FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-3658
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THE FIRST AMERICAN FINANCIAL CORPORATION
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(Exact name of registrant as specified in its charter)
Incorporated in California 95-1068610
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
114 East Fifth Street, Santa Ana, California 92701-4699
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(Address of principal executive offices) (Zip Code)
(714)558-3211
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(Registrant's telephone number, including area code)
__________________________________________________________________________
(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 ___________ No _________
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports to be filed by Section 12,13 or 15(d) of the Securities Exchange Act of
1934 subsequent to the distribution of securities under a plan confirmed by a
court.
Yes ___________ No __________
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
$1 par value - 60,025,471 as of November 10, 1998
INFORMATION INCLUDED IN REPORT
------------------------------
Part I: Financial Information
Item 1. Financial Statements
A. Condensed Consolidated Balance Sheets
B. Condensed Consolidated Statements of Income
C. Condensed Consolidated Statements of Cash Flows
D. Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Part II: Other Information
Item 2. Changes in Securities and Use of Proceeds
Item 6. Exhibits and Reports on Form 8-K
Items 1, 3-5 have been omitted because they are not applicable with
respect to the current reporting period.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FIRST AMERICAN FINANCIAL CORPORATION
----------------------------------------
(Registrant)
/s/ Thomas A. Klemens
---------------------------------------------
Thomas A. Klemens
Executive Vice President, Chief Financial Officer
(Principal Financial Officer and Duly
Authorized to Sign on Behalf of
Registrant)
Date: November 12, 1998
1
Part I: Financial Information
---------------------
Item 1. Financial Statements
--------------------
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Balance Sheets
-------------------------------------
(Unaudited)
September 30, 1998 December 31, 1997
------------------- -------------------
Assets
Cash and cash equivalents $ 336,630,000 $ 181,531,000
------------------- -------------------
Accounts and accrued income receivable, net 187,983,000 128,017,000
------------------- -------------------
Investments:
Deposits with savings and loan associations and banks 23,654,000 29,029,000
Debt securities 221,893,000 151,503,000
Equity securities 23,677,000 13,904,000
Other long-term investments 46,057,000 35,047,000
------------------- -------------------
315,281,000 229,483,000
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Loans receivable 68,294,000 63,378,000
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Property and equipment, at cost 449,808,000 323,065,000
Less- accumulated depreciation (155,476,000) (122,688,000)
------------------- -------------------
294,332,000 200,377,000
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Title plants and other indexes 203,911,000 100,626,000
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Assets acquired in connection with claim settlements
(net of valuation reserves of $10,127,000 and
$11,135,000) 19,989,000 21,119,000
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Deferred income taxes 14,493,000 31,563,000
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Goodwill and other intangibles, net 169,648,000 132,361,000
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Deferred policy acquisition costs 28,349,000 25,016,000
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Other assets 69,984,000 54,673,000
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$ 1,708,894,000 $ 1,168,144,000
=================== ===================
Liabilities and Stockholders' Equity
Demand deposits $ 64,285,000 $ 62,475,000
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Accounts payable and accrued liabilities 236,344,000 168,133,000
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Deferred revenue 127,733,000 104,124,000
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Reserve for known and incurred but not reported claims 267,476,000 250,826,000
------------------- -------------------
Income taxes payable 32,507,000 3,987,000
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Notes and contracts payable (Note 4) 132,215,000 41,973,000
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Minority interests in consolidated subsidiaries 97,092,000 25,214,000
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Guaranteed Preferred Beneficial Interests in Company's
Junior Subordinated Deferrable Interest Debentures 100,000,000 100,000,000
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Stockholders' equity:
Preferred stock, $1 par value
Authorized - 500,000 shares; outstanding - none
Common stock, $1 par value (Note 5)
Authorized - 108,000,000 shares
Outstanding - 58,296,000 and 52,122,000 shares 58,296,000 52,122,000
Additional paid-in capital (Note 5) 106,739,000 9,205,000
Retained earnings 479,179,000 344,645,000
Net unrealized gain on securities 7,028,000 5,440,000
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651,242,000 411,412,000
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$ 1,708,894,000 $ 1,168,144,000
=================== ===================
2
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Statements of Income
-------------------------------------------
(Unaudited)
For the Three Months Ended For the Nine Months Ended
September 30 September 30
------------------------------- ---------------------------------
1998 1997 1998 1997
--------------- --------------- ---------------- ----------------
Revenues
Operating revenues $742,978,000 $495,181,000 $2,000,055,000 $1,315,053,000
Investment and other income 10,323,000 6,667,000 62,578,000 20,046,000
------------ ------------ -------------- --------------
753,301,000 501,848,000 2,062,633,000 1,335,099,000
------------ ------------ -------------- --------------
Expenses
Salaries and other personnel costs 231,893,000 168,434,000 650,082,000 467,033,000
Premiums retained by agents 217,587,000 144,959,000 552,614,000 396,114,000
Other operating expenses 148,878,000 114,768,000 433,214,000 290,417,000
Provision for title losses and other claims 29,358,000 24,540,000 88,889,000 65,589,000
Depreciation and amortization 14,020,000 7,437,000 42,323,000 25,578,000
Premium taxes 5,632,000 3,833,000 15,017,000 12,555,000
Interest 4,393,000 3,312,000 13,412,000 6,972,000
------------ ------------ -------------- --------------
651,761,000 467,283,000 1,795,551,000 1,264,258,000
------------ ------------ -------------- --------------
Income before income taxes and
minority interests 101,540,000 34,565,000 267,082,000 70,841,000
Income taxes 35,700,000 13,000,000 95,000,000 26,600,000
------------ ------------ -------------- --------------
Income before minority interests 65,840,000 21,565,000 172,082,000 44,241,000
Minority interests 9,992,000 993,000 26,163,000 2,287,000
------------ ------------ -------------- --------------
Net income $ 55,848,000 $ 20,572,000 $ 145,919,000 $ 41,954,000
============ ============ ============== ==============
Net income per share (Note 5):
Basic $ .97 $ .40 $ 2.67 $ .81
============ ============ ============== ==============
Diluted $ .93 $ .39 $ 2.56 $ .79
============ ============ ============== ==============
Cash dividends per share (Note 5) $ .06 $ .04 $ .16 $ .12
============ ============ ============== ==============
Weighted average number of shares (Note 5):
Basic 57,387,000 52,038,000 54,694,000 52,088,000
============ ============ ============== ==============
Diluted 60,300,000 53,241,000 56,936,000 53,106,000
============ ============ ============== ==============
3
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended
September 30
------------------------------
1998 1997
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Cash flows from operating activities:
Net income $ 145,919,000 $ 41,954,000
Adjustments to reconcile net income to cash
provided by operating activities-
Provision for title losses and other claims 88,889,000 65,589,000
Depreciation and amortization 42,323,000 20,098,000
Minority interests in net income 26,163,000 2,287,000
Investment gain (Note 2) (32,449,000)
Other, net (3,125,000) (494,000)
Changes in assets and liabilities excluding effects of
company acquisitions and noncash transactions-
Claims paid, including assets acquired, net of recoveries (71,464,000) (56,276,000)
Net change in income tax accounts 41,450,000 12,373,000
Increase in accounts and accrued income receivable (42,453,000) (20,565,000)
Increase in accounts payable and accrued liabilities 51,971,000 2,081,000
Increase (decrease) in deferred revenue 13,426,000 (731,000)
Other, net (10,207,000) (5,723,000)
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Cash provided by operating activities 250,443,000 60,593,000
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Cash flows from investing activities:
Net cash effect of company acquisitions 18,753,000 (39,519,000)
Net decrease (increase) in deposits with banks 5,579,000 (10,792,000)
Net increase in loans receivable (4,916,000) (7,864,000)
Purchases of debt and equity securities (116,841,000) (53,345,000)
Proceeds from sales of debt and equity securities 25,334,000 35,014,000
Proceeds from maturities of debt securities 13,787,000 14,070,000
Net decrease (increase) in other investments 229,000 (1,706,000)
Capital expenditures (110,243,000) (60,845,000)
Proceeds from sale of property and equipment 879,000 992,000
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Cash used for investing activities (167,439,000) (123,995,000)
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Cash flows from financing activities:
Net change in demand deposits 1,810,000 8,610,000
Proceeds from issuance of junior subordinated
deferrable interest debentures 100,000,000
Proceeds from issuance of senior debentures 99,456,000
Repayment of debt (23,277,000) (39,098,000)
Purchase of Company shares (3,903,000)
Proceeds from excercise of stock options 2,242,000 1,397,000
Proceeds from issuance of stock to employee savings plan 14,440,000
Distributions to minority shareholders (11,191,000)
Cash dividends (11,385,000) (6,482,000)
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Cash provided by financing activities 72,095,000 60,524,000
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Net increase (decrease) in cash and cash equivalents 155,099,000 (2,878,000)
Cash and cash equivalents- Beginning of year 181,531,000 173,439,000
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- End of third quarter $ 336,630,000 $ 170,561,000
============= =============
Supplemental information:
Cash paid during the first three quarters for:
Interest $ 6,792,000 $ 3,364,000
Premium taxes $ 14,497,000 $ 14,915,000
Income taxes $ 57,640,000 $ 15,469,000
Noncash investing and financing activities:
Shares issued for stock bonus plan $ 2,637,000 $ 2,185,000
Liabilities incurred in connection with company acquisitions $ 117,821,000 $ 46,330,000
Net unrealized gain on securities $ 1,588,000 $ 2,239,000
Company acquisitions in exchange for common stock $ 84,389,000 $ 192,000
4
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Notes to Condensed Consolidated Financial Statements
----------------------------------------------------
(Unaudited)
Note 1 - Basis of Condensed Consolidated Financial Statements
- -------------------------------------------------------------
The condensed consolidated financial information included in this report has
been prepared in conformity with the accounting principles and practices
reflected in the consolidated financial statements included in the annual report
filed with the Commission for the preceding calendar year. All adjustments are
of a normal recurring nature and are, in the opinion of management, necessary to
a fair statement of the consolidated results for the interim periods. Certain
1997 interim amounts have been reclassified to conform with the current period
presentation. This report should be read in conjunction with the Company's
Annual Report on Form 10-K for the year ended December 31, 1997.
Note 2 - Business Combinations
- ------------------------------
On January 1, 1998, the Company formed a limited liability corporation (LLC)
with Experian Group (Experian). The purpose of the LLC is to combine certain
operations of the Company's subsidiary, First American Real Estate Information
Services, Inc., with Experian's Real Estate Solutions division (RES). The LLC
is 80% owned by the Company and 20% owned by Experian. RES is a supplier of
core real estate data, providing, among other things, property valuation
information, title and tax information and imaged title documents. This
business combination has been accounted for under the purchase method of
accounting, and accordingly, the purchase price was allocated to the assets
acquired and liabilities assumed based on the estimated fair values at January
1, 1998. In addition, as a result of the transaction, the Company recognized an
investment gain of $32.4 million in the first quarter 1998. The operating
results of the LLC are included in the Company's consolidated financial
statements commencing January 1, 1998.
On June 3, 1998, the Company acquired Data Tree Corporation, a California
company in the business of providing database management and document imaging
systems to county recorders, governmental agencies and the title industry. This
acquisition has been accounted for by the purchase method of accounting and
accordingly, the assets acquired and liabilities assumed have been recorded at
their estimated fair value at the date of acquisition.
During the nine months ended September 30, 1998, the Company also acquired 17
companies accounted for under the purchase method of accounting. These
acquisitions, individually and in the aggregate, were not material. Also during
the period, the Company accounted for 2 business combinations under the pooling
of interests method of accounting. These combinations, individually and in the
aggregate, were not material and, accordingly, prior year results have not been
restated.
Note 3 - Other Comprehensive Income
- -----------------------------------
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." This statement requires
the reporting of comprehensive income in addition to net income. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income. Currently, the only comprehensive
income item that affects the Company is unrealized gains and losses on debt and
equity securities.
The Company reported a net unrealized gain of $1.6 million and $2.2 million for
the nine-month period ended September 1998 and 1997, respectively. Accordingly,
comprehensive income for the two respective periods was $147.5 million and $44.2
million.
Note 4 - Senior Debentures
- --------------------------
On April 7, 1998, the Company issued and sold $100.0 million of 7.55% senior
debentures, due April 1, 2028. The 30-year bonds were issued at 99.456% of the
principal amount. The Company has used a portion of the net proceeds from the
sale of these 30-year securities to repay certain debt obligations and purchase
land for the Company's new corporate facilities. The remaining proceeds will be
used for general corporate purposes.
5
Note 5 - Stock Split
- --------------------
On July 17, 1998, the Company distributed, to shareholders of record on July 7,
1998, a 3-for-1 common stock split in the form of a 200% stock dividend. This
resulted in an increase of 37,895,936 common shares outstanding with the par
value of these additional shares being capitalized by a transfer from additional
paid-in-capital to the common stock account. In order to effect the stock
split, the Company increased its authorized shares from 36,000,000 to
108,000,000. All references in the consolidated financial statements with
regards to common stock, additional paid-in-capital, number of shares of common
stock and per share amounts have been restated to reflect the stock split.
6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
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of Operations
- -------------
Any statements in this document looking forward in time involve risks and
uncertainties, including but not limited to the following risks: the effect of
interest rate fluctuations; changes in the performance of the real estate
markets; the effect of changing economic conditions; the demand for and the
acceptance of the Company's products; and contingencies associated with the Year
2000 issue.
RESULTS OF OPERATIONS
Three and nine months ended September 30:
OVERVIEW
Low mortgage interest rates and an improving national real estate economy
resulted in strong revenues and income for the three and nine months ended
September 30, 1997. However, profits for the nine months ended September 30,
1997 were adversely affected by the need for title operations to increase
staffing levels in order to service the relatively high number of title orders
opened during the period. Furthermore, the Company's information services
operations experienced higher overhead as they integrated acquisitions and
transitioned new accounts to their systems. Favorable real estate conditions
continued throughout 1997 and, coupled with market share increases in all of the
Company's primary business segments, culminated in the best year overall in the
Company's history. Starting in the fourth quarter 1997 and continuing to date,
lower mortgage interest rates and higher consumer confidence have led to
record-setting residential resale activity as well as a substantial increase in
refinance transactions nationwide. This, coupled with the particularly strong
California real estate market, contributed to record-setting revenues and net
income for the three and nine months ended September 30, 1998. Net income and
net income per diluted share for the third quarter 1998 was $55.8 million and
$0.93, respectively. Net income and net income per diluted share for the nine
months ended September 30, 1998, (excluding a previously announced first quarter
investment gain of $19.6 million on an after-tax basis, or $0.34 per diluted
share, relating to the joint venture with Experian) was $126.3 million and $2.22
per diluted share, respectively.
OPERATING REVENUES
Set forth below is a summary of operating revenues for each of the Company's
segments.
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------------ -------------------------------------------
($000) ($000)
1998 % 1997 % 1998 % 1997 %
---------- ------- ---------- ------ ----------- ------- ------------ -----
Title Insurance:
Direct operations $286,264 39 $205,882 42 $ 786,810 39 $ 540,432 41
Agency operations 269,983 36 179,940 36 690,038 35 492,706 37
-------- ----- -------- ----- ---------- ----- ---------- -----
556,247 75 385,822 78 1,476,848 74 1,033,138 78
Real Estate Information 164,828 22 91,620 18 461,683 23 233,323 18
Home Warranty 15,580 2 12,570 3 43,027 2 33,852 3
Trust and Banking 6,323 1 5,169 1 18,497 1 14,740 1
-------- ----- -------- ----- ---------- ----- ---------- -----
Total $742,978 100 $495,181 100 $2,000,055 100 $1,315,053 100
======== ===== ======== ===== ========== ===== ========== =====
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
Title Insurance. Operating revenues from direct title operations increased 39.0%
and 45.6% for the three and nine months ended September 30, 1998, respectively,
when compared with the same periods of the prior year. These increases were
primarily attributable to an increase in the number of title orders closed by
the Company's direct operations, as well as an increase in the average revenues
per order closed. The Company's direct operations closed 310,900 and 873,500
title orders during the three and nine months ended September 30,1998,
respectively, representing increases of 31.8% and 35.1% when compared with the
same periods of the prior year. These increases were due in large part to the
factors mentioned above in the overview, primarily the resurgence of real estate
activity in California, a state heavily concentrated with direct operations, as
well as increases in the Company's national market share. The average revenues
per order closed were $921 and $901 for the three and nine months ended
September 30, 1998, respectively, increases of 5.5% and 7.8% when compared with
$873 and $836 for the same periods of the prior year. These increases were
primarily due to appreciating residential real estate values. Operating revenues
from agency operations increased 50.0% and 40.1% for the three and nine months
ended September 30, 1998, respectively, when compared with the same periods of
the prior year. These increases were primarily due to the same factors mentioned
above, compounded by the inherent delay in reporting by agents.
Real Estate Information. Real estate information operating revenues increased
79.9% and 97.9% for the three and nine months ended September 30, 1998,
respectively, when compared with the same periods of the prior year. These
increases were primarily attributable to the same economic factors affecting
title insurance mentioned above, as well as $36.1 million and $110.2 million of
operating revenues contributed by new acquisitions for the respective periods.
Home Warranty. Home warranty operating revenues increased 23.9% and 27.1% for
the three and nine months ended September 30, 1998, respectively, when compared
with the same periods of the prior year. These increases were primarily
attributable to improvements in the residential resale markets in which this
business segment operates.
INVESTMENT AND OTHER INCOME
Investment and other income totaled $10.3 million and $62.6 million for the
three and nine months ended September 30, 1998, respectively, increases of $3.7
million and $42.5 million when compared with the same periods of the prior year.
The increase for the current three-month period was primarily due to a 44.6%
increase in the average investment portfolio balance, a $0.3 million increase in
equity in earnings of affiliates and a $0.5 million increase in realized
investment gains. The increase for the current nine-month period was primarily
attributable to an investment gain of $32.4 million recognized in the first
quarter relating to the joint venture agreement with Experian.
TOTAL OPERATING EXPENSES
Title Insurance. Salaries and other personnel costs were $169.1 million and
$474.2 million for the three and nine months ended September 30, 1998,
respectively, increases of 31.1% and 32.5% when compared with the same periods
of the prior year. These increases were primarily due to costs incurred
servicing the record-setting number of transactions processed during the current
three and nine month periods.
Agents retained $217.6 million and $552.6 million of title premiums generated by
agency operations for the three and nine months ended September 30, 1998,
respectively, which compares with $145.0 million and $396.1 million for the same
periods of the prior year. The percentage of title premiums retained by agents
ranged from 80.1% to 80.6% due to regional variances (i.e., the agency share
varies from region to region and thus the geographical mix of agency revenues
causes this variation).
Other operating expenses were $77.6 million and $223.4 million for the three and
nine months ended September 30, 1998, respectively, increases of 16.6% and 26.7%
when compared with the same periods of the prior year. These increases were
primarily attributable to the impact of certain incremental costs associated
with processing the record-setting title order volume during the respective
periods.
The provision for title losses as a percentage of title insurance operating
revenues was 3.6% and 3.8% for the nine months ended September 30, 1998 and
1997, respectively. The decrease in rate was due to an improvement in the
Company's claims experience.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
Premium taxes for title insurance were $14.3 million and $11.9 million for the
nine months ended September 30, 1998 and 1997, respectively. Expressed as a
percentage of title insurance operating revenues, premium taxes were 1.0% for
the nine months ended September 30, 1998 and 1.2% for the same period of the
prior year. The decrease in percentage was primarily due to an increase in the
Company's California underwritten title company subsidiary's contribution to
revenues.
Real Estate Information. Real estate information personnel and other operating
expenses were $121.7 million and $339.7 million for the three and nine months
ended September 30, 1998, respectively, increases of 64.8% and 83.0% when
compared with the same periods of the prior year. These increases were
primarily due to costs incurred servicing the increased business volume, $29.8
million and $63.0 million of costs associated with new acquisitions for the
respective periods, and higher overhead costs attributable to the integration of
the new acquisitions and transitioning new accounts to their systems.
Home Warranty. Home warranty personnel and other operating expenses were $4.4
million and $12.5 million for the three and nine months ended September 30,
1998, respectively, increases of 37.5% and 30.5% when compared with the same
periods of the prior year. These increases were primarily attributable to costs
incurred servicing the increased business volume and expansion into new
territories. The provision for home warranty losses expressed as a percentage
of home warranty operating revenues was 56.5% and 59.0% for the nine months
ended September 30, 1998 and 1997, respectively. The decrease in loss ratio was
primarily due to a decrease in the average number of claims per contract.
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS
Set forth below is a summary of income before income taxes and minority
interests for each of the Company's segments.
Three Months Ended Nine Months Ended
September 30 September 30
----------------------------------------------- ---------------------------------------------
($000) ($000)
1998 % 1997 % 1998 % 1997 %
----------------------------------------------- ---------------------------------------------
Title Insurance $ 67,703 63 $28,257 65 $154,359 59 $ 49,638 54
Real Estate Information 35,805 33 11,672 27 91,773 35 32,639 36
Home Warranty 2,270 2 2,208 5 8,607 4 6,288 7
Trust and Banking 2,037 2 1,171 3 5,647 2 3,023 3
-------- ---- ------- ---- -------- ---- -------- ----
Total before corporate 107,815 100 43,308 100 260,386 100 91,588 100
---- ---- ---- ----
Corporate (6,275) (8,743) 6,696 (20,747)
-------- ------- -------- --------
Total $101,540 $34,565 $267,082 $ 70,841
======== ======= ======== ========
In general, the title insurance business is a lower profit margin business when
compared to the Company's other segments. The lower profit margins reflect the
high cost of producing title evidence whereas the corresponding revenues are
subject to regulatory and competitive pricing restraints. Due to this
relatively high proportion of fixed costs, title insurance profit margins
generally improve as closed order volumes increase. In addition, title
insurance profit margins are affected by the composition (residential or
commercial) and type (resale, refinancing or new construction) of real estate
activity. Profit margins from resale and new construction transactions are
generally higher than from refinancing transactions because in many states there
are premium discounts on, and cancellation rates are higher for, refinance
transactions. Title insurance profit margins are also affected by the
percentage of operating revenues generated by agency operations. Profit margins
from direct operations are generally higher than from agency operations due
primarily to the large portion of the premium that is retained by the agent.
Real estate information pretax profits are generally unaffected by the type of
real estate activity but increase as the volume of residential real estate loan
transactions increase. Included in Corporate for the nine months ended
September 30, 1998 was an investment gain of $32.4 million (see Note 2 to the
condensed consolidated financial statements).
INCOME TAXES
The effective income tax rate was 35.6% for the nine months ended September 30,
1998, and 37.5% for the same period of the prior year. The decrease in
effective rate was primarily attributable to changes in the ratio of permanent
differences to income before income taxes, offset in part by an increase in
state income and franchise taxes attributable to the increased profitability of
the Company's non-insurance operations.
9
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
MINORITY INTERESTS
Minority interest expense was $10.0 million for the three months ended September
30, 1998, an increase of $9.0 million when compared with the same period of the
prior year. Minority interest expense was $26.2 million for the nine months
ended September 30, 1998, an increase of $23.9 million when compared with the
same period of the prior year. These increases were primarily attributable to
the strong operating results of the Company's 80/20 joint venture with Experian.
NET INCOME
Net income for the three and nine months ended September 30, 1998, was $55.8
million, or $0.93 per diluted share, and $145.9 million, or $2.56 per diluted
share, respectively. Net income for the nine months ended September 30, 1998,
included an investment gain of $19.6 million on an after-tax basis, or $0.34 per
diluted share, relating to the joint venture with Experian. Net income for the
three and nine months ended September 30, 1997, was $20.6 million, or $0.39 per
diluted share, and $42.0 million, or $0.79 per diluted share, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Total cash and cash equivalents increased $155.1 million and decreased $2.9
million for the nine months ended September 30, 1998 and 1997, respectively.
The increase for the current year period was primarily attributable to cash
provided by operating activities and proceeds from the issuance and sale of
senior debentures, offset in part by capital expenditures, net purchases of debt
and equity securities and the repayment of debt. The decrease for the prior
year period was primarily due to the cash effect of company acquisitions, the
net purchases of debt and equity securities, capital expenditures and the
repayment of debt, offset in part by the proceeds from the issuance of junior
subordinated debentures
On April 7, 1998, the Company issued and sold $100.0 million of 7.55% senior
debentures, due April 1, 2028. The Company has used a portion of the net
proceeds from the sale to repay certain debt obligations and purchase land for
the Company's new corporate facilities. The remaining proceeds will be used for
general corporate purposes.
Notes and contracts payable as a percentage of total capitalization increased to
13.5% at September 30, 1998, from 7.3% at December 31, 1997. This increase was
primarily due to the issuance and sale of the $100.0 million senior debentures,
offset in part by an increase in total capitalization due primarily to shares
issued in connection with company acquisitions, increased minority interests and
net income for the period.
Management believes that all of its anticipated cash requirements for the
immediate future will be met from internally generated funds and from the
remaining proceeds of the senior debentures.
Year 2000 Issue
Overview. With the help of an outside consulting firm, the Company has created
a Year 2000 Program Management Office and adopted a five-step plan to address
the Year 2000 Problem. The five steps of the plan are: (1) awareness, (2)
inventory/assessment, (3) renovation, (4) testing, and (5) implementation. To
implement the plan, the Company was divided into "business units" comprised of:
(a) the reporting regions of the title insurance subsidiaries, (b) the
subsidiary companies of the real estate information services business, (c) the
home warranty subsidiaries, (d) the trust and banking subsidiaries and (e)
various other subsidiaries.
The "awareness" phase involves communicating the nature and scope of the Year
2000 Problem to the management of the business units in order to engender strong
management support for its resolution. The "inventory/assessment" phase
involves the identification of information systems and non-information systems,
which require renovation or replacement to become Year 2000 compliant. The
"renovation" phase involves the repair and/or replacement of the systems
identified in the prior phase. The "testing" phase involves the testing of
repaired and replaced systems. The "implementation" phase involves the
integration of tested systems into daily operations.
All phases of the plan are currently active. The awareness phase will continue
throughout 1998 and 1999. September 30, 1998 was the target date for completion
of the inventory/assessment phase; that phase is substantially complete.
However, all of the phases of the plan must be revisited each time the Company
acquires a new business. Accordingly, the inventory/assessment phase remains
active. The Company has established the following target dates: (1) December
31, 1998 for completion of renovation, (2) April 30, 1999 for completion of
testing, and (3) June 30, 1999 for completion of implementation. In each case,
completion of the applicable phase is subject to the limitation noted above for
newly acquired businesses. The Company makes no assurance that it will be able
to meet these target dates.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations (continued)
- -------------------------
The Company's efforts to survey the Year 2000 readiness of its significant
vendors, suppliers and customers continues. To date, the Company has not
received sufficient information from these parties about their Year 2000 plans
to predict the outcome of their efforts. Even after responses are received,
there can be no assurance that the systems of the Company's significant vendors,
suppliers and customers will be timely renovated.
Costs for the year 2000 problem. To date the Company has spent approximately $5
million in implementing the Year 2000 plan. The Company expects to incur an
additional $25 million to $35 million in completing the Year 2000 plan. About
half the costs will be for hardware and software replacement and about half will
be for labor. The costs for hardware and software will be capitalized and
amortized over their estimated useful lives. Labor costs will be expensed as
incurred. Year 2000 plan costs are being funded through operating cash flow.
Contingency plans. With the help of a professional disaster planner, the
Company is in the process of creating contingency plans for unexpected systems
failures as a result of the Year 2000 Problem. The Company anticipates having
the contingency plans in effect by the end of 1998.
Review of the year 2000 plan. The Company has engaged a consultant to review
its Year 2000 plan. Under the terms of this engagement, the consultant will (1)
review the operations of the Year 2000 Program Management Office, (2) review the
Company's Year 2000 plan, and (3) review the implementation of the Year 2000
plan at selected locations. From time to time during the review, the consultant
will report its findings to the Audit Committee of the Company's Board of
Directors.
Assurances. The costs to implement the Year 2000 plan and the target dates for
completion of the various phases of the Year 2000 plan are based on current
estimates. These estimates reflect numerous assumptions about future events,
including the continued availability of certain resources, the timing and
effectiveness of third party renovation plans and other factors. The Company
can give no assurance that these estimates will be achieved, and actual results
could differ materially from these estimates.
11
Part II: Other Information
-----------------
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
(c) During the period covered by this report, the Company has issued
unregistered shares of its common stock listed below to sellers in business
combinations.
Consideration
Date of Sale Number of Shares Received
------------------- ---------------- -------------
April 15, 1998 242,188 $15,500,000
May 6, 1998 41,925 $ 2,587,167
May 7, 1998 9,030 $ 435,698
May 29, 1998 37,013 $ 2,850,000
September 15, 1998 17,925 $ 525,000
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits
(27) Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarterly period
covered by this report. Subsequent to that period, the Company filed a
report on Form 8-K dated October 22, 1998, reporting on certain information
and issues involving the "Year 2000 Problem."
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EXHIBIT INDEX
Sequentially
------------
Exhibit No. Description Numbered Page
- ----------- ----------- -------------
(27) Financial Data Schedule
13