FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 (Mark One) [ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 [ ] 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 1-12688 STEWART INFORMATION SERVICES CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 74-1677330 - ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 1980 Post Oak Blvd., Houston TX 77056 ------------------------------------------------------------ (Address of principal executive offices, including zip code) (713) 625-8100 ---------------------------------------------------- (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, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common 6,493,556 Class B Common 525,006
FORM 10-Q QUARTERLY REPORT Quarter Ended September 30, 1998 TABLE OF CONTENTS Item No. Page - -------- ---- Part I 1. Financial Statements 1 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 5 Part II 1. Legal Proceedings 10 5. Other Information 11 6. Exhibits and Reports on Form 8-K 9 Signature 12
STEWART INFORMATION SERVICES CORPORATION CONSOLIDATED STATEMENTS OF EARNINGS FOR THE QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 1998 and 1997 <TABLE> <CAPTION> THIRD QUARTER NINE MONTHS --------------------- --------------------- 1998 1997 1998 1997 ---------- ---------- ---------- ---------- ($000 Omitted) ($000 Omitted) <S> <C> <C> <C> <C> Revenues Title premiums, fees and other revenues 233,385 168,924 632,912 466,522 Real estate information services 12,265 9,616 36,112 24,221 Investment income 4,703 3,962 13,479 11,550 Investment gains - net 72 124 403 305 --------- -------- -------- ------- 250,425 182,626 682,906 502,598 Expenses Amounts retained by agents 114,465 84,504 304,156 235,679 Employee costs 62,690 48,236 180,935 135,749 Other operating expenses 35,219 29,580 99,701 80,936 Title losses and related claims 10,284 8,035 28,523 22,138 Depreciation and amortization 3,809 3,110 10,670 8,729 Interest 306 400 1,089 966 Minority interests 1,233 561 3,662 1,471 --------- -------- -------- ------- 228,006 174,426 628,736 485,668 --------- -------- -------- ------- Earnings before taxes 22,419 8,200 54,170 16,930 Income taxes 8,371 2,713 20,239 5,851 --------- -------- -------- ------- Net earnings 14,048 5,487 33,931 11,079 ========= ======== ======== ======= Average number of shares outstanding (000) 7,094 6,900 7,064 6,867 Earnings per share - basic 2.00 0.80 4.87 1.63 Earnings per share - diluted 1.98 0.80 4.80 1.61 ========= ========= ======== ======= Comprehensive earnings: Net earnings 14,048 5,487 33,931 11,079 Changes in unrealized investment gains, net of taxes 2,582 2,032 1,971 1,288 --------- -------- -------- ------- Comprehensive earnings 16,630 7,519 35,902 12,367 ========= ========= ======== ======= </TABLE> -1-
STEWART INFORMATION SERVICES CORPORATION CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 <TABLE> <CAPTION> SEP 30 DEC 31 1998 1997 ---------- ---------- ($000 Omitted) <S> <C> <C> Assets Cash and cash equivalents 43,066 30,391 Short-term investments 49,022 35,761 Investments - statutory reserve funds 148,280 138,462 Investments - other 76,891 71,044 Receivables 37,706 31,868 Property and equipment 33,562 30,415 Title plants 23,631 21,778 Goodwill 19,069 18,427 Deferred income taxes 14,735 15,632 Other 25,635 23,913 ---------- ---------- 471,597 417,691 ========== ========== Liabilities Notes payable 16,631 19,087 Accounts payable and accrued liabilities 34,829 27,917 Estimated title losses 168,680 156,791 Minority interests 5,350 4,392 Contingent liabilities and commitments Stockholders' equity Common and Class B Common Stock and additional paid-in capital 61,886 59,828 Retained earnings 177,714 145,140 Other comprehensive earnings 6,507 4,536 ---------- ----------- Total stockholders' equity ($35.07 per share at September 30, 1998) 246,107 209,504 ---------- ----------- 471,597 417,691 ========== =========== </TABLE> -2-
STEWART INFORMATION SERVICES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 <TABLE> <CAPTION> 1998 1997 -------- -------- ($000 Omitted) <S> <C> <C> Cash provided by operating activities (Note) 58,697 16,894 Investing activities: Purchases of property and equipment and title plants - net (13,914) (9,612) Proceeds from investments matured and sold 37,281 33,020 Purchases of investments (62,772) (36,552) Increases in notes receivable (1,644) (1,756) Collections on notes receivable 1,303 594 Cash paid for the acquisition of subsidiaries - net (1,476) (2,608) ---------- --------- Cash used by investing activities (41,222) (16,914) Financing activities: Dividends paid (1,357) (1,196) Distribution to minority interests (2,763) (1,361) Proceeds from issuance of stock 2,228 96 Proceeds of notes payable 5,466 8,803 Payments on notes payable (8,374) (2,714) ---------- --------- Cash (used) provided by financing activities (4,800) 3,628 ---------- --------- Increase in cash and cash equivalents 12,675 3,608 ========== ========== </TABLE> NOTE: Reconciliation of net earnings to the above amounts - <TABLE> <S> <C> <C> Net earnings 33,931 11,079 Add (deduct): Depreciation and amortization 10,670 8,729 Provision for title losses in excess of payments 11,102 5,050 Provision for uncollectible amounts - net (502) 403 Increase in accounts receivable - net (4,033) (4,477) Increase (decrease) in accounts payable and accrued liabilities - net 7,389 (2,715) Minority interest expense 3,662 1,471 Equity in net earnings of investees (701) (922) Realized investment gains - net (403) (305) Other - net (2,418) (1,419) ---------- --------- Cash provided by operating activities 58,697 16,894 ========== ========= </TABLE> -3-
STEWART INFORMATION SERVICES CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1: Interim Financial Statements The financial information contained in this report for the nine month periods ended September 30, 1998 and 1997, and as at September 30, 1998, is unaudited. In the opinion of management, all adjustments necessary for a fair presentation of this information for all unaudited periods, consisting only of normal recurring accruals, have been made. The results of operations for the interim periods are not necessarily indicative of results for a full year. Certain amounts in the 1997 consolidated financial statements have been reclassified for comparative purposes. Net earnings, as previously reported, were not affected. -4-
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL The Company provides title insurance and related services through more than 4,000 issuing locations in the United States and several international markets. A leading provider of real estate information technology and connectivity, Stewart also meets the needs of the real estate and mortgage industry through the electronic delivery of services needed for settlement. These services include title insurnace, title reports, flood determinations, property appraisals, document preparation, credit reports and other real estate information. In addition, Stewart provides expertise in tax-deferred exchanges, surveys and field services. In general, the principal factors which contribute to increases in title revenues include declining mortgage interest rates (which usually increase home sales), increases in refinancing transactions, rising home prices, higher premium rates, increased market share, additional revenues from new offices and increased revenue from non-residential, commercial transactions. Although relatively few in number, large commercial transactions usually yield higher premiums. A comparison of the results of operations of the Company for the first nine months of 1998 with the first nine months of 1997 follows: REVENUES Revenues from title premiums and fees increased $166.4 million, or 35.7%, from the comparable period in 1997. Mortgage interest rates declined by 67 basis points from the first week in October 1997 to the last week in September 1998, falling to 6.64%. Refinancing transactions, in particular, were higher in 1998. The number of closings handled by the Company increased 48.9%. Closings increased in California, Texas, Colorado and most other states. The average revenue per closing decreased slightly in 1998 due, in part, to a larger number of refinancings with their lower premiums. Increases in commercial transactions and revenues from agents also contributed to higher revenues in 1998. A 3% reduction in Texas title premiums became effective August 1, 1998. However, the Company is experiencing new home equity business in Texas that did not exist before 1998. Real estate information revenues were $36.1 million in 1998 and $24.2 million in 1997. The increase was primarily due to a significant number of new businesses started by the Company in 1997. Investment income increased 16.7% in 1998 due to an increase in the average balances invested and the increased yield on the balances. EXPENSES Amounts retained by agents increased $68.5 million, or 29.1%, over the comparable period in 1997. The percentage of retention by agents to the amounts of revenues from agents was 80.3% and 80.7% for the nine months ended September 30, 1998 and September 30, 1997, respectively. Employee expenses increased $45.2 million, or 33.3%, in 1998 primarily because of a higher average number of employees during 1998 compared to a year ago and increased average rates of compensation, including bonuses and profit sharing. The Company continued to maintain higher staff levels in comparison with a year ago. Increases were in areas of title operations from increased traction volume, automating services rendered to customers and improving its own processes, real estate information services that are being developed and sold to customers and the expansion of its national marketing efforts. The Company believes the development and sale of new products and services is important to its future. Through automated operating processes, the Company expects to add customer revenues and reduce operating expenses and title losses in the future. Other operating expenses increased by $18.8 million, or 23.2%, primarily because of the increase in transaction volume. Expenses that increased include appraisal fees, premium taxes, expenses of new offices, business promotion and search fees. Other operating expenses also include rent, supplies, travel, policy forms, delivery costs, title plant expenses and telephone. Most of these expenses follow, to varying degrees, the changes in transaction volume and revenues. -5-
Provisions for title losses and related claims were up $6.4 million, or 28.8% in 1998. The industry and the Company continue to have improved claim experience. As a percentage of title premiums, fees and other revenues, the provision in 1998 decreased to 4.5% versus 4.8% in 1997. The provision for income taxes represented effective tax rates of 37% and 35% in 1998 and 1997, respectively. A comparison of the results of operations of the Company for the third quarter of 1998 with the third quarter of 1997 follows: REVENUES Revenues from title premiums and fees increased $64.5 million, or 38.2%, from a year ago. Mortgage interest rates were approximately 60 basis points lower in the third quarter of 1998 than the same period a year ago, increasing real estate transactions. Refinancing transactions, in particular, were higher in 1998. The number of closings handled by the Company increased 46.2%. Closings increased in Texas, California, Colorado and most other states. The average revenue per closing decreased slightly in 1998 due, in part, to a larger number of refinancings with their lower premiums. Increases in commercial transactions and revenues from agents also contributed to higher revenues in 1998. A 3% reduction in Texas title premiums became effective August 1, 1998. However, the Company is experiencing new home equity business in Texas that did not exist before 1998. Real estate information revenues were $12.3 million in 1998 and $9.6 million in 1997. The increase was primarily due to a significant number of new businesses started by the company in 1997. Investment income increased 18.7% in 1998 due to an increase in the average balances invested and the increased yield on the balances. EXPENSES Amounts retained by agents increased $30.0 million, or 35.5%, over the comparable period in 1997. The percentage of retention by agents to the amounts of revenues by agents was 80.6% and 80.8% for the nine months ended September 30, 1998 and September 30, 1997, respectively. Employee expenses increased $14.5 million, or 30.0%, in 1998 primarily because of a higher average number of employees during 1998 compared to a year ago and increased average rates of compensation, including bonuses and profit sharing. The Company continued to maintain higher staff levels in comparison with a year ago. Increases were in areas of title operations from increased transaction volume, automating services rendered to customers and improving its own processes, real estate information services that are being developed and sold to customers and the expansion of its national marketing efforts. The Company believes the development and sale of new products and services is important to its future. Through automated operating processes, the Company expects to add customer revenues and reduce operating expenses and title losses in the future. Other operating expenses increased by $5.6 million, or 19.1%, primarily because of the increase in transaction volume. Expenses that increased include premium taxes, search fees, telephone and supplies. Other operating expenses also include rent, travel, policy forms, delivery costs, title plant expenses and business promotion. Most of these expenses follow, to varying degrees, the changes in transaction volume and revenues. Provisions for title losses and related claims were up $2.2 million, or 28.0% in 1998. The industry and the Company continue to have improved claim experience. As a percentage of title premiums, fees and other revenues, the provision in the third quarter of 1998 decreased to 4.4% versus 4.8% in the third quarter of 1997. The provision for income taxes represented effective tax rates of 37% and 33% in 1998 and 1997, respectively. The 1998 effective tax rate was higher primarily because nontaxable income from municipal bonds was significantly less in relation to pretax profits and due to refunds received in 1997 for a federal net operating loss carryforward and a change in the filing method for a certain state. -6-
Year 2000 Issue Information technology is a crucial part of the Company's business. The Company recognizes the technological challenges associated with the Year 2000 Issue ("Y2K"). It has established a formal compliance plan to address these challenges and a Y2K Team to carry out this plan. The plan includes several distinct phases: (1) assessment, (2) remediation, (3) testing and (4) implementation. The progress of the work of the Y2K Team is monitored by the Company's senior management and the audit committee of the Company's board of directors. Computer software is used in the title and real estate information segments of the Company's business. The uses of software in the title segment include searching and examining titles, closing transactions, accounting for agent policies and claims. In the real estate information segment, software is used in providing mortgage services, such as flood determinations, appraisals and assignments. Most of this software was developed by the Company in recent years, with Y2K issues in mind. The Company has substantially completed its assessment and remediation of all this software. All remaining remediation and testing of this software is scheduled to be completed by the first quarter of 1999. Implementation is expected to be completed by the second quarter of 1999. In addition to its work on its internally-developed computer software, the Company has conducted an inventory of its systems worldwide. This inventory includes software and hardware acquired from third parties for use by the Company. The inventory also includes critical non-information technology systems which may house non-compliant, imbedded technology, such as fax machines, photocopiers, telephone facilities and other common devices. Assessment and remediation of these systems is scheduled for completion by the first quarter of 1999. Mission critical systems have been given high priority. Certain subsidiaries that have been acquired by the Company and still operate with different systems from the Company's have been given high priority under the Company's Y2K plan. The Company expects to complete all phases of Y2K compliance for these subsidiaries in the first quarter of 1999. In addition to addressing the Company's own systems, as described above, the Y2K Team must assess the state of readiness of the systems of other entities with which it does business. These include independent title insurance agents and other business partners, such as county courthouses and lenders, whose condition or operational capability is important to the Company. Failure by these third parties to adequately resolve their Y2K problems could have a material adverse effect on the Company's operations. The Company believes its success in being Y2K compliant will not be conclusively known until the year 2000 is actually reached. Failure by one or more of the Company's own systems could result in lost revenues and additional expenses required to carry out manual processing of transactions. The magnitude of the failure of external forces on the business of the Company cannot be predicted. Failures by the telecommunications industry, banking institutions and others could have far-reaching, materially adverse effects on the Company, the title insurance industry and the entire economy. The Company expects to complete its Y2K program in a timely manner. However, the Company believes that it is not possible to determine with certainty that all Y2K problems affecting the Company have been identified or corrected. The number of devices that could be affected and the interactions among these devices are simply too numerous. In addition, the Company cannot accurately predict how many failures related to the Y2K problem will occur or the severity, duration or financial consequences of such failures. The Company has hired an outside Y2K consultant to assist the Company in meeting its goals and in developing contingency plans to define and address the worst-case scenario likely to be faced by the Company. The plan is expected to be in place in the first quarter of 1999. The Company has expended approximately $0.5 million during 1997 and the first three quarters of 1998 directly related to assessing, remediating and testing its information technology systems. These amounts have been funded from operations. As stated previously, the Company only recently developed most of the software it uses today. It has also purchased substantial amounts of hardware since 1996. The software development and hardware purchases were done as a part of the Company's goal to automate its operations rather than solely for the purpose of achieving Y2K compliance. These costs have been significant but are not included in the amount shown in the preceding paragraph. -7-
The Company currently estimates that the total cost of its Y2K compliance program will not exceed $3.5 million. Approximately half of the remaining amount to be spent is for depreciable hardware purchases for certain offices which may need to be upgraded sooner than planned due to Y2K issues. Additional amounts relate to travel and labor costs associated with installing compliant internally-developed software, allocated management time and consulting fees. A significant portion of the remaining costs are expected to be incurred during the first and second quarters of 1999. This entire section ("Year 2000 Issue") is hereby designated a "Year 2000 Readiness Disclosure", as defined in the Year 2000 Information and Readiness Disclosure Act. LIQUIDITY AND CAPITAL RESOURCES Operating margins represent the primary source of financing for the Company, but this may be supplemented by bank borrowings. The capital resources of the Company, and the present debt-to-equity relationship, are considered satisfactory. FORWARD LOOKING STATEMENTS All statements, other than statements of historical facts, included in this report which address activities, events or developments that the Company expects or anticipates will or may occur in the future are forward-looking statements. Such forward-looking statements are subject to risks and uncertainties including, among other things, changes in mortgage interest rates, employment levels, actions of competitors, changes in real estate markets, general economic conditions and legislation, primarily legislation related to insurance, and other risks and uncertainties discussed in the Company's filings with the Securities and Exchange Commission. -8-
PART II Page ---------- Item 1. Legal Proceedings 10 Item 5. Other Information 11 Item 6. Exhibits and Reports on Form 8-K (a) Index to exhibits (b) There were no reports on Form 8-K filed during the quarter ended September 30, 1998. -9-
ITEM 1. LEGAL PROCEEDINGS The Registrant is a party to routine lawsuits incidental to its business, most of which involve disputed policy claims. In many of these suits, the plaintiff seeks exemplary or treble damages in excess of policy limits based on the alleged malfeasance of an issuing agent of the Registrant. The Registrant does not expect that any of these proceedings will have a material adverse effect on its financial condition. -10-
ITEM 5. OTHER INFORMATION Proxies for the Company's annual meeting of stockholders to be held in 1999 may confer discretionary power to vote on any matter that may come before the meeting unless, with respect to a particular matter (i) the Company receives notice, by certified mail, return receipt requested, addressed to the Company's Secretary, not later than the 15th day of February next preceding the meeting that the matter will be presented at the annual meeting and (ii) the Company fails to include in its proxy statement for the annual meeting advice on the nature of the matter and how the Company intends to exercise its discretion to vote on the matter. -11-
SIGNATURE Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Stewart Information Services Corporation ---------------------------------------- (Registrant) November 12, 1998 - ---------------- Date /S/ MAX CRISP ----------------------------------------------- Max Crisp (Vice President-Finance, Secretary-Treasurer, Director and Principal Financial and Accounting Officer) -12-
INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.2 - By-Laws of the Registrant, as amended September 1, 1998 4 - Rights of Common and Class B Common Stockholders 27.0 - Financial data schedule 28.2 - Details of investments, as reported in the Quarterly Report to Shareholders