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 June 30, 1999
-------------------------------------------
OR
[_] 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 0-3658
---------------------------------------------------
THE FIRST AMERICAN FINANCIAL CORPORATION
---------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Incorporated in California 95-1068610
- ------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
114 East Fifth Street, Santa Ana, California 92701-4699
---------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(714) 558-3211
---------------------------------------------------------------------
(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 [X] 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 - 65,195,756 as of August 10, 1999
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
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Part II: Other Information
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
Items 2-5 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: August 12, 1999
1
Part I: Financial Information
---------------------
Item 1. Financial Statements
--------------------
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Balance Sheets
-------------------------------------
(Unaudited)
June 30, 1999 December 31, 1998
---------------- -----------------
Assets
Cash and cash equivalents $ 300,723,000 $ 381,293,000
-------------- --------------
Accounts and accrued income receivable, net 222,161,000 201,165,000
-------------- --------------
Investments:
Deposits with savings and loan associations and banks 31,292,000 39,480,000
Debt securities 204,455,000 235,628,000
Equity securities 36,666,000 32,573,000
Other long-term investments 75,325,000 63,244,000
-------------- --------------
347,738,000 370,925,000
-------------- --------------
Loans receivable 78,016,000 72,035,000
-------------- --------------
Property and equipment, at cost 613,123,000 503,580,000
Less - accumulated depreciation (205,057,000) (181,489,000)
-------------- --------------
408,066,000 322,091,000
-------------- --------------
Title plants and other indexes 229,717,000 216,711,000
-------------- --------------
Assets acquired in connection with claim settlements
(net of valuation reserves of $10,506,000 and $11,135,000) 14,819,000 17,051,000
-------------- --------------
Deferred income taxes 19,395,000 16,324,000
-------------- --------------
Goodwill and other intangibles, net 213,660,000 187,106,000
-------------- --------------
Other assets 89,595,000 68,030,000
-------------- --------------
$1,923,890,000 $1,852,731,000
============== ==============
Liabilities and Stockholders' Equity
Demand deposits $ 69,299,000 $ 67,404,000
-------------- --------------
Accounts payable and accrued liabilities 239,873,000 264,834,000
-------------- --------------
Deferred revenue 163,920,000 119,202,000
-------------- --------------
Reserve for known and incurred but not reported claims 264,203,000 272,921,000
-------------- --------------
Income taxes payable 1,993,000 22,734,000
-------------- --------------
Notes and contracts payable 141,235,000 143,466,000
-------------- --------------
Minority interests in consolidated subsidiaries 96,942,000 99,905,000
-------------- --------------
Mandatorily redeemable preferred securities of
the Company's subsidiary trust whose sole assets
are the Company's $100,000,000 8.5% deferrable
interest subordinated notes due 2012 100,000,000 100,000,000
-------------- --------------
Stockholders' equity:
Preferred stock, $1 par value
Authorized - 500,000 shares; outstanding - none
Common stock, $1 par value
Authorized - 180,000,000 shares
Outstanding - 65,152,000 and 63,120,000 shares 65,152,000 63,120,000
Additional paid-in capital 184,514,000 146,624,000
Retained earnings 589,867,000 544,783,000
Accumulated other comprehensive income 6,892,000 7,738,000
-------------- --------------
846,425,000 762,265,000
-------------- --------------
$1,923,890,000 $1,852,731,000
============== ==============
2
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Statements of Income
-------------------------------------------
(Unaudited)
For the Three Months Ended For the Six Months Ended
June 30 June 30
----------------------------- ---------------------------------
1999 1998 1999 1998
------------ ------------ -------------- --------------
Revenues
Operating revenues $758,153,000 $717,141,000 $1,468,515,000 $1,301,492,000
Investment and other income 12,245,000 9,279,000 23,925,000 53,144,000
------------ ------------ -------------- --------------
770,398,000 726,420,000 1,492,440,000 1,354,636,000
------------ ------------ -------------- --------------
Expenses
Salaries and other personnel costs 259,603,000 229,240,000 515,015,000 439,110,000
Premiums retained by agents 228,212,000 194,982,000 438,780,000 335,027,000
Other operating expenses 174,443,000 157,810,000 332,606,000 301,957,000
Provision for title losses and other claims 28,420,000 33,793,000 55,441,000 63,094,000
Depreciation and amortization 19,148,000 14,955,000 36,067,000 28,972,000
Premium taxes 5,987,000 5,327,000 11,296,000 9,575,000
Interest 3,032,000 5,677,000 7,821,000 9,497,000
------------ ------------ -------------- --------------
718,845,000 641,784,000 1,397,026,000 1,187,232,000
------------ ------------ -------------- --------------
Income before income taxes and
minority interests 51,553,000 84,636,000 95,414,000 167,404,000
Income taxes 18,300,000 30,100,000 33,200,000 59,800,000
------------ ------------ -------------- --------------
Income before minority interests 33,253,000 54,536,000 62,214,000 107,604,000
Minority interests 4,027,000 8,418,000 9,115,000 16,171,000
------------ ------------ -------------- --------------
Net income 29,226,000 46,118,000 53,099,000 91,433,000
------------ ------------ -------------- --------------
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on securities (923,000) 743,000 (615,000) 1,132,000
Minimum pension liability adjustment 19,000 (231,000)
------------ ------------ -------------- --------------
(904,000) 743,000 (846,000) 1,132,000
------------ ------------ -------------- --------------
Comprehensive income $ 28,322,000 $ 46,861,000 $ 52,253,000 $ 92,565,000
============ ============ ============== ==============
Net income per share:
Basic $.45 $0.78 $0.83 $1.57
============ ============ ============== ==============
Diluted $.44 $0.75 $0.80 $1.51
============ ============ ============== ==============
Cash dividends per share $.06 $.05 $.12 $.10
============ ============ ============== ==============
Weighted average number of shares:
Basic 64,763,000 59,048,000 64,202,000 58,407,000
============ ============ ============== ==============
Diluted 66,325,000 61,180,000 66,322,000 60,432,000
============ ============ ============== ==============
3
THE FIRST AMERICAN FINANCIAL CORPORATION
AND SUBSIDIARY COMPANIES
------------------------
Condensed Consolidated Statements of Cash Flows
-----------------------------------------------
(Unaudited)
For the Six Months Ended
June 30
------------------------------
1999 1998
------------- -------------
Cash flows from operating activities:
Net income $ 53,099,000 $ 91,433,000
Adjustments to reconcile net income to cash
provided by operating activities-
Provision for title losses and other claims 55,441,000 63,094,000
Depreciation and amortization 36,067,000 28,972,000
Minority interests in net income 9,115,000 16,171,000
Investment gain (32,449,000)
Other, net 707,000 (421,000)
Changes in assets and liabilities excluding effects of
company acquisitions and noncash transactions-
Claims paid, including assets acquired, net of recoveries (53,195,000) (49,216,000)
Net change in income tax accounts (27,937,000) 27,751,000
Increase in accounts and accrued income receivable (20,326,000) (24,049,000)
(Decrease) increase in accounts payable and accrued liabilities (30,958,000) 33,099,000
Increase in deferred revenue 44,718,000 5,399,000
Other, net (15,164,000) (3,942,000)
------------- -------------
Cash provided by operating activities 51,567,000 155,842,000
------------- -------------
Cash flows from investing activities:
Net cash effect of company acquisitions/dispositions (34,047,000) 5,031,000
Net decrease (increase) in deposits with banks 8,188,000 (2,197,000)
Net increase in loans receivable (5,981,000) (5,263,000)
Purchases of debt and equity securities (29,397,000) (93,289,000)
Proceeds from sales of debt and equity securities 43,945,000 19,942,000
Proceeds from maturities of debt securities 9,421,000 21,854,000
Net decrease in other investments 4,048,000 271,000
Capital expenditures (116,956,000) (77,188,000)
Proceeds from sale of property and equipment 3,203,000 254,000
------------- -------------
Cash used for investing activities (117,576,000) (130,585,000)
------------- -------------
Cash flows from financing activities:
Net change in demand deposits 1,895,000 904,000
Proceeds from issuance of senior debentures 99,456,000
Proceeds from issuance of debt 630,000 2,740,000
Repayment of debt (10,841,000) (10,173,000)
Proceeds from excercise of stock options 3,165,000 2,660,000
Proceeds from issuance of stock to employee savings plan 4,794,000 8,531,000
Distributions to minority shareholders (6,189,000) (6,559,000)
Cash dividends (8,015,000) (6,046,000)
------------- -------------
Cash (used for) provided by financing activities (14,561,000) 91,513,000
------------- -------------
Net (decrease) increase in cash and cash equivalents (80,570,000) 116,770,000
Cash and cash equivalents - Beginning of year 381,293,000 181,531,000
------------- -------------
- End of first half $ 300,723,000 $ 298,301,000
============= =============
Supplemental information:
Cash paid during the first half for:
Interest $ 8,000,000 $ 6,773,000
Premium taxes $ 14,740,000 $ 10,421,000
Income taxes $ 62,694,000 $ 36,681,000
Noncash investing and financing activities:
Shares issued for stock bonus plan $ 3,369,000 $ 2,637,000
Liabilities incurred in connection with company acquisitions $ 9,113,000 $ 89,779,000
Company acquisitions in exchange for common stock $ 28,594,000 $ 66,447,000
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. This
report should be read in conjunction with the Company's Annual Report on Form
10-K for the year ended December 31, 1998. All consolidated results have been
restated to reflect the 1999 acquisition accounted for under the pooling-of-
interests method of accounting. Certain 1998 interim amounts have been
reclassified to conform with the 1999 presentation.
Note 2 - Revenue Recognition Accounting Policy
- ----------------------------------------------
Effective January 1, 1999, the Company implemented a change to the accounting
policy for tax service contracts. The new accounting policy was adopted
prospectively and applies to all new loans serviced beginning January 1, 1999.
The new policy provides for a more ratable recognition of revenues, reducing the
amount recognized at the inception of the contract and recognizing it over the
expected service period. The amortization rates applied to recognize the
revenues assume a 10-year contract life and are adjusted to reflect prepayments.
The resulting rates by year (starting with year one) are 32%, 24%, 14%, 9%, 7%,
5%, 4%, 2%, 2% and 1%. The Company periodically reviews its tax service contract
portfolio to determine if there have been changes in contract lives and/or
changes in the number and/or timing of prepayments; accordingly, the Company may
adjust the rates to reflect current trends. Adoption of this new policy resulted
in an after tax earnings decrease of $7.2 million and $14.6 million, or $0.11
per diluted share and $0.22 per diluted share, for the three and six months
ended June 30, 1999, respectively.
Note 3 - Business Combinations
- ------------------------------
During the six months ended June 30, 1999, the Company acquired twelve companies
accounted for under the purchase method of accounting. These acquisitions were
individually not material and are included in the title insurance, real estate
information and consumer information businesses. Their aggregate purchase price
was $30.4 million in cash, $4.2 million in notes and 1,119,321 shares of the
Company's common stock. The purchase price for each was allocated to the assets
acquired and liabilities assumed based on estimated fair values and
approximately $30.1 million in goodwill was recorded. Goodwill is being
amortized on a straight-line basis over its estimated useful life of 20 years.
The operating results of these acquired companies were included in the Company's
consolidated financial statements from their respective acquisition dates.
Assuming these acquisitions had occurred January 1, 1998, pro forma revenues,
net income and net income per diluted share would have been $1,503.2 million,
$54.5 million and $0.81, respectively, for the six months ended June 30, 1999,
and $1,376.6 million, $93.3 million and $1.52, respectively for the six months
ended June 30, 1998. All pro forma results include amortization of goodwill and
interest expense on acquisition debt. The pro forma results are not necessarily
indicative of the operating results that would have been obtained had the
acquisitions occurred at the beginning of the periods presented, nor are they
necessarily indicative of future operating results.
Effective May 14, 1999, the Company completed its merger of National Information
Group ("NAIG"). Under the terms of the definitive merger agreement, each of the
NAIG shareholders received .67 of a share of the Company's common stock for each
NAIG common share they owned. To complete the merger, the Company issued
3,004,800 shares, in exchange for 100% of the outstanding common stock of NAIG.
The information services provided by NAIG include outsourcing services, flood
zone determination services, real tax tracking, hazard and motor vehicle
insurance tracking, lender placed insurance and flood insurance.
This merger was accounted for under the pooling-of-interests method of
accounting and, as a result, the Company has restated all previously reported
results to reflect this merger. Included in other operating expenses for the
three and six months ended June 30, 1999, were merger-related charges of $10.8
million, $7.0 million after tax, or $0.10 per diluted share. These nonrecurring
costs include severance payments, lease terminations and consulting services.
Combined and separate results of the Company and NAIG during the periods
preceding the merger were as follows:
5
Three Months Ended Six Months Ended
(in thousands) March 31, 1999 June 30, 1998 June 30, 1998
-------------- ------------- ----------------
Revenues:
First American $706,926 $709,776 $1,322,013
NAIG 15,116 16,644 32,623
-------- -------- ----------
$722,042 $726,420 $1,354,636
======== ======== ==========
Net income:
First American $ 24,877 $ 45,699 $ 90,432
NAIG (1,004) 419 1,001
-------- -------- ----------
$ 23,873 $ 46,118 $ 91,433
======== ======== ==========
Net income (loss) per
diluted share:
First American $ 0.40 $ 0.79 $ 1.58
NAIG (0.04) (0.04) (0.07)
-------- -------- ----------
$ 0.36 $ 0.75 $ 1.51
======== ======== ==========
Note 4 - Business Segments
- --------------------------
During the second quarter 1999, the Company restructured its business segments
to more accurately reflect the Company's current operating structure. The
restructured segments are title insurance; real estate information services
which includes mortgage origination, mortgage servicing and database products
and services; and consumer information and services which provides home
warranties, automotive tracking services, resident screening, pre-employment
screening, lender-placed flood and hazard insurance, investment advisory and
trust and banking services. All previously reported segment information has
been restated to be consistent with the current presentation.
Note 5 - New Accounting Pronouncements
- --------------------------------------
Effective January 1, 1999, the Company adopted Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP 98-1 requires the Company to capitalize interest costs
incurred and certain payroll-related costs of employees directly associated with
developing software, in addition to incremental payments to third parties.
Note 6 - Litigation
- -------------------
On May 19, 1999, The People of the State of California, Kathleen Connell,
Controller of the State of California, and Chuck Quackenbush, Insurance
Commissioner of the State of California, filed a class action suit in the
Sacramento Superior Court. This suit seeks to certify as a class of defendants
certain title insurers, underwritten title companies, controlled escrow
companies and independent escrow companies that conduct, and have conducted,
business in the State of California. This potential class of defendants would
include certain subsidiaries of The First American Financial Corporation. The
plaintiffs allege certain unlawful acts in the escheatment of unclaimed
property; charging of fees for services and; in the procurement of earnings on
escrow funds. No subsidiary of First American has yet been served in this suit.
Subsequent to the filing of this suit, First American Title Insurance Company, a
subsidiary of First American, was named and served as a defendant in a private
class action suit entitled Michael J. Kananack v. First American Title Insurance
-----------------------------------------------------
Company, which was filed in the Los Angeles County Superior Court. The
- -------
allegations in the Kananack suit include some, but not all, of the allegations
contained in the complaint filed by the State of California. The Kananack action
seeks injunctive relief, attorneys' fees, damages and penalties in unspecified
amounts.
First American intends to defend both suits vigorously. At this time, no
estimate of loss can be made.
6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
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 real estate markets;
the effect of changing economic conditions; general volatility in the capital
markets; the demand for and the acceptance of the Company's products; changes in
applicable government regulations; consolidation among the Company's customers;
and contingencies associated with the Year 2000 issue. The Company's actual
results, performance or achievement could differ materially from those expressed
in or implied by forward looking statements. Accordingly, no assurances can be
given that any of the events anticipated by the forward looking statements will
transpire or occur or, if any of them do so, what impact they will have on the
results of operations and financial condition of the Company.
RESULTS OF OPERATIONS
Three and six months ended June 30:
OVERVIEW
Low mortgage interest rates and high consumer confidence, coupled with the
particularly strong California real estate market, resulted in strong revenues
and net income for the Company in the first half of 1998. These conditions
continued throughout 1998 and into 1999, resulting in record-setting second
quarter and first half of the year revenues for the three and six months ended
June 30, 1999, respectively. However, during the second quarter 1999, new
orders began to soften as rising interest rates led to a decline in refinance
transactions, although residential resale and commercial activity remained
relatively strong. The operating results for the current year periods were
impacted by the previously announced change to the revenue recognition policy
for tax service contracts. This change, which became effective January 1, 1999,
on a prospective basis, resulted in an after tax earnings decrease of $7.2
million, or $0.11 per diluted share, and $14.6 million, or $0.22 per diluted
share, for the three and six months ended June 30, 1999, respectively. The new
policy provides for a more ratable recognition of revenues, reducing the amount
recognized at the inception of the contract and recognizing it over the expected
service period. Although this accounting change will cause a reduction in tax
service revenues and earnings recognized in the early years of each tax service
contract, the Company anticipates that commencing in the second year following
adoption, this method will begin to reduce the volatility in reported financial
results arising from the inherent cyclicality of the Company's tax service
business. Net income and net income per diluted share for the second quarter
1999 was $29.2 million and $0.44, respectively. Net income and net income per
diluted share for the first half of 1999 was $53.1 million and $0.80,
respectively.
OPERATING REVENUES
Set forth below is a summary of operating revenues for each of the Company's
segments.
Three Months Ended Six Months Ended
June 30 June 30
-------------------------------------- -------------------------------------
($000) ($000)
1999 % 1998 % 1999 % 1998 %
----------- ---- --------- --- ---------- --- ---------- ---
Title Insurance:
Direct operations $280,007 37 $274,827 38 $ 540,331 37 $ 500,545 38
Agency operations 284,852 38 243,519 34 545,513 37 420,055 32
-------- ---- -------- --- ---------- --- ---------- ---
564,859 75 518,346 72 1,085,844 74 920,600 71
Real Estate Information 144,082 19 157,112 22 287,726 20 298,961 23
Consumer Information 49,212 6 41,683 6 94,945 6 81,931 6
-------- ---- -------- --- ---------- --- ---------- ---
Total $758,153 100 $717,141 100 $1,468,515 100 $1,301,492 100
======== ==== ======== === ========== === ========== ===
Title Insurance. Operating revenues from direct title operations increased 1.9%
and 7.9% for the three and six months ended June 30, 1999, 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, offset in part by a decrease in the average
revenues per order closed. The Company's direct operations closed 319,000 and
614,100 title orders during the three and six months ended June 30,1999,
respectively, representing increases of 5.6% and 9.2% 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 section. The average revenues per order
closed were $878 and $880 for the three and six months ended June 30, 1999,
respectively,
7
decreases of 3.5% and 1.1% when compared with the same periods of the prior
year. Operating revenues from agency operations increased 17.0% and 29.9% for
the three and six months ended June 30, 1999, respectively, when compared with
the same periods of the prior year. These increases were primarily due to the
same factors affecting direct operations mentioned above, compounded by the
inherent delay in reporting by agents.
Real Estate Information. Real estate information operating revenues decreased
8.3% and 3.8% for the three and six months ended June 30, 1999, respectively,
when compared with the same periods of the prior year. These decreases were
primarily due to the revenue recognition change for tax service contracts and
the reduction in order volume attributable to the decrease in refinance
activity, offset in part by $5.6 million and $13.0 million of operating revenues
contributed by new acquisitions for the respective periods. The revenue
recognition change resulted in a decrease in operating revenues of $14.6
million and $29.6 million for the three and six months ended June 30, 1999,
respectively.
Consumer Information. Consumer risk operating revenues increased 18.1% and
15.9% for the three and six months ended June 30, 1999, respectively, when
compared with the same periods of the prior year. These increases were
primarily attributable to an increased awareness and acceptance of this business
segment's products, as well as $1.3 million of operating revenues contributed by
new acquisitions for both the three and six months ended June 30, 1999.
INVESTMENT AND OTHER INCOME
Investment and other income totaled $12.2 million for the three months ended
June 30, 1999, an increase of $3.0 million when compared with the same period of
the prior year. This increase was primarily due to a 29.9% increase in the
average investment portfolio balance. Investment and other income totaled $23.9
million for the six months ended September 30, 1999, a decrease of $29.2 million
when compared with the same period of the prior year. This decrease was
primarily attributable to an investment gain of $32.4 million recognized in the
first quarter 1998 relating to the joint venture agreement with Experian, offset
in part by a 36.8% increase in the average investment portfolio balance.
TOTAL OPERATING EXPENSES
Title Insurance. Salaries and other personnel costs were $184.3 million and
$361.3 million for the three and six months ended June 30, 1999, respectively,
increases of 15.1% and 18.4% when compared with the same periods of the prior
year. These increases were primarily due to the costs incurred servicing the
increased number of orders processed during the current three and six month
periods, as well as $5.1 million and $10.5 million of personnel costs associated
with new acquisitions.
Agents retained $228.2 million and $438.8 million of title premiums generated by
agency operations for the three and six months ended June 30, 1999,
respectively, which compares with $195.0 million and $335.0 million for the same
periods of the prior year. The percentage of title premiums retained by agents
ranged from 79.8% to 80.1% 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 $78.2 million and $154.8 million for the three and
six months ended June 30, 1999, respectively, increases of 0.4% and 6.2% 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 increase in title order volume during the respective
periods, as well as $2.6 million and $5.6 million of costs associated with new
acquisitions, partially offset by the results of the Company's cost-containment
programs.
The provision for title losses as a percentage of title insurance operating
revenues was 3.0% for the six months ended June 30, 1999 and 3.9% for the same
period of the prior year. The decrease in loss percentage was due to an
improvement in claims experience.
Premium taxes for title insurance were $10.5 million and $8.9 million for the
six months ended June 30, 1999 and 1998, respectively. Expressed as a
percentage of title insurance operating revenues, premium taxes were 1.0% for
the six months ended June 30, 1999 and 1998.
Real Estate Information. Real estate information personnel and other operating
expenses were $123.3 million and $248.7 million for the three and six months
ended June 30, 1999, respectively, increases of 8.3% and 12.2% when compared
with the same periods of the prior year. These increases were primarily
attributable to expenses associated with the Year 2000 issue totaling $3.5
million and $7.0 million for the three and six months ended June 30, 1999,
respectively. Also contributing to the increases for the respective periods
were $4.1 million and $9.5 million of costs associated with new acquisitions.
Consumer Information. Consumer risk personnel and other operating expenses were
$30.9 million and $60.3 million for the three and six months ended June 30,
1999, respectively, increases of 22.0% and 17.6% when compared with the same
periods
8
of the prior year. These increases were primarily attributable to costs incurred
servicing the increased business volume and $0.9 million of costs associated
with new acquisitions for both the three and six months ended June 30, 1999.
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 Six Months Ended
June 30 June 30
----------------------------------------------------------------
($000) ($000)
1999 % 1998 % 1999 % 1998 %
-------- --- -------- --- -------- --- -------- ---
Title Insurance $ 49,075 70 $ 56,395 59 $ 84,237 69 $ 86,656 56
Real Estate Information 11,949 17 31,184 33 21,237 17 53,730 35
Consumer Information 8,933 13 7,794 8 17,144 14 14,047 9
-------- --- -------- --- -------- --- -------- ---
Total before corporate expenses 69,957 100 95,373 100 122,618 100 154,433 100
=== === === ===
Corporate expenses (18,404) (10,737) (27,204) 12,971
-------- -------- -------- --------
Total $ 51,553 $ 84,636 $ 95,414 $167,404
======== ======== ======== ========
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. As noted in the Overview section, real estate
information pretax profits were adversely impacted by the change to the revenue
recognition policy for tax service contracts. Included in Corporate for the
three and six months ended June 30,1999, are $10.8 million of nonrecurring
merger-related charges incurred in the NAIG acquisition. These nonrecurring
charges include severence payments, lease terminations and consulting services.
Included in Corporate for the six months ended June 30, 1998, is an investment
gain of $32.4 million.
INCOME TAXES
The effective income tax rate was 34.8% for the six months ended June 30, 1999,
and 35.7% for the same period of the prior year. The decrease in effective rate
was primarily attributable to a decrease in state income and franchise taxes
which resulted from the Company's non-insurance subsidiaries reduced
contribution to pretax profits.
MINORITY INTERESTS
Minority interest expense was $4.0 million for the three months ended June 30,
1999, a decrease of $4.4 million when compared with the same period of the prior
year. Minority interest expense was $9.1 million for the six months ended June
30, 1999, a decrease of $7.1 million when compared with the same period of the
prior year. These decreases were primarily attributable to the decrease in
operating results of the Company's joint venture with Experian caused primarily
by the previously noted revenue recognition change.
NET INCOME
Net income for the three and six months ended June 30, 1999, was $29.2 million,
or $0.44 per diluted share, and $53.1 million, or $0.80 per diluted share,
respectively. Net income for the three and six months ended June 30, 1998, was
$46.1 million, or $0.75 per diluted share, and $91.4 million, or $1.51 per
diluted share, respectively. Net income for the six months ended June
9
30, 1998, included an investment gain of $19.6 million on an after-tax basis, or
$0.32 per diluted share, relating to the joint venture with Experian.
LIQUIDITY AND CAPITAL RESOURCES
Total cash and cash equivalents decreased $80.6 million and increased $116.8
million for the six months ended June 30, 1999 and 1998, respectively. The
decrease for the current year period was primarily attributable to capital
expenditures, company acquisitions and the repayment of debt. The increase for
the prior year period was primarily due 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.
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 decreased to
11.9% at June 30, 1999, from 13.0% at December 31, 1998. This decrease was
primarily due to net income for the period, as well as increased stockholders'
equity resulting from the issuance of common stock in connection with company
acquisitions.
On July 2, 1999, the Company entered into a credit agreement that provided for a
$100.0 million line of credit. Pursuant to the terms of the credit agreement,
the Company is required to maintain minimum levels of capital and earnings and
meet predetermined debt to capitalization ratios. The line of credit provided
for in this agreement is currently unused.
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 Update
- ----------------------
Overview - With the help of an outside consulting firm, in January 1997 the
Company 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 subsidiary, (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 that
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.
Substantially all of the phases of the plan have been completed. However, all of
the phases of the plan must be revisited each time the Company acquires a new
business. Accordingly, all phases of the plan are still active.
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 significant vendors, suppliers and
customers will be timely renovated.
Costs for the year 2000 problem - To date the Company has spent approximately
$25 million in implementing the Year 2000 plan. The Company expects to incur an
additional $5 million to complete the Year 2000 plan. Approximately $20 million
of the expenditures to date have been for labor and $5 million for hardware and
software replacement. The costs for hardware and software are capitalized and
amortized over their estimated useful lives. Labor costs are expensed as
incurred. Year 2000 plan costs are being funded through operating cash flow.
Contingency plans - Contingency plans for unexpected systems failures as a
result of the Year 2000 problem have been substantially completed by Company's
business units.
Review of the year 2000 plan - The Company engaged a consultant to review its
Year 2000 plan. Under the terms of this engagement, the consultant (1) reviewed
the operations of the Year 2000 Program Management Office, (2) reviewed the
Company's Year 2000 plan, and (3) reviewed the implementation of the Year 2000
plan at selected locations. From time to
10
time during the review, the consultant reported its findings to the Audit
Committee of the Company's Board of Directors and appropriate actions were taken
by the Company in response.
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.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
The Company's primary exposure to market risk relates to interest rate risk
associated with certain other financial instruments. Although the Company
monitors its risk associated with fluctuations in interest rates, it does not
currently use derivative financial instruments to hedge these risks.
The Company is also subject to equity price risk as related to its equity
securities. Although the Company has operations in certain foreign countries,
these operations, in the aggregate, are not material to the Company's financial
condition or results of operations.
There have been no material changes in the Company's risk since filing its Form
10K for the year ended December 31, 1998.
11
Part II: Other Information
-----------------
Item 1. Legal Proceedings
-----------------
Subsequent to the filing of the civil class action entitled People of
---------
the State of California, et al. v. Fidelity National Title Insurance
--------------------------------------------------------------------
Company, etc., et al., which the Company reported in its current
----------------------
report on Form 8-K dated May 27, 1999, the Company's subsidiary,
First American Title Insurance Company ("First American"), was named
and served as a defendant in a private class action entitled Michael
-------
J. Kananack v. First American Title Insurance Company, filed in Los
------------------------------------------------------
Angeles County Superior Court Case No. BC 211798. The allegations in
the Kananack suit include some, but not all, of the allegations set
forth in the complaint filed by the State of California, which are
described in the above-mentioned Form 8-K. The Kananack action seeks
--------
injunctive relief, attorneys' fees, and damages and penalties in
unspecified amounts. First American intends to defend its position
vigorously.
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
(10)(a) Amendment No. 4, dated April 22, 1999, to 1996 Stock
Option Plan.
(10)(b) Credit Agreement dated as of July 2, 1999.
(27) Financial Data Schedule
(b) Reports on Form 8-K
During the quarterly period covered by this report, the Company filed
a report on Form 8-K dated May 27, 1999, reporting on the filing of a
civil class action entitled People of the State of California, et al.
-----------------------------------------
v. Fidelity National Title Insurance Company, etc., et al.
----------------------------------------------------------
12
EXHIBIT INDEX
Sequentially
Exhibit No. Description Numbered Page
- ----------- ----------- -------------
(10)(a) Amendment No. 4, dated April 22, 1999,
to 1996 Stock Option Plan.
(10)(b) Credit Agreement dated as of
July 2, 1999.
(27) Financial Data Schedule
13