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 March 31, 2003
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 CORPORATION | ||
| (Exact name of registrant as specified in its charter) |
| Incorporated in California |
95-1068610 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
| 1 First American Way, Santa Ana, California |
92707-5913 | |
| (Address of principal executive offices) |
(Zip Code) | |
| (714) 800-3000 |
| (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 ¨
Indicate by check mark if the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
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 - 76,231,151 shares as of May 6 , 2003
INFORMATION INCLUDED IN REPORT
| Part I: |
Financial Information | |
| Item 1. |
Financial Statements | |
| A. Condensed Consolidated Balance Sheets | ||
| B. Condensed Consolidated Statements of Income and Comprehensive 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 | |
| Item 4. |
Controls and Procedures | |
| Part II: |
Other Information | |
| Item 6. |
Exhibits and Reports on Form 8-K | |
| Items 1-5 have been omitted because they are not applicable with respect to the current reporting period. |
Part I: Financial Information
Item 1: Financial Statements
THE FIRST AMERICAN CORPORATION
AND SUBSIDIARY COMPANIES
Condensed Consolidated Balance Sheets
(Unaudited)
| March 31, 2003 |
December 31, 2002 |
|||||||
| Assets |
||||||||
| Cash and cash equivalents |
$ |
942,874,000 |
|
$ |
900,863,000 |
| ||
| Accounts and accrued income receivable, net |
|
345,773,000 |
|
|
299,040,000 |
| ||
| Investments: |
||||||||
| Deposits with savings and loan associations and banks |
|
26,104,000 |
|
|
38,328,000 |
| ||
| Debt securities |
|
320,251,000 |
|
|
309,864,000 |
| ||
| Equity securities |
|
36,219,000 |
|
|
36,931,000 |
| ||
| Other long-term investments |
|
186,618,000 |
|
|
142,392,000 |
| ||
|
|
569,192,000 |
|
|
527,515,000 |
| |||
| Loans receivable, net |
|
108,111,000 |
|
|
108,162,000 |
| ||
| Property and equipment, at cost: |
||||||||
| Land |
|
43,237,000 |
|
|
43,185,000 |
| ||
| Buildings |
|
181,332,000 |
|
|
183,045,000 |
| ||
| Furniture and equipment |
|
267,044,000 |
|
|
270,004,000 |
| ||
| Capitalized software |
|
288,434,000 |
|
|
284,537,000 |
| ||
|
|
780,047,000 |
|
|
780,771,000 |
| |||
| Less—accumulated depreciation and amortization |
|
(352,103,000 |
) |
|
(347,695,000 |
) | ||
|
|
427,944,000 |
|
|
433,076,000 |
| |||
| Title plants and other indexes |
|
381,686,000 |
|
|
375,401,000 |
| ||
| Deferred income taxes |
|
14,089,000 |
|
|
20,951,000 |
| ||
| Goodwill, net |
|
559,269,000 |
|
|
563,991,000 |
| ||
| Other assets |
|
189,035,000 |
|
|
169,046,000 |
| ||
| $ |
3,537,973,000 |
|
$ |
3,398,045,000 |
| |||
| Liabilities and Stockholders' Equity |
||||||||
| Demand deposits |
$ |
84,888,000 |
|
$ |
84,473,000 |
| ||
| Accounts payable and accrued liabilities |
|
470,710,000 |
|
|
539,069,000 |
| ||
| Deferred revenue |
|
375,312,000 |
|
|
358,747,000 |
| ||
| Reserve for known and incurred but not reported claims |
|
367,812,000 |
|
|
360,305,000 |
| ||
| Income taxes payable |
|
45,913,000 |
|
|
1,518,000 |
| ||
| Notes and contracts payable |
|
431,011,000 |
|
|
425,705,000 |
| ||
| Minority interests in consolidated subsidiaries |
|
172,739,000 |
|
|
163,639,000 |
| ||
| 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—75,937,000 and 73,636,000 shares |
|
75,937,000 |
|
|
73,636,000 |
| ||
| Additional paid-in capital |
|
405,891,000 |
|
|
359,644,000 |
| ||
| Retained earnings |
|
1,067,752,000 |
|
|
987,768,000 |
| ||
| Accumulated other comprehensive loss |
|
(59,992,000 |
) |
|
(56,459,000 |
) | ||
|
|
1,489,588,000 |
|
|
1,364,589,000 |
| |||
| $ |
3,537,973,000 |
|
$ |
3,398,045,000 |
| |||
See notes to condensed consolidated financial statements.
3
THE FIRST AMERICAN CORPORATION
AND SUBSIDIARY COMPANIES
Condensed Consolidated Statements of Income and Comprehensive Income
(Unaudited)
| For the Three Months Ended March 31 |
||||||||
| 2003 |
2002 |
|||||||
| Revenues |
||||||||
| Operating revenues |
$ |
1,304,863,000 |
|
$ |
1,023,340,000 |
| ||
| Investment and other income |
|
24,567,000 |
|
|
18,803,000 |
| ||
| Net realized investment gains |
|
12,545,000 |
|
|
59,000 |
| ||
|
|
1,341,975,000 |
|
|
1,042,202,000 |
| |||
| Expenses |
||||||||
| Salaries and other personnel costs |
|
407,217,000 |
|
|
345,325,000 |
| ||
| Premiums retained by agents |
|
365,709,000 |
|
|
284,294,000 |
| ||
| Other operating expenses |
|
293,387,000 |
|
|
237,358,000 |
| ||
| Provision for policy losses and other claims |
|
67,239,000 |
|
|
47,099,000 |
| ||
| Depreciation and amortization |
|
26,015,000 |
|
|
24,148,000 |
| ||
| Premium taxes |
|
10,456,000 |
|
|
7,199,000 |
| ||
| Interest |
|
8,459,000 |
|
|
8,220,000 |
| ||
|
|
1,178,482,000 |
|
|
953,643,000 |
| |||
| Income before income taxes and minority interests |
|
163,493,000 |
|
|
88,559,000 |
| ||
| Income taxes |
|
56,000,000 |
|
|
31,000,000 |
| ||
| Income before minority interests |
|
107,493,000 |
|
|
57,559,000 |
| ||
| Minority interests |
|
19,913,000 |
|
|
13,484,000 |
| ||
| Net income |
|
87,580,000 |
|
|
44,075,000 |
| ||
| Other comprehensive loss, net of tax |
||||||||
| Unrealized loss on securities |
|
(433,000 |
) |
|
(535,000 |
) | ||
| Minimum pension liability adjustment |
|
(3,100,000 |
) |
|
(2,275,000 |
) | ||
|
|
(3,533,000 |
) |
|
(2,810,000 |
) | |||
| Comprehensive income |
$ |
84,047,000 |
|
$ |
41,265,000 |
| ||
| Net income per share (Note 2): |
||||||||
| Basic |
$ |
1.18 |
|
$ |
0.63 |
| ||
| Diluted |
$ |
1.05 |
|
$ |
0.57 |
| ||
| Cash dividends per share |
$ |
.10 |
|
$ |
.07 |
| ||
| Weighted average number of shares (Note 2): |
||||||||
| Basic |
|
74,159,000 |
|
|
69,995,000 |
| ||
| Diluted |
|
85,098,000 |
|
|
80,985,000 |
| ||
See notes to condensed consolidated financial statements.
4
THE FIRST AMERICAN CORPORATION
AND SUBSIDIARY COMPANIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| For the Three Months Ended March 31 |
||||||||
| 2003 |
2002 |
|||||||
| Cash flows from operating activities: |
||||||||
| Net income |
$ |
87,580,000 |
|
$ |
44,075,000 |
| ||
| Adjustments to reconcile net income to cash provided by operating activities— |
||||||||
| Provision for policy losses and other claims |
|
67,239,000 |
|
|
47,099,000 |
| ||
| Depreciation and amortization |
|
26,015,000 |
|
|
24,148,000 |
| ||
| Minority interests in net income |
|
19,913,000 |
|
|
13,484,000 |
| ||
| Net investment gains |
|
(12,545,000 |
) |
|
(59,000 |
) | ||
| Other, net |
|
(15,343,000 |
) |
|
(7,908,000 |
) | ||
| Changes in assets and liabilities excluding effects of company acquisitions and noncash transactions— |
||||||||
| Claims paid, net of recoveries |
|
(63,604,000 |
) |
|
(36,500,000 |
) | ||
| Net change in income tax accounts |
|
49,298,000 |
|
|
14,591,000 |
| ||
| Increase in accounts and accrued income receivable |
|
(49,014,000 |
) |
|
(17,662,000 |
) | ||
| Decrease in accounts payable and accrued liabilities |
|
(27,878,000 |
) |
|
(17,862,000 |
) | ||
| Increase in deferred revenue |
|
16,450,000 |
|
|
12,910,000 |
| ||
| Other, net |
|
(15,271,000 |
) |
|
(20,783,000 |
) | ||
| Cash provided by operating activities |
|
82,840,000 |
|
|
55,533,000 |
| ||
| Cash flows from investing activities: |
||||||||
| Net cash effect of company acquisitions/dispositions |
|
(9,929,000 |
) |
|
(11,257,000 |
) | ||
| Net decrease (increase) in deposits with banks |
|
12,224,000 |
|
|
(9,496,000 |
) | ||
| Net decrease (increase) in loans receivable |
|
51,000 |
|
|
(1,003,000 |
) | ||
| Purchases of debt and equity securities |
|
(59,904,000 |
) |
|
(57,978,000 |
) | ||
| Proceeds from sales of debt and equity securities |
|
37,547,000 |
|
|
7,314,000 |
| ||
| Proceeds from maturities of debt securities |
|
12,772,000 |
|
|
36,274,000 |
| ||
| Net decrease in other investments |
|
5,009,000 |
|
|
2,392,000 |
| ||
| Capital expenditures |
|
(21,932,000 |
) |
|
(20,662,000 |
) | ||
| Purchases of capitalized data |
|
(4,820,000 |
) |
|
(3,477,000 |
) | ||
| Proceeds from sale of property and equipment |
|
607,000 |
|
|
134,000 |
| ||
| Cash used for investing activities |
|
(28,375,000 |
) |
|
(57,759,000 |
) | ||
| Cash flows from financing activities: |
||||||||
| Net change in demand deposits |
|
415,000 |
|
|
733,000 |
| ||
| Proceeds from issuance of debt |
|
7,030,000 |
|
|
677,000 |
| ||
| Repayment of debt |
|
(8,548,000 |
) |
|
(5,072,000 |
) | ||
| Proceeds from exercise of stock options |
|
4,502,000 |
|
|
3,406,000 |
| ||
| Proceeds from the issuance of stock to employee benefit plans |
|
1,774,000 |
|
|
1,264,000 |
| ||
| Distributions to minority shareholders |
|
(10,031,000 |
) |
|
(6,424,000 |
) | ||
| Cash dividends |
|
(7,596,000 |
) |
|
(5,702,000 |
) | ||
| Cash used for financing activities |
|
(12,454,000 |
) |
|
(11,118,000 |
) | ||
| Net increase (decrease) in cash and cash equivalents |
|
42,011,000 |
|
|
(13,344,000 |
) | ||
| Cash and cash equivalents —Beginning of year |
|
900,863,000 |
|
|
645,240,000 |
| ||
| —End of first quarter |
$ |
942,874,000 |
|
$ |
631,896,000 |
| ||
| Supplemental information: |
||||||||
| Cash paid during the first quarter for: |
||||||||
| Interest |
$ |
6,357,000 |
|
$ |
1,452,000 |
| ||
| Premium taxes |
$ |
17,124,000 |
|
$ |
9,127,000 |
| ||
| Income taxes |
$ |
7,825,000 |
|
$ |
16,146,000 |
| ||
| Noncash investing and financing activities: |
||||||||
| Shares issued for employee benefit plans |
$ |
42,272,000 |
|
$ |
17,491,000 |
| ||
| Liabilities incurred in connection with company acquisitions |
$ |
13,840,000 |
|
$ |
8,827,000 |
| ||
| Company acquisitions in exchange for common stock |
$ |
26,380,000 |
| |||||
See notes to condensed consolidated financial statements.
5
THE FIRST AMERICAN 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 Securities and Exchange 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, 2002.
Note 2 – Earnings Per Share
| For the Three Months Ended March 31 | ||||||
| 2003 |
2002 | |||||
| Numerator: |
||||||
| Net Income—numerator for basic net income per share |
$ |
87,580,000 |
$ |
44,075,000 | ||
| Effect of dilutive securities |
||||||
| Convertible debt—interest expense (net of tax) |
|
1,723,000 |
|
1,773,000 | ||
| Net Income—numerator for dilutive net income per share |
$ |
89,303,000 |
$ |
45,848,000 | ||
| Denominator |
||||||
| Weighted average shares—denominator For basic net income per share |
|
74,159,000 |
|
69,995,000 | ||
| Effect of dilutive securities: |
||||||
| Employee stock options |
|
2,496,000 |
|
2,396,000 | ||
| Convertible debt |
|
8,443,000 |
|
8,594,000 | ||
| Denominator for diluted net income per share |
|
85,098,000 |
|
80,985,000 | ||
| Basic net income per share |
$ |
1.18 |
$ |
0.63 | ||
| Diluted net income per share |
$ |
1.05 |
$ |
0.57 | ||
For the three months ended March 31, 2003 and 2002, respectively, 3,414,000 and 3,818,000 stock options were excluded from the computation of diluted earnings per share due to their antidilutive effect.
Note 3 – Stock Options
Effective December 15, 2002, the Company adopted Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, which amends Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation” (SFAS 148). In accounting for its plans, the Company, as allowable under the provisions of SFAS 148, applies Accounting Principles Board Opinions No. 25, “Accounting for Stock issued to Employees.” As a result of this election, the Company does not recognize compensation expense for its stock option plans. Had the Company determined compensation cost based on the fair value for its stock options at grant date, net income and earnings per share would have been reduced to the pro forma amounts as follows:
6
| For the Three Months Ended March 31, | ||||||
| 2003 |
2002 | |||||
| Net income: |
||||||
| As reported |
$ |
87,580,000 |
$ |
44,075,000 | ||
| Pro forma |
$ |
86,463,000 |
$ |
42,842,000 | ||
| Earnings per share: |
||||||
| As reported |
||||||
| Basic |
$ |
1.18 |
$ |
0.63 | ||
| Diluted |
$ |
1.05 |
$ |
0.57 | ||
| Pro forma |
||||||
| Basic |
$ |
1.17 |
$ |
0.61 | ||
| Diluted |
$ |
1.04 |
$ |
0.55 | ||
Note 4 – Business Combinations
During the three months ended March 31, 2003, the Company acquired three companies. These acquisitions were not material individually or in the aggregate. Two of the acquisitions have been included in the Company’s title insurance segment and one in the Company’s property information segment. The aggregate purchase price was $8.4 million in cash and $6.2 million in notes payable. The purchase price for each was allocated to the assets acquired and liabilities assumed using a variety of valuation techniques including discounted cash flow analysis. As a result of these acquisitions, the Company recorded approximately $5.3 million of intangible assets with definite lives and $5.8 million of goodwill.
Note 5 – Segment Information
The Company has seven reporting segments that fall within two primary business groups, Financial Services and Information Technology. The Financial Services Group includes Title Insurance and Services, Specialty Insurance and Trust and Other Services. The Information Technology Group includes Mortgage Information, Property Information, Credit Information and Screening Information. Selected financial information by reporting segment is as follows:
| For the three months ended March 31, 2003 |
Revenues |
Income (loss) before income taxes and minority interests |
Depreciation and amortization |
Capital expenditures | |||||||||
| Financial Services |
|||||||||||||
| Title Insurance and Services |
$ |
944,391,000 |
$ |
86,766,000 |
|
$ |
9,312,000 |
$ |
9,611,000 | ||||
| Specialty Insurances |
|
48,584,000 |
|
5,839,000 |
|
|
422,000 |
|
204,000 | ||||
| Trust and Other Services |
|
9,851,000 |
|
2,441,000 |
|
|
229,000 |
|
8,000 | ||||
|
|
1,002,826,000 |
|
95,046,000 |
|
|
9,963,000 |
|
9,823,000 | |||||
| Information Technology |
|||||||||||||
| Mortgage Information |
|
141,877,000 |
|
45,797,000 |
|
|
3,795,000 |
|
2,556,000 | ||||
| Property Information |
|
87,441,000 |
|
23,443,000 |
|
|
5,482,000 |
|
3,041,000 | ||||
| Credit Information |
|
78,046,000 |
|
26,607,000 |
|
|
3,145,000 |
|
1,243,000 | ||||
| Screening Information |
|
31,618,000 |
|
515,000 |
|
|
1,785,000 |
|
1,504,000 | ||||
|
|
338,982,000 |
|
96,362,000 |
|
|
14,207,000 |
|
8,344,000 | |||||
|
|
1,341,808,000 |
|
191,408,000 |
|
|
24,170,000 |
|
18,167,000 | |||||
| Corporate |
|
167,000 |
|
(27,915,000 |
) |
|
1,845,000 |
|
3,765,000 | ||||
| $ |
1,341,975,000 |
$ |
163,493,000 |
|
$ |
26,015,000 |
$ |
21,932,000 | |||||
| For the three months ended March 31, 2002 |
Revenues |
Income (loss) before income taxes and minority interests |
Depreciation and amortization |
Capital expenditures | |||||||||
| Financial Services |
|||||||||||||
| Title Insurance and Services |
$ |
751,141,000 |
$ |
39,652,000 |
|
$ |
11,801,000 |
$ |
9,444,000 | ||||
| Specialty Insurances |
|
31,567,000 |
|
5,682,000 |
|
|
293,000 |
|
509,000 | ||||
| Trust and Other Services |
|
11,136,000 |
|
4,225,000 |
|
|
291,000 |
|
13,000 | ||||
|
|
793,844,000 |
|
49,559,000 |
|
|
12,385,000 |
|
9,966,000 | |||||
| Information Technology |
|||||||||||||
| Mortgage Information |
|
109,552,000 |
|
31,505,000 |
|
|
2,136,000 |
|
1,832,000 | ||||
| Property Information |
|
58,473,000 |
|
11,645,000 |
|
|
4,374,000 |
|
2,775,000 | ||||
| Credit Information |
|
56,632,000 |
|
12,653,000 |
|
|
2,809,000 |
|
3,199,000 | ||||
| Screening Information |
|
22,754,000 |
|
782,000 |
|
|
558,000 |
|
919,000 | ||||
|
|
247,411,000 |
|
56,585,000 |
|
|
9,877,000 |
|
8,725,000 | |||||
|
|
1,041,255,000 |
|
106,144,000 |
|
|
22,262,000 |
|
18,691,000 | |||||
| Corporate |
|
947,000 |
|
(17,585,000 |
) |
|
1,886,000 |
|
1,971,000 | ||||
| $ |
1,042,202,000 |
$ |
88,559,000 |
|
$ |
24,148,000 |
$ |
20,662,000 | |||||
Note 6 – Goodwill and Other Intangible Assets
The Company’s reporting units for purposes of the annual testing for impairment of goodwill are title insurance, home warranty, property and casualty insurance, trust and other services, mortgage origination products and services, mortgage servicing products and services, property information services, conventional credit information, sub-prime credit information, pre-employment and drug screening, and tenant screening.
A reconciliation of the changes in the carrying amount of net goodwill, by operating segment, for the three months ended March 31, 2003, is as follows:
| Balance as of December 31, 2002 |
Acquired (Disposed of) During the Period |
Impairment Losses |
Balance as of March 31, 2003 | ||||||||||
| Financial Services |
|||||||||||||
| Title Insurance and Services |
$ |
149,013,000 |
$ |
— |
|
$ |
— |
$ |
149,013,000 | ||||
| Specialty Insurances |
|
19,794,000 |
|
— |
|
|
— |
|
19,794,000 | ||||
| Trust and Other Services |
|
— |
|
— |
|
|
— |
|
— | ||||
| Information Technology |
|||||||||||||
| Mortgage Information |
|
72,423,000 |
|
— |
|
|
— |
|
72,423,000 | ||||
| Property Information |
|
124,678,000 |
|
5,840,000 |
|
|
— |
|
130,518,000 | ||||
| Credit Information |
|
86,900,000 |
|
(10,562,000 |
) |
|
— |
|
76,338,000 | ||||
| Screening Information |
|
111,183,000 |
|
— |
|
|
— |
|
111,183,000 | ||||
| $ |
563,991,000 |
$ |
(4,722,000 |
) |
$ |
— |
$ |
559,269,000 | |||||
The Company had $30.4 million of intangible assets including in “Other assets” at March 31, 2003, with definite lives ranging from three to seven years. These assets, comprised primarily of customer lists and noncompete agreements, are being amortized in a manner consistent with periods prior to the adoption of SFAS 142.
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Certain statements made in this 10-Q, including those relating to anticipated cash requirements, are forward looking. Risks and uncertainties exist which may cause results to differ materially from those set forth in these forward-looking statements. Factors that could cause the anticipated results to differ from those described in the forward-looking statements include: interest rate fluctuations; changes in the performance of the real estate markets; general volatility in the capital markets; changes in applicable government regulations; consolidation among the Company’s significant customers and competitors; the Company’s continued ability to identify businesses to be acquired; changes in the Company’s ability to integrate businesses which it acquires; and other factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, filed with the Securities and Exchange Commission. The forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies used in the preparation of the Company’s financial statements that require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosure of contingencies. A summary of these policies can be found in Management’s Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
OVERVIEW
Elevated levels of mortgage applications in the fourth quarter of 2002 produced strong order closings in the current quarter, which contributed to a record-breaking first quarter in the real estate-related segments of the Company’s Financial Services and Information Technology groups. Net income for the three months ended March 31, 2003, was $87.6 million, or $1.05 per diluted share. Net income for the three months ended March 31, 2002 was $44.1 million, or $0.57 per diluted share. The current year quarter includes a realized pretax gain on the merger of the Company’s Credit Online business with DealerTrack Holdings, Inc. of $13.1 million, $8.0 million on an after-tax basis, or $0.09 per diluted share.
9
OPERATING REVENUES
Set forth below is a summary of operating revenues for each of the Company’s segments.
| Three Months Ended March 31 | ||||||||||
| ($000) | ||||||||||
| 2003 |
% |
2002 |
% | |||||||
| Financial Services: |
||||||||||
| Title Insurance: |
||||||||||
| Direct operations |
$ |
484,308 |
37 |
$ |
387,174 |
38 | ||||
| Agency operations |
|
448,996 |
34 |
|
356,797 |
35 | ||||
|
|
933,304 |
71 |
|
743,971 |
73 | |||||
| Specialty Insurance |
|
46,144 |
4 |
|
29,312 |
3 | ||||
| Trust and Other Services |
|
9,905 |
1 |
|
11,156 |
1 | ||||
|
|
989,353 |
76 |
|
784,439 |
77 | |||||
| Information Technology: |
||||||||||
| Mortgage Information |
|
139,108 |
11 |
|
108,130 |
11 | ||||
| Property Information |
|
82,280 |
6 |
|
55,110 |
5 | ||||
| Credit Information |
|
62,528 |
5 |
|
52,999 |
5 | ||||
| Screening Information |
|
31,594 |
2 |
|
22,662 |
2 | ||||
|
|
315,510 |
24 |
|
238,901 |
23 | |||||
| Total |
$ |
1,304,863 |
100 |
$ |
1,023,340 |
100 | ||||
Financial Services. Operating revenues from direct title operations increased 25.1% for the current quarter 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 and an increase in the average revenues per order closed. The Company’s direct operations closed 455,700 title orders during the current three month period, an increase of 16.0% when compared with 393,000 title orders closed during the same period of the prior year. This increase was primarily due to the high level of real estate activity. The average revenues per order closed were $1,063 for the three months ended March 31, 2003, an increase of 7.9% when compared with $985 for the three months ended March 31, 2002. This increase was primarily due to appreciating home values. Operating revenues from agency operations increased 25.8% for the current quarter when compared with the same period of the prior year. This increase was primarily due to the same factor affecting direct operations, as well as the timing of the reporting of agency remittances. Specialty insurance operating revenues increased 57.4% for the current quarter when compared with the same period of the prior year. This increase was primarily due to market share growth at the property and casualty insurance division and geographic expansion at the Company’s home warranty division. Trust and other services operating revenues decreased 11.2% for the current quarter when compared with the same period of the prior year. This decrease was primarily attributable to a reduction in fees earned do to the declining values of the investment portfolios managed by this segment.
Information Technology. Operating revenues for the mortgage information, property information and credit information segments increased 28.7%, 49.3% and 18.0%, respectively, for the three months ended March 31, 2003, when compared with the same period of the prior year. These increases were primarily due to the high level of real estate activity, and for the property information segment, $12.2 million of operating revenues contributed by new acquisitions. Screening information operating revenues increased 39.4% for the three months ended March 31, 2003, when compared with the same period of the prior year. This increase was primarily attributable to $6.8 million of operating revenues contributed by new acquisitions.
INVESTMENT AND OTHER INCOME
Investment and other income totaled $24.6 million for the three months ended March 31, 2003, an increase of $5.8 million, or 30.7%, when compared with the same period of the prior year. This increase primarily reflects increased earnings from affiliated companies, which are accounted for under the equity method of accounting, offset in part by lower yields on cash equivalents and the Company’s investment portfolio due to the current lower rate environment.
10
NET REALIZED INVESTMENT GAINS
Net realized investment gains totaled $12.5 million for the three months ended March 31, 2003, respectively, compared with $59,000 for the same period of the prior year. The current year quarter included a $13.1 million realized investment gain associated with the merger of the Company’s Credit Online business with DealerTrack Holdings, Inc.
TOTAL OPERATING EXPENSES
Financial Services. Salaries and other personnel costs for the Financial Services group, which primarily reflects the title insurance segment, were $294.7 million for the three months ended March 31, 2003, an increase of $39.5 million, or 15.5%, when compared with the same period of the prior year. This increase was primarily attributable to labor costs associated with the processing and closing of increased order volumes (i.e., overtime, part time help and commissions) at the title insurance operations, where the Company experienced a 25.9% increase in total order volume for the three months ended March 31, 2003, when compared with the same period of the prior year. Salaries and other personnel costs as a percentage of operating revenues for the Financial Services group were 29.8% for the three months ended March 31, 2003, down from 32.5% for the same period of the prior year.
Agents retained $365.7 million, or 81.5% of title premiums generated by agency operations for the three months ended March 31, 2003, which compares with $284.3 million, or 79.7% for the same period of the prior year. The change in the percentage of title premiums retained by agents was 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 for the Financial Services group, which primarily reflect the title insurance segment, were $161.8 million for the three months ended March 31, 2003, an increase of $22.2 million, or 15.9% when compared with the same period of the prior year. This increase was primarily the result of incremental costs incurred to service the increase in business volume. Other operating expenses as a percentage of operating revenues for the Financial Services group were 16.4% for the three months ended March 31, 2003 down from 17.8% for the same period of the prior year.
The provision for policy losses and other claims primarily represents title insurance claims, home warranty claims and property and casualty insurance claims. For the title insurance segment, the claims provision as a percentage of title insurance operating revenues was 4.0% for both the current quarter and the same period of the prior year. For the home warranty segment, the claims provision as a percentage of home warranty operating revenues was 44.2% for the current quarter, down from 47.5% for the same period of the prior year. This decrease was due to the elimination of higher-cost contractors. In the property and casualty insurance segment, the provision for losses as a percentage of property and casualty insurance operating revenues was 78.9% for the current quarter, up from 57.2% for the same quarter of the prior year. This increase was due to high claims activity experienced during the current quarter resulting primarily from insured property damaged in Southern California as a result of extraordinarily high winds experienced during the beginning of the quarter.
Premium taxes, which relate to the title insurance and specialty insurance segments, were $10.5 million and $7.2 million for the three months ended March 31, 2003 and 2002, respectively. Premium taxes as a percentage of title insurance and specialty insurance operating revenues ranged from 0.9% to 1.1%. This slight variation was primarily due to the composition and geographical mix of the operating revenues (i.e., tax rates and bases vary from state to state).
Information Technology. Information technology personnel and other operating expenses were $224.6 million for the three months ended March 31, 2003, an increase of $46.6 million, or 26.2%, when compared with the same period of the prior year. Excluding acquisitions, the increase was $34.1 million, or 19.1%. This increase was primarily due to costs incurred to service the increase in business volume, costs incurred to integrate new acquisitions and increased technology costs. Personnel and other operating expenses as a percentage of operating revenues for the Information Technology group were 71.2% for the three months ended March 31, 2003, down from 74.5% for the same period of the prior year.
11
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 March 31 | ||||||||||||
| ($000) | ||||||||||||
| 2003 |
% |
2002 |
% | |||||||||
| Financial Services: |
||||||||||||
| Title Insurance |
$ |
86,766 |
|
46 |
$ |
39,652 |
|
37 | ||||
| Specialty Insurance |
|
5,839 |
|
3 |
|
5,682 |
|
5 | ||||
| Trust and Other Services |
|
2,441 |
|
1 |
|
4,225 |
|
4 | ||||
|
|
95,046 |
|
50 |
|
49,559 |
|
46 | |||||
| Information Technology: |
||||||||||||
| Mortgage Information |
|
45,797 |
|
24 |
|
31,505 |
|
30 | ||||
| Property Information |
|
23,443 |
|
12 |
|
11,645 |
|
11 | ||||
| Credit Information |
|
26,607 |
|
14 |
|
12,653 |
|
12 | ||||
| Screening Information |
|
515 |
|
0 |
|
782 |
|
1 | ||||
|
|
96,362 |
|
50 |
|
56,585 |
|
54 | |||||
| Total before corporate expenses |
|
191,408 |
|
100 |
|
106,144 |
|
100 | ||||
| Corporate expenses |
|
(27,915 |
) |
|
(17,585 |
) |
||||||
| Total |
$ |
163,493 |
|
$ |
88,559 |
|
||||||
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. Most of the businesses included in the Information Technology group are database intensive, with a relatively high proportion of fixed costs. As such, profit margins generally improve as revenues increase. Revenues for the mortgage and property information segments, like the title insurance segment, are primarily dependent on the level of real estate activity and the cost and availability of mortgage funds. Revenues for the credit information segment are in part impacted by real estate activity, but also by the consumer and automobile sectors. Corporate expenses totaled $27.9 million for the current quarter, an increase of $10.3 million when compared with the same period of the prior year. This increase was primarily due to a $1.7 million increase in technology costs and higher general costs associated with the support effort needed to service the Company’s expanded national and international operations
INCOME TAXES
The effective income tax rate (income tax expense as a percentage of pretax income after minority interest expense) was 39.0% for the three months ended March 31 2003, and 41.3% for the same period of the prior year. The decrease in effective rate was primarily attributable to changes in the ratio of permanent differences to pretax profits. A large portion of the Company’s minority interest is attributable to a limited liability company subsidiary that, for tax purposes, is treated as a partnership; and accordingly, no income taxes have been provided.
12
MINORITY INTERESTS
Minority interest expense was $19.9 million for the three months ended March 31, 2003, an increase of $6.4 million when compared with the same period of the prior year. This increase was primarily attributable to the increase in operating results of the Company’s joint venture with Experian.
NET INCOME
Net income for the three months ended March 31, 2003, was $87.6 million, or $1.05 per diluted share. Net income for the three months ended March 31, 2002, was $44.1 million, or $0.57 per diluted share. The current year quarter included a realized pretax gain on the merger of the Company’s Credit Online business with DealerTrack Holdings, Inc. of $13.1 million, $8.0 million on an after-tax basis, or $0.09 per diluted share.
LIQUIDITY AND CAPITAL RESOURCES
Total cash and cash equivalents increased $42.0 million and decreased $13.3 million for the three months ended March 31, 2003 and 2002, respectively. The increase for the current period was due primarily to cash provided by operating activities, offset in part by capital expenditures, cash paid for company acquisitions, payments to minority shareholders and cash dividends. The decrease for the prior-year period was primarily due to purchases of debt and equity securities, capital expenditures, cash paid for company acquisitions, payments to minority shareholders and cash dividends, offset in part by cash provided by operating activities.
Notes and contracts payable as a percentage of total capitalization decreased to 19.7% at March 31, 2003 from 20.7% at December 31, 2002. This decrease was primarily due to an increase in equity due primarily to the net income for the current period.
Management believes that all of its anticipated operating cash requirements for the immediate future will be met from internally generated funds.
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 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, 2002.
Item 4. Controls and Procedures
| (a) | Based upon an evaluation by the Company’s President and Chief Financial Officer within 90 days prior to the filing date of this Quarterly Report on Form 10-Q, they have concluded that the Company’s disclosure controls and procedures as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended, are effective for gathering, analyzing and disclosing the information the Company is required to disclose in its reports filed under such Act. |
| (b) | there were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above. |
Part II: Other Information
Item 6. Exhibits and Reports on Form 8-K.
| (a) | Exhibits |
| (10) |
Amendment No. 2, dated February 1, 2003, to Deferred Compensation Plan | |
| (99)(a) |
Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. | |
| (99)(b) |
Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. |
13
(b) Reports on Form 8-K
During the quarterly period covered by this report, the Company filed a report on Form 8-K dated February 12, 2003 (reporting on fourth quarter and full year 2002 earnings). Subsequent to such quarterly period, the Company filed a report on Form 8-K dated April 23, 2003 (reporting on first quarter 2003 earnings).
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 CORPORATION (Registrant) |
| /s/ THOMAS A. KLEMENS |
| Thomas A. Klemens Executive Vice President Chief Financial Officer |
| /S/ MAX O. VALDES |
| Max O. Valdes Vice President Chief Accounting Officer |
Date: May 15, 2003
14
CERTIFICATIONS
I, Parker S. Kennedy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The First American Corporation (“registrant”);
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
| /s/ PARKER S. KENNEDY |
| Parker S. Kennedy President (Principal Executive Officer) |
15
I, Thomas A. Klemens, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The First American Corporation (“ registrant”);
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 1ad-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
| /s/ THOMAS A. KLEMENS |
| Thomas A. Klemens Senior Executive Vice President, Chief Financial Officer (Principal Financial Officer) |
16
EXHIBIT INDEX
| Exhibit No. |
Description |
Sequentially Numbered Page | ||
| (10) |
Amendment No. 2, dated February 1, 2003, to Deferred Compensation Plan. |
|||
| (99)(a) |
Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. |
|||
| (99)(b) |
Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. |
17