	342,595	351,477	357,933
Foreign	222,740	219,932	229,750	228,237
U.S. Treasury Bonds	12,947	12,525	12,838	12,602
	645,903	637,883	665,646	671,441

Foreign debt securities consist of Canadian government and corporate bonds, United Kingdom treasury bonds, and Mexican government bonds.

Gross unrealized gains and losses on investments in debt securities are as follows:



	June 30, 2018		December 31, 2017
	Gains	Losses	Gains	Losses
	($000 omitted)
Municipal	463	469	1,263	175
Corporate	2,372	7,156	6,953	497
Foreign	1,320	4,128	1,742	3,255
U.S. Treasury Bonds	1	423	—	236
	4,156	12,176	9,958	4,163

Debt securities as of June 30, 2018 mature, according to their contractual terms, as follows (actual maturities may differ due to call or prepayment rights):



	Amortized costs	Fair values
	($000 omitted)
In one year or less	55,856	55,917
After one year through five years	359,043	355,605
After five years through ten years	190,383	186,494
After ten years	40,621	39,867
	645,903	637,883

Gross unrealized losses on investments in debt securities and the fair values of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2018, were:



	Less than 12 months		More than 12 months		Total
	Losses	Fair values	Losses	Fair values	Losses	Fair values
	($000 omitted)
Municipal	198	21,849	271	5,756	469	27,605
Corporate	6,916	268,573	240	4,755	7,156	273,328
Foreign	897	73,483	3,231	88,709	4,128	162,192
U.S. Treasury Bonds	157	5,732	266	6,686	423	12,418
	8,168	369,637	4,008	105,906	12,176	475,543

The number of specific debt investment holdings held in an unrealized loss position as of June 30, 2018 was 313. Of these securities, 64 securities were in unrealized loss positions for more than 12 months. Since the Company does not intend to sell and will more likely than not maintain each investment security until its maturity or anticipated recovery, and no significant credit risk is deemed to exist, these investments are not considered as other-than-temporarily impaired. The Company believes its investment portfolio is diversified and expects no material loss to result from the failure to perform by issuers of the debt securities it holds. Investments made by the Company are not collateralized.



	Less than 12 months		More than 12 months		Total
	Losses	Fair values	Losses	Fair values	Losses	Fair values
	($000 omitted)
Municipal	58	17,023	117	5,784	175	22,807
Corporate	386	81,632	111	4,926	497	86,558
Foreign	1,528	116,130	1,727	39,031	3,255	155,161
U.S. Treasury Bonds	53	5,830	183	6,772	236	12,602
	2,025	220,615	2,138	56,513	4,163	277,128

NOTE 4

Fair value measurements. The Fair Value Measurements and Disclosures Topic (Topic 820) of the FASB Accounting Standards Codification (ASC) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal, or most advantageous, market for the asset or liability in an orderly transaction between market participants at the measurement date. Topic 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs when possible.

The three levels of inputs used to measure fair value are as follows:


•	Level 1 – quoted prices in active markets for identical assets or liabilities;


•	Level 2 – observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data; and


•	Level 3 – unobservable inputs that are supported by little or no market activity and that are significant to the fair values of the assets or liabilities, including certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

As of June 30, 2018, financial instruments measured at fair value on a recurring basis are summarized below:



	Level 1	Level 2	Fair value measurements
	($000 omitted)
Investments in securities:
Debt securities:
Municipal	—	62,831	62,831
Corporate	—	342,595	342,595
Foreign	—	219,932	219,932
U.S. Treasury Bonds	—	12,525	12,525
Equity securities	35,450	—	35,450
	35,450	637,883	673,333

As of December 31, 2017, financial instruments measured at fair value on a recurring basis are summarized below:



	Level 1	Level 2	Fair value measurements
	($000 omitted)
Investments in securities:
Debt securities:
Municipal	—	72,669	72,669
Corporate	—	357,933	357,933
Foreign	—	228,237	228,237
U.S. Treasury Bonds	—	12,602	12,602
Equity securities	37,914	—	37,914
	37,914	671,441	709,355

As of June 30, 2018, Level 1 financial instruments consist of equity securities. Level 2 financial instruments consist of municipal, governmental, and corporate bonds, both U.S. and foreign. In accordance with the Company’s policies and guidelines which incorporate relevant statutory requirements, the Company’s third-party registered investment manager invests only in securities rated as investment grade or higher by the major rating services, where observable valuation inputs are significant. The fair value of the Company's investments in available-for-sale securities are primarily determined using a third-party pricing service provider. The third-party pricing service provider calculates the fair values using both market approach and model valuation methods, as well as pricing information obtained from brokers, dealers and custodians. Management ensures the reasonableness of the third-party service valuations by comparing them with pricing information from the Company's investment manager.

There were no transfers of investments between levels during the six months ended June 30, 2018 and 2017.

NOTE 5

Investment and other (losses) gains - net. Investments and other (losses) gains are detailed as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	($000 omitted)
Realized gains	603		279		1,166		845
Realized losses	(38	)	(955	)	(68	)	(1,234	)
Net unrealized investment gains (losses) recognized on equity securities held	1,828		—		(376	)	—
	2,393		(676	)	722		(389	)

Following the adoption of ASU 2016-01 discussed in Notes 1 and 3, net investment losses recognized during the three and six months ended June 30, 2018 related to investments in equity securities still held as of June 30, 2018 are calculated as follows ($000 omitted):



	June 30, 2018
	Three Months Ended		Six Months Ended
	($000 omitted)
Total net investment gains (losses) recognized on equity securities during the period	1,612		(614	)
Less: Net realized losses on equity securities sold during the period	(216	)	(238	)
Net unrealized investment gains (losses) recognized on equity securities still held	1,828		(376	)

Proceeds from sales of investments in securities are as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2018	2017	2018	2017
	($000 omitted)
Proceeds from sales of debt securities	8,003	33,776	21,149	48,826
Proceeds from sales of equity securities	2,353	36	4,573	829
Total proceeds from sales of investment in securities	10,356	33,812	25,722	49,655

NOTE 6

Goodwill and other intangibles. The summary of changes in goodwill is as follows.



	Title	Ancillary Services and Corporate	Consolidated Total
		($000 omitted)
Balances at December 31, 2017	225,699	5,729	231,428
Acquisitions	11,308	—	11,308
Balances at June 30, 2018	237,007	5,729	242,736

During the first quarter 2018, the Company acquired certain title businesses which increased goodwill related to the title segment by a total of $11.3 million, which is substantially deductible for income tax purposes over a period of 15 years. Also, in connection with the acquisitions, the Company identified and recorded $3.6 million of other intangibles, primarily related to employment and non-compete agreements, to be amortized over 3 years from the date of acquisition.

NOTE 7

Estimated title losses. A summary of estimated title losses for the six months ended June 30 is as follows:



	2018		2017
	($000 omitted)
Balances at January 1	480,990		462,572
Provisions:
Current year	41,372		43,850
Previous policy years	(3,694	)	1,313
Total provisions	37,678		45,163
Payments, net of recoveries:
Current year	(5,263	)	(5,966	)
Previous policy years	(33,590	)	(39,664	)
Total payments, net of recoveries	(38,853	)	(45,630	)
Effects of changes in foreign currency exchange rates	(4,355	)	3,189
Balances at June 30	475,460		465,294
Loss ratios as a percentage of title operating revenues:
Current year provisions	4.6	%	4.9	%
Total provisions	4.2	%	5.1	%

During the six months ended June 30, 2018, the Company decreased its loss provisioning rate due to lower loss experience and reduced prior policy year reserves as a result of the actuarial reserve review. This resulted in a $3.7 million favorable loss development for previous policy years and decreased total title loss provisions for the six months ended June 30, 2018 compared to the same period in 2017.

NOTE 8

Share-based payments. Prior to 2018, the Company granted executives and senior management shares of restricted common stock, consisting of time-based shares, which vest on each of the first three anniversaries of the grant date, and performance-based shares, which vest upon achievement of certain financial objectives over the period of three years. Starting on January 1, 2018, the Company began granting time-based and performance-based restricted stock units, which have vesting conditions generally similar to those restricted common stock shares awarded previously. Each restricted stock unit represents a contractual right to receive a share of the Company's common stock.

The aggregate grant-date fair values of these awards during 2018 and 2017 were $4.7 million (109,000 shares with an average grant price per share of $43.39) and $4.7 million (107,000 shares with an average grant price per share of $44.21), respectively. Awards were made pursuant to the Company’s employee incentive compensation plans and the compensation expense associated with restricted stock awards is recognized over the corresponding vesting period. Additionally, during the second quarters 2018 and 2017, the Company granted its board of directors, as a component of annual director retainer compensation, 14,300 and 13,000 shares, respectively, of common stock, which vested immediately. The aggregate fair values of these director awards at the grant dates in 2018 and 2017 were both $0.6 million.

NOTE 9

Earnings per share. Basic earnings per share (EPS) attributable to Stewart is calculated by dividing net income attributable to Stewart by the weighted-average number of shares of Common Stock outstanding during the reporting periods. Outstanding shares of Common Stock granted to employees that are not yet vested (restricted shares) are excluded from the calculation of the weighted-average number of shares outstanding for calculating basic EPS. To calculate diluted EPS, the number of shares is adjusted to include the number of additional shares that would have been outstanding if the restricted shares and restricted units were vested. In periods of loss, dilutive shares are excluded from the calculation of the diluted EPS and diluted EPS is computed in the same manner as basic EPS.

The calculation of the basic and diluted EPS is as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2018	2017	2018	2017
	($000 omitted, except per share)
Numerator:
Net income attributable to Stewart	22,377	18,568	18,598	22,657

Denominator (000):
Basic average shares outstanding	23,546	23,444	23,527	23,438
Average number of dilutive shares relating to grants of restricted shares and units	79	176	80	175
Diluted average shares outstanding	23,625	23,620	23,607	23,613

Basic earnings per share attributable to Stewart	0.95	0.79	0.79	0.97

Diluted earnings per share attributable to Stewart	0.95	0.79	0.79	0.96

NOTE 10

Contingent liabilities and commitments. In the ordinary course of business, the Company guarantees the third-party indebtedness of certain of its consolidated subsidiaries. As of June 30, 2018, the maximum potential future payments on the guarantees are not more than the related notes payable recorded in the condensed consolidated balance sheets. The Company also guarantees the indebtedness related to lease obligations of certain of its consolidated subsidiaries. The maximum future obligations arising from these lease-related guarantees are not more than the Company’s future minimum lease payments. As of June 30, 2018, the Company also had unused letters of credit aggregating $5.4 million related to workers’ compensation and other insurance. The Company does not expect to make any payments on these guarantees.

NOTE 11

Regulatory and legal developments. The Company is subject to claims and lawsuits arising in the ordinary course of its business, most of which involve disputed policy claims. In some of these lawsuits, the plaintiff seeks exemplary or treble damages in excess of policy limits. The Company does not expect that any of these ordinary course proceedings will have a material adverse effect on its consolidated financial condition or results of operations. In addition, along with the other major title insurance companies, the Company is party to class action lawsuits concerning the title insurance industry. The Company believes that it has adequate reserves for the various litigation matters and contingencies discussed in this paragraph and that the likely resolution of these matters will not materially affect its consolidated financial condition or results of operations.

Additionally, the Company receives from time to time various other inquiries from governmental regulators concerning practices in the insurance industry. Many of these practices do not concern title insurance. To the extent the Company is in receipt of such inquiries, it believes that it has adequately reserved for these matters and does not anticipate that the outcome of these inquiries will materially affect its consolidated financial condition or results of operations.

The Company is subject to various other administrative actions and inquiries into its business conduct in certain of the states in which it operates. While the Company cannot predict the outcome of the various regulatory and administrative matters, it believes that it has adequately reserved for these matters and does not anticipate that the outcome of any of these matters will materially affect its consolidated financial condition or results of operations.

NOTE 12

Segment information. The Company reports two operating segments: title and ancillary services and corporate. The title segment provides services needed to transfer title to property in a real estate transaction and includes services such as searching, examining, closing and insuring the condition of the title to the property. In addition, the title segment includes centralized title services, home and personal insurance services and Internal Revenue Code Section 1031 tax-deferred exchanges. The ancillary services and corporate segment includes search and valuation services, which are the principal offerings of ancillary services, and expenses of the parent holding company and certain other enterprise-wide overhead costs, net of centralized administrative services costs allocated to respective operating businesses.

Selected statement of operations information related to these segments is as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	($000 omitted)
Title segment:
Revenues	479,125		470,449		904,536		896,246
Depreciation and amortization	5,249		5,321		10,566		10,547
Income before taxes and noncontrolling interest	37,737		39,467		42,862		51,744

Ancillary services and corporate segment:
Revenues	13,744		15,003		25,563		32,247
Depreciation and amortization	905		1,120		1,822		2,272
Loss before taxes and noncontrolling interest	(6,416	)	(6,320	)	(14,796	)	(12,729	)

Consolidated Stewart:
Revenues	492,869		485,452		930,099		928,493
Depreciation and amortization	6,154		6,441		12,388		12,819
Income before taxes and noncontrolling interest	31,321		33,147		28,066		39,015

The Company does not provide asset information by reportable operating segment as it does not routinely evaluate the asset position by segment.

Revenues generated in the United States and all international operations are as follows:



	Three Months Ended June 30,		Six Months Ended June 30,
	2018	2017	2018	2017
	($000 omitted)
United States	460,529	451,766	873,833	871,019
International	32,340	33,686	56,266	57,474
	492,869	485,452	930,099	928,493

NOTE 13

Other comprehensive (loss) income. Changes in the balances of each component of other comprehensive (loss) income and the related tax effects are as follows:



	Three Months Ended June 30, 2018						Three Months Ended June 30, 2017
	Before-Tax Amount		Tax Expense (Benefit)		Net-of-Tax Amount		Before-Tax Amount		Tax Expense (Benefit)		Net-of-Tax Amount
	($000 omitted)
Net unrealized (losses) gains on investments:
Change in net unrealized gains and losses on investments	(3,074	)	(646	)	(2,428	)	548		193		355
Less: reclassification adjustment for net gains included in net income	(292	)	(61	)	(231	)	(145	)	(51	)	(94	)
	(3,366	)	(707	)	(2,659	)	403		142		261
Foreign currency translation adjustments	(4,575	)	(537	)	(4,038	)	4,334		1,130		3,204
Other comprehensive (loss) income	(7,941	)	(1,244	)	(6,697	)	4,737		1,272		3,465

	Six Months Ended June 30, 2018						Six Months Ended June 30, 2017
	Before-Tax Amount		Tax Expense (Benefit)		Net-of-Tax Amount		Before-Tax Amount		Tax Expense (Benefit)		Net-of-Tax Amount
	($000 omitted)
Net unrealized (losses) gains on investments:
Change in net unrealized gains and losses on investments	(13,208	)	(2,774	)	(10,434	)	4,343		1,521		2,822
Less: reclassification adjustment for net gains included in net income	(607	)	(127	)	(480	)	(710	)	(249	)	(461	)
	(13,815	)	(2,901	)	(10,914	)	3,633		1,272		2,361
Foreign currency translation adjustments	(6,854	)	(1,224	)	(5,630	)	6,014		1,485		4,529
Other comprehensive (loss) income	(20,669	)	(4,125	)	(16,544	)	9,647		2,757		6,890

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S OVERVIEW

We reported net income attributable to Stewart of $22.4 million ($0.95 per diluted share) for the second quarter 2018 compared to net income attributable to Stewart of $18.6 million ($0.79 per diluted share) for the second quarter 2017. Pretax income before noncontrolling interests for the second quarter 2018 was $31.3 million compared to a pretax income before noncontrolling interests of $33.1 million for the second quarter 2017.

On March 18, 2018, Stewart entered into an agreement and plan of merger with Fidelity National Financial, Inc. (FNF), in which the outstanding shares of Stewart will be exchanged for a combination of cash and shares of FNF, and the Company will be merged into a subsidiary of FNF (the Mergers). We announced in the first quarter 2018 that we had begun the regulatory approval process for Stewart’s merger with FNF by submitting our preliminary Hart-Scott-Rodino filings to the Federal Trade Commission (FTC) and the Form A filings to the states of Texas and New York, the domiciles of Stewart’s two main underwriters. During the second quarter 2018, we received an expected second request for additional information and documentary material from the FTC and are in the process of responding to this request. In addition, we have received approval from a majority of the states with which a Form E was filed and are awaiting approval from the remaining states. Subject to approval by our stockholders and regulatory authorities and the satisfaction of customary closing conditions, the Mergers are expected to close by the first or second quarter 2019.

Summary results of the title segment are as follows ($ in millions, except pretax margin):



	For the Three Months Ended June 30,
	2018		2017		% Change

Total operating revenues	471.5		466.0		1	%
Investment income and other net gains	7.6		4.4		73	%
Pretax income	37.7		39.5		(4	)%
Pretax margin	7.9	%	8.4	%

Title operating revenues in the second quarter 2018 increased $5.5 million from the prior year quarter, driven by increased commercial and independent agency revenues, which were partially offset by lower residential direct title revenues. Pretax income declined $1.8 million in the second quarter 2018 compared to the second quarter 2017. The title segment incurred higher employee costs due to increased commissions and additional employee costs from acquisitions, which were partially offset by lower title losses and other operating expenses. Included in the segment’s results were $4.0 million of net policy loss reserve reductions resulting from our midyear actuarial reserve review, partially offset by charges to policy loss expenses of $3.9 million related to two ongoing escrow litigation matters, and $1.8 million of net unrealized gains relating to changes in fair value of investments in equity securities (which were previously being recorded to other comprehensive income, but are now included in investment and other net gains due to an adoption of a new accounting standard in 2018).

Included in the non-commercial domestic revenues (as shown under the Results of Operations - Title revenues section) were revenues from purchase transactions and centralized title operations (processing primarily refinancing and default title orders) which decreased $1.9 million (1%) and $5.5 million (46%), respectively, in the second quarter 2018 compared to the prior year quarter due to lower closed orders, primarily on refinancing activities. Total commercial revenues improved 8% from the prior year quarter due to our continued focus on delivering quality service and underwriting to our domestic and international commercial customers. Total international title revenues in the second quarter 2018 decreased $1.8 million compared to the prior year quarter as a result of lower volumes, principally from our Canada operations, partially offset by the positive impact of the stronger foreign exchange rates against the U.S. dollar.

Gross revenues from independent agency operations in the second quarter 2018 increased $12.9 million compared to the second quarter 2017. The independent agency remittance rate in the second quarter 2018 remained comparable to the prior year quarter. Agency revenues, net of agency retention, improved 4% in the second quarter 2018, compared to the prior year quarter, as we maintain our focus on enhancing customer service and technology connectivity.

Summary results of the ancillary services and corporate segment are as follows ($ in millions):



	For the Three Months Ended June 30,
	2018		2017		% Change

Total revenues	13.7		15.0		(8	)%
Pretax loss	(6.4	)	(6.3	)	(2	)%

Second quarter 2018 segment revenues declined $1.3 million compared to the prior year quarter, primarily due to a 23% revenue decrease in the valuation services business which was partially offset by a 6% increase in the search services business. The segment’s pretax results for the second quarter 2018 were comparable to the prior year quarter as a result of lower employee costs, which fully offset the revenue decline for the quarter. The segment’s results for the second quarter 2018 and 2017 included approximately $6.3 million and $5.9 million, respectively, of net expenses attributable to parent company and corporate operations

CRITICAL ACCOUNTING ESTIMATES

The preparation of the Company’s condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosures surrounding contingencies and commitments.

Actual results can differ from our accounting estimates. While we do not anticipate significant changes in our estimates, there is a risk that such changes could have a material impact on our consolidated financial condition or results of operations for future periods. During the six months ended June 30, 2018, we made no material changes to our critical accounting estimates as previously disclosed in Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Operations. Our primary business is title insurance and settlement-related services. We close transactions and issue title policies on homes, commercial and other real properties located in all 50 states, the District of Columbia and international markets through policy-issuing offices, agencies and centralized title services centers. Our ancillary services and corporate segment includes our parent holding company expenses and certain enterprise-wide overhead costs, along with our remaining ancillary services operations, principally search and valuation services.

Factors affecting revenues. The principal factors that contribute to changes in operating revenues for our title and ancillary services and corporate segments include:


•	mortgage interest rates;


•	availability of mortgage loans;


•	number and average value of mortgage loan originations;


•	ability of potential purchasers to qualify for loans;


•	inventory of existing homes available for sale;


•	ratio of purchase transactions compared with refinance transactions;


•	ratio of closed orders to open orders;


•	home prices;


•	consumer confidence, including employment trends;


•	demand by buyers;


•	number of households;


•	premium rates;


•	foreign currency exchange rates;


•	market share;


•	ability to attract and retain highly productive sales associates;


•	independent agency remittance rates;


•	opening of new offices and acquisitions;


•	number and value of commercial transactions, which typically yield higher premiums;


•	government or regulatory initiatives, including tax incentives and the implementation of the new integrated disclosure requirements;


•	acquisitions or divestitures of businesses;


•	volume of distressed property transactions; and


•	seasonality and/or weather.

Premiums are determined in part by the values of the transactions we handle. To the extent inflation or market conditions cause increases in the prices of homes and other real estate, premium revenues are also increased. Conversely, falling home prices cause premium revenues to decline. As an overall guideline, a 5% change in median home prices results in an approximate 3.7% change in title premiums. Home price changes may override the seasonal nature of the title insurance business. Historically, our first quarter is the least active in terms of title insurance revenues as home buying is generally depressed during winter months. Our second and third quarters are the most active as the summer is the traditional home buying season, and while commercial transaction closings are skewed to the end of the year, individually large commercial transactions can occur any time of year.

RESULTS OF OPERATIONS

Comparisons of our results of operations for the three and six months ended June 30, 2018 with the three and six months ended June 30, 2017 are set forth below. Factors contributing to fluctuations in the results of operations are presented in the order of their monetary significance, and we have quantified, when necessary, significant changes. Segment results are included in the discussions and, when relevant, are discussed separately.

Our statements on home sales and loan activity are based on published industry data from sources including Fannie Mae, the National Association of Realtors® (NAR), the Mortgage Bankers Association (MBA) and Freddie Mac. We also use information from our direct operations.

Operating environment. Actual existing home sales in the second quarter 2018 declined approximately 2% from the second quarter 2017. June 2018 existing home sales totaled 570,000, which was down 5% from a year ago, but up 7% from May 2018. According to NAR, the shortage of home listings in the market continues to elevate current home prices, which is pricing out would-be buyers and slowing home sales. June 2018 median and average home prices rose approximately 5% and 4%, respectively, compared to June 2017 prices. June 2018 housing starts declined 12% sequentially from May 2018 and also decreased 4% from a year ago. Newly issued building permits in June 2018 were down 2% sequentially from May 2018 and also down 3% from a year ago. According to Fannie Mae, one-to-four family residential lending declined 5% to $468 billion in the second quarter 2018 from $492 billion in the second quarter 2017, primarily driven by a 14%, or $21 billion, reduction in refinance originations. Purchase lending slightly decreased 2%, or $3 billion, in the second quarter 2018 compared to the prior year quarter. Refinance lending is forecasted to decrease $26 billion, or 20%, in the third quarter 2018 compared to the second quarter 2018. On average, refinance title premium rates are 60% of the premium rates for a similarly priced sale transaction.

Title revenues. Direct title revenue information is presented below:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018	2017	% Change		2018	2017	% Change
	($ in millions)				($ in millions)
Non-commercial
Domestic	145.7	153.1	(5	)%	261.5	276.1	(5	)%
International	22.8	27.2	(16	)%	41.0	45.5	(10	)%
	168.5	180.3	(7	)%	302.5	321.6	(6	)%
Commercial:
Domestic	48.2	46.5	4	%	95.7	88.2	9	%
International	7.5	4.9	53	%	11.6	9.3	25	%
	55.7	51.4	8	%	107.3	97.5	10	%
Total direct title revenues	224.2	231.7	(3	)%	409.8	419.1	(2	)%

Revenues from direct title operations, which include residential, commercial, international and centralized title services transactions, decreased $7.5 million and $9.3 million in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, due to lower closed orders (primarily on refinancing activities), partially offset by improved commercial revenues. Revenues from our centralized title operations, which primarily process refinancing and default title orders, decreased $5.5 million, or 46%, and $10.9 million, or 43% in the second quarter and first six months of 2018 compared to the second quarter and first six months of 2017, respectively, primarily due to decreased refinancing orders and lower demand for default services, which are in line with industry trends. Our residential revenues, which comprise approximately 60% of our total direct revenues, slightly declined 1% ($1.9 million and $3.7 million, respectively) in the second quarter and first six months of 2018, compared to the same periods in 2017.

Our direct operations include local offices and international operations, and we generate commercial revenues both domestically and internationally. U.S. commercial revenues during the second quarter and first six months of 2018 increased $1.7 million and $7.5 million, compared to the second quarter and first six months of 2017, respectively, primarily due to our continued focus on delivering quality service and underwriting to our customers. Total international revenues in the second quarter and first six months of 2018 declined $1.8 million, or 6%, and $2.2 million, or 4%, respectively, compared to the same periods in 2017, primarily as a result of decreased transaction volume from our Canada operations, offset by increased commercial revenues and the stronger foreign currency exchange rates against the U.S. dollar. Direct revenues constituted 48% and 46% of our total title revenues in the second quarter and first six months of 2018, respectively, compared to 50% and 47%, respectively, in the same periods in 2017.

Orders information for the three and six months ended June 30 is as follows:



	Three Months Ended June 30,						Six Months Ended June 30,
	2018	2017	Change		% Change		2018	2017	Change		% Change
Opened Orders:
Commercial	8,353	10,788	(2,435	)	(23	)%	17,327	22,238	(4,911	)	(22	)%
Purchase	66,074	67,823	(1,749	)	(3	)%	122,565	129,065	(6,500	)	(5	)%
Refinance	21,615	24,183	(2,568	)	(11	)%	44,747	47,639	(2,892	)	(6	)%
Other	2,531	4,423	(1,892	)	(43	)%	5,544	9,019	(3,475	)	(39	)%
Total	98,573	107,217	(8,644	)	(8	)%	190,183	207,961	(17,778	)	(9	)%

Closed Orders:
Commercial	6,968	8,167	(1,199	)	(15	)%	13,488	15,493	(2,005	)	(13	)%
Purchase	49,069	52,362	(3,293	)	(6	)%	85,750	92,564	(6,814	)	(7	)%
Refinance	14,582	16,298	(1,716	)	(11	)%	29,461	35,506	(6,045	)	(17	)%
Other	2,536	4,135	(1,599	)	(39	)%	5,651	7,333	(1,682	)	(23	)%
Total	73,155	80,962	(7,807	)	(10	)%	134,350	150,896	(16,546	)	(11	)%

Gross revenues from independent agency operations increased $12.9 million, or 6%, and $16.4 million, or 4% in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily as a result of revenue increases in the states of New York, Texas, Pennsylvania, Arizona, Wisconsin, Ohio and Louisiana, partially offset by decreases in the states of Massachusetts, Michigan and Colorado. Agency revenues, net of retention, improved $1.6 million, or 4%, and $1.1 million, or 1%, in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily due to the higher gross agency revenues and comparable average agency remittance rates. Refer further to the "Retention by agencies" discussion under Expenses below.

Ancillary services revenues. Ancillary services operating revenues decreased $1.4 million, or 9%, and $6.9 million, or 21%, in the second quarter and first six months of 2018 compared to the same periods in 2017, primarily due to lower revenues generated by the valuation services operations resulting from reduced orders from our principal customers.

Investment income. Investment income during the second quarter and first six months of 2018 was comparable to the same periods in 2017.

Investment and other gains (losses) - net. Investment and other gains - net for the second quarter and first six months of 2018 included $1.8 million of net unrealized gains and $0.4 million of net unrealized losses, respectively, related to equity securities investments (refer to Note 5 to the condensed consolidated financial statements for details), and $0.6 million of net realized gains from changes in the fair value of a contingent liability related to a prior acquisition. Investments and other losses - net for the second quarter and first six months of 2017 included $0.8 million net realized losses from changes in the fair value of a contingent liability related to a prior acquisition.

Expenses. An analysis of expenses is shown below:



	Three Months Ended June 30,						Six Months Ended June 30,
	2018		2017		% Change		2018		2017		% Change
	($ in millions)						($ in millions)

Amounts retained by agencies	203.8		192.6		6	%	399.0		383.7		4	%
As a % of agency revenues	82.4	%	82.1	%			82.4	%	82.0	%
Employee costs	146.3		139.3		5	%	285.1		279.1		2	%
As a % of operating revenues	30.1	%	29.0	%			31.0	%	30.4	%
Other operating expenses	86.0		88.8		(3	)%	166.2		167.1		(1	)%
As a % of operating revenues	17.7	%	18.5	%			18.1	%	18.2	%
Title losses and related claims	18.7		24.5		(24	)%	37.7		45.2		(17	)%
As a % of title revenues	4.0	%	5.2	%			4.2	%	5.1	%

Retention by agencies. Amounts retained by title agencies are based on agreements between agencies and our title underwriters. Amounts retained by independent agencies, as a percentage of revenues generated by them, averaged 82.4% and 82.1% in the second quarters 2018 and 2017, respectively, and 82.4% and 82.0% in the first six months of 2018 and 2017, respectively. The average retention percentage may vary from period to period due to the geographical mix of agency operations, the volume of title revenues and, in some states, laws or regulations. Due to the variety of such laws or regulations, as well as competitive factors, the average retention rate can differ significantly from state to state. In addition, a high proportion of our independent agencies are in states with retention rates greater than 80%. We continue to focus on increasing profit margins in every state, increasing premium revenue in states where remittance rates are above 20%, and maintaining the quality of our agency network, which we believe to be the industry’s best, in order to mitigate claims risk and drive consistent future performance. While market share is important in our agency operations channel, it is not as important as margins, risk mitigation and profitability.

Employee costs. Total employee costs increased $7.0 million, or 5%, and $6.0 million, or 2%, in the second quarter and first six months of 2018, respectively, compared to the same periods in 2017, primarily due to higher commissions on increased commercial title revenues and additional employee costs attributed to previous acquisitions in the title segment, which were partially offset by decreased salaries resulting from reduced employee counts. During the second quarter and first six months of 2018, average employee counts decreased approximately 6%, primarily related to the continued volume declines in our ancillary services and centralized title operations, and staff departures in direct operations during the second quarter 2017.

Employee costs in the title segment increased $7.9 million, or 6%, and $11.4 million, or 4%, in the second quarter and first six months of 2018, compared to the second quarter and first six months of 2017, primarily due to increased commissions and additional costs from previous acquisitions. In the ancillary services and corporate segment, employee costs decreased $1.0 million, or 11%, and $5.4 million, or 26%, in the second quarter and first six months of 2018, compared to the same periods in 2017, primarily as a result of the reductions in average employee count.

Other operating expenses. Other operating expenses include costs that are fixed in nature, costs that follow, to varying degrees, changes in transaction volumes and revenues and costs that fluctuate independently of revenues. Costs that are fixed in nature include attorney and professional fees, third-party outsourcing provider fees, equipment rental, insurance, rent and other occupancy expenses, repairs and maintenance, technology costs, telephone and title plant expenses. Costs that follow, to varying degrees, changes in transaction volumes and revenues include attorney fee splits, bad debt expenses, ancillary services cost of sales expenses, copy supplies, delivery fees, outside search fees, postage, premium taxes and title plant maintenance expenses. Costs that fluctuate independently of revenues include general supplies, litigation defense, business promotion and marketing and travel.

Consolidated other operating expenses decreased $2.8 million, or 3%, and $0.9 million, or 1%, in the second quarter and first six months of 2018 compared to the same periods in 2017; while as a percentage of total operating revenues, other operating expenses were 17.7% and 18.5% in the second quarters 2018 and 2017, respectively, and 18.1% and 18.2% in the first six months of 2018 and 2017, respectively. During the first quarter 2018, we incurred $2.3 million of third-party advisory expenses recorded in the ancillary services and corporate segment relating to the strategic alternatives review. Excluding these non-operating charges, other operating expenses as a percentage of operating revenues during the first six months of 2018 were 17.8%.

Costs that follow, to varying degrees, changes in transaction volumes and revenues decreased $3.6 million, or 8%, and $5.2 million, or 7%, in the second quarter and first six months of 2018, compared to the same periods in 2017, primarily due to reduced outside title search fees and costs of services related to lower revenues from our centralized title and ancillary services operations. Costs that fluctuate independently of revenues increased $1.3 million, or 13%, and $1.8 million, or 10%, in the second quarter and first six months of 2018, compared to the same periods in 2017, primarily due to increased travel and marketing expenses. Excluding the charges mentioned above, costs that are fixed in nature decreased $1.3 million, or 4%, and $0.8 million, or 1%, in the second quarter and first six months of 2018, compared to the same periods in 2017, primarily due to reduced third-party outsourcing provider fees and professional fees.

Title losses. Provisions for title losses, as a percentage of title operating revenues, were 4.0% and 5.2% for the second quarter 2018 and 2017, respectively, and 4.2% and 5.1% for the first six months of 2018 and 2017, respectively. Title losses decreased $5.8 million, or 24%, and $7.5 million, or 17%, in the second quarter and first six months of 2018, respectively, compared to the similar periods in 2017, primarily as a result of our reduced loss provisioning rate during the first half of 2018 based on lower loss experience. During the second quarter 2018, we recorded $4.0 million of prior policy year loss reserve reductions as a result of our actuarial reserve review, while we also incurred charges of $3.9 million related to two ongoing escrow litigation matters. The title loss ratio in any given quarter can be significantly influenced by changes in new large claims incurred, escrow losses and adjustments to reserves for existing large claims. We expect our loss provisioning rate will range between 4.0% to 4.5% for the year 2018.

Cash claim payments in the second quarter and first six months of 2018, compared to the similar periods in 2017, decreased $1.2 million, or 5%, and $6.8 million, or 15%, respectively, primarily due to a reduction in payments on existing claims. We continue to manage and resolve large claims prudently and in keeping with our commitments to our policyholders.

The composition of title policy loss expense is as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	($ in millions)				($ in millions)
Provisions – known claims:
Current year	6.0		2.1		7.5		4.2
Prior policy years	15.5		15.9		30.2		34.7
	21.5		18.0		37.7		38.9
Provisions – IBNR
Current year	16.5		21.3		33.9		39.7
Prior policy years	(3.8	)	1.1		(3.7	)	1.3
	12.7		22.4		30.2		41.0
Transferred from IBNR to known claims	(15.5	)	(15.9	)	(30.2	)	(34.7	)
Total provisions	18.7		24.5		37.7		45.2

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