-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JXloh1cZf50KG9mblv8vprNE63+LJJA7E4pw2X8qc84MiLrYwQ0ixk8vB3JUz0Ay 7fAVjaRVncubzwPLRKYdgg== 0001017062-99-001940.txt : 19991117 0001017062-99-001940.hdr.sgml : 19991117 ACCESSION NUMBER: 0001017062-99-001940 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991115 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST AMERICAN FINANCIAL CORP CENTRAL INDEX KEY: 0000036047 STANDARD INDUSTRIAL CLASSIFICATION: TITLE INSURANCE [6361] IRS NUMBER: 951068610 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13585 FILM NUMBER: 99752886 BUSINESS ADDRESS: STREET 1: 114 E FIFTH ST CITY: SANTA ANA STATE: CA ZIP: 92701-4699 BUSINESS PHONE: 7145583211 MAIL ADDRESS: STREET 1: 114 E FIFTH STREET CITY: SANTA ANA STATE: CA ZIP: 92701 FORMER COMPANY: FORMER CONFORMED NAME: FIRST AMERICAN TITLE INSURANCE & TRUST C DATE OF NAME CHANGE: 19690515 10-Q 1 QUARTERLY REPORT DATED SEPTEMBER 30, 1999 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, 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) incorporation or organization) Identification No. 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 - 65,241,687 as of November 9, 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: November 12, 1999 1 Part I: Financial Information --------------------- Item 1. Financial Statements -------------------- THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES ------------------------ Condensed Consolidated Balance Sheets ------------------------------------- (Unaudited)
September 30, 1999 December 31, 1998 ------------------ ----------------- Assets Cash and cash equivalents $ 307,242,000 $ 381,293,000 ------------------ ----------------- Accounts and accrued income receivable, net 204,392,000 201,165,000 ------------------ ----------------- Income tax receivable 12,034,000 ------------------ Investments: Deposits with savings and loan associations and banks 32,585,000 39,480,000 Debt securities 203,546,000 235,628,000 Equity securities 39,519,000 32,573,000 Other long-term investments 79,269,000 63,244,000 ------------------ ----------------- 354,919,000 370,925,000 ------------------ ----------------- Loans receivable 81,513,000 72,035,000 ------------------ ----------------- Property and equipment, at cost 640,216,000 503,580,000 Less--accumulated depreciation (197,631,000 (181,489,000) ------------------ ----------------- 442,585,000 322,091,000 ------------------ ----------------- Title plants and other indexes 234,410,000 216,711,000 ------------------ ----------------- Assets acquired in connection with claim settlements (net of valuation reserves of $10,620,000 and $11,135,000) 14,224,000 17,051,000 ------------------ ----------------- Deferred income taxes 19,234,000 16,324,000 ------------------ ----------------- Goodwill and other intangibles, net 223,652,000 187,106,000 ------------------ ----------------- Other assets 89,971,000 68,030,000 ------------------ ----------------- $1,984,176,000 $1,852,731,000 ================== ================= Liabilities and Stockholders' Equity Demand deposits $ 74,442,000 $ 67,404,000 ------------------ ----------------- Accounts payable and accrued liabilities 253,644,000 264,834,000 ------------------ ----------------- Deferred revenue 182,762,000 119,202,000 ------------------ ----------------- Reserve for known and incurred but not reported claims 266,083,000 272,921,000 ------------------ ----------------- Income taxes payable 22,734,000 ----------------- Notes and contracts payable 148,350,000 143,466,000 ------------------ ----------------- Minority interests in consolidated subsidiaries 97,625,000 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 - 65,247,000 and 63,120,000 shares 65,247,000 63,120,000 Additional paid-in capital 184,993,000 146,624,000 Retained earnings 607,894,000 544,783,000 Accumulated other comprehensive income 3,136,000 7,738,000 ------------------ ----------------- 861,270,000 762,265,000 ------------------ ----------------- $1,984,176,000 $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 Nine Months Ended September 30 September 30 -------------------------------- -------------------------------- 1999 1998 1999 1998 -------------- -------------- -------------- -------------- Revenues Operating revenues $ 745,267,000 $ 764,158,000 $2,213,782,000 $2,065,650,000 Investment and other income 17,325,000 10,870,000 41,250,000 64,014,000 -------------- -------------- -------------- -------------- 762,592,000 775,028,000 2,255,032,000 2,129,664,000 -------------- -------------- -------------- -------------- Expenses Salaries and other personnel costs 264,809,000 242,953,000 779,824,000 682,063,000 Premiums retained by agents 229,966,000 217,587,000 668,746,000 552,614,000 Other operating expenses 169,994,000 156,104,000 502,600,000 458,061,000 Provision for title losses and other claims 30,108,000 30,838,000 85,549,000 93,932,000 Depreciation and amortization 19,507,000 15,303,000 55,574,000 44,275,000 Premium taxes 5,829,000 5,755,000 17,125,000 15,330,000 Interest 4,001,000 4,728,000 11,822,000 14,225,000 -------------- -------------- -------------- -------------- 724,214,000 673,268,000 2,121,240,000 1,860,500,000 -------------- -------------- -------------- -------------- Income before income taxes and minority interests 38,378,000 101,760,000 133,792,000 269,164,000 Income taxes 13,700,000 35,600,000 46,900,000 95,400,000 -------------- -------------- -------------- -------------- Income before minority interests 24,678,000 66,160,000 86,892,000 173,764,000 Minority interests 2,738,000 9,992,000 11,853,000 26,163,000 -------------- -------------- -------------- -------------- Net income 21,940,000 56,168,000 75,039,000 147,601,000 -------------- -------------- -------------- -------------- Other comprehensive income (loss), net of tax: Unrealized gain (loss) on securities (3,584,000) 314,000 (4,199,000) 1,446,000 Minimum pension liability adjustment (172,000) - (403,000) -------------- -------------- -------------- -------------- (3,756,000) 314,000 (4,602,000) 1,446,000 -------------- -------------- -------------- -------------- Comprehensive income $ 18,184,000 $ 56,482,000 $ 70,437,000 $ 149,047,000 ============== ============== ============== ============== Net income per share: Basic $ .34 $0.91 $1.16 $2.49 ============== ============== ============== ============== Diluted $ .33 $0.87 $1.13 $2.39 ============== ============== ============== ============== Cash dividends per share $ .06 $ .07 $ .18 $ .17 ============== ============== ============== ============== Weighted average number of shares: Basic 65,213,000 61,597,000 64,564,000 59,310,000 ============== ============== ============== ============== Diluted 66,166,000 64,303,000 66,296,000 61,702,000 ============== ============== ============== ==============
3 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES ------------------------ Condensed Consolidated Statements of Cash Flows ----------------------------------------------- (Unaudited)
For the Nine Months Ended September 30 ------------------------------------ 1999 1998 -------------- ------------- Cash flows from operating activities: Net income $ 75,039,000 $ 147,601,000 Adjustments to reconcile net income to cash provided by operating activities- Provision for title losses and other claims 85,549,000 93,932,000 Depreciation and amortization 55,575,000 44,275,000 Minority interests in net income 11,853,000 26,163,000 Investment gain (5,160,000) (32,449,000) Other, net (805,000) (3,125,000) Changes in assets and liabilities excluding effects of company acquisitions and noncash transactions- Claims paid, including assets acquired, net of recoveries (82,328,000) (76,685,000) Net change in income tax accounts (39,661,000) 41,284,000 Increase in accounts and accrued income receivable (2,077,000) (43,668,000) (Decrease) increase in accounts payable and accrued liabilities (18,185,000) 47,079,000 Increase in deferred revenue 63,560,000 14,365,000 Other, net (17,025,000) (10,011,000) -------------- ------------- Cash provided by operating activities 126,335,000 248,761,000 -------------- ------------- Cash flows from investing activities: Net cash effect of company acquisitions/dispositions (37,436,000) 16,133,000 Net decrease in deposits with banks 6,914,000 5,579,000 Net increase in loans receivable (9,478,000) (4,916,000) Purchases of debt and equity securities (41,130,000) (125,200,000) Proceeds from sales of debt and equity securities 51,409,000 25,741,000 Proceeds from maturities of debt securities 11,083,000 29,330,000 Net decrease in other investments 4,257,000 229,000 Capital expenditures (173,067,000) (113,658,000) Proceeds from sale of property and equipment 4,008,000 879,000 -------------- ------------- Cash used for investing activities (183,440,000) (165,883,000) -------------- ------------- Cash flows from financing activities: Net change in demand deposits 7,038,000 1,810,000 Proceeds from issuance of senior debentures 99,456,000 Proceeds from issuance of debt 734,000 4,740,000 Repayment of debt (12,856,000) (24,081,000) Proceeds from excercise of stock options 3,739,000 2,996,000 Proceeds from issuance of stock to employee savings plan 4,794,000 14,440,000 Distributions to minority shareholders (8,467,000) (11,191,000) Cash dividends (11,928,000) (12,198,000) -------------- ------------- Cash (used for) provided by financing activities (16,946,000) 75,972,000 -------------- ------------- Net (decrease) increase in cash and cash equivalents (74,051,000) 158,850,000 Cash and cash equivalents - Beginning of year 381,293,000 183,269,000 -------------- ------------- - End of third quarter $ 307,242,000 $ 342,119,000 ============== ============= Supplemental information: Cash paid during the three quarters for: Interest $ 8,731,000 $ 7,627,000 Premium taxes $ 20,471,000 $ 15,233,000 Income taxes $ 88,466,000 $ 57,640,000 Noncash investing and financing activities: Shares issued for stock bonus plan $ 3,369,000 $ 2,637,000 Liabilities incurred in connection with company acquisitions $ 10,795,000 $ 117,821,000 Company acquisitions in exchange for common stock $ 28,594,000 $ 84,389,000
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 $7.1 million and $21.7 million, or $0.11 per diluted share and $0.33 per diluted share, for the three and nine months ended September 30, 1999, respectively. Note 3 - Business Combinations - ------------------------------ During the nine months ended September 30, 1999, the Company acquired fifteen 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 $32.3 million in cash, $11.8 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 $43.4 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 $2,266.0 million, $74.4 million and $1.12, respectively, for the nine months ended September 30, 1999, and $2,170.7 million, $148.8 million and $2.40, respectively for the nine months ended September 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 nine months ended September 30, 1999, were merger-related charges of $10.8 million, $7.0 million after tax, or $0.10 per diluted share. These 5 nonrecurring charges 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:
Three Months Ended Nine Months Ended (in thousands) September 30, 1998 September 30, 1998 ------------------ ------------------ Revenues: First American $758,034 $2,080,047 NAIG 16,994 49,617 -------- ---------- $775,028 $2,129,664 ======== ========== Net income: First American $ 55,260 $ 145,692 NAIG 908 1,909 -------- ---------- $ 56,168 $ 147,601 ======== ========== Net income (loss) per diluted share: First American $ 0.89 $ 2.47 NAIG (0.02) (0.08) -------- ---------- $ 0.87 $ 2.39 ======== ==========
Note 4 - Business Segments - -------------------------- During the second quarter 1999, the Company restructured its business segments to more accurately reflect a change in 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; continued consolidation among the Company's customers; consolidation among significant competitors; the impact of the legal proceedings commenced by the California attorney general and related litigation; the continued ability to identify businesses to be acquired; changes in the Company's ability to integrate businesses which it acquires 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, any 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 nine months ended September 30: OVERVIEW Low mortgage interest rates and high consumer confidence, coupled with a particularly strong California real estate market, resulted in strong revenues and net income for the Company for the nine months ended September 30, 1998. These conditions continued throughout the remainder of 1998 and into 1999, resulting in record-setting first half of the year revenues for the six months ended June 30, 1999. However, commencing in 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. During the third quarter 1999, the trend of higher interest rates and low refinance transactions continued. On a Company-wide basis, refinance transactions for the third quarter 1999 declined approximately 60 percent when compared with the same period of the prior year. The current three- month-period was also marked by a decrease in consumer confidence and seasonal factors. New orders continued to decline, including residential resale transactions. Also impacting the current three-month period as well as the current nine-month period was 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 $7.1 million, or $0.11 per diluted share, and $21.7 million, or $0.33 per diluted share, for the three and nine months ended September 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 third quarter 1999 was $21.9 million and $0.33, respectively. Net income and net income per diluted share for the nine months ended September 30, 1999 was $75.0 million and $1.13, 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) 1999 % 1998 % 1999 % 1998 % ---------- --- ---------- --- ---------- --- ---------- --- Title Insurance: Direct operations $ 273,310 37 $ 286,265 37 $ 813,640 37 $ 786,811 38 Agency operations 286,077 38 269,983 35 831,590 37 690,038 34 ---------- --- ---------- --- ---------- --- ---------- --- 559,387 75 556,248 72 1,645,230 74 1,476,849 72 Real Estate Information 130,757 18 160,099 22 418,484 19 459,059 22 Consumer Information 55,123 7 47,811 6 150,068 7 129,742 6 ---------- --- ---------- --- ---------- --- ---------- --- Total $ 745,267 100 $ 764,158 100 $2,213,782 100 $2,065,650 100 ========== === ========== === ========== === ========== ===
7 Title Insurance. Operating revenues from direct title operations for the three months ended September 30, 1999, decreased 4.5% when compared with the same period of the prior year. This decrease was primarily attributable to a decrease in the number of title orders closed by the Company's direct operations, offset in part by an increase in the average revenues per order closed. The Company's direct operations closed 276,700 title orders during the three months ended September 30,1999, a decrease of 11.0% when compared with the same period of the prior year. This decrease was primarily due to the significant decline in refinance transactions and a decrease in consumer confidence (see Overview section above). The average revenues per order closed were $988 for the current three-month period, as compared with $921 for the same period of the prior year. This increase was primarily attributable to the shift in the mix of business from refinance to resale. Operating revenues from direct title operations for the nine months ended September 30, 1999, increased 3.4% when compared with the same period of the prior year. This increase was primarily due 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 890,800 title orders during the current nine-month period, an increase of 2.0% when compared with the same period of the prior year. This increase was primarily due to the relatively low mortgage interest rates and high consumer confidence that marked the first half of the current year (see Overview section). The average revenues per order closed were $913 for the current nine-month period, as compared with $901 for the same period of the prior year. This increase was primarily due to the shift in the mix of business from refinance to resale. Operating revenues from agency operations increased 6.0% and 20.5% for the three and nine months ended September 30, 1999, respectively, when compared with the same periods of the prior year. These increases were primarily due to the inherent delay in reporting by agents and reflects the strong second quarter closings experienced by the Company's agents. Real Estate Information. Real estate information operating revenues decreased 18.3% and 8.8% for the three and nine months ended September 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 $6.3 million and $19.3 million of operating revenues contributed by new acquisitions for the respective periods. The revenue recognition change resulted in a decrease in operating revenues of $14.5 million and $44.1 million for the three and nine months ended September 30, 1999, respectively. Consumer Information. Consumer information operating revenues increased 15.3% and 15.7% for the three and nine months ended September 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 $2.2 million and $3.5 million of operating revenues contributed by new acquisitions for the three and nine months ended September 30, 1999, respectively. INVESTMENT AND OTHER INCOME Investment and other income totaled $17.3 million for the three months ended September 30, 1999, an increase of $6.4 million when compared with the same period of the prior year. This increase was primarily due to a $5.2 million gain resulting from stock received in the demutualization of a life insurance company which insures a large portion of the Company's corporate-owned life insurance portfolio and an increase in the average investment portfolio balance. Investment and other income totaled $41.3 million for the nine months ended September 30, 1999, a decrease of $22.8 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 an increase in the average investment portfolio balance. TOTAL OPERATING EXPENSES Title Insurance. Salaries and other personnel costs were $188.9 million and $550.2 million for the three and nine months ended September 30, 1999, respectively, increases of 11.8% and 16.0% when compared with the same periods of the prior year. These increases reflect the costs associated with the relatively high number of employees added during the prior year and beginning of the current year in order to service the volume of orders processed during those periods. The Company has initiated personnel and other cost reduction programs in response to the subsequent decrease in business volume. During the three months ended September 30, 1999, title insurance staffing levels were reduced by 7.3%, however, because of separation costs, the benefits of these reductions will not be realized until the fourth quarter 1999. Contributing to the increases in salaries and other personnel costs were $5.7 million and $16.4 million of personnel costs associated with new acquisitions. Agents retained $230.0 million and $668.7 million of title premiums generated by agency operations for the three and nine months ended September 30, 1999, respectively, which compares with $217.6 million and $552.6 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). 8 Other operating expenses were $83.4 million and $238.2 million for the three and nine months ended September 30, 1999, respectively, increases of 7.5% and 6.6% when compared with the same periods of the prior year. These increases were primarily attributable to $2.6 million and $7.7 million of costs associated with new acquisitions for the respective periods, a $2.5 million charge in the third quarter 1999 resulting from a previously announced fine imposed by the California insurance commissioner, approximately $2.0 million of impaired asset write-offs during the current three-month period, Y2K costs and general price level increases, offset in part by a reduction in certain incremental costs associated with the decline in title order volume and 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 nine months ended September 30, 1999 and 3.6% 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 $15.9 million and $14.3 million for the nine months ended September 30, 1999 and 1998, respectively. Expressed as a percentage of title insurance operating revenues, premium taxes were 1.0% for both periods. Real Estate Information. Real estate information personnel and other operating expenses were $117.8 million for the three months ended September 30, 1999, a decrease of 1.0% when compared with the same period of the prior year. This decrease was primarily attributable to a reduction in costs resulting from the Company's cost-containment programs initiated in response to the decrease in business volume, offset in part by approximately $5.7 million of Y2K expenses and $5.0 million of costs associated with new acquisitions. Real estate information personnel and other operating expenses were $366.4 million for the nine months ended September 30, 1999, an increase of 7.6% when compared with the same period of the prior year. This increase was primarily attributable to $12.7 million of expenses associated with Y2K and $14.5 million of costs associated with new acquisitions. Consumer Information. Consumer information personnel and other operating expenses were $35.5 million and $95.8 million for the three and nine months ended September 30, 1999, respectively, increases of 20.3% and 18.6% when compared with the same periods of the prior year. These increases were primarily attributable to costs incurred servicing the increased business volume as well as $1.6 million and $2.4 million of costs associated with new acquisitions for the three and nine months ended September 30, 1999, respectively. 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) 1999 % 1998 % 1999 % 1998 % -------- --- -------- --- -------- --- -------- --- Title Insurance $ 31,947 69 $ 67,703 63 $116,183 69 $154,359 59 Real Estate Information 3,156 7 32,901 30 24,394 14 86,631 33 Consumer Information 10,910 24 7,431 7 28,054 17 21,478 8 -------- --- -------- --- -------- --- -------- --- Total before corporate expenses 46,013 100 108,035 100 168,631 100 262,468 100 === === === === Corporate expenses (7,635) (6,275) (34,839) 6,696 -------- -------- -------- -------- Total $ 38,378 $101,760 $133,792 $269,164 ======== ======== ======== ========
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 profits are generally unaffected by the type of real estate activity but increase or decrease based on the volume of residential real estate loan transactions. Consumer information profits are unaffected by real estate or interest rate activity 9 and increase as the level of business volume increases. 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 nine months ended September 30, 1999, are $10.8 million of nonrecurring merger-related charges incurred in the NAIG acquisition. Included in Corporate for the nine months ended September 30, 1998, is an investment gain of $32.4 million relating to the joint venture with Experian. INCOME TAXES The effective income tax rate was 35.1% for the nine months ended September 30, 1999, and 35.4% 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 $2.7 million for the three months ended September 30, 1999, a decrease of $7.3 million when compared with the same period of the prior year. Minority interest expense was $11.9 million for the nine months ended September 30, 1999, a decrease of $14.3 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 nine months ended September 30, 1999, was $21.9 million, or $0.33 per diluted share, and $75.0 million, or $1.13 per diluted share, respectively. Net income for the three and nine months ended September 30, 1998, was $56.2 million, or $0.87 per diluted share, and $147.6 million, or $2.39 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 $0.32 per diluted share, relating to the joint venture with Experian. LIQUIDITY AND CAPITAL RESOURCES Total cash and cash equivalents decreased $74.1 million and increased $158.9 million for the nine months ended September 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, offset in part by cash provided by operating activities. 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 deb t. On April 7, 1998, the Company issued and sold $100.0 million of 7.55% senior debentures, due April 1, 2028. The Company used the net proceeds from the sale to repay certain debt obligations, purchase land for and construct the Company's new corporate facilities and for general corporate purposes. 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. Notes and contracts payable as a percentage of total capitalization decreased to 12.3% at September 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. Management believes that all of its anticipated cash requirements for the immediate future will be met from internally generated funds. 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 10 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 - From inception of the plan to date, the Company has spent approximately $35 million in implementing the Year 2000 plan. The Company expects to incur an additional $3 million to complete the Year 2000 plan. Approximately $28 million of the expenditures to date have been for labor and $7 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 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 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 (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 July 22, 1999 (reporting on the Company's second quarter earnings). Prior to such quarterly period, the Company filed reports on Form 8-K dated February 10, 1999 (reporting on a change in the Company's method of recognizing revenues from tax service contracts), April 23, 1999 (reporting on the Company's first quarter earnings) and 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 - ----------- ----------- ------------- (27) Financial Data Schedule 13 EX-27 2 FINANCIAL DATA SCHEDULE
7 9-MOS DEC-31-1998 JAN-01-1999 SEP-30-1999 203,546,000 0 0 39,519,000 0 0 354,919,000 307,242,000 0 9,675,000 1,984,176,000 266,083,000 0 0 0 148,350,000 0 0 65,247,000 796,023,000 1,984,176,000 2,213,782,000 39,615,000 1,635,000 0 85,549,000 0 0 121,939,000 46,900,000 75,039,000 0 0 0 75,039,000 1.16 1.13 0 0 0 0 0 0 0
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