UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003 Commission File No. 1-10308
Cendant Corporation (Exact name of Registrant as specified in its charter)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed in 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 ý No o
Indicate by check mark whether the Registrant is an accelerated filer (as defined in the Exchange Act Rule 12b-2): Yes ý No o
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the Registrant's common stock was 1,013,773,152 shares as of July 31, 2003.
Cendant Corporation and Subsidiaries
Table of Contents
FORWARD-LOOKING STATEMENTS
Forward-looking statements in our public filings or other public statements are subject to known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements. Forward-looking statements include the information concerning our future financial performance, business strategy, projected plans and objectives. Statements preceded by, followed by or that otherwise include the words "believes", "expects", "anticipates", "intends", "projects", "estimates", "plans", "may increase", "may fluctuate" and similar expressions or future or conditional verbs such as "will", "should", "would", "may" and "could" are generally forward-looking in nature and not historical facts. You should understand that the following important factors and assumptions could affect our future results and could cause actual results to differ materially from those expressed in such forward-looking statements:
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Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements, and the failure of such other assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control.
You should consider the areas of risk described above in connection with any forward-looking statements that may be made by us and our businesses generally. Except for our ongoing obligations to disclose material information under the federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless required by law. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
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PART I—FINANCIAL INFORMATION
Item 1. Financial Statements
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors and Stockholders ofCendant CorporationNew York, New York
We have reviewed the accompanying consolidated condensed balance sheet of Cendant Corporation and subsidiaries (the "Company") as of June 30, 2003, the related consolidated condensed statements of income for the three and six month periods ended June 30, 2003 and 2002, and the related consolidated condensed statements of cash flows for the six month periods ended June 30, 2003 and 2002. These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such consolidated condensed financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of the Company as of December 31, 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 5, 2003 (March 3, 2003 as to the subsequent events described in Note 31), we expressed an unqualified opinion (and included an explanatory paragraph with respect to the adoption of the non-amortization provisions for goodwill and other indefinite lived intangible assets, the modification of the accounting treatment relating to securitization transactions and the accounting for derivative instruments and hedging activities and the revision of certain revenue recognition policies, as discussed in Note 1 to the consolidated financial statements) on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated condensed balance sheet as of December 31, 2002 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Deloitte & Touche LLPNew York, New YorkAugust 6, 2003
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Cendant Corporation and Subsidiaries CONSOLIDATED CONDENSED STATEMENTS OF INCOME (In millions, except per share data)
See Notes to Consolidated Condensed Financial Statements.
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Cendant Corporation and Subsidiaries CONSOLIDATED CONDENSED BALANCE SHEETS (In millions, except share data)
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Cendant Corporation and Subsidiaries CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (In millions)
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Cendant Corporation and Subsidiaries NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unless otherwise noted, all amounts are in millions, except per share amounts)
1. Summary of Significant Accounting Policies
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2. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share ("EPS").
The following table summarizes the Company's outstanding common stock equivalents, which were antidilutive and, therefore, excluded from the computation of diluted EPS.
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3. Acquisitions
2002 AcquisitionsIn April 2002, the Company acquired NRT for $230 million, resulting in goodwill of approximately $1.6 billion, and Trendwest Resorts, Inc. ("Trendwest") for $936 million, resulting in goodwill of $687 million. The following table sets forth the Company's results of operations on a pro forma basis as if the acquisitions of NRT and Trendwest had occurred on January 1, 2002:
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Budget Group, Inc. (assets acquired in November 2002)
Galileo International, Inc. (acquired October 2001)
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Acquisition and Integration Related CostsDuring the three and six months ended June 30, 2003, the Company incurred $12 million and $22 million, respectively, of acquisition and integration related costs, of which $4 million and $7 million, respectively, represented the non-cash amortization of the contractual pendings and listings intangible asset. The remaining costs ($8 million and $15 million during the three and six months ended June 30, 2003, respectively) primarily related to the integration of Budget's information technology systems with the Company's platform and the integration of real estate brokerages acquired by NRT.
4. Discontinued Operations
5. Intangible Assets
Intangible assets consisted of:
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The changes in the carrying amount of goodwill are as follows:
6. Mortgage Servicing Activities
Substantially all of the mortgage loans within this servicing portfolio were sold by the Company without recourse. However, approximately $2.7 billion (approximately 2%) of loans within this servicing portfolio as of June 30, 2003 were sold with recourse. The majority of such loans were sold under a program where the Company retains the credit risk for a limited period of time and only for a specific default event. For these loans, the Company accrues a provision (equal to the fair value of the recourse obligation) for expected losses. As of June 30, 2003, the provision approximated $4 million and was recorded as a component of accounts payable and other current liabilities on the Consolidated Condensed Balance Sheets. There was no significant activity during 2003 that would cause the Company to utilize any of this provision. The Company believes that this provision is adequate to cover expected losses and that such losses would not be material to its results of operations.
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As of June 30, 2003, the Company expects MSR amortization expense for the remainder of 2003 and the five succeeding fiscal years to approximate $175 million, $350 million, $255 million, $220 million, $190 million and $160 million, respectively. As of June 30, 2003, the MSR portfolio had a weighted average life of approximately 4.2 years.
The Company uses derivatives to mitigate the impact that accelerated prepayments have on the fair value of its MSR asset. Such derivatives, which are primarily designated as fair value hedging instruments, tend to increase in value as interest rates decline and conversely decline in value as interest rates increase. The activity in the Company's derivatives related to mortgage servicing rights asset consisted of:
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The net impact to the Company's Consolidated Condensed Statements of Income resulting from changes in the fair value of the Company's MSR asset, after giving effect to hedging and other derivative activity, was as follows:
7. Long-term Debt and Borrowing Arrangements
Long-term debt consisted of:
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The number of shares of common stock potentially issuable for each of the Company's contingently convertible debt securities are detailed below (in millions):
Committed Credit FacilitiesAs of June 30, 2003, there were no outstanding borrowings under the Company's $2.9 billion revolving credit facility; however, letters of credit of $1.1 billion were issued and outstanding. These letters of credit were issued primarily as credit enhancements to provide additional collateralization for the Company's vehicle rental financing arrangements. Accordingly, as of June 30, 2003, the Company had approximately $1.8 billion of availability under this facility (including $630 million of availability to issue additional letters of credit, which reflects an increase of $500 million in the Company's capacity to issue letters of credit under this facility).
As of June 30, 2003, the Company also had $400 million of availability for public debt or equity issuances under a shelf registration statement.
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Debt Maturities and CovenantsAggregate maturities of debt (excluding the Upper DECS) based upon maturity or earliest mandatory redemption dates are as follows:
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8. Debt Under Management and Mortgage Programs and Borrowing Arrangements
Debt under management and mortgage programs consisted of:
Available Funding Arrangements and Committed Credit FacilitiesAs of June 30, 2003, available funding under the Company's asset-backed debt programs and committed credit facilities related to the Company's management and mortgage programs consisted of:
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Debt Maturities and CovenantsThe following table provides the contractual maturities for debt under management and mortgage programs at June 30, 2003 (except for notes issued under the Company's vehicle management program, where the underlying indentures require payments based on cash inflows relating to the corresponding assets under management and mortgage programs and for which appropriate estimates have been used).
9. Off-Balance Sheet Financing Arrangements
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10. Commitments and Contingencies
11. Stockholders' Equity
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12. Stock-Based Compensation
13. Related Party Transactions
FFD Development Company, LLCFFD has been included within the Company's consolidated results of operations, cash flows and financial position since February 3, 2003. During the six months ended June 30, 2003 (through the date of acquisition) and the three and six months ended June 30, 2002, the Company recognized non-cash dividend income on its preferred interest of $1 million, $3 million and $6 million, respectively. Such amounts are recorded within other revenues on the Company's Consolidated Condensed Statements of Income.
Trip Network, Inc.Trip Network has been included in the Company's consolidated results of operations, cash flows and financial position since March 31, 2003. During the six months ended June 30, 2003 (through the date of acquisition) and the three and six months ended June 30, 2002, the Company recorded $1 million, $1 million and $5 million, respectively, of revenue within its Consolidated Condensed Statements of Income in connection with its relationship with Trip Network.
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Trilegiant CorporationTrilegiant operates membership-based clubs and programs and other incentive-based programs through an outsourcing arrangement with the Company. Pursuant to such arrangement, the Company retained substantially all of the assets and liabilities of its existing membership business and licensed Trilegiant the right to market products utilizing the Company's intellectual property to new members. Accordingly, the Company continues to collect membership fees from, and is obligated to provide membership benefits to, members of the Company's individual membership business that existed as of July 2, 2001 (referred to as "existing members"), including their renewals, and Trilegiant provides fulfillment services for these members in exchange for a servicing fee pursuant to the Third Party Administrator agreement. Furthermore, Trilegiant collects the membership fees from, and is obligated to provide membership benefits to, any members who joined the membership based clubs and programs and all other incentive programs subsequent to July 2, 2001 (referred to as "new members") and recognizes the related revenue and expenses. Similar to the Company's franchise businesses, the Company receives a royalty from Trilegiant on all future revenue generated by the new members.
NRT IncorporatedNRT has been included in the Company's consolidated results of operations, cash flows and financial position since April 17, 2002. Reflected within the Company's Consolidated Condensed Statement of Income for the three months ended June 30, 2002 (through the date of acquisition) are $17 million of revenues (comprised of $13 million of royalty and marketing fees, $2 million of dividend income and $2 million of real estate referral fees) and $1 million of non-program related depreciation and amortization expense. Reflected within the Company's Consolidated Condensed Statement of Income for the six months ended June 30, 2002 (through the date of acquisition) are $101 million of revenues (comprised of $66 million of royalty and marketing fees, $10 million of dividend income, $9 million of real estate referral fees and $16 million of termination fees) and $7 million of non-program related depreciation and amortization expense.
Entertainment Publications, Inc.On March 25, 2003, the Company sold its common stock investment in Entertainment Publications, Inc. for approximately $33 million in cash. The Company recorded a gain of approximately $30 million on this disposition, which is included within other revenue on the Consolidated Condensed Statement of Income for the six months ended June 30, 2003. At December 31, 2002, the Company's investment of $5 million was accounted for using the equity method and was included within other non-current assets of its Corporate and Other segment.
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14. Segment Information
15. Subsequent Events
On July 3, 2003, the terms of PHH's $750 million committed credit facility, which was scheduled to mature in February 2004, were amended to extend the maturity date to February 2005 and reduce the capacity to $500 million.
On July 17, 2003, the Company amended certain terms of its Sierra conduit facility used to securitize timeshare receivables, including increasing the facility limit to $600 million.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our Consolidated Condensed Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2002 Annual Report on Form 10-K filed with the Commission on March 5, 2003. Unless otherwise noted, all dollar amounts are in millions.
We are one of the foremost providers of travel and real estate services in the world. Our businesses provide a wide range of consumer and business services and are intended to complement one another and create cross-marketing opportunities both within and among our following five business segments. Our Real Estate Services segment franchises our three residential and one commercial real estate brands, provides real estate brokerage services, provides home buyers with mortgages, title, appraisal review and closing services and facilitates employee relocations; our Hospitality segment develops, markets, sells and manages vacation ownership interests, provides consumer financing to individuals purchasing these interests, facilitates the exchange of vacation ownership intervals, franchises our nine lodging brands and markets vacation rental properties in Europe; our Travel Distribution segment provides global distribution and computer reservation and travel agency services; our Vehicle Services segment operates and franchises our Avis and Budget vehicle rental brands and provides fleet management and fuel card services; our Financial Services segment provides financial institution enhancement products, insurance-based and loyalty solutions, operates and franchises tax preparation offices and provides a variety of membership programs through an outsourcing arrangement with Trilegiant Corporation.
We are focused on building long-term value through operational excellence and growing our businesses organically. Historically, a significant portion of our growth has been generated through the strategic acquisitions of businesses that have strengthened our position in the travel and real estate services industries and helped us to develop a hedged and diversified portfolio of businesses. Now that we have assembled our vertically integrated portfolio of businesses, we have sharply curtailed the pace of acquisitions and our operating management has emphasized organic growth and the generation of cash flow as principal objectives. Throughout 2003, our spending on new acquisitions has been inconsequential, aggregating only $44 million in cash. We remain highly disciplined in our acquisition activity and may augment organic growth through the select acquisition of (or possible joint venture with) complementary businesses primarily in our real estate brokerage operations. The purchase price of any such acquisitions is expected to be funded with cash generated by our core operations in 2003. Currently, we expect to use approximately $100 million for such acquisitions.
With the curtailment of acquisitions, we are steadfast in our commitment to deploy our cash to strengthen our liquidity position and increase shareholder value. To this end, we completed the first phase of our corporate debt reduction program during first quarter 2003, which was to replace current maturities of corporate indebtedness with longer-term debt, and we are well into the second phase of the program where, by the end of 2004, we intend to reduce outstanding corporate indebtedness by $2 billion. Our plan is to capitalize upon the opportunity to use call provisions and maturities wherever possible rather than paying a significant premium to repurchase our debt in the open market. In addition to replacing our near-term obligations, the redemption/retirement of our convertible debt instruments has, to date, eliminated 83 million shares of potential dilution to our future earnings per share. Further, through July 2003, we have repurchased 37.3 million shares of our common stock at an average price of $14.88 and beginning in 2004, we intend to return additional value to our shareholders through the payment of a quarterly cash dividend of 7 cents per share (28 cents per share annually), subject to final approval by our Board of Directors. We expect to increase this dividend over time as our earnings and cash flow grow.
In addition, we routinely review and evaluate our portfolio of existing businesses to determine if they continue to meet our growth objectives and, from time to time, engage in discussions concerning possible divestitures, joint ventures and related corporate transactions to redirect our portfolio of businesses to achieve company-wide objectives.
Finally, during the first half of 2003, we made significant progress toward our goal of simplifying our corporate structure as demonstrated by the acquisition of two affiliated but previously unconsolidated businesses, FFD Development Company LLC and Trip Network, Inc. We believe that our consolidation of Trilegiant Corporation (following which we will have consolidated all of our off-balance-sheet operating affiliates) and Bishop's Gate Residential Mortgage Trust in the third quarter of 2003 will further enhance the transparency of our financial results. Additionally, we requested that the boards of directors of the qualified special purpose entities we use to securitize our timeshare receivables amend these structures to enable us to begin consolidating these entities.
In summary, we continue to pay close attention to the profitability and growth of our businesses, the generation and deployment of cash flow and the building of long-term shareholder value.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 VS. THREE MONTHS ENDED JUNE 30, 2002
Our consolidated results from continuing operations comprised the following:
Net revenues and total expenses increased approximately $796 million (21%) and $589 million (17%), respectively, principally due to the acquisitions of the following businesses, which contributed incremental revenues and expenses aggregating $664 million and $665 million, respectively.
In addition to the contributions made by acquired businesses, the diversity of our portfolio of businesses allowed us to mitigate the effects of a challenging economic and geo-political environment, particularly for our travel-related businesses. Weak comparisons in our travel-related businesses were more than offset by organic growth in our real estate services businesses, particularly in our mortgage business where revenues increased 55% quarter-over-quarter. The growth in our mortgage business also contributed to the increase in total expenses to support the continued high level of mortgage loan production and related servicing activities. Partially offsetting the increase in total expenses incurred by our mortgage business was (i) a decrease of $195 million in acquisition and integration related costs primarily due to the amortization in 2002 of the pendings and listings intangible asset acquired as part of the acquisition of NRT, which was amortized over the closing period of the underlying contracts (less than five months), and (ii) a decrease of $32 million in losses incurred on the early extinguishments of debt. Our overall effective tax rate decreased to 33% for second quarter 2003 from 35% for the comparable period in 2002. The effective tax rate was lower primarily due to a decrease in taxes on our foreign operations, which was partially offset by higher state taxes and an increase in non-deductible items. As a result of the above-mentioned items, income from continuing operations increased $143 million (60%).
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Discussed below are the results of operations for each of our reportable segments. Management evaluates the operating results of each of our reportable segments based upon revenue and "EBITDA," which is defined as income from continuing operations before non-program related depreciation and amortization, non-program related interest, amortization of pendings and listings, income taxes and minority interest. On January 1, 2003, we changed our performance measure used to evaluate the operating results of our reportable segments and, as such, the information presented below for second quarter 2002 has been revised to reflect this change. Our presentation of EBITDA may not be comparable to similar measures used by other companies.
Real Estate ServicesRevenues and EBITDA increased $335 million (23%) and $39 million (12%), respectively, in second quarter 2003 compared with 2002.
Revenues and EBITDA were greatly impacted by increased production volume at our mortgage business and the April 17, 2002 acquisition of NRT and subsequent acquisitions by NRT of other real estate brokerages (the operating results of which have been included from their acquisition dates forward). NRT (inclusive of the title and closing business) and NRT's significant brokerage acquisitions, subsequent to our ownership, contributed an incremental $166 million of revenues and an EBITDA decline of $7 million from April 1, 2003 through April 16, 2003. This EBITDA decline is reflective of the seasonality of the real estate brokerage business, whereby the operating results are typically weakest in the early part of the calendar year and progressively strengthen during the second and third quarters. Excluding the incremental impact of the NRT acquisition and NRT's significant acquisitions of real estate brokerages subsequent to our acquisition of NRT, net brokerage commission revenues increased $6 million in 2003. Prior to our acquisition of NRT, we received royalty and marketing fees from NRT of $13 million and real estate referral fees of $2 million during second quarter 2002. We also had a preferred stock investment in NRT, prior to our acquisition, which generated dividend income of $2 million during second quarter 2002. Upon the acquisition of NRT, we merged our pre-existing title and appraisal businesses with and into the larger-scale title and closing business of NRT and made certain accounting reclassifications within our pre-existing businesses to conform to NRT's accounting presentation. Such reclassification changes resulted in an increase in revenues of $25 million with no impact on EBITDA in second quarter 2003. Excluding such reclassification, our settlement services business generated incremental revenues of $30 million compared with second quarter 2002. Title, appraisal and other closing fees all increased due to higher volumes, consistent with the growth in the mortgage origination markets, and cross-selling initiatives.
On a comparable basis, including post-acquisition intercompany royalties paid by NRT to our real estate franchise business, our real estate franchise brands generated incremental royalties and marketing fund revenues of $8 million in second quarter 2003, an increase of 5% over second quarter 2002 primarily due to a 6% increase in the average price of homes sold. Royalty increases in the real estate franchise business are recognized with little or no corresponding increase in expenses due to the significant operating leverage within our franchise operations.
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Revenues from mortgage-related activities grew $95 million (55%) in second quarter 2003 compared with second quarter 2002 due to a significant increase in mortgage loan production as low interest rates have prompted record levels of mortgage refinancing activity. Revenues from mortgage loan production increased $166 million (89%) in second quarter 2003 compared with the prior year quarter and was derived from growth in our fee-based mortgage origination operations (discussed below) and an increase in the volume of loans that we packaged and sold, which more than doubled quarter-over-quarter. We sold $16.3 billion of mortgage loans in second quarter 2003 compared with $8.1 billion in second quarter 2002, generating incremental production revenues of $118 million. In addition, production revenues generated from our fee-based mortgage-origination activity increased $48 million (89%) as compared with second quarter 2002. Production fee income on fee-based loans is generated at the time of closing, whereas originated mortgage loans held for sale generate revenues at the time of sale (typically 30-60 days after closing). Accordingly, our production revenue in second quarter 2003 was driven by a mix of mortgage loans closed and mortgage loans sold. Total mortgage loans closed increased $10.9 billion (87%) to $23.3 billion in second quarter 2003, comprised of a $9.3 billion (121%) increase in closed loans to be securitized (sold by us) and a $1.6 billion (33%) increase in closed loans that were fee-based. The increase in loan origination volume was principally driven by continued substantial refinancing activity during second quarter 2003. Refinancings increased $9.7 billion (226%) to $14.0 billion and purchase mortgage closings grew $1.2 billion (14%) to $9.3 billion.
Net revenues from servicing mortgages loans declined $71 million, although recurring servicing fees (fees received for servicing existing loans in the portfolio) increased $7 million (7%) driven by a 16% quarter-over-quarter increase in the size of our average servicing portfolio to $119.8 billion. Net servicing revenues included an increase of $143 million in mortgage servicing rights ("MSRs") amortization and provision for impairment (both of which are recorded against revenue) due to the high levels of refinancings and related loan prepayments, resulting from the lower interest rate environment. However, this was partially offset by $72 million of incremental gains from hedging and other derivative activities to protect against changes in the fair value of MSRs due to fluctuations in interest rates. Excluding the impact from the acquisition of NRT and its subsequent acquisitions, operating and administrative expenses within this segment increased approximately $100 million, primarily due to the direct costs incurred in connection with continued high level of mortgage loan production and related servicing activities.
HospitalityRevenues increased $70 million (12%), while EBITDA declined $23 million (13%) in second quarter 2003 compared with second quarter 2002. We completed the acquisitions of Trendwest, a leading vacation ownership company, in June 2002 (90% was acquired in April 2002), and certain European vacation rental companies during 2002 (the operating results of which have been included from their acquisition dates forward). Accordingly, Trendwest and the other acquired vacation rental companies contributed incremental revenues of $40 million and $12 million, respectively, and EBITDA of $4 million and $1 million, respectively, in second quarter 2003 compared with second quarter 2002. Excluding the impact from these acquisitions, revenues increased $18 million (3%), while EBITDA declined $28 million (16%) quarter-over-quarter. Sales of vacation ownership interests in our developed timeshare units contributed incremental revenues of $20 million in second quarter 2003, a 12% increase over second quarter 2002, primarily as a result of increased tour flow and higher revenue per tour at our Fairfield subsidiary resort sites. Financial income from the funding we provided to the purchasers of our timeshare units decreased $8 million principally due to an 11% reduction in the securitization of such receivables. Timeshare subscription and exchange fee revenues within our timeshare exchange business increased $8 million (7%) primarily due to a 14% increase in the average fee per exchange, which was partially offset by a 5% reduction in the volume of exchange transactions, which we believe was driven by apprehension over the military conflict in Iraq.
Royalties and marketing and reservation fund revenues within our lodging franchise operations declined $6 million (6%) in second quarter 2003 due to a 5% decline in the number of weighted average rooms available following our decision to remove from our franchise system certain properties that were not meeting required standards. Revenue per available room remained relatively unchanged quarter-over-quarter. Our lodging franchise business and our franchisees were unfavorably impacted in second quarter 2003 by the military conflict in Iraq, which compounded an already weak travel environment. As a result, during second quarter 2003, we recorded an incremental $5 million non-cash expense related to the doubtful collectibility of certain franchise receivables. Excluding acquisitions, operating and administrative expenses within this segment increased approximately $40 million in second quarter 2003 principally due to increased timeshare sales-related expenses, including variable expense increases on higher sales volumes and an increased investment in guest generation spending to enhance tour flows. In addition, expense increases represent volume-related growth in our timeshare exchange business in prior quarters and our maintenance of current service levels.
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Travel DistributionRevenues and EBITDA declined $12 million (3%) and $26 million (20%), respectively, in second quarter 2003 compared with second quarter 2002. Galileo air travel booking fees decreased $30 million (9%) due to a 10% decline in worldwide air booking volumes. Like other industry participants, we experienced a decline in travel demand affecting volumes and revenues across the majority of our travel distribution businesses due to a number of factors, including military conflict in Iraq, continuing economic pressures, terrorist threat alerts, and health concerns in the Asia/Pacific region and other parts of the world (SARS). However, as apprehension regarding the military conflict in Iraq and the risk posed by SARS subsided, air travel booking volumes have begun to rebound during second quarter with quarter-over-quarter booking volumes having progressively improved in each respective month during second quarter 2003. To mitigate the impact of the industry decline, we initiated aggressive global cost containment efforts within this business segment. Galileo subscriber fees and EBITDA during second quarter 2003 increased $14 million and $4 million, respectively, due to the acquisition of national distribution companies (NDCs) in Europe during 2002. NDCs are independent organizations that market and sell Galileo global distribution and computer reservation services to travel agents and other subscribers.
Trip Network, which we acquired in April 2003 and which operates Cheap Tickets, contributed $10 million in revenues and an EBITDA loss of $11 million in second quarter 2003 due to factors contributing to reductions in travel demand, as noted above. In addition, during the summer of 2002, we acquired two other companies that supply reservation and distribution services to the hospitality industry. The operating results of such companies were included from their acquisition dates forward and collectively contributed revenue of $11 million with a nominal EBITDA impact during second quarter 2003. Additionally, revenues from our travel agency business declined $6 million due to a general industry decline in travel demand as discussed above, reductions in commission rates paid by airlines, the lack of reduced-rate air inventory availability and a decline in travel-related clubs which are serviced by us. However, the impact on EBITDA of lower travel agency revenues was offset by variable expense savings on lower revenues and expense reductions due to cost containment initiatives relating to our travel agency business implemented in 2002 and 2003.
Vehicle ServicesRevenues and EBITDA increased $433 million (42%) and $9 million (7%), respectively, in second quarter 2003 compared with the prior year quarter. In November 2002, we acquired substantially all of the domestic assets of the vehicle rental business of Budget, as well as selected international operations. Budget's operating results, including integration costs, were included from the acquisition date forward and contributed revenues and EBITDA of $458 million and $13 million, respectively, in second quarter 2003. Excluding Budget's second quarter 2003 results, revenue and EBITDA declined $25 million (2%) and $4 million (3%), respectively, in second quarter 2003, which is primarily attributable to reduced car rental demand offset by increased pricing at Avis. Avis domestic car rental revenues declined $41 million (7%) in second quarter 2003 compared with second quarter 2002. The net reduction in domestic car rental revenues at Avis was primarily due to a 10% quarter-over-quarter reduction in domestic car rental days, which was partially offset by a 1% increase in time and mileage revenue per domestic rental day, reflecting an increase in pricing that substantially flows to EBITDA. In addition, EBITDA, quarter-over-quarter, includes favorable interest costs of $8 million on the financing of vehicles due to lower interest rates, which were offset by incremental vehicle-related net expenses and customer service costs. The increase in vehicle-related net expenses includes incremental maintenance and damage costs due to a reduction in warranty-related services provided to car manufacturers, a decline in gas reimbursements from Avis car rental customers and higher vehicle license and registration costs. Despite reduced Avis revenue domestically, revenues from Avis' international operations increased $10 million due to increased transaction volume and the favorable impact to revenues of exchange rates, principally in Australia, which was principally offset in EBITDA by the unfavorable impact on expenses. Avis' and Budget's revenues are primarily derived from car rentals at airport locations. Wright Express, our fuel card business, recognized incremental revenues of $6 million (20%) in second quarter 2003 compared with the prior year second quarter. This was primarily due to growth in fuel cards, card usage and higher gasoline prices whereby Wright Express earns a percentage of the total gas purchased by its clients.
Financial ServicesRevenues and EBITDA decreased $36 million (12%) and $13 million (15%), respectively, in second quarter 2003 compared with the prior year quarter. Revenue and EBITDA reflect a continued attrition of the membership base retained by us in connection with the outsourcing of our individual membership business to Trilegiant; however, the impact on EBITDA was mitigated by a net reduction in expenses from servicing fewer members. A smaller membership base resulted in a net revenue reduction of $51 million (net of $4 million of royalty income from Trilegiant), which was partially offset in EBITDA by favorable membership operating expenses of $35 million. See the section entitled "Liquidity and Capital Resources—Affiliated Entities" for a discussion concerning our consolidation of Trilegiant on July 1, 2003 pursuant to FASB Interpretation No. 46, "Consolidation of Variable
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Interest Entities" ("FIN 46"). Partially offsetting the impact from the attrition of the membership business was the increased operating results of our Jackson Hewitt tax preparation franchise and the favorable impact of foreign currency exchange rates on the revenues of our international membership business. Jackson Hewitt generated incremental revenues of $7 million in second quarter 2003, which was primarily driven by franchise royalty growth and by the timing of certain financial product program revenues as such revenues were earned in the second quarter of 2003 when in 2002 those revenues were earned in the third quarter. Franchise royalties grew at Jackson Hewitt as a result of a 9% increase in the total tax return volume and an 18% increase in average price per return. EBITDA, in second quarter 2003, was also impacted by an $8 million expense incurred in connection with a litigation settlement.
Corporate and OtherRevenues and EBITDA increased $6 million and $37 million, respectively in second quarter 2003 compared with second quarter 2002. EBITDA reflects a greater absorption of overhead expenses by our reportable operating segments during second quarter 2003 compared with second quarter 2002, principally due to expense allocations in second quarter 2003 to companies that were acquired during 2002 and did not receive overhead allocations in the second quarter of last year. Also contributing to favorable EBITDA quarter-over-quarter was the absence of costs incurred in second quarter 2002 associated with the December 2001 outsourcing of substantially all of our domestic data center operations and other information technology functions.
SIX MONTHS ENDED JUNE 30, 2003 VS. SIX MONTHS ENDED JUNE 30, 2002
Net revenues and total expenses increased approximately $2.3 billion (36%) and $2.1 billion (37%), respectively, principally due to the acquisitions of the following businesses, which contributed incremental revenues and expenses each aggregating $2.0 billion.
In addition to the contributions made by acquired businesses, the diversity of our portfolio of businesses allowed us to mitigate the effects of a challenging economic and political environment, particularly for our travel-related businesses. Weak comparisons in our travel-related businesses were more than offset by organic growth in our real estate services businesses, especially in our mortgage business where revenues increased 69% period-over-period. The growth in our mortgage business also contributed to the increase in total expenses in order to support the continued high level of mortgage loan production and related servicing activities. Partially offsetting the increase in total expenses incurred by our mortgage business was a decrease of $185 million in acquistion and integration related costs primarily due to the amortization in 2002 of the pendings and listings intangible asset acquired as part of the acquistion of NRT, which was amortized over the closing period of the underlying contracts (less than five months). Our overall effective tax rate decreased to 33% for the six months ended June 30, 2003 from 34% for the comparable period in 2002. The effective tax rate was lower primarily due to a decrease in taxes on our foreign operations, which was partially offset by higher state taxes and an increase in non-deductible items. As a result of the above-mentioned items, income from continuing operations increased $137 million (25%).
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Discussed below are the results of operations for each of our reportable segments. The information presented for the six months ended June 30, 2002 has been revised to reflect the previously described change in the performance measure that we use to evaluate the operating results of our reportable segments.
Real Estate ServicesRevenues and EBITDA increased $1,276 million (69%) and $82 million (16%), respectively, in six months 2003 compared with six months 2002.
Revenues and EBITDA were primarily impacted by increased production volume at our mortgage business and by the April 17, 2002 acquisition of NRT and subsequent acquisitions by NRT of other real estate brokerages (the operating results of which have been included from the acquisition dates forward). NRT (inclusive of its title and closing business) and NRT's significant brokerage acquisitions subsequent to our ownership contributed an incremental $954 million of revenues and an EBITDA decline of $25 million from January 1, 2003 through April 16, 2003. This EBITDA decline is reflective of the seasonality of the real estate brokerage business, whereby the operating results are typically weakest in the early part of the calendar year and progressively strengthen during the second and third quarters. Excluding the incremental impact of the NRT acquisition and NRT's significant acquisitions of real estate brokerages subsequent to our acquisition, net brokerage commission revenues increased $6 million in 2003. Prior to our acquisition of NRT, during six months 2002, we received royalty and marketing fees from NRT of $66 million, real estate referral fees of $9 million, and a $16 million fee in connection with the termination of a franchise agreement under which NRT operated our ERA real estate brand. We also had a preferred stock investment in NRT, prior to our acquisition, which generated dividend income of $10 million during six months 2002. In addition, revenues in six months 2003 benefited by $72 million from certain accounting reclassifications made in 2003 (with no impact on EBITDA), primarily in connection with the merger of our pre-existing title and appraisal businesses with and into the larger-scale title and closing business of NRT. Upon the combining of such businesses, we changed certain accounting presentations used by our pre-existing businesses to conform to the presentations used by NRT. Excluding such reclassifications, our settlement services business generated incremental revenues of $36 million compared with six months 2002. Title, appraisal and other closing fees all increased due to higher volumes, consistent with the growth in the mortgage origination markets, and cross-selling initiatives.
On a comparable basis, including post-acquisition intercompany royalties paid by NRT to our real estate franchise business, our real estate franchise brands generated incremental royalties and marketing fund revenues of $21 million in six months 2003, an increase of 7% over six months 2002 due to a 7% increase in the average price of homes sold and a 2% increase in volume of home sales transactions. Royalty increases in the real estate franchise business are recognized with little or no corresponding increase in expenses due to the significant operating leverage within our franchise operations.
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Revenues from mortgage-related activities grew $219 million (69%) in six months 2003 compared with six months 2002 due to a significant increase in mortgage loan production as low interest rates have prompted record levels of mortgage refinancing activity. Revenues from mortgage loan production increased $276 million (75%) in six months 2003 compared with the prior year quarter and was derived from growth in our fee-based mortgage origination operations (discussed below) and a 74% increase in the volume of loans that we packaged and sold. We sold $29.0 billion of mortgage loans in six months 2003 compared with $16.7 billion in six months 2002, generating incremental production revenues of $197 million. In addition, production revenues generated from our fee-based mortgage-origination activity increased $79 million (79%) as compared with six months 2002. Production fee income on fee-based loans is generated at the time of closing, whereas originated mortgage loans held for sale generate revenues at the time of sale (typically 30-60 days after closing). Accordingly, our production revenue in six months 2003 was driven by a mix of mortgage loans closed and mortgage loans sold. Total mortgage loans closed increased $16.1 billion (64%) to $41.2 billion in six months 2003, comprised of a $13.8 billion (89%) increase in closed loans to be securitized (sold by us) and a $2.3 billion (24%) increase in closed loans that were fee-based. Refinancings increased $14.2 billion (124%) to $25.7 billion and purchase mortgage closings grew $1.9 billion (14%) to $15.4 billion.
Net revenues from servicing mortgage loans declined $57 million, although recurring servicing fees (fees received for servicing existing loans in the portfolio) increased $19 million (9%) driven by a 16% period-over-period increase in the size of our average servicing portfolio to $117.8 billion. Net servicing revenues included an increase of $215 million in MSR amortization and provision for impairment (both of which are recorded against revenue) due to the high levels of refinancings and related loan prepayments resulting from the lower interest rate environment. However, this was partially offset by $141 million of incremental gains from hedging and other derivative activities to protect against changes in the fair value of MSR due to fluctuations in interest rates. Excluding the impact from the acquisition of NRT and its subsequent acquisitions, operating and administrative expenses within this segment increased approximately $145 million, primarily due to the direct costs incurred in connection with continued high level of mortgage loan production and related servicing activities.
HospitalityRevenues and EBITDA increased $246 million (25%) and $9 million (3%) respectively, in six months 2003 compared with six months 2002. We completed the acquisitions of Trendwest, a leading vacation ownership company, in June 2002 (90% was acquired in April 2002), Equivest Finance, Inc. in February 2002 and certain European vacation rental companies during 2002. The operating results of the acquired companies were included from the acquisition dates forward and therefore were incremental for the portions of six months 2003 that were pre-acquisition periods in 2002. Accordingly, Trendwest, Equivest, and the acquired vacation rental companies contributed incremental revenues of $169 million, $8 million and $46 million, respectively, and EBITDA of $23 million, $2 million and $13 million, respectively, in six months 2003 compared with six months 2002. Excluding the impact from these acquisitions, revenues increased $23 million (2%) while EBITDA declined $29 million (10%), for the comparable six month periods in 2003 and 2002. Sales of vacation ownership interests in our developed timeshare units contributed incremental revenues of $16 million in six months 2003, a 5% increase over six months 2002, primarily as a result of increased tour flow at our Fairfield subsidiary resort sites. Timeshare subscription and exchange fee revenues within our timeshare exchange business increased $15 million (7%), primarily due to a 12% increase in the average fee per exchange which was partially offset by a 5% reduction in the volume of exchange transactions which we believe was driven by apprehension over the military conflict in Iraq.
Royalties and marketing and reservation fund revenues within our lodging franchise operations declined $5 million (3%) in six months 2003 due to a 5% decline in the number of weighted average rooms available following our decision to remove from our franchise system certain properties that were not meeting required standards. This was partially offset by a 1% period-over-period increase in revenue per available room. Our lodging franchise business and our franchisees were unfavorably impacted in six months 2003 by the military conflict in Iraq, which compounded an already weak travel environment. As a result, during six months 2003, we recorded an incremental $11 million non-cash expense related to the doubtful collectibility of certain franchise receivables. Excluding acquisitions, operating and administrative expenses within this segment increased approximately $45 million in six months 2003, principally due to increased timeshare sales-related expenses, including variable expense increases on higher sales volumes and an increased investment in guest generation spending to enhance tour flows. In addition, expense increases represent volume-related growth in our timeshare exchange business in prior quarters, and our maintenance of current service levels.
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Travel DistributionRevenues and EBITDA declined $40 million (5%) and $45 million (16%), respectively, in six months 2003 compared with six months 2002. Galileo air travel booking fees decreased $61 million (9%) due to an 11% decline in worldwide air booking volumes. Like other industry participants, we experienced a decline in travel demand affecting volumes and revenues across the majority of our travel distribution businesses due to a number of factors, including military conflict in Iraq, continuing economic pressures, terrorist threat alerts, and health concerns in the Asia/Pacific region and other parts of the world (SARS). However, as apprehension regarding the military conflict in Iraq and the risk posed by SARS subsided, air travel booking volumes have begun to rebound with booking volumes having progressively improved in each respective month during the second quarter of 2003. To mitigate the impact of the industry decline, we initiated aggressive global cost containment efforts within this business segment. Galileo subscriber fees and EBITDA during six months 2003 increased $28 million and $8 million, respectively, due to the acquisition of national distribution companies (NDCs) in Europe during 2002. NDCs are independent organizations that market and sell Galileo global distribution and computer reservation services to travel agents and other subscribers.
Trip Network, which we acquired in April 2003 and which operates Cheap Tickets, contributed $10 million in revenues and an EBITDA decline of $11 million in six months 2003 due to factors contributing to reductions in travel demand, as noted above. In addition, during the summer of 2002, we acquired two other companies that supply reservation and distribution services to the hospitality industry. The operating results of such companies were included from the acquisition dates forward and collectively contributed revenue of $21 million with a nominal EBITDA impact during six months 2003. Additionally, revenues from our travel agency business declined $17 million in six months 2003 due to a general industry decline in travel demand, as discussed above, reductions in commission rates paid by airlines, the lack of reduced-rate air inventory availability and a decline in travel-related clubs which are serviced by us. However, the impact on EBITDA of lower travel agency revenues was more than offset by variable expense savings on lower revenues and expense reductions due to cost containment initiatives relating to our travel agency business implemented in 2002 and 2003. EBITDA in six months 2003 was favorably impacted by $8 million in connection with a contract termination settlement during first quarter 2003.
Vehicle ServicesRevenues increased $823 million (42%) while EBITDA declined $11 million (6%), in six months 2003 compared with the prior year period, primarily due to our acquisition of Budget. Budget's operating results, including integration costs, were included from the acquisition date forward and contributed revenues of $847 million and EBITDA losses of $7 million in six months 2003. Excluding Budget's six months 2003 results, revenue and EBITDA declined $24 million (1%) and $4 million (2%), respectively, in six months 2003, which is primarily attributable to reduced car rental demand offset by increased pricing at Avis. Avis domestic car rental revenues declined $61 million (6%) in six months 2003 compared with six months 2002. The net reduction in domestic car rental revenues at Avis was primarily due to an 8% period-over-period reduction in domestic car rental days, which was partially offset by a 2% increase in time and mileage revenue per domestic rental day, reflecting an increase in pricing that substantially flows to EBITDA. In addition, EBITDA, period-over-period, includes favorable interest costs of $18 million on the financing of vehicles due to lower interest rates, which were offset by incremental vehicle-related net expenses and customer service costs. The increase in vehicle-related net expenses includes incremental maintenance and damage costs due to a reduction in warranty-related services provided to car manufacturers, a decline in gas reimbursements from Avis car rental customers and higher vehicle license and registration costs. Despite reduced Avis revenue domestically, revenues from Avis' international operations increased $22 million, due to increased transaction volume and the favorable impact to revenues of exchange rates, in Australia, New Zealand, and Canada, which was principally offset in EBITDA by the unfavorable impact on expenses. Wright Express, our fuel card business, recognized incremental revenues of $17 million (28%) in six months 2003 compared with the prior year period. This was primarily due to growth in fuel cards, card usage and higher gasoline prices whereby Wright Express earns a percentage of the total gas purchased by its clients.
Financial ServicesRevenues and EBITDA decreased $66 million (9%) and $12 million (5%), respectively, in six months 2003 compared with the comparable prior year six months. Revenue and EBITDA reflect a continued attrition of the membership base retained by us in connection with the outsourcing of our individual membership business to Trilegiant; however, the impact on EBITDA was mitigated by a net reduction in expenses from servicing fewer members. A smaller membership base resulted in a net revenue reduction of $114 million (net of $8 million of royalty income from Trilegiant), which was partially offset in EBITDA by favorable membership operating expenses of $74 million. See the section entitled "Liquidity and Capital Resources—Affiliated Entities" for a discussion concerning our consolidation of Trilegiant on July 1, 2003 pursuant to FIN 46. Partially offsetting the impact from the attrition of the membership business was growth in our Jackson Hewitt tax preparation franchise operations.
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Jackson Hewitt generated incremental franchise royalty and tax preparation revenues of $20 million in six months 2003 compared with six months 2002, which was principally driven by a 12% increase in tax return volume and a 10% increase in the average price per return. Favorable results in the tax preparation franchise business are recognized with nominal increases in expenses due to significant operating leverage within this business. In addition, Jackson Hewitt also generated $11 million of incremental revenues from financial products and programs primarily due to timing, as revenues from a certain financial product program were earned in the first six months of 2003, when in 2002 such revenues were earned in the third quarter. Revenues benefited $13 million from incremental foreign currency translation gains at our international membership business. EBITDA, in six months 2003, was also impacted by an $8 million expense incurred in connection with a litigation settlement.
Corporate and OtherRevenues and Adjusted EBITDA increased $35 million and $78 million, respectively in six months 2003 compared with six months 2002. Revenues and EBITDA include a $30 million gain in connection with the sale of our equity investment in Entertainment Publication, Inc., during first quarter 2003. EBITDA also reflects a greater absorption of overhead expenses by our reportable operating segments during six months 2003 compared with six months 2002, principally due to expense allocations in six months 2003 to companies that were acquired during 2002 and did not receive overhead allocations in the six months of last year. Also contributing to an increase in EBITDA period-over-period was the absence of costs incurred in six months 2002 associated with the December 2001 outsourcing of substantially all of our domestic data center operations and other information technology functions.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Within our vehicle rental, vehicle management, relocation, mortgage services and vacation ownership businesses, we purchase assets or finance the purchase of assets on behalf of our clients. Assets generated in this process are classified as assets under management and mortgage programs. We seek to offset the interest rate exposures inherent in these assets by matching them with financial liabilities that have similar term and interest rate characteristics. As a result, we minimize the interest rate risk associated with managing these assets and create greater certainty around the financial income that they produce. Fees generated from our clients are used, in part, to repay the interest and principal associated with the financial liabilities. Funding for our assets under management and mortgage programs is also provided by both unsecured borrowings and asset-backed financing arrangements, which are classified as liabilities under management and mortgage programs, as well as securitization facilities with special purpose entities. Cash inflows and outflows relating to the generation or acquisition of such assets and the principal debt repayment or financing of such assets are classified as activities of our management and mortgage programs. Our finance activities vary from the rest of our businesses based upon the impact of the relative business and financial risks and asset attributes, as well as the nature and timing associated with the respective cash flows. Accordingly, we believe that it is appropriate to segregate our assets under management and mortgage programs and our liabilities under management and mortgage programs separately from the assets and liabilities of the rest of our businesses because, ultimately, the source of repayment of such liabilities is the realization of such assets.
FINANCIAL CONDITION
Total assets exclusive of assets under management and mortgage programs decreased slightly primarily due to (i) a reduction in timeshare-related inventory as a result of a reclassification to assets under management and mortgage programs as such assets were financed under a program during first quarter 2003, (ii) a decrease in non-current deferred income taxes primarily resulting from the utilization of a portion of our net operating loss carryforward and (iii) the sale of properties and the related mortgages, which we had acquired upon foreclosure due to borrowers'
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delinquencies. Such decreases were partially offset by an increase of $501 million in cash and cash equivalents (see "Liquidity and Capital Resources—Cash Flows" below for a detailed discussion of such increase).
Total liabilities exclusive of liabilities under management and mortgage programs decreased slightly primarily due to the repurchase/redemption of approximately $2.7 billion of debt securities, which was substantially offset by the issuance of approximately $2.6 billion in longer-term debt securities during first quarter 2003 (see "Liquidity and Capital Resources—Financial Obligations—Corporate Indebtedness" for a detailed account of this activity).
Assets under management and mortgage programs increased primarily due to (i) the purchase of vehicles used primarily in our vehicle rental operations, (ii) the acquisition of FFD Development Company LLC and the timeshare financing referred to above and (iii) timing differences in the balance of mortgage loans held for sale arising between the origination and sales of such loans. Such increases were partially offset by a net reduction of $387 million in our mortgage servicing rights assets, including the related derivatives (see Note 6 to our Consolidated Condensed Financial Statements for a detailed account of the change in our mortgage servicing rights asset and related derivative assets).
Liabilities under management and mortgage programs increased primarily due to issuances of debt during 2003 to support the growth in our portfolio of assets under management and mortgage programs, as discussed above (see "Liquidity and Capital Resources—Financial Obligations—Debt Related to Management and Mortgage Programs" for a detailed account of the change in debt related to management and mortgage programs).
Stockholders' equity increased primarily due to (i) $691 million of net income generated during the six months ended June 30, 2003 and (ii) $117 million related to the exercise of employee stock options. Such increases were partially offset by our repurchase of $461 million (32.3 million shares) in common stock.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash on hand and our ability to generate cash through operations and financing activities, as well as available credit and securitization facilities, each of which is discussed below.
CASH FLOWSAt June 30, 2003, we had $627 million of cash on hand, an increase of $501 million from $126 million at December 31, 2002. The following table summarizes such increase:
During the first half of 2003, we generated approximately $2.4 billion of net cash from operating activities as compared to using $684 million of net cash during the comparable period in 2002. This change principally reflects the completion of our funding the principal stockholder litigation settlement liability in 2002, as noted in the table above. Excluding the effects of the principal stockholder litigation settlement funding, net cash provided by operating activities increased by $198 million. Such change primarily represents (i) greater net income, (ii) better management of our working capital and (iii) proceeds received from the termination of fair value hedges of corporate debt instruments (we subsequently reset these hedge positions to create a desired balance between its floating rate debt and floating rate assets). These increases were partially offset in the operating activities of our management and mortgage programs due to a decrease in net cash inflows provided by mortgage origination and sale activities, which results from a timing difference on the receipt of proceeds from the sales of originated loans.
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During the first half of 2003, we used approximately $1.8 billion of net cash for investing activities as compared to generating $216 million of net cash during the comparable period in 2002. This change principally reflects the absence in 2003 of (i) $1.41 billion of proceeds received in 2002 from the stockholder litigation settlement trust, which represented funds that we deposited to the trust in 2001 that were then used in 2002 to fund the stockholder litigation settlement liability, as discussed above, and (ii) $1.2 billion in proceeds received from the May 2002 sale of our car parking facility business. Excluding these amounts, we used $602 million less cash for investing activities during 2003 as compared to the same period in 2002. This decrease primarily reflects our decision to significantly curtail acquisitions, as evidenced by an almost $500 million reduction in cash used for this purpose. Also contributing to this change aggregate proceeds of $72 million received in 2003 on the sale of our investment in Entertainment Publications, Inc. ($33 million) and the sale/leaseback of one of our New Jersey facilities ($39 million). The investing activities of our management and mortgage programs remained relatively flat period-over-period as the increase in net cash used to acquire vehicles was partially offset by greater cash inflows on derivative contracts used to manage the interest rate risk inherent in our MSR asset. We also used $59 million more cash in 2003 for capital expenditures to support operational growth and businesses acquired in 2002 and to enhance marketing opportunities and develop operating efficiencies through technological improvements. We continue to anticipate aggregate capital expenditure investments for 2003 to be in the range of $450 million to $480 million.
During the first half of 2003, we used $995 million less cash for financing activities as compared to the first half of 2002. While we benefited from approximately $2.6 billion of proceeds received during 2003 on the issuance of fixed-rate debt, this cash was deployed to increase debt repayments by approximately $1.7 billion and to increase share repurchases by $324 million period-over-period. These changes demonstrate our dedication to strengthening our liquidity position. Further contributing to this change is an increase of $427 million in the financing activities of our management and mortgage programs, which primarily represents greater borrowings in 2003 to support the purchase of vehicles used in our vehicle rental operations. See "Liquidity and Capital Resources—Financial Obligations" for a detailed discussion of financing activities during the six months ended June 30, 2003.
Throughout the second half of 2003, we intend to deploy our available cash and the cash generated through our operations primarily to reduce/retire corporate indebtedness and repurchase outstanding shares of our common stock. Management currently expects that we will use $229 million of cash in December 2003 to retire our 73/4% notes. Additionally, management currently intends to use cash to redeem our zero coupon senior convertible contingent notes and zero coupon convertible debentures on their call dates (February 2004 and May 2004, respectively); however, holders of these instruments may convert them into shares of our common stock if the price of such stock exceeds the stipulated thresholds. We also intend to begin paying a quarterly cash dividend in 2004. While we expect the quarterly dividend to start at 7 cents per share (or 28 cents per share annually), we anticipate increasing the dividend over time as our earnings and cash flow grow.
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FINANCIAL OBLIGATIONSAt June 30, 2003, we had approximately $20.1 billion of indebtedness (including corporate indebtedness of $5.5 billion, Upper DECS of $863 million, debt under management and mortgage programs of $13.3 billion and our mandatorily redeemable preferred interest of $375 million).
Corporate IndebtednessCorporate indebtedness consisted of:
The change in our total corporate debt reflects the issuance of $2.6 billion in notes with maturity dates ranging from five to eleven years, the proceeds of which were primarily used to repurchase debt with nearer-term maturities. Through second quarter 2003, we have repurchased a total of $2.1 billion in debt, $1.6 billion of which was scheduled to mature or potentially become due in 2003 (73/4% notes and zero coupon convertible debentures). Through these repurchases, we have not only eliminated a significant liquidity need, we have also removed 49.7 million shares of potential dilution from our future earnings per share which, together with the repurchase of $396 million of our 37/8% convertible senior debentures, brings the total number of shares of potential dilution removed to 83 million.
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The number of shares of common stock potentially issuable for each of our contingently convertible debt securities are detailed below (in millions):
Debt Under Management and Mortgage ProgramsThe following table summarizes the components of our debt under management and mortgage programs:
The following table provides the contractual maturities for our debt under management and mortgage programs at June 30, 2003 (except for notes issued under our vehicle management program, where the underlying indentures require payments based on cash inflows relating to the corresponding assets under management and mortgage programs and for which appropriate estimates have been used):
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AVAILABLE FUNDING ARRANGEMENTS AND COMMITTED CREDIT FACILITIESAt June 30, 2003, we had approximately $5.1 billion of available funding arrangements and credit facilities (including availability of approximately $1.8 billion at the corporate level and approximately $3.3 billion available for use in our management and mortgage programs). As of June 30, 2003, the committed credit facilities at the corporate level consisted of:
Available funding under our asset-backed debt programs and committed credit facilities related to our management and mortgage programs as of June 30, 2003 consisted of:
As of June 30, 2003, we also had $400 million of availability for public debt or equity issuances under a shelf registration statement and our PHH subsidiary had an additional $874 million of availability for public debt issuances under a shelf registration statement.
Off Balance-Sheet Financing ArrangementsWe sell specific assets under management and mortgage programs in exchange for cash. Within our timeshare business, timeshare receivables are sold to Sierra Receivables Funding Company LLC, a bankruptcy remote qualifying special purpose entity (prior to the establishment of Sierra, we sold timeshare receivables to multiple bankruptcy remote qualifying special purpose entities). At our PHH subsidiary, we sell relocation receivables to Apple Ridge Funding LLC, a bankruptcy remote qualifying special purpose entity. Our PHH subsidiary also sells loans originated by our mortgage business into the secondary market, which is customary practice in the mortgage industry. Such mortgage loans are sold into the secondary market primarily through one of the following means: (i) the direct sale to a government-sponsored entity, (ii) through capacity under a subsidiary's public registration statement (which approximated $1.97 billion as of June 30, 2003) or (iii) through Bishop's Gate Residential Mortgage Trust, a bankruptcy remote special purpose entity. The assets sold to and the debt issued by these entities are not presented on our Consolidated Condensed Balance Sheets.
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Presented below is detailed information as of June 30, 2003 regarding off-balance sheet financing and sale arrangements.
When securitizing assets under management and mortgage programs, we make representations and warranties customary to the securitization markets, including eligibility characteristics of the assets transferred and servicing responsibilities. However, the receivables and mortgage loans transferred to the above special purpose entities, as well as the mortgage loans sold to the secondary market through other means, are generally non-recourse to us and to PHH. Pretax gains recognized on all securitizations of financial assets, which are recorded within net revenues on our Consolidated Condensed Statements of Income, were as follows:
Pursuant to FIN 46, we will consolidate Bishop's Gate on July 1, 2003 through the application of the prospective transition method (see Note 1 to our Consolidated Condensed Financial Statements for more information on FIN 46 and the future consolidation of Bishop's Gate). The consolidation of this entity will not affect our results of operations or cause any changes to our prior period consolidated financial statements (including first and second quarters of 2003). However, the consolidation of Bishop's Gate will cause our total assets and liabilities under management and mortgage programs to increase by approximately $2.1 billion each on July 1, 2003.
Additionally in third quarter 2003, we requested that the boards of directors of the qualified special purpose entities we use to securitize our timeshare receivables amend these structures to enable us to begin consolidating these entities. We would continue to transfer timeshare receivables to these entities; however, gains would no longer be recognized at the time of such transfers. While the requested amendments have not yet been approved, we anticipate that the consolidation of these entities would increase our assets and liabilities under management and mortgage programs by approximately $1 billion each and, as previously disclosed, we estimate that the change in the timing of income recognition resulting from the likely consolidation would reduce our 2003 earnings per share by $0.01 to $0.02.
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LIQUIDITY RISKOur liquidity position may be negatively affected by unfavorable conditions in any one of the industries in which we operate. Additionally, our liquidity as it relates to both management and mortgage programs, could be adversely affected by (i) the deterioration in the performance of the underlying assets of such programs, (ii) the impairment of our ability to access the principal financing program for our vehicle rental subsidiaries if General Motors Corporation or Ford Motor Company should not be able to honor its obligations to repurchase a substantial number of our vehicles and (iii) our inability to access the secondary market for mortgage loans or certain of our securitization facilities and our inability to act as servicer thereto, which could become limited in the event that our or PHH's credit ratings are downgraded below investment grade and, in certain circumstances, where we or PHH fail to meet certain financial ratios. Further, access to our credit facilities may be limited if we were to fail to meet certain financial ratios. We do not believe that our or PHH's credit ratings are likely to fall below investment grade. Additionally, we monitor the maintenance of required financial ratios and as of June 30, 2003, we were in compliance with all covenants under our credit and securitization facilities. Currently our credit ratings are as follows:
All of the above credit ratings, with the exception of those assigned to PHH's short-term debt, are currently on negative outlook. A security rating is not a recommendation to buy, sell or hold securities and is subject to revision or withdrawal by the assigning rating organization. Each rating should be evaluated independently of any other rating.
CONTRACTUAL OBLIGATIONSAs of June 30, 2003, our future contractual obligations have not changed significantly from the amounts reported within our 2002 Annual Report on Form 10-K with the exception of our commitment to purchase vehicles during 2003, which now approximates $1.4 billion, a decrease of approximately $1.2 billion from the amount previously disclosed. Any changes to our obligations related to corporate indebtedness and debt under management and mortgage programs are presented above within the section entitled "Financial Obligations" herein and also within Notes 7 and 8 to our Consolidated Condensed Financial Statements.
AFFILIATED OPERATING ENTITIESAs of June 30, 2003, the only affiliated operating entity that we had not consolidated was Trilegiant Corporation. In connection with our adoption of FIN 46, we will begin consolidating Trilegiant in the third quarter of 2003, which will result in a non-cash charge of approximately $300 million recorded on July 1, 2003 as a cumulative effect of accounting change. This non-cash charge does not impact income from continuing operations or the related per share amounts. Although we will be recording Trilegiant's profits and losses in our consolidated results of operations (beginning July 1, 2003), we are not obligated to infuse capital or otherwise fund or cover any losses incurred by Trilegiant. Therefore, our maximum exposure to loss as a result of our involvement with Trilegiant is substantially limited to the advances and loans we made to Trilegiant, as well as any receivables due from Trilegiant (collectively aggregating $112 million as of June 30, 2003), as such amounts may not be recoverable if Trilegiant were to cease operations. Upon consolidation of Trilegiant, our total assets and liabilities will increase by approximately $100 million and $400 million (approximately $250 million of which represents deferred income), respectively.
Trilegiant operates membership-based clubs and programs and other incentive-based programs through an outsourcing arrangement with us. Pursuant to such arrangement, we retained substantially all of the assets and liabilities of our existing membership business and licensed Trilegiant the right to market products utilizing our intellectual property to new members. Accordingly, we continue to collect membership fees from, and are obligated to provide membership benefits to, members of our individual membership business that existed as of July 2, 2001 (referred to as "existing members"), including their renewals and Trilegiant provides fulfillment services for these members in exchange for a servicing fee pursuant to the Third Party Administrator agreement. Furthermore, Trilegiant collects the membership fees from, and is obligated to provide membership benefits to, any members who
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joined the membership based clubs and programs and all other incentive programs subsequent to July 2, 2001 (referred to as "new members") and recognizes the related revenue and expenses. Similar to our franchise businesses, we receive a royalty from Trilegiant on all future revenue generated by the new members.
During the three months ended June 30, 2003 and 2002, revenues from existing members approximated $84 million and $139 million, respectively. Trilegiant charged us $34 million and $44 million during the three months ended June 30, 2003 and 2002, respectively, in connection with providing fulfillment services to these members. During the three months ended June 30, 2003 and 2002, we also recorded revenues of $16 million and $13 million, respectively, (representing royalties and licensing and leasing fees) and marketing expenses of $4 million and $2 million, respectively (related to the advance made to Trilegiant in 2001) in connection with the outsourcing arrangement. The resultant impact of these activities to our cash position was a net inflow of $7 million and $9 million to cash provided by operating activities during the three months ended June 30, 2003 and 2002, respectively.
During the six months ended June 30, 2003 and 2002, revenues from existing members approximated $174 million and $296 million, respectively. Trilegiant charged us $70 million and $95 million during the six months ended June 30, 2003 and 2002, respectively, in connection with providing fulfillment services to these members. During the six months ended June 30, 2003 and 2002, we also recorded revenues of $33 million and $24 million, respectively (representing royalties and licensing and leasing fees) and marketing expenses of $8 million and $12 million, respectively (related to the advance made to Trilegiant in 2001) in connection with the outsourcing arrangement. The resultant impact of these activities to our cash position was a net inflow of $29 million and $36 million to cash provided by operating activities during the six months ended June 30, 2003 and 2002, respectively.
As of June 30, 2003, our equity ownership interest in Trilegiant approximated 35% on a fully diluted basis; however, after giving consideration to the applicable stockholder's agreement, we believe that we have the right to acquire an additional 7% ownership interest.
ACCOUNTING POLICIESThe majority of our businesses operate in environments where we are paid a fee for a service performed. Therefore, the results of the majority of our recurring operations are recorded in our financial statements using accounting policies that are not particularly subjective, nor complex. However, in presenting our financial statements in conformity with generally accepted accounting principles, we are required to make estimates and assumptions that affect the amounts reported therein. Several of the estimates and assumptions that we are required to make pertain to matters that are inherently uncertain as they relate to future events. Presented within the section entitled "Critical Accounting Policies" of our 2002 Annual Report on Form 10-K are the accounting policies that we believe require subjective and/or complex judgments that could potentially affect reported results (mortgage servicing rights, retained interests from securitizations, financial instruments and goodwill and other intangible assets). There have not been any significant changes to those accounting policies nor to our assessment of which accounting policies we would consider to be critical accounting policies. From time to time, we evaluate the estimates used in recording goodwill in connection with the acquisition of a business. In certain circumstances, those estimates may be based upon preliminary or outdated information. Accordingly, the allocation to goodwill is subject to revision when we receive new information. Revisions to the estimates are recorded as further adjustments to goodwill or within the Consolidated Condensed Statements of Income, as appropriate.
On January 1 2003, we adopted the fair value method of accounting for stock-based compensation provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" and all the provisions of SFAS No. 148, "Accounting for Stock-Based Compensation—Transition and Disclosure." As a result, we changed our accounting policy for stock-based compensation.
Also on January 1, 2003, we adopted the following standards as a result of the issuance of new accounting pronouncements by the Financial Accounting Standards Board ("FASB") in 2002:
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During 2003, the FASB also issued the following pronouncements, which we will adopt on July 1, 2003:
For more detailed information regarding any of these pronouncements and the impact thereof on our business, see Note 1 to our Consolidated Condensed Financial Statements.
Item 3. Quantitative And Qualitative Disclosures About Market Risks
As previously discussed in our 2002 Annual Report on Form 10-K, we assess our market risk based on changes in interest and foreign currency exchange rates utilizing a sensitivity analysis. The sensitivity analysis measures the potential loss in earnings, fair values, and cash flows based on a hypothetical 10% change (increase and decrease) in our market risk sensitive positions. We used June 30, 2003 market rates to perform a sensitivity analysis separately for each of our market risk exposures. The estimates assume instantaneous, parallel shifts in interest rate yield curves and exchange rates. We have determined, through such analyses, that the impact of a 10% change in interest and foreign currency exchange rates and prices on our earnings, fair values and cash flows would not be material.
Item 4. Controls and Procedures
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
In Re Homestore.com Securities Litigation, No. 10-CV-11115 (MJP) (U.S.D.C., C.D. Cal.). On November 15, 2002, Cendant and Richard A. Smith, one of our officers, were added as defendants in a purported class action. The 26 other defendants in such action include Homestore.com, Inc., certain of its officers and directors and its auditors. Such action was filed on behalf of persons who purchased stock of Homestore.com (an Internet-based provider of residential real estate listings) between January 1, 2000 and December 31, 2001. The complaint in this action alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act based on purported misconduct in connection with the accounting of certain revenues in financial statements published by Homestore.com during the class period. On January 10, 2003, we, together with Mr. Smith, filed a motion to dismiss plaintiffs' claims for failure to state a claim upon which relief could be granted. A hearing on our motion to dismiss was held on February 14, 2003 and at the conclusion thereof the motion was submitted to the court for determination. On March 7, 2003, the court granted our motion and dismissed the complaint, as against Cendant and Mr. Smith, with prejudice. On April 14, 2003, plaintiffs filed a motion for an order certifying an issue for interlocutory appeal. In an order dated July 11, 2003, the court denied plaintiffs' motion.
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Item 4. Submission of Matters to a Vote of Security Holders
We held an Annual Meeting of Stockholders on May 20, 2003, pursuant to a Notice of Annual Meeting of Stockholders and Proxy Statement dated March 28, 2003, a copy of which has been filed previously with the Securities and Exchange Commission, at which our stockholders approved the election of five directors for a term of three years, the ratification of the appointment of Deloitte & Touche LLP as independent auditors of the financial statements for fiscal year 2003 and an increase in shares available under the Cendant Corporation Amended and Restated 1998 Employee Stock Purchase Plan.
Item 6. Exhibits and Reports on Form 8-K
See Exhibit Index
On April 4, 2003, we filed a current report on Form 8-K to report under Item 5 that our Board of Directors had authorized a $500 million increase in our share repurchase program.
On April 16, 2003, we filed a current report on Form 8-K to report under Item 5 that Ronald L. Nelson will join Cendant as Chief Financial Officer and a member of our Board of Directors.
On April 22, 2003, we filed a current report on Form 8-K to report under Item 12 our first quarter 2003 financial results.
On June 30, 2003, we filed a current report on Form 8-K to report under Item 5 that we intend to begin paying a cash dividend on our common stock in the first quarter of 2004. We also reiterated our previously announced cash flow projections and announced that we expect to meet or exceed our second quarter 2003 earnings projection.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: August 7, 2003
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Exhibit Index
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