10-Q 1 d10q.htm THE FIRST AMERICAN CORPORATION FORM 10-Q The First American Corporation Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-13585

 

 

THE FIRST AMERICAN CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Incorporated in California   95-1068610

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1 First American Way, Santa Ana, California   92707-5913
(Address of principal executive offices)   (Zip Code)

(714) 250-3000

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x

 

Accelerated Filer  ¨

Non-accelerated filer  ¨ (Do not check if a smaller reporting company)

 

Smaller reporting company  ¨

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports to be filed by Section 12,13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ¨    No  ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

On October 24, 2008, there were 92,867,638 Common shares outstanding.

 

 

 


Table of Contents

THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

INFORMATION INCLUDED IN REPORT

 

Part I:

   Financial Information    4

Item 1.

   Financial Statements (unaudited)    4
   A. Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007    4
   B. Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2008 and 2007    5
   C. Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007    6
   D. Condensed Consolidated Statement of Stockholders’ Equity    7
   E. Notes to Condensed Consolidated Financial Statements    8

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    24

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    39

Item 4.

   Controls and Procedures    39

Part II:

   Other Information    39

Item 1.

   Legal Proceedings    39

Item 1A.

   Risk Factors    40

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    40

Item 6.

   Exhibits    40

Items 3 through 5 of Part II have been omitted because they are not applicable with respect to the current reporting period.

CERTAIN STATEMENTS MADE IN THIS QUARTERLY REPORT ON FORM 10-Q INCLUDING THE ULTIMATE CONSUMMATION OF THE PROPOSED SPIN-OFF TRANSACTION AND TAX FREE NATURE THEREOF; THE EFFECT OF CURRENT MARKET VOLATILITY ON GOODWILL; CONTRIBUTIONS TO PENSION AND 401(K) PLANS; PURCHASE ACCOUNTING ADJUSTMENTS FOR ACQUISITIONS AND FINAL PURCHASE PRICE ALLOCATIONS; THE EFFECT OF LAWSUITS, REGULATORY AUDITS AND INVESTIGATIONS AND OTHER LEGAL PROCEEDINGS ON THE COMPANY’S FINANCIAL CONDITION, RESULTS OF OPERATIONS OR CASH FLOWS; CHANGES IN UNRECOGNIZED TAX POSITIONS; THE REDUCTION OF POLICY CLAIM LOSSES IN THE DATA AND ANALYTIC SOLUTIONS SEGMENT FOLLOWING THE SPIN-OFF; AND THE SUFFICIENCY OF THE COMPANY’S RESOURCES TO SATISFY OPERATIONAL CASH REQUIREMENTS ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE AND OTHER FORWARD-LOOKING STATEMENTS MAY CONTAIN THE WORDS “BELIEVE,” “ANTICIPATE,” “EXPECT,” “PLAN,” “PREDICT,” “ESTIMATE,” “PROJECT,” “WILL BE,” “WILL CONTINUE,” “WILL LIKELY RESULT,” AND OTHER SIMILAR WORDS AND PHRASES. RISKS AND UNCERTAINTIES EXIST THAT MAY CAUSE RESULTS TO DIFFER MATERIALLY FROM THOSE SET FORTH IN THESE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE THE ANTICIPATED RESULTS TO DIFFER FROM THOSE DESCRIBED IN THE FORWARD-LOOKING STATEMENTS INCLUDE: INTEREST RATE FLUCTUATIONS; CHANGES IN THE PERFORMANCE OF THE REAL ESTATE MARKETS; LIMITATIONS ON ACCESS TO PUBLIC RECORDS AND OTHER DATA; GENERAL VOLATILITY IN THE CAPITAL MARKETS; CHANGES IN APPLICABLE GOVERNMENT REGULATIONS; HEIGHTENED SCRUTINY BY LEGISLATORS AND REGULATORS OF THE COMPANY’S TITLE INSURANCE AND SERVICES SEGMENT AND CERTAIN OTHER OF THE COMPANY’S BUSINESSES; CONSOLIDATION AMONG THE COMPANY’S

 

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SIGNIFICANT CUSTOMERS AND COMPETITORS; CHANGES IN THE COMPANY’S ABILITY TO INTEGRATE BUSINESSES WHICH IT ACQUIRES; SYSTEMS INTERRUPTIONS AND INTRUSIONS; THE COMPANY’S INABILITY TO REALIZE THE BENEFITS OF ITS OFFSHORE STRATEGY; PRODUCT MIGRATION; THE INABILITY TO CONSUMMATE THE SPIN-OFF TRANSACTION AS A RESULT OF, AMONG OTHER FACTORS, THE INABILITY TO OBTAIN NECESSARY REGULATORY APPROVALS OR THE FAILURE TO OBTAIN THE FINAL APPROVAL OF THE COMPANY’S BOARD OF DIRECTORS; THE INABILITY TO RECOGNIZE THE BENEFITS OF THE SPIN-OFF TRANSACTION AS A RESULT OF, AMONG OTHER FACTORS, UNEXPECTED CORPORATE OVERHEAD COSTS, UNFAVORABLE REACTION FROM CUSTOMERS, EMPLOYEES, RATINGS AGENCIES OR OTHER INTERESTED PERSONS, THE TRIGGERING OF RIGHTS AND OBLIGATIONS BY THE SPIN-OFF, ACCOMMODATIONS REQUIRED TO BE MADE TO OBTAIN CONSENTS OR WAIVERS OR THE INABILITY TO TRANSFER ASSETS INTO THE ENTITY BEING SPUN-OFF; AND OTHER FACTORS DESCRIBED IN PART I, ITEM 1A OF THE COMPANY’S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2007 AS UPDATED IN PART II, ITEM 1A OF THE COMPANY’S QUARTERLY REPORTS ON FORM 10-Q FOR THE QUARTERS ENDED MARCH 31, 2008, AND JUNE 30, 2008, RESPECTIVELY, AND AS FURTHER UPDATED HEREIN. THE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE THEY ARE MADE. THE COMPANY DOES NOT UNDERTAKE TO UPDATE FORWARD-LOOKING STATEMENTS TO REFLECT CIRCUMSTANCES OR EVENTS THAT OCCUR AFTER THE DATE THE FORWARD-LOOKING STATEMENTS ARE MADE.

 

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PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements.

THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Balance Sheets

(in thousands)

(unaudited)

 

     September 30,
2008
    December 31,
2007
 

Assets

    

Cash and cash equivalents

   $ 825,662     $ 1,162,569  
                

Accounts and accrued income receivable, net

     592,665       559,996  
                

Income tax receivable

     156,299       39,187  

Investments:

    

Deposits with savings and loan associations and banks

     282,139       198,055  

Debt securities

     1,607,453       1,368,212  

Equity securities

     133,397       147,102  

Other long-term investments

     407,736       457,764  
                
     2,430,725       2,171,133  
                

Loans receivable, net

     131,443       116,751  
                

Property and equipment, net

     699,247       755,435  
                

Title plants and other indexes

     676,328       645,679  
                

Deferred income taxes

     55,380       23,274  
                

Goodwill

     2,621,431       2,567,340  
                

Other intangible assets, net

     313,401       346,207  
                

Other assets

     243,387       260,350  
                
   $ 8,745,968     $ 8,647,921  
                

Liabilities and Stockholders’ Equity

    

Demand deposits

   $ 1,097,046     $ 743,685  

Accounts payable and accrued liabilities

     961,361       1,123,624  

Deferred revenue

     741,562       756,202  

Reserve for known and incurred but not reported claims

     1,331,252       1,357,632  

Notes and contracts payable

     935,359       906,046  

Deferrable interest subordinated notes

     100,000       100,000  
                
     5,166,580       4,987,189  
                

Minority interests in consolidated subsidiaries

     671,541       675,907  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $1 par value Authorized—500 shares; outstanding—none

    

Common stock, $1 par value:

    

Authorized—180,000 shares

    

Outstanding—92,865 and 91,830 shares

     92,865       91,830  

Additional paid-in capital

     797,081       762,734  

Retained earnings

     2,185,490       2,205,994  

Accumulated other comprehensive loss

     (167,589 )     (75,733 )
                
     2,907,847       2,984,825  
                
   $ 8,745,968     $ 8,647,921  
                

See notes to condensed consolidated financial statements.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Income and Comprehensive Income

(in thousands, except per share amounts)

(unaudited)

 

     For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
     2008     2007     2008     2007

Revenues

        

Operating revenues

   $ 1,510,739     $ 1,982,445     $ 4,767,618     $ 6,046,869

Investment and other income

     53,639       71,510       175,708       229,408

Gain on stock issued by a subsidiary

     —         123       1,325       9,426

Net realized investment (losses) gains

     (50,201 )     (2,885 )     (97,415 )     39,516
                              
     1,514,177       2,051,193       4,847,236       6,325,219
                              

Expenses

        

Salaries and other personnel costs

     513,710       651,099       1,654,224       1,974,103

Premiums retained by agents

     345,045       546,994       1,079,220       1,627,762

Other operating expenses

     445,103       514,643       1,373,722       1,565,491

Provision for policy losses and other claims

     121,903       137,225       343,885       664,351

Depreciation and amortization

     59,993       54,979       177,219       172,668

Premium taxes

     12,487       16,110       36,773       51,506

Interest

     15,113       22,132       48,187       60,869
                              
     1,513,354       1,943,182       4,713,230       6,116,750
                              

Income before income taxes and minority interests

     823       108,011       134,006       208,469

Income taxes (benefit) provision

     (1,033 )     41,443       47,960       61,117
                              

Income before minority interests

     1,856       66,568       86,046       147,352

Minority interests

     10,196       19,979       45,463       82,972
                              

Net (loss) income

     (8,340 )     46,589       40,583       64,380
                              

Other comprehensive (loss) income, net of tax

        

Unrealized (loss) gain on securities

     (27,941 )     4,642       (78,750 )     5,395

Foreign currency translation adjustments

     (23,219 )     9,394       (19,319 )     10,561

Minimum pension liability adjustment

     2,047       (1,107 )     6,213       3,297
                              
     (49,113 )     12,929       (91,856 )     19,253
                              

Comprehensive (loss) income

   $ (57,453 )   $ 59,518     $ (51,273 )   $ 83,633
                              

Net (loss) income per share (Note 7):

        

Basic

   $ (0.09 )   $ 0.50     $ 0.44     $ 0.67
                              

Diluted

   $ (0.09 )   $ 0.49     $ 0.44     $ 0.66
                              

Cash dividends per share

   $ 0.22     $ 0.22     $ 0.66     $ 0.66
                              

Weighted average number of shares (Note 7):

        

Basic

     92,659       93,746       92,388       95,624
                              

Diluted

     92,659       95,064       93,172       97,407
                              

See notes to condensed consolidated financial statements

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

     For the Nine Months Ended
September 30,
 
     2008     2007  

Cash flows from operating activities:

    

Net income

   $ 40,583     $ 64,380  

Adjustments to reconcile net income to cash provided by operating activities-

    

Provision for policy losses and other claims

     343,885       664,351  

Depreciation and amortization

     177,219       172,668  

Minority interests in net income

     45,463       82,972  

Net realized investment losses (gains)

     96,090       (48,942 )

Stock-based compensation expense

     20,972       22,278  

Equity in earnings of affiliates

     (38,057 )     (35,298 )

Changes in assets and liabilities excluding effects of company acquisitions and noncash transactions-

    

Claims paid, net of recoveries

     (370,227 )     (324,103 )

Net change in income tax accounts

     (108,578 )     (182,787 )

Increase in accounts and accrued income receivable

     (31,199 )     (107,944 )

(Decrease) increase in accounts payable and accrued liabilities

     (108,532 )     155,155  

Decrease in deferred revenue

     (14,641 )     (3,229 )

Other, net

     (20,724 )     (1,991 )
                

Cash provided by operating activities

     32,254       457,510  
                

Cash flows from investing activities:

    

Net cash effect of company acquisitions and dispositions

     (115,014 )     (217,045 )

Net increase in deposits with banks

     (84,084 )     (51,324 )

Increase in loans receivable

     (14,692 )     (15,709 )

Purchases of debt and equity securities

     (705,507 )     (511,503 )

Proceeds from sales of debt and equity securities

     166,281       132,529  

Proceeds from maturities of debt securities

     154,734       211,761  

Net decrease in other investments

     33,632       69,645  

Capital expenditures

     (112,744 )     (170,391 )

Purchases of capitalized data

     (24,404 )     (18,778 )

Proceeds from sales

     19,048       23,786  
                

Cash used for investing activities

     (682,750 )     (547,029 )
                

Cash flows from financing activities:

    

Net change in demand deposits

     353,361       (75,681 )

Proceeds from issuance of debt

     298,801       425,528  

Repayment of debt

     (266,909 )     (246,469 )

Repurchase of company stock

     —         (288,923 )

Proceeds from exercise of stock options

     14,053       39,763  

Proceeds from the issuance of stock to employee benefit plans

     5,219       6,808  

Excess tax benefits from stock-based compensation

     1,143       7,011  

Contributions from minority shareholders

     —         15,637  

Distributions to minority shareholders

     (31,215 )     (53,382 )

Cash dividends

     (60,864 )     (59,725 )
                

Cash provided by (used for) financing activities

     313,589       (229,433 )
                

Net decrease in cash and cash equivalents

     (336,907 )     (318,952 )

Cash and cash equivalents—Beginning of year

     1,162,569       1,404,884  
                

             —End of the period

   $ 825,662     $ 1,085,932  
                

Supplemental information:

    

Cash paid during the period for:

    

Interest

   $ 51,755     $ 52,825  

Premium taxes

   $ 47,098     $ 54,165  

Income taxes

   $ 133,953     $ 137,516  

Noncash investing and financing activities:

    

Liabilities incurred in connection with company acquisitions

   $ 977     $ 137,303  

Company acquisitions in exchange for common stock

   $ 3,588     $ 646  

Exchange of net assets for interest in unconsolidated affiliate

   $ —       $ 39,193  

See notes to condensed consolidated financial statements.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Condensed Consolidated Statement of Stockholders’ Equity

(in thousands)

(unaudited)

 

     Shares    Common
Stock
   Additional
paid-in
capital
   Retained
earnings
    Accumulated
other
comprehensive
loss
    Total  

Balance at December 31, 2007

   91,830    $ 91,830    $ 762,734    $ 2,205,994     $ (75,733 )   $ 2,984,825  

Net income for nine months ended September 30, 2008

              40,583         40,583  

Dividends on common shares

              (61,087 )       (61,087 )

Shares issued in connection with option, benefit and savings plans

   910      910      18,360          19,270  

Share-based compensation

           12,524          12,524  

Shares issued in connection with acquisitions

   125      125      3,463          3,588  

Other comprehensive loss

                (91,856 )     (91,856 )
                                           

Balance at September 30, 2008

   92,865    $ 92,865    $ 797,081    $ 2,185,490     $ (167,589 )   $ 2,907,847  
                                           

See notes to condensed consolidated financial statements.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Note 1 – Basis of Condensed Consolidated Financial Statements

The condensed consolidated financial information included in this report has been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Securities and Exchange Commission (SEC) Form 10-Q and Article 10 of SEC Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. The condensed consolidated financial statements included herein are unaudited; however, in the opinion of management, they contain all normal recurring adjustments necessary for a fair statement of the consolidated results for the interim periods. Certain 2007 amounts have been reclassified to conform to the 2008 presentation.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value within generally accepted accounting principles (GAAP), and expands disclosure requirements regarding fair value measurements. Although SFAS 157 does not require any new fair value measurements, its application may, in certain instances, change current practice. Where applicable, SFAS 157 simplifies and codifies fair value related guidance previously issued within GAAP. The Company has adopted FASB Staff Position 157-2 “Effective Date of FASB Statement No. 157” (FSP 157-2), issued February 2008, and as a result the Company has applied the provisions of SFAS 157 that are applicable as of January 1, 2008, which had no effect on its consolidated financial statements. FSP 157-2 delays the effective date of FAS 157 for non-financial assets and non-financial liabilities until January 1, 2009. See Note 4 for the interim disclosures required by SFAS 157. In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active (FSP 157-3). FSP 157-3 clarifies the application of SFAS 157, which the Company adopted as of January 1, 2008, in cases where a market is not active. The Company has considered FSP 157-3 in its determination of estimated fair values as of September 30, 2008, and the impact was not material.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits companies to choose to measure many financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company adopted SFAS 159 effective January 1, 2008. The Company did not apply SFAS 159 to any assets or liabilities and, therefore, the adoption has had no effect on its consolidated financial statements.

Note 2 – Spin-off

On January 15, 2008, the Company announced its intention to separate its financial services companies from the information solutions companies via a spin-off transaction, resulting in two separate publicly traded entities.

The Company continues to proceed with preparations for the anticipated separation. However, because of negative trends and continued uncertainty in the real estate and mortgage credit markets and the Company’s desire to focus on responding to these conditions, among other factors, the Company’s Board of Directors determined on July 30, 2008, to delay the consummation of the transaction. While there has been no change to the intention to separate the Company’s financial services businesses from its information solutions businesses, the Company intends to monitor market conditions continuously and consummate the transaction when such conditions warrant it.

The transaction remains subject to customary conditions, including final approval by the Board of Directors, filing and effectiveness of a Form 10 Registration Statement with the Securities and Exchange Commission, receipt of a tax ruling from the Internal Revenue Service and the approval of applicable regulatory authorities.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Note 3 – Escrow and Trust Deposits

The Company administers escrow deposits as a service to its customers. Escrow deposits totaled $6.0 billion and $5.1 billion at September 30, 2008 and December 31, 2007, respectively, of which $999.1 million and $679.7 million, respectively, were held at the Company’s trust and thrift division. The escrow deposits held at the Company’s trust and thrift division are included in the accompanying condensed consolidated balance sheets, with $168.9 million included in cash and cash equivalents and $830.2 million in debt and equity securities at September 30, 2008 and $679.7 million included in debt securities at December 31, 2007, with offsetting liabilities included in demand deposits. The remaining escrow deposits were held at third party financial institutions.

Trust deposits totaled $3.8 billion and $3.7 billion at September 30, 2008 and December 31, 2007, respectively. Escrow deposits held at third party financial institutions and trust deposits are not considered assets of the Company and, therefore, are not included in the accompanying condensed consolidated balance sheets. However, the Company could be held liable for the disposition of these assets.

Note 4 – Debt and Equity Securities

The amortized cost and estimated fair value of investments in debt securities are as follows:

 

(in thousands)

   Amortized
cost
   Gross unrealized     Estimated
fair value
      gains    losses    

September 30, 2008

          

U.S. Treasury bonds

   $ 38,837    $ 1,934    $ (9 )   $ 40,762

Municipal bonds

     83,761      675      (1,353 )     83,083

Foreign bonds

     117,582      987      (300 )     118,269

Governmental agency bonds

     78,684      486      (299 )     78,871

Governmental agency mortgage-backed and asset-backed securities

     1,082,012      1,710      (22,893 )     1,060,829

Non-agency mortgage-backed and asset-backed securities

     150,179      —        (36,393 )     113,786

Corporate debt securities

     121,700      1,824      (11,671 )     111,853
                            
   $ 1,672,755    $ 7,616    $ (72,918 )   $ 1,607,453
                            

December 31, 2007

          

U.S. Treasury bonds

   $ 42,034    $ 1,429    $ (9 )   $ 43,454

Municipal bonds

     90,033      1,405      (232 )     91,206

Foreign bonds

     110,738      269      (559 )     110,448

Governmental agency bonds

     132,051      933      (33 )     132,951

Governmental agency mortgage-backed and asset-backed securities

     708,042      1,356      (7,107 )     702,291

Non-agency mortgage-backed and asset-backed securities

     152,051      489      (2,574 )     149,966

Corporate debt securities

     136,376      3,111      (1,591 )     137,896
                            
   $ 1,371,325    $ 8,992    $ (12,105 )   $ 1,368,212
                            

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

The cost and estimated fair value of investments in equity securities are as follows:

 

(in thousands)

   Cost    Gross unrealized     Estimated
fair value
      gains    losses    

September 30, 2008

          

Preferred stocks

   $ 52,535    $ 62    $ (9,915 )   $ 42,682

Common stocks

     138,982      2,153      (50,420 )     90,715
                            
   $ 191,517    $ 2,215    $ (60,335 )   $ 133,397
                            

December 31, 2007

          

Preferred stocks

   $ 6,600    $ 138    $ (894 )   $ 5,844

Common stocks

     78,172      66,917      (3,831 )     141,258
                            
   $ 84,772    $ 67,055    $ (4,725 )   $ 147,102
                            

The fair value of debt and equity securities was determined primarily using estimated market prices obtained from independent third party pricing services and quoted market prices. Sales of debt and equity securities resulted in gross realized gains of $1.6 million and $0.5 million and gross realized losses of $2.5 million and $0.3 million for the three months ended September 30, 2008 and 2007, respectively. Sales of debt and equity securities resulted in gross realized gains of $6.2 million and $1.9 million and gross realized losses of $4.6 million and $0.8 million for the nine months ended September 30, 2008 and 2007, respectively. The unrealized losses on common stock are primarily related to a strategic investment held by the risk mitigation and business solutions segment that previously was accounted for under the equity method; due to a sale of a portion of the investment, the investment is now accounted for at fair value.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

The Company had the following gross unrealized losses as of September 30, 2008 and December 31, 2007:

 

      12 months or less     12 months or longer     Total  

(in thousands)

   Fair value    Unrealized
losses
    Fair value    Unrealized
losses
    Fair value    Unrealized
losses
 

September 30, 2008

               

Debt securities

               

U.S. Treasury bonds

   $ 455    $ (9 )   $ —      $ —       $ 455    $ (9 )

Municipal bonds

     4,052      (107 )     48,228      (1,246 )     52,280      (1,353 )

Foreign bonds

     26,555      (240 )     6,418      (60 )     32,973      (300 )

Governmental agency bonds

     24,842      (252 )     11,208      (47 )     36,050      (299 )

Governmental agency mortgage-backed and asset-backed securities

     394,747      (7,548 )     475,611      (15,345 )     870,358      (22,893 )

Non-agency mortgage-backed and asset-backed securities

     29,042      (7,253 )     78,894      (29,140 )     107,936      (36,393 )

Corporate debt securities

     42,433      (1,920 )     84,601      (9,751 )     127,034      (11,671 )
                                             

Total debt securities

     522,126      (17,329 )     704,960      (55,589 )     1,227,086      (72,918 )

Equity securities

     94,054      (55,548 )     23,307      (4,787 )     117,361      (60,335 )
                                             

Total

   $ 616,180    $ (72,877 )   $ 728,267    $ (60,376 )   $ 1,344,447    $ (133,253 )
                                             

December 31, 2007

               

Debt securities

               

U.S. Treasury bonds

   $ —      $ —       $ 2,326    $ (9 )   $ 2,326    $ (9 )

Municipal bonds

     250      (1 )     14,719      (231 )     14,969      (232 )

Foreign bonds

     19,220      (73 )     49,805      (486 )     69,025      (559 )

Governmental agency bonds

     1,118      (3 )     10,601      (30 )     11,719      (33 )

Governmental agency mortgage-backed and asset-backed securities

     12,173      (451 )     538,101      (6,656 )     550,274      (7,107 )

Non-agency mortgage-backed and asset-backed securities

     —        —         99,037      (2,574 )     99,037      (2,574 )

Corporate debt securities

     14,457      (317 )     65,676      (1,274 )     80,133      (1,591 )
                                             

Total debt securities

     47,218      (845 )     780,265      (11,260 )     827,483      (12,105 )

Equity securities

     4,673      (862 )     22,301      (3,863 )     26,974      (4,725 )
                                             

Total

   $ 51,891    $ (1,707 )   $ 802,566    $ (15,123 )   $ 854,457    $ (16,830 )
                                             

When, in the opinion of management, a decline in the fair value of an investment is considered to be other-than-temporary, such investment is written down to its fair value. Management has determined that the unrealized losses from debt and equity securities at September 30, 2008 are temporary in nature. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been below cost, the probability that the Company will be unable to collect all amounts due under the contractual terms of the security, the seniority and duration of the securities, the financial condition and prospects of the issuer (including credit ratings), macro-economic changes, and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

The Company recognized a $34.8 million pre-tax impairment charge in the third quarter of 2008 related to its investments in perpetual preferred securities issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The impairment was due to actions taken by the United States government with respect to Fannie Mae and Freddie Mac.

SFAS No. 157 established a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The hierarchy level assigned to each security in the Company’s available-for-sale portfolio is based on management’s assessment of the transparency and reliability of the inputs used in the valuation of such instrument at the measurement date. The three hierarchy levels are defined as follows:

Level 1 – Valuations based on unadjusted quoted market prices in active markets for identical securities. The fair value of equity securities included in the Level 1 category was based on quoted prices that are readily and regularly available in an active market.

Level 2 – Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. The fair value of fixed maturity and short-term investments included in the Level 2 category was based on the market values obtained from an independent pricing service that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other market information and price quotes from well established independent broker-dealers. This pricing service is a leading provider of financial market data, analytics and related services to financial institutions. The independent pricing service monitors market indicators, industry and economic events, and for broker-quoted only securities, obtains quotes from market makers or broker-dealers that it recognizes to be market participants. The Level 2 category includes corporate bonds, foreign government bonds, and municipal bonds. When the value from an independent pricing service is utilized, management obtains an understanding of the valuation models and assumptions utilized by the service and has controls in place to determine that the values provided represent current values. Typical inputs and assumptions to pricing models used to value securities include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, issue spreads, benchmark securities, bids, offers, reference data and industry and economic events. For mortgage and asset-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit ratings.

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement, and involve management judgment. Currently the Company does not have any items classified as Level 3.

If the inputs used to measure fair value fall in different levels of the fair value hierarchy, a financial security’s hierarchy level is based upon the lowest level of input that is significant to the fair value measurement. A number of the Company’s investment grade corporate bonds are frequently traded in active markets and market prices for these securities existed at September 30, 2008. These securities were classified as Level 2 at September 30, 2008 because the third party pricing service use valuation models which use observable market inputs in addition to traded prices.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Assets measured at fair value on a recurring basis as of September 30, 2008:

 

(in thousands)

   Carrying Balance as
of September 30, 2008
   Level 1    Level 2

Debt securities

        

U.S. Treasury bonds

   $ 40,762    $ —      $ 40,762

Municipal bonds

     83,083      —        83,083

Foreign bonds

     118,269      —        118,269

Governmental agency bonds

     78,871      —        78,871

Governmental agency mortgage-backed and asset-backed securities

     1,060,829      —        1,060,829

Non-agency mortgage-backed and asset-backed securities

     113,786      —        113,786

Corporate debt securities

     111,853      —        111,853
                    
     1,607,453      —        1,607,453
                    

Equity securities

        

Preferred stocks

     42,682      42,682      —  

Common stocks

     90,715      90,715      —  
                    
     133,397      133,397      —  
                    
   $ 1,740,850    $ 133,397    $ 1,607,453
                    

Note 5 – Goodwill

A reconciliation of the changes in the carrying amount of goodwill, by operating segment, for the nine months ended September 30, 2008, is as follows:

 

(in thousands)

   Balance as of
December 31,
2007
   Acquisitions    Dispositions     Post
Acquisition

and Other
Adjustments
    Balance as of
September 30,
2008

Financial Services:

            

Title Insurance and Services

   $ 716,976    $ 712    $ (6,025 )   $ (15,504 )   $ 696,159

Specialty Insurance

     39,959      4,531      —         —         44,490

Information Solutions:

            

Information and Outsourcing Solutions

     650,968      —        —         (2,339 )     648,629

Data and Analytic Solutions

     446,968      14,566      —         758       462,292

Risk Mitigation and Business Solutions

     712,469      21,713      —         35,679       769,861
                                    
   $ 2,567,340    $ 41,522    $ (6,025 )   $ 18,594     $ 2,621,431
                                    

The Company’s reporting units, for purposes of applying the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), are title insurance, home warranty, property and casualty insurance, trust and other services, data and analytic solutions, information and outsourcing solutions, lender services, data services, dealer services, employer services, multifamily services and investigative and litigation support services.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Recent market conditions and economic events have had an overall negative impact on the Company’s operations and related financials results. As a result of acquisitions, the Company has goodwill of approximately $2.6 billion at September 30, 2008. There have been no impairments of goodwill during the nine months ending September 30, 2008. In accordance with SFAS 142 and consistent with prior years, the Company’s policy is to perform an annual impairment test for each reporting unit in the fourth quarter. If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value, goodwill will be evaluated between annual tests. The valuation of goodwill requires assumptions and estimates of many critical factors including revenue growth, cash flows, market multiples and discount rates. Forecasts of future operations are based, in part, on operating results and management’s expectations as to future market conditions. Many of the factors used in assessing fair value are outside the control of management including future economic and market conditions. If the fair value of a reporting unit exceeds its carrying value, then its goodwill is not considered impaired. In the event that the carrying value of a reporting entity exceeds its fair value then further testing must be performed to determine if the carrying value of goodwill exceeds the fair value of goodwill. Due to significant volatility in the current markets, the Company’s operations may be negatively impacted in the future to the extent that exposure to impairment charges may be increased.

Note 6 – Other Intangible Assets

Other intangible assets consist of the following:

 

(in thousands)

   September 30,
2008
    December 31,
2007
 

Covenants not to compete

   $ 62,206     $ 66,254  

Customer lists

     361,895       363,934  

Trademarks and licenses

     61,923       58,054  
                
     486,024       488,242  

Accumulated amortization

     (172,623 )     (142,035 )
                
   $ 313,401     $ 346,207  
                

Amortization expense for other intangible assets, with definite lives ranging from two to twenty years, was $14.1 million and $39.4 million for the three and nine months ended September 30, 2008 and $12.9 million and $38.5 million for the three and nine months ended September 30, 2007, respectively.

Estimated amortization expense for other finite-lived intangible assets anticipated for the next five years is as follows:

 

Year

   (in thousands)

Remainder of 2008

   $ 13,390

2009

   $ 46,580

2010

   $ 43,951

2011

   $ 39,367

2012

   $ 35,767

2013

   $ 33,953

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Note 7 – Earnings Per Share

 

     For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 

(in thousands, except per share amounts)

   2008     2007     2008     2007  

Numerator:

        

Net (loss) income—numerator for basic net (loss) income per share

   $ (8,340 )   $ 46,589     $ 40,583     $ 64,380  

Effect of dilutive securities

        

Convertible debt—interest expense (net of tax)

     —         19       —         68  

Subsidiary potential dilutive shares

     —         (38 )     (42 )     (199 )
                                

Net (loss) income—numerator for dilutive net (loss) income per share

   $ (8,340 )   $ 46,570     $ 40,541     $ 64,249  
                                

Denominator:

        

Weighted average shares-denominator for basic net (loss) income per share

     92,659       93,746       92,388       95,624  

Effect of dilutive securities:

        

Employee stock options and restricted stock units

     —         1,279       784       1,599  

Convertible debt

     —         39       —         184  
                                

Denominator for diluted net (loss) income per share

     92,659       95,064       93,172       97,407  
                                

Basic net (loss) income per share

   $ (0.09 )   $ 0.50     $ 0.44     $ 0.67  
                                

Diluted net (loss) income per share

   $ (0.09 )   $ 0.49     $ 0.44     $ 0.66  
                                

For the three months ended September 30, 2008, 3.5 million potential dilutive shares of common stock (representing all potential dilutive shares) were excluded due to the net loss for the period. For the nine months ended September 30, 2008, 1.7 million stock options and restricted stock units were excluded from the computation of diluted earnings per share due to their antidilutive effect. For the three and nine months ended September 30, 2007, 0.8 million and 0.4 million stock options and restricted stock units were excluded from the computation of diluted earnings per share due to their antidilutive effect.

Note 8 – Employee Benefit Plans

Net periodic pension cost for the Company’s defined benefit pension and supplemental benefit plans (the Plans) includes the following components:

 

     For the Three Months Ended
September 30,
    For the Nine Months Ended
September 30,
 

(in thousands)

   2008     2007     2008     2007  

Expense:

        

Service Cost

   $ 1,363     $ 2,721     $ 5,162     $ 8,418  

Interest Cost

     8,239       8,635       25,090       25,254  

Expected return on plan assets

     (6,306 )     (5,669 )     (18,765 )     (16,819 )

Amortization of prior service (benefit) cost

     (323 )     (1 )     (968 )     19  

Amortization of net loss

     3,476       4,907       10,530       13,802  
                                
   $ 6,449     $ 10,593     $ 21,049     $ 30,674  
                                

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

The Company has contributed $24.8 million in cash to the Plans for the nine months ended September 30, 2008, and expects to contribute an additional $1.8 million in cash during the remainder of 2008. These contributions are both those required by funding regulations as well as discretionary contributions necessary to provide benefit payments to participants of certain of the Company’s non-qualified supplemental benefit plans.

The Company contributed $34.0 million and $35.9 million to the First American 401(k) plan during the first nine months of 2008 and 2007, respectively.

Note 9 – Share-Based Compensation

The Company currently utilizes restricted stock units (RSUs) as its share-based compensation for employees and directors. The fair value of any RSU grant is based on the market value of the Company’s shares on the date of grant and is recognized as compensation expense over the vesting period. RSUs receive dividend equivalents that are reinvested in RSUs having the same vesting requirements as the RSUs initially granted.

The following table illustrates the share-based compensation expense recognized for the three and nine months ended September 30, 2008 and 2007:

 

     For the Three Months Ended
September 30,
   For the Nine Months Ended
September 30,

(in thousands)

   2008    2007    2008    2007

Stock options

   $ 418    $ 1,724    $ 1,113    $ 5,692

Restricted stock units

     3,030      706      10,490      3,616

Employee stock purchase plan

     214      326      921      1,200
                           
   $ 3,662    $ 2,756    $ 12,524    $ 10,508
                           

In addition to the share-based compensation above, the Company’s consolidated financial statements include share-based compensation related to the two of the Company’s subsidiaries, First Advantage Corporation and First American CoreLogic Holdings, Inc. (First American CoreLogic). First Advantage Corporation’s share-based compensation totaled $2.4 million and $7.5 million for the three and nine months ending as of September 30, 2008, respectively, and $2.0 million and $10.9 million for the three and nine months ending as of September 30, 2007, respectively. First American CoreLogic’s share-based compensation totaled $0.3 million and $0.9 million for three and nine months ended as of September 30, 2008.

Restricted stock unit activity for the nine months ended September 30, 2008, is as follows:

 

(in thousands, except weighted-average grant-date fair value)

   Shares     Weighted-average
grant-date

fair value

Nonvested restricted stock units at December 31, 2007

   352     $ 47.11

Granted during 2008

   737     $ 34.26

Vested during 2008

   (76 )   $ 47.19

Forfeited during 2008

   (12 )   $ 39.97
            

Nonvested restricted stock units at September 30, 2008

   1,001     $ 37.75
            

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

The following table summarizes stock option activity related to the Company’s plans:

 

(in thousands, except weighted-average exercise price and contractual term )

   Number
outstanding
    Weighted-average
exercise price
   Weighted-average
remaining
contractual term

(in years)
   Aggregate
intrinsic
value

Balance at December 31, 2007

   4,118     $ 30.23      

Exercised during 2008

   (595 )   $ 23.35      

Forfeited during 2008

   (178 )   $ 40.39      
                  

Balance at September 30, 2008

   3,345     $ 30.92    5.1    $ 13,056
                        

Vested and expected to vest at September 30, 2008

   3,321     $ 30.82    5.1    $ 13,056
                        

Exercisable at September 30, 2008

   2,476     $ 27.64    4.5    $ 13,032
                        

Note 10 – Business Combinations

During the nine months ended September 30, 2008, the Company completed one acquisition. This acquisition was not material and was included in the Company’s risk mitigation and business solutions segment. The purchase price for the acquisition was $16.3 million in cash and was allocated to the assets acquired and liabilities assumed using a variety of valuation techniques including discounted cash flow analysis. As a result of the acquisition, the Company recorded approximately $13.1 million of goodwill and $2.3 million of intangible assets with finite lives.

In addition, during the nine months ended September 30, 2008, the Company purchased minority interests in five companies already included in the Company’s consolidated financial statements. The total purchase price of these transactions was $60.9 million in cash. As a result of these five transactions, the Company recorded approximately $28.3 million of goodwill and $0.4 million of intangible assets with finite lives. In addition to the above transactions, the Company paid out $2.3 million for affiliate purchases and $35.5 million for acquisition earn outs and other prior year acquisition adjustments.

The Company is awaiting information necessary to finalize the purchase accounting adjustments for certain of these acquisitions and the final purchase price allocations could result in a change to the recorded assets and liabilities. However, any changes are not expected to have a material effect on the Company’s financial statements as of, or for the period ended, September 30, 2008.

Note 11 – Segment Information

The Company has reorganized its two business groups and underlying segments to reflect how the assets and operations will be divided and managed when the spin-off is consummated. The segment presentation below is consistent with the manner in which these businesses have been evaluated by the Company’s management since January 1, 2008. All previously reported segment information has been restated to conform to this presentation.

The Company now presents two business groups with the following five business segments:

Financial Services Group

 

   

Title Insurance and Services: The title insurance and services segment’s principal product is policies of title insurance on residential and commercial property. This segment also accommodates tax-deferred exchanges of real estate, and provides escrow services, investment advisory services, trust services, lending and deposit products and other related products and services.

 

   

Specialty Insurance: The specialty insurance segment’s primary business focus is providing residential service contracts that cover many of the major systems and appliances in homes against failures that occur as a result of normal usage during the coverage period and in offering property and casualty insurance.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Information Solutions Group

 

   

Information and Outsourcing Solutions: The information and outsourcing solutions segment focuses on providing a wide-range of products and services including tax monitoring, flood zone certification and monitoring, asset valuation and management services, building and maintaining geospatial proprietary software and databases, default management services, and loan administration and production services.

 

   

Data and Analytic Solutions: The Company’s data and analytic solutions segment provides licenses and analyzes data relating to mortgage securities and loans and real property, offers risk management and collateral assessment analytics and provides database management and automated appraisal services. This segment’s product offerings also include management of databases of title and tax records, known as title plants, which are used primarily by title insurance companies in the issuance of title insurance policies, technology solutions for real estate brokers and agents and title-related products for second lien and home equity loans.

 

   

Risk Mitigation and Business Solutions: The Company’s risk mitigation and business solutions segment is comprised entirely of First Advantage Corporation, a public company whose shares of Class A common stock trade on the NASDAQ Global Market under the ticker symbol “FADV.” First Advantage’s product offerings include credit reporting, employment screening and related hiring solutions, resident screening services, corporate litigation and investigative services, credit automation and lead generation for automobile dealers and lenders and a wide-range of data information offerings. First Advantage operates in six primary business groups: lender services, data services, dealer services, employer services, multifamily services, and investigative and litigation support services.

Selected financial information by reporting segment is as follows:

For the three months ended September 30, 2008:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
and minority
interests
    Depreciation
and
amortization
   Capital
expenditures

Financial Services:

         

Title Insurance and Services

   $ 957,080     $ (27,024 )   $ 20,814    $ 14,978

Specialty Insurance

     72,758       317       940      1,926
                             
     1,029,838       (26,707 )     21,754      16,904
                             

Information Solutions:

         

Information and Outsourcing Solutions

     184,637       29,784       5,749      1,638

Data and Analytic Solutions

     142,548       10,179       16,849      8,831

Risk Mitigation and Business Solutions

     188,064       21,366       12,171      7,561
                             
     515,249       61,329       34,769      18,030
                             
     1,545,087       34,622       56,523      34,934

Corporate

     1,743       (33,799 )     3,470      1,169

Eliminations

     (32,653 )     —         —        —  
                             
   $ 1,514,177     $ 823     $ 59,993    $ 36,103
                             

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

For the three months ended September 30, 2007:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
and minority
interests
    Depreciation
and
amortization
   Capital
expenditures

Financial Services:

         

Title Insurance and Services

   $ 1,418,114     $ 43,743     $ 18,327    $ 14,282

Specialty Insurance

     82,407       10,067       692      2,476
                             
     1,500,521       53,810       19,019      16,758
                             

Information Solutions:

         

Information and Outsourcing Solutions

     191,236       40,225       5,645      3,225

Data and Analytic Solutions

     162,710       25,902       15,093      17,262

Risk Mitigation and Business Solutions

     220,387       32,795       10,861      8,295
                             
     574,333       98,922       31,599      28,782
                             
     2,074,854       152,732       50,618      45,540

Corporate

     529       (44,721 )     4,361      2,419

Eliminations

     (24,190 )     —         —        —  
                             
   $ 2,051,193     $ 108,011     $ 54,979    $ 47,959
                             

For the nine months ended September 30, 2008:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
and minority
interests
    Depreciation
and
amortization
   Capital
expenditures

Financial Services:

         

Title Insurance and Services

   $ 3,083,950     $ (23,014 )   $ 60,067    $ 38,037

Specialty Insurance

     225,376       17,491       2,390      6,026
                             
     3,309,326       (5,523 )     62,457      44,063
                             

Information Solutions:

         

Information and Outsourcing Solutions

     574,387       123,151       17,632      12,907

Data and Analytic Solutions

     457,581       57,453       51,948      27,241

Risk Mitigation and Business Solutions

     588,327       64,453       33,958      26,323
                             
     1,620,295       245,057       103,538      66,471
                             
     4,929,621       239,534       165,995      110,534

Corporate

     2,339       (105,528 )     11,224      2,210

Eliminations

     (84,724 )     —         —        —  
                             
   $ 4,847,236     $ 134,006     $ 177,219    $ 112,744
                             

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

For the nine months ended September 30, 2007:

 

(in thousands)

   Revenues     Income (loss)
before
income taxes
and minority
interests
    Depreciation
and
amortization
   Capital
expenditures

Financial Services:

         

Title Insurance and Services

   $ 4,335,826     $ (59,190 )   $ 60,716    $ 57,671

Specialty Insurance

     245,275       35,555       1,581      5,156
                             
     4,581,101       (23,635 )     62,297      62,827
                             

Information Solutions:

         

Information and Outsourcing Solutions

     613,817       134,086       16,345      7,300

Data and Analytic Solutions

     568,300       160,836       48,592      62,744

Risk Mitigation and Business Solutions

     659,485       84,862       32,040      28,873
                             
     1,841,602       379,784       96,977      98,917
                             
     6,422,703       356,149       159,274      161,744

Corporate

     (15,912 )     (147,680 )     13,394      8,647

Eliminations

     (81,572 )     —         —        —  
                             
   $ 6,325,219     $ 208,469     $ 172,668    $ 170,391
                             

Note 12 – Litigation and Regulatory Contingencies

The Company and its subsidiaries have been named in various lawsuits, most of which relate to their title insurance operations. In cases where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on facts known to the Company. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (SFAS 5), the Company maintained a reserve for these lawsuits totaling $63.7 million at September 30, 2008. Actual losses may materially differ from the amounts recorded. The Company does not believe that the ultimate resolution of these cases, either individually or in the aggregate, will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

The Company’s title insurance, property and casualty insurance, home warranty, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of the Company’s operations. These audits or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry and title insurance customer acquisition and retention practices. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on facts known to the Company. In accordance with SFAS 5, the Company maintained a reserve for these matters totaling $2.4 million at September 30, 2008. While the ultimate disposition of each such audit or investigation is not yet determinable, the Company does not believe that individually or in the aggregate, they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These audits or investigations could result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

In November 2007, the New York Attorney General (NYAG) filed a lawsuit challenging an appraisal program in which a subsidiary of the Company participated. Since that time, the NYAG publicly announced the initiation of inquiries into the practices of several other participants in the mortgage lending market as well as the practices of participants in the mortgage securitization market, including Freddie Mac and Fannie Mae. In connection with these inquiries, Freddie Mac and Fannie Mae agreed to adopt a Home

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Valuation Code of Conduct (Code of Conduct) and agreed to refrain from purchasing certain loans from lenders not abiding by that code. The Code of Conduct provides, among other matters, that in underwriting a loan a lender shall not utilize an appraisal report prepared by an appraiser employed by a lender, an affiliate of a lender, an entity that is owned in whole or in part by a lender, a real estate settlement services provider or an entity that is owned in whole or in part by a settlement services provider. Certain of the Company’s appraisal operations may fall into one or more of these categories. The Code of Conduct was subject to a comment period, which ended on April 30, 2008. A number of federal regulators have objected to certain aspects of the Code of Conduct. It is not clear what impact, if any, the comments and objections will have on the Code of Conduct. The director of the Federal Housing Finance Agency has indicated that there will be some modifications to the Code of Conduct and that implementation may be delayed for up to three months. The Company does not believe that the lawsuit filed by the NYAG will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. Given the outstanding comments and objections and uncertainty as to what changes, if any, may be made to the Code of Conduct, the Company is unable to determine at this time the effect of the Code of Conduct.

The Company also is involved in numerous ongoing routine legal and regulatory proceedings related to its operations. While the ultimate disposition of each proceeding is not determinable, the Company does not believe that any of such proceedings, individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows.

Note 13 – Loss Reserves

A summary of the Company’s loss reserves, broken down into its components of known title claims, incurred but not reported title claims and non-title claims, follows:

 

(in thousands except percentages)

   As of September 30, 2008     As of December 31, 2007  

Known title claims

   $ 235,459    17.7 %   $ 188,210    13.9 %

IBNR

     1,022,932    76.8 %     1,096,230    80.7 %
                          

Total title claims

     1,258,391    94.5 %     1,284,440    94.6 %

Non-title claims

     72,861    5.5 %     73,192    5.4 %
                          

Total loss reserves

   $ 1,331,252    100.0 %   $ 1,357,632    100.0 %
                          

Note 14 – Investment and Other Income

The components of investment and other income are as follows:

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,

(in thousands)

   2008    2007    2008    2007

Interest:

           

Cash equivalents and deposits with savings and loan associations and banks

   $ 8,996    $ 16,364    $ 35,806    $ 68,393

Debt securities

     13,945      19,107      41,458      48,025

Other long-term investments

     5,375      12,913      19,561      40,073

Loans receivable

     2,223      2,222      6,514      6,356

Dividends on marketable equity securities

     1,935      4,448      4,174      7,689

Equity in earnings of unconsolidated affiliates

     9,801      10,683      38,057      35,298

Trust and banking activities

     6,078      2,874      19,058      9,172

Other

     5,286      2,899      11,080      14,402
                           
   $ 53,639    $ 71,510    $ 175,708    $ 229,408
                           

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Note 15 – Income Taxes

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with SFAS No. 109, “Accounting for Income Taxes”, and prescribes a recognition threshold and measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

As of September 30, 2008, the liability for income taxes associated with uncertain tax positions was $35.4 million. This liability can be reduced by $4.7 million of offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments, state income taxes and timing adjustments. The net amount of $30.7 million, if recognized, would favorably affect the company’s effective tax rate.

The Company’s continuing practice is to recognize interest and penalties, if any, related to uncertain tax positions in tax expense. As of September 30, 2008, the Company had accrued $4.1 million of interest (net of tax benefit) related to uncertain tax positions.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, various state jurisdictions and various non-U.S. jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and non-U.S. income tax examinations by taxing authorities for years prior to 2003.

It is reasonably possible that the amount of the unrecognized benefit with respect to certain of the Company’s unrecognized tax positions will significantly increase or decrease within the next 12 months. These changes may be the result of items such as ongoing audits, competent authority proceedings related to transfer pricing or the expiration of federal and state statute of limitations for the assessment of taxes.

The effective income tax rate (income tax expense as a percentage of pretax income before minority interest expense) was 35.8% for the nine months ended September 30, 2008, and 29.3% for the same period of the prior year. The increase in the effective rate was primarily attributable to changes in the ratio of permanent differences to income before income taxes and minority interests and the effect of interest and penalties recognized for the nine months ended September 30, 2008, relating to FIN 48. A large portion of the Company’s minority interest expense is attributable to a limited liability company subsidiary, which for tax purposes, is treated as a partnership. Accordingly, no income taxes have been provided for that portion of the minority interest expense. The change in the quarter in the liability for income taxes associated with uncertain tax positions, the net amount that favorably affects the effective tax rate and the change in the amount accrued for interest and penalties primarily relates to a foreign transfer pricing matter impacted by recent administrative and judicial developments. The Company continues to monitor the realizability of recognized, impairment and unrecognized losses recorded through September 30, 2008. The Company believes it is more likely than not that the tax benefits associated with those losses will be realized. However, this determination is a judgment and could be impacted by further market fluctuations.

Note 16 – Stockholders’ Equity

On May 18, 2004, the Company announced a share repurchase program, which program was amended to add additional authorized amounts thereunder on May 19, 2005, June 26, 2006, and January 15, 2008. The total amount authorized under the program, as amended, is $800.0 million, of which $360.4 million remains available. The Company has not repurchased any shares in the current nine-month period.

 

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THE FIRST AMERICAN CORPORATION

AND SUBSIDIARY COMPANIES

Notes to Condensed Consolidated Financial Statements—(continued)

(Unaudited)

 

Note 17 – Recent Accounting Pronouncements

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R) “Business Combinations” (SFAS 141(R)). This Statement retains the fundamental requirements in Statement of Financial Accounting Standards No. 141 “Business Combinations”, that the acquisition method of accounting, previously known as the purchase method, be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, changes in fair value to be recognized in earnings until settled. SFAS 141(R) also requires acquisition-related transaction and restructuring costs to be expensed rather than treated as part of the cost of the acquisition. The provisions for SFAS 141(R) are effective for the Company beginning January 1, 2009. SFAS 141(R) will be applied prospectively and early adoption is prohibited. The Company is currently assessing the impact of adopting SFAS 141(R) on its consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160 “Noncontrolling Interest in Consolidated Financial Statements—an amendment of ARB No. 51” (SFAS 160). SFAS 160 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 also establishes reporting requirements that provide disclosures that identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for the Company beginning January 1, 2009, and early adoption is prohibited. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 will be applied prospectively. The Company is currently assessing the impact of SFAS 160 on its consolidated financial statements.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESULTS OF OPERATIONS

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are those policies used in the preparation of the Company’s financial statements that require management to make estimates and judgments that affect the reported amounts of certain assets, liabilities, revenues, expenses and related disclosure of contingencies. A summary of these policies can be found in the Management’s Discussion and Analysis section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value within generally accepted accounting principles (GAAP), and expands disclosure requirements regarding fair value measurements. Although SFAS 157 does not require any new fair value measurements, its application may, in certain instances, change current practice. Where applicable, SFAS 157 simplifies and codifies fair value related guidance previously issued within GAAP. The Company has adopted FASB Staff Position 157-2 “Effective Date of FASB Statement No. 157” (FSP 157-2), issued February 2008, and as a result the Company has applied the provisions of SFAS 157 that are applicable as of January 1, 2008, which had no effect on its consolidated financial statements. FSP 157-2 delays the effective date of FAS 157 for non-financial assets and non-financial liabilities until January 1, 2009. In October 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active (FSP 157-3). FSP 157-3 clarifies the application of SFAS 157, which the Company adopted as of January 1, 2008, in cases where a market is not active. The Company has considered FSP 157-3 in its determination of estimated fair values as of September 30, 2008, and the impact was not material.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits companies to choose to measure many financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company adopted SFAS 159 effective January 1, 2008. The Company did not apply SFAS 159 to any assets or liabilities and therefore the adoption has had no effect on its consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R) “Business Combinations” (SFAS 141(R)). This Statement retains the fundamental requirements in Statement of Financial Accounting Standards No. 141 “Business Combinations”, that the acquisition method of accounting, previously known as the purchase method, be used for all business combinations and for an acquirer to be identified for each business combination. SFAS 141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) requires contingent consideration to be recognized at its fair value on the acquisition date and, for certain arrangements, changes in fair value to be recognized in earnings until settled. SFAS 141(R) also requires acquisition-related transaction and restructuring costs to be expensed rather than treated as part of the cost of the acquisition. The provisions for SFAS 141(R) are effective for the Company beginning January 1, 2009. SFAS 141(R) will be applied prospectively and early adoption is prohibited. The Company is currently assessing the impact of adopting SFAS 141(R) on its consolidated financial statements.

 

24


Table of Contents

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160 “Noncontrolling Interest in Consolidated Financial Statements—an amendment of ARB No. 51” (SFAS 160). SFAS 160 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 also establishes reporting requirements that provide disclosures that identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for the Company beginning January 1, 2009, and early adoption is prohibited. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 will be applied prospectively. The Company is currently assessing the impact of SFAS 160 on its consolidated financial statements.

OVERVIEW

This Management’s Discussion and Analysis contains certain financial measures, in particular presentation of certain balances excluding the impact of acquisitions and other non-recurring items that are not presented in accordance with generally accepted accounting principles (GAAP). The Company is presenting these non-GAAP financial measures because they provide the Company’s management and readers of the Quarterly Report on Form 10-Q with additional insight into the operational performance of the Company relative to earlier periods and relative to the Company’s competitors. The Company does not intend for these non-GAAP financial measures to be a substitute for any GAAP financial information. Readers of this Quarterly Report on Form 10-Q should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures.

On January 15, 2008, the Company announced its intention to separate its financial services companies from the information solutions companies via a spin-off transaction, resulting in two separate publicly traded entities. The Company continues to proceed with preparations for the anticipated separation. However, because of negative trends and continued uncertainty in the real estate and mortgage credit markets and the Company’s desire to focus on responding to these conditions, among other factors, the Company’s Board of Directors determined on July 30, 2008, to delay the consummation of the transaction. While there has been no change to the intention to separate the Company’s financial services businesses from its information solutions businesses, the Company intends to monitor market conditions continuously and consummate the transaction when such conditions warrant it.

The transaction remains subject to customary conditions, including final approval by the Board of Directors, filing and effectiveness of a Form 10 Registration Statement with the Securities and Exchange Commission, receipt of a tax ruling from the Internal Revenue Service and the approval of applicable regulatory authorities.

Effective January 1, 2008, the Company reorganized its two business groups and underlying segments to reflect how the assets and operations will be divided and managed when the previously announced spin-off is consummated. The segment presentation below reflects this reorganization. All previously reported segment information has been restated to conform to this presentation.

The Company now presents two business groups with the following five business segments:

Financial Services Group

 

   

Title Insurance and Services: The title insurance and services segment’s principal product is policies of title insurance on residential and commercial property. This segment also accommodates tax-deferred exchanges of real estate, and provides escrow services, investment advisory services, trust services, lending and deposit products and other related products and services.

 

   

Specialty Insurance: The specialty insurance segment’s primary business focus is providing residential service contracts that cover many of the major systems and appliances in homes against failures that occur as a result of normal usage during the coverage period and in offering property and casualty insurance.

 

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Table of Contents

Information Solutions Group

 

   

Information and Outsourcing Solutions: The information and outsourcing solutions segment focuses on providing a wide-range of products and services including tax monitoring, flood zone certification and monitoring, asset valuation and management services, building and maintaining geospatial proprietary software and databases, default management services, and loan administration and production services.

 

   

Data and Analytic Solutions: The Company’s data and analytic solutions segment provides licenses and analyzes data relating to mortgage securities and loans and real property, offers risk management and collateral assessment analytics and provides database management and automated appraisal services. This segment’s product offerings also include management of databases of title and tax records, known as title plants, which are used primarily by title insurance companies in the issuance of title insurance policies, technology solutions for real estate brokers and agents and title-related products for second lien and home equity loans.

 

   

Risk Mitigation and Business Solutions: The Company’s risk mitigation and business solutions segment is comprised entirely of First Advantage Corporation, a public company whose shares of Class A common stock trade on the NASDAQ Global Market under the ticker symbol “FADV.” First Advantage’s product offerings include credit reporting, employment screening and related hiring solutions, resident screening services, corporate litigation and investigative services, credit automation and lead generation for automobile dealers and lenders and a wide-range of data information offerings. First Advantage operates in six primary business groups: lender services, data services, dealer services, employer services, multifamily services, and investigative and litigation support services.

Summary

Mortgage originations decreased in the third quarter of 2008 when compared with the same period of the prior year according to the Mortgage Bankers Association’s October 21, 2008, Long-term Mortgage Finance Forecast (the MBA Forecast). This decrease in mortgage originations was primarily due to a significant decline in refinance originations and the continued softening in the purchase market. According to the MBA Forecast, the dollar amount of refinance originations and purchase originations decreased 30.6% and 15.0%, respectively, in the third quarter of 2008 when compared with the same quarter of the prior year. The overall decline in mortgage originations, as well as the continued decline in home values, impacted the Company’s Financial Services group, which experienced a 28.3% and 25.7% drop in operating revenues in the third quarter 2008 and the first nine months of 2008, respectively, when compared with the same periods of the prior year. The Information Solutions group was also impacted by the decline in mortgage originations as well as difficulties in the credit and securitization markets combined with economic difficulties experienced by its customers. Offsetting the impact of these factors were growth in default-related revenues, market share growth at the group’s larger mortgage banking customers, increases in risk management related sales of data analytics and the relatively consistent revenues generated by subscription-based businesses, resulting in operating revenues for the Information Solutions group declining 9.9% and 8.6% in the third quarter 2008 and the first nine months of 2008, respectively. On a consolidated basis, total operating revenues for the Company decreased 23.8% and 21.2% for the three and nine months ended September 30, 2008, respectively, when compared with the same periods of the prior year.

The Company recognized a $34.8 million pre-tax impairment charge in the third quarter of 2008 related to its investments in perpetual preferred securities issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The title insurance segment incurred $30.3 million of the charge, the data and analytic solutions segment $3.6 million and the specialty insurance segment $0.9 million. The impairment was due to actions taken by the United States government with respect to Fannie Mae and Freddie Mac. Additionally, during 2008 the Company recognized a $37.3 million investment loss related to the permanent impairment of one of the Title segment’s long-term investments. Total realized pre-tax net investment losses were $50.2 million and $97.4 million for the three and nine months ended September 30, 2008. Total realized net investment losses were $2.9 million for the three months ended September 30, 2007, with net realized investment gains totaling $39.5 million reported for the nine months ended September 30, 2007.

 

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Table of Contents

Total expenses, before income taxes and minority interests, decreased 22.1% and 22.9% for the three and nine months ended September 30, 2008, respectively, when compared with the same periods of the prior year. These decreases primarily reflected a decline in title insurance agent retention due in large part to the decline in title insurance agent revenues, reductions in employee compensation expense, primarily reflecting employee reductions and reduced benefit costs, as well as a decline in other operating expenses due to overall cost-containment programs and a reduction in interest expense. Contributing to the decrease for the current nine month period was a reduction in title insurance claims expense primarily due to a reserve strengthening adjustment recorded in the prior year period.

Net loss for the three months ended September 30, 2008 was $8.3 million, or $0.09 per diluted share. Net income for the nine months ended September 30, 2008 was $40.6 million, or $0.44 per diluted share. Net income for the three and nine months ended September 30, 2007 was $46.6 million, or $0.49 per diluted share, and $64.4 million, or $0.66 per diluted share, respectively.

Declines in real estate prices and transactions, as well as tightening of mortgage credit and decreases in general economic conditions continue to impact the demand for many of the Company’s products and services. These conditions have also had an impact on, and continue to impact, the performance and financial condition of some of the Company’s customers in many of the segments in which the Company operates; should these parties continue to encounter significant issues, those issues may lead to negative impacts on the Company’s revenue, claims, earnings and liquidity.

Management expects continued weakness in the real estate and mortgage markets to continue impacting many of the Company’s lines of business. Given this outlook, management is focusing on expense reductions, operating efficiencies, and increasing market share throughout the Company.

FINANCIAL SERVICES GROUP

Title Insurance and Services

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Direct operating revenues

   $ 531,330     $ 685,980     $ (154,650 )   (22.5 )   $ 1,697,095     $ 2,143,103     $ (446,008 )   (20.8 )

Agent operating revenues

     433,399       683,433       (250,034 )   (36.6 )     1,354,434       2,024,928       (670,494 )   (33.1 )

Investment and other income

     36,952       53,008       (16,056 )   (30.3 )     115,814       181,866       (66,052 )   (36.3 )

Net realized investment (losses) gains

     (44,601 )     (4,307 )     (40,294 )   (935.5 )     (83,393 )     (14,071 )     (69,322 )   (492.7 )
                                                            
     957,080       1,418,114       (461,034 )   (32.5 )     3,083,950       4,335,826       (1,251,876 )   (28.9 )
                                                            

Expenses

                

Salaries and other personnel costs

     304,107       408,368       (104,261 )   (25.5 )     984,697       1,242,723       (258,026 )   (20.8 )

Premiums retained by agents

     344,580       545,930       (201,350 )   (36.9 )     1,076,983       1,624,311       (547,328 )   (33.7 )

Other operating expenses

     231,656       289,691       (58,035 )   (20.0 )     741,224       869,075       (127,851 )   (14.7 )

Provision for policy losses and other claims

     68,547       88,408       (19,861 )   (22.5 )     197,933       525,755       (327,822 )   (62.4 )

Depreciation and amortization

     20,814       18,327       2,487     13.6       60,067       60,716       (649 )   (1.1 )

Premium taxes

     11,180       14,743       (3,563 )   (24.2 )     33,001       47,313       (14,312 )   (30.2 )

Interest

     3,220       8,904       (5,684 )   (63.8 )     13,059       25,123       (12,064 )   (48.0 )
                                                            
     984,104       1,374,371       (390,267 )   (28.4 )     3,106,964       4,395,016       (1,288,052 )   (29.3 )
                                                            

Income (loss) before income taxes and minority interests

   $ (27,024 )   $ 43,743     $ (70,767 )   (161.8 )   $ (23,014 )   $ (59,190 )   $ 36,176     61.1  
                                                            

Margins

     (2.8 )%     3.1 %     (5.9 )%   (191.5 )     (0.7 )%     (1.4 )%     0.6 %   45.3  
                                                            

 

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Operating revenues from direct title operations were $531.3 million and $1.70 billion for the three and nine months ended September 30, 2008, respectively, decreases of 22.5% and 20.8% when compared with the respective periods of the prior year. These decreases were due to a decline in the number of title orders closed by the Company’s direct operations and in the average revenues per order closed. The Company’s direct operations closed 323,200 and 1,114,000 title orders during the current three and nine month periods, respectively, decreases of 22.1% and 17.9% when compared with 415,000 and 1,356,800 title orders closed during the respective periods of the prior year. These decreases primarily reflected the decline in mortgage originations. The average revenues per order closed were $1,644 and $1,523 for the three and nine months ended September 30, 2008, respectively, decreases of 0.6% and 3.5% when compared with $1,653 and $1,580 for the respective periods of the prior year. These decreases were primarily due to a decline in home values and the shift in the composition of new mortgage loans to include more conforming loans and fewer jumbo loans.

Operating revenues from agency operations were $433.4 million and $1.35 billion for the three and nine months ended September 30, 2008, respectively, decreases of 36.6% and 33.1% when compared with the respective periods of the prior year. These decreases were primarily due to the same factors impacting direct operations and the cancellation of certain agency relationships. Management is continuing to analyze the terms and profitability of its title agent relationships and is working to amend agent agreements to the extent possible. Amendments being sought include, among others, changing the percentage of premium retained by the agent and the deductible paid by the agent on claims; if changes to the agreements cannot be made, management may elect to terminate certain agreements.

Total operating revenues for the title insurance segment (direct and agency operations) contributed by new acquisitions were $1.4 million and $8.4 million for the three and nine months ended September 30, 2008, respectively.

Investment and other income totaled $37.0 million and $115.8 million for the three and nine months ended September 30, 2008, respectively, decreases of 30.3% and 36.3% when compared with the respective periods of the prior year. These decreases primarily reflected declining yields earned from the investment portfolio and decreases in equity in earnings of unconsolidated affiliates.

Net realized investment losses for the title insurance segment totaled $44.6 million and $83.4 million for the three and nine months ended September 30, 2008, respectively, increases of $40.3 million and $69.3 million when compared with the comparable periods of the prior year. The current quarter net losses were primarily driven by the above mentioned $30.3 million impairment loss on Fannie Mae and Freddie Mac preferred securities. The net losses for the current nine month period included a $37.3 million write-down taken in the second quarter to reflect the permanent impairment of a long-term investment in a title insurance agent.

Salaries and other personnel costs for the title insurance segment were $304.1 million and $984.7 million for the three and nine months ended September 30, 2008, respectively, decreases of $104.3 million, or 25.5%, and $258.0 million, or 20.8%, when compared with the respective periods of the prior year. These decreases were primarily due to employee reductions, salary reductions, the modification of bonus programs as well as reductions in employee benefits expense primarily due to the determination that the Company will not meet the requirement for a profit driven 401(k) match. The Company has reduced staff by approximately 5,800 since the end of the first quarter 2007, including approximately 1,000 reductions in the first quarter of 2008, 700 in the second quarter 2008 and 1,250 in the third quarter of 2008. Acquisitions contributed $0.9 million and $6.4 million to salaries and other personnel costs for the three and nine months ended September 30, 2008. Employee separation costs included in salaries and other personnel costs for the current three and nine-month periods totaled $8.5 million and $15.7 million, respectively.

 

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Agents retained $344.6 million and $1.08 billion of title premiums generated by agency operations for the three and nine months ended September 30, 2008, which compares with $545.9 million and $1.62 billion for the same periods of the prior year. The percentage of title premiums retained by agents was 79.5% for the three and nine months ended September 30, 2008, down from 79.9% and 80.2% for the same periods of the prior year. This change was primarily due to the cancellation and/or modification of certain agency relationships with unfavorable splits, as well as regional variances (i.e., the agency share or split varies from region to region and thus the geographic mix of agency revenues causes this variation).

Other operating expenses for the title insurance and services segment were $231.7 million and $741.2 million for the three and nine months ended September 30, 2008, respectively, decreases of $58.0 million, or 20.0%, and $127.9 million, or 14.7%, when compared with the same periods of the prior year. Acquisitions contributed $0.5 million and $3.2 million to other operating expenses for the three and nine months ended September 30, 2008, respectively. The decreases in other operating expenses when compared with the same periods of the prior year were primarily due to a decline in title production costs associated with the decline in business volume, lower occupancy costs as a result of the consolidation of certain title branches and other cost-containment programs.

The provision for title insurance policy losses were $68.5 million and $197.9 million for the three and nine months ended September 30, 2008, respectively, decreases of $19.9 million, or 22.5%, and $327.8 million, or 62.4%, when compared with the same periods of the prior year. The provision for title insurance policy losses as a percentage of title insurance operating revenues (including escrow fees and other title fees) was 6.5% for the current nine-month period and 12.6% for the same period of the prior year. The current period rate reflects the expected claims experience for policy year 2008, with minor reserve estimate adjustments required for prior policy years. The expected claims experience for policy year 2008 was projected to be 6.2% as of June 30, 2008. The increase to 6.5% reflects the Company’s current best estimate for policy year 2008 after analyzing third quarter 2008 experience. The rate for the first nine months of 2007 reflected an expected claims rate of 6.4% for policy year 2007 and adverse development primarily for policy years 2006, 2005 and 2004.

Premium taxes were $33.0 million and $47.3 million for the nine months ended September 30, 2008 and 2007, respectively. Premium taxes as a percentage of operating revenues were 1.1% for the current nine-month period and for the same period of the prior year.

In general, the title insurance business is a lower profit margin business when compared to the Company’s other segments. The lower profit margins reflect the high cost of producing title evidence whereas the corresponding revenues are subject to regulatory and competitive pricing restraints. Due to this relatively high proportion of fixed costs, title insurance profit margins generally improve as closed order volumes increase. Title insurance profit margins are affected by the composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. In addition, profit margins from refinance transactions vary depending on whether they are centrally processed or locally processed. Profit margins from resale, new construction and centrally processed refinance transactions are generally higher than from locally processed refinancing transactions because in many states there are premium discounts on, and cancellation rates are higher for, refinance transactions. Title insurance profit margins are also affected by the percentage of operating revenues generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Pre-tax margin losses for the current three and nine-month periods of 2008 were 2.8% and 0.7%, respectively. Pre-tax margins for the current three and nine-month periods of 2008 were 0.3% and 1.4%, respectively, when excluding the $30.3 million impairment loss on Fannie Mae and Freddie Mac preferred securities and the second quarter impact of the $37.3 million investment impairment loss.

 

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Specialty Insurance

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Operating revenues

   $ 72,016     $ 77,338     $ (5,322 )   (6.9 )   $ 216,196     $ 230,298     $ (14,102 )   (6.1 )

Investment and other income

     3,825       4,829       (1,004 )   (20.8 )     11,893       13,975       (2,082 )   (14.9 )

Net realized investment (losses) gains

     (3,083 )     240       (3,323 )   (1,384.6 )     (2,713 )     1,002       (3,715 )   (370.8 )
                                                            
     72,758       82,407       (9,649 )   (11.7 )     225,376       245,275       (19,899 )   (8.1 )
                                                            

Expenses

                

Salaries and other personnel costs

     14,147       14,532       (385 )   (2.6 )     44,055       45,956       (1,901 )   (4.1 )

Other operating expenses

     12,285       13,328       (1,043 )   (7.8 )     36,949       36,855       94     0.3  

Provision for policy losses and other claims

     43,869       42,567       1,302     3.1       121,118       121,600       (482 )   (0.4 )

Depreciation and amortization

     940       692       248     35.8       2,390       1,581       809     51.2  

Premium taxes

     1,192       1,216       (24 )   (2.0 )     3,364       3,723       (359 )   (9.6 )

Interest

     8       5       3     60.0       9       5       4     80.0  
                                                            
     72,441       72,340       101     0.1       207,885       209,720       (1,835 )   (0.9 )
                                                            

Income (loss) before income taxes and minority interests

   $ 317     $ 10,067     $ (9,750 )   (96.8 )   $ 17,491     $ 35,555     $ (18,064 )   (50.8 )
                                                            

Margins

     0.4 %     12.2 %     (11.8 )%   (96.4 )     7.8 %     14.5 %     (6.7 )%   (46.5 )
                                                            

Operating revenues for the specialty insurance segment were $72.0 million and $216.2 million for the three and nine months ended September 30, 2008, decreases of $5.3 million, or 6.9% and $14.1 million, or 6.1%, when compared with the respective periods of the prior year. These decreases primarily reflected a decline in business volume impacting both the property and casualty insurance division and the home warranty division.

Investment and other income totaled $3.8 million and $11.9 million for the three and nine months ended September 30, 2008, respectively, decreases of $1.0 million, or 20.8% and $2.1 million, or 14.9% when compared with the respective periods of the prior year. These decreases were primarily due to a decline in the average investment portfolio balance as well as a decrease in yields earned from the portfolio.

Net realized investment losses for the specialty insurance segment totaled $3.1 million and $2.7 million for the three and nine months ended September 30, 2008, respectively, increases of $3.3 million and $3.7 million when compared with the comparable periods of the prior year. The current period net losses were primarily driven by realized losses on the sale of certain securities as well as the above mentioned $0.9 million impairment loss on Fannie Mae and Freddie Mac preferred securities.

Specialty insurance salaries and other personnel costs and other operating expenses were $26.4 million and $81.0 million for the three and nine months ended September 30, 2008, decreases of $1.4 million, or 5.1% and $1.8 million, or 2.2% when compared with the same periods of the prior year. These decreases were primarily due to employee reductions as well as other cost-containment programs.

For the home warranty business, the claims provision as a percentage of home warranty operating revenues was 67.7% for the current three-month period and 57.8% for the same period of the prior year. This increase in rate was primarily due to an increase in contractor and supplier claims coupled with reduced operating revenues. For the property and casualty business, the claims provision as a percentage of property and casualty insurance operating revenues was 50.5% for the current three-month period, relatively unchanged when compared with 50.8% for the same period of the prior year.

Premium taxes were $3.4 million and $3.7 million for the nine months ended September 30, 2008 and 2007, respectively. Premium taxes as a percentage of operating revenues were 1.6% for the current nine-month period and for the same period of the prior year.

 

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A large part of the revenues for the specialty insurance businesses are not dependent on the level of real estate activity, with a large portion generated from renewals. With the exception of loss expense, the majority of the expenses for this segment are variable in nature and therefore generally fluctuate consistent with revenue fluctuations. Accordingly, profit margins for this segment (before loss expense) are relatively constant, although as a result of some fixed expenses, profit margins (before loss expense) should nominally improve as revenues increase. Pre-tax margins for both the current three and nine-month periods were 0.4% and 7.8%, down from 12.2% and 14.5% for the comparable periods of the prior year. These decreases primarily reflected increased claims activity at the home warranty business and investment losses.

INFORMATION SOLUTIONS

Information and Outsourcing Solutions

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Operating revenues

   $ 173,503     $ 180,401     $ (6,898 )   (3.8 )   $ 535,167     $ 585,892     $ (50,725 )   (8.7 )

Investment and other income

     11,103       10,835       268     2.5       39,227       27,928       11,299     40.5  

Net realized investment (losses) gains

     31       —         31     —         (7 )     (3 )     (4 )   (133.3 )
                                                            
     184,637       191,236       (6,599 )   (3.5 )     574,387       613,817       (39,430 )   (6.4 )
                                                            

Expenses

                

Salaries and other personnel costs

     48,239       52,986       (4,747 )   (9.0 )     148,986       165,557       (16,571 )   (10.0 )

Other operating expenses

     97,102       89,566       7,536     8.4       273,284       289,023       (15,739 )   (5.4 )

Provision for policy losses and other claims

     5,304       4,178       1,126     27.0       15,896       12,729       3,167     24.9  

Depreciation and amortization

     5,749       5,645       104     1.8       17,632       16,345       1,287     7.9  

Interest

     (1,541 )     (1,364 )     (177 )   (13.0 )     (4,562 )     (3,923 )     (639 )   (16.3 )
                                                            
     154,853       151,011       3,842     2.5       451,236       479,731       (28,495 )   (5.9 )
                                                            

Income (loss) before income taxes and minority interests

   $ 29,784     $ 40,225     $ (10,441 )   (26.0 )   $ 123,151     $ 134,086     $ (10,935 )   (8.2 )
                                                            

Margins

     16.1 %     21.0 %     (4.9 )%   (23.3 )     21.4 %     21.8 %     (0.4 )%   (1.9 )
                                                            

Information and outsourcing solutions had total operating revenues of $173.5 million and $535.2 million in the three and nine months ended September 30, 2008, respectively, decreases of $6.9 million, or 3.8%, and $50.7 million, or 8.7%, when compared with the same periods of the prior year. Acquisition activity contributed $0.8 million and $4.6 million of operating revenue for the information and outsourcing solutions segment for the three and nine months ended September 30, 2008. These revenue decreases primarily reflected a decline in volume at the tax service, flood certification and traditional appraisal businesses due to the decline in mortgage originations, offset in part by an increase in production volume for default and outsourcing services and default-related valuation products due to an increase in default and foreclosure activity. Also impacting the revenues at the tax service business were adjustments to deferred revenue totaling $10.2 million and $14.6 million in the three and nine months ended September 30, 2008 due to the lengthening of the service period associated with that portfolio.

Information and outsourcing solutions investment and other income totaled $11.1 million and $39.2 million for the three and nine months ended September 30, 2008, respectively. Information and outsourcing solutions had investment and other income of $10.8 million and $27.9 million for the prior year three and nine-month period. The increases in investment income primarily reflect the results of the segment’s national joint ventures.

 

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Information and outsourcing solutions salaries and other personnel costs were $48.2 million and $149.0 million for the three and nine months ended September 30, 2008, decreases of $4.7 million, or 9.0%, and $16.6 million, or 10.0%, when compared with the same periods of the prior year. Excluding acquisition activity, information and outsourcing solutions salaries and other personnel costs decreased $5.5 million, or 10.4%, and $19.1 million, or 11.5%, in the current three and nine-month periods. These decreases were primarily due to general expense reductions in response to the decrease in business volume, including year-to-date gross domestic headcount reductions in force of 6%, and reductions in employee benefit expenses, including bonus and the profit-driven 401(k) match, the reduction in the profit driven 401(k) match is due to the determination that the Company will not meet the requirement for a 401(k) plan match. These decreases were offset by increased expenses at the default-related businesses due to increased revenues at those entities due to the current market conditions. Also offsetting these decreases were increases in severance expense of $2.1 million and $1.6 million in the three and nine-month periods ended September 30, 2008 relative to the comparable periods of the prior year.

Information and outsourcing solutions other operating expenses were $97.1 million and $273.3 million for the three and nine months ended September 30, 2008, an increase of $7.5 million, or 8.4%, compared to the three-month period of the prior year, and a decrease of $15.7 million, or 5.4%, when compared to the nine-month period of the prior year. Excluding acquisition activity, information and outsourcing solutions other operating expenses increased $7.0 million, or 7.8%, and decreased $17.8 million, or 6.2%, in the current three and nine-month periods, respectively. The current quarter increases are primarily attributed to increased cost of goods sold associated with increased default-related revenues as well as increased legal fees primarily associated with appraisal-related cases. The year to date decreases were primarily due to general expense reductions in response to the decrease in business volume, primarily at the tax servicing, flood and appraisal-related businesses, as well as the impact of management’s cost savings initiatives, offset by increased expenses at the default-related businesses due to increased revenues at those entities resulting from the current market conditions.

Most of the businesses included in the information and outsourcing solutions segment are database intensive, with a relatively high proportion of fixed costs. As such, profit margins generally decline as revenues decline. Revenues for the information and outsourcing solutions segment are primarily dependent on the level of mortgage origination and servicing activity. The information and outsourcing solutions segment had pre-tax margins for the current three and nine-month periods of 2008 of 16.1% and 21.4%, respectively, down from 21.0% and 21.8% margins for the prior year three and nine-month periods. The margins were impacted by the reduction in revenues, a shift in the revenues and the impact of the adjustments to the tax service revenue in the quarter. Offsetting these factors were benefits from cost reduction efforts as well as the strength of the segment’s relationships with large, national lenders that have experienced market share growth in spite of the current market conditions.

In November 2007, the New York Attorney General (NYAG) filed a lawsuit challenging an appraisal program in which a subsidiary of the Company participated. Since that time, the NYAG publicly announced the initiation of inquiries into the practices of several other participants in the mortgage lending market as well as the practices of participants in the mortgage securitization market, including Freddie Mac and Fannie Mae. In connection with these inquiries, Freddie Mac and Fannie Mae agreed to adopt a Home Valuation Code of Conduct (Code of Conduct) and agreed to refrain from purchasing certain loans from lenders not abiding by that code. The Code of Conduct provides, among other matters, that in underwriting a loan a lender shall not utilize an appraisal report prepared by an appraiser employed by a lender, an affiliate of a lender, an entity that is owned in whole or in part by a lender, a real estate settlement services provider or an entity that is owned in whole or in part by a settlement services provider. Certain of the Company’s appraisal operations may fall into one or more of these categories. The Code of Conduct was subject to a comment period, which ended on April 30, 2008. A number of federal regulators have objected to certain aspects of the Code of Conduct. It is not clear what impact, if any, the comments and objections will have on the Code of Conduct. The director of the Federal Housing Finance Agency has indicated that there will be some modifications to the Code of Conduct and that implementation may be delayed for up to three months. The Company does not believe that the lawsuit filed by the NYAG will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. Given the outstanding comments and objections and uncertainty as to what changes, if any, may be made to the Code of Conduct, the Company is unable to determine at this time the effect of the Code of Conduct.

 

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Data and Analytic Solutions

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Direct operating revenues

   $ 142,844     $ 157,671     $ (14,827 )   (9.4 )   $ 452,205     $ 484,068     $ (31,863 )   (6.6 )

Agent operating revenues

     985       1,758       (773 )   (44.0 )     4,144       5,685       (1,541 )   (27.1 )

Investment and other income

     2,306       804       1,502     (186.8 )     4,773       3,864       909     23.5  

Net realized investment (losses) gains

     (3,587 )     2,477       (6,064 )   (244.8 )     (3,541 )     74,683       (78,224 )   (104.7 )
                                                            
     142,548       162,710       (20,162 )   (12.4 )     457,581       568,300       (110,719 )   (19.5 )
                                                            

Expenses

                

Salaries and other personnel costs

     78,551       85,760       (7,209 )   (8.4 )     251,001       251,000       1     —    

Premiums retained by agents

     465       1,064       (599 )   (56.3 )     2,237       3,451       (1,214 )   (35.2 )

Other operating expenses

     30,308       30,487       (179 )   (0.6 )     79,820       93,520       (13,700 )   (14.6 )

Provision for policy losses and other claims

     4,183       2,062       2,121     102.9       8,938       4,257       4,681     110.0  

Depreciation and amortization

     16,849       15,093       1,756     11.6       51,948       48,592       3,356     6.9  

Premium taxes

     115       151       (36 )   (23.8 )     408       470       (62 )   (13.2 )

Interest

     1,898       2,191       (293 )   (13.4 )     5,776       6,174       (398 )   (6.4 )
                                                            
     132,369       136,808       (4,439 )   (3.2 )     400,128       407,464       (7,336 )   (1.8 )
                                                            

Income (loss) before income taxes and minority interests

   $ 10,179     $ 25,902     $ (15,723 )   (60.7 )   $ 57,453     $ 160,836     $ (103,383 )   (64.3 )
                                                            

Margins

     7.1 %     15.9 %     (8.8 )%   (55.1 )     12.6 %     28.3 %     (15.7 )%   (55.6 )
                                                            

Operating revenues for the data and analytic solutions segment were $143.8 million and $456.3 million for the three and nine months ended September 30, 2008, respectively, decreases of $15.6 million, or 9.8%, and $33.4 million, or 6.8%, when compared with the same periods of the prior year. These decreases were primarily due to the effects of the continued slowdown in mortgage originations and the ongoing tightening of the credit markets. These conditions have resulted in a decrease for many of the segment’s traditional loan origination related products, a decrease in mortgage securitization risk analytics, and a drop in the demand for some of the mortgage analytic product offerings; these decreases were offset in part by growth in risk mitigation, custom and licensing product revenues.

Data and analytic solutions investment and other income totaled $2.3 million and $4.8 million for the three and nine months ended September 30, 2008, respectively. Data and analytic solutions investment and other income totaled $0.8 million and $3.9 million for the three and nine months ended September 30, 2007, respectively.

Data and analytic solutions net realized investment losses totaled $3.6 million and $3.5 million for the three and nine months ended September 30, 2008, respectively. Data and analytic solutions had net realized investment gains of $2.5 million and $74.7 million for the prior year three and nine-month periods. The $3.6 million net related investment loss during the current quarter reflects the previously disclosed loss on Fannie Mae and Freddie Mac securities. The prior year nine-month period included a $77.1 million realized gain included in the information and outsourcing solutions segment resulting from the combination of the Company’s RES division with CoreLogic Systems, Inc., as well as a $4.9 million write-down of two investments in unconsolidated affiliates.

Data and analytic solutions salaries and other personnel costs were $78.6 million and $251.0 million for the three and nine months ended September 30, 2008, respectively, a decrease of $7.2 million, or 8.4%, in the current three months and stable for the current nine-month period when compared with the same periods of the prior year. Excluding acquisition activity, data and analytic solutions salaries and other personnel costs decreased $2.3 million, or 0.9%, for the current nine-month period. When excluding the impact of employees transferred into the segment during the current year for management reporting purposes, salaries and other personnel expenses were down $10.3 million in the nine months ended September 30, 2008 relative to the same period in the prior year. These decreases were primarily due to general expense reductions in response to the decrease in business volume, including year-to-date gross domestic headcount reductions in force of 10%, and reductions in employee benefit expenses, including bonus and the profit-driven 401(k) match, the reduction in the profit driven 401(k) match is due to the determination that the Company will not meet the requirement for a 401(k) plan match. Offsetting these decreases were increases in severance expense of $0.4 million and $0.7 million in the three and nine month periods ended September 30, 2008 relative to the comparable periods of the prior year.

 

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Data and analytic solutions other operating expenses were $30.3 million and $79.8 million for the three and nine months ended September 30, 2008, respectively, decreases of $0.2 million, or 0.6%, and $13.7 million, or 14.6%, when compared with the same periods of the prior year. Excluding acquisition activity, data and analytic solutions other operating expenses decreased $15.7 million, or 16.8%, for the current nine-month period. These decreases were primarily due to the overall decline in business volumes and the impact of cost savings initiatives implemented by management. Offsetting these decreases were increases in restructuring costs totaling $0.3 million in the three-month period ended September 30, 2008 and increased legal fees.

The provision for policy losses and other claims was $4.2 million and $8.9 million for the three and nine months ended September 30, 2008, respectively, increases of $2.1 million, or 102.9%, and $4.7 million, or 110.0%, when compared with the same periods of the prior year. The provision for policy losses and other claims increased approximately $2.0 million and $4.7 million in the three and nine-month periods ended September 30, 2008 due to loss expense related to prior year claims on the segment’s second lien product. The losses arise due to the policy claim operating agreement currently in place with the Company’s title insurance operations; upon completion of the announced spin-off or a restructuring of the operating agreement for this business, it is anticipated that the operating agreement will be modified such that the policy claim losses will no longer be born by the segment.

Most of the businesses included in the data and analytic solutions segment are database intensive, with a relatively high proportion of fixed costs. As such, profit margins generally decline as revenues decrease. Revenues for the data and analytic solutions segment are, in part, dependent on real estate activity but are less cyclical as a result of a more diversified customer base and a greater percentage of subscription-based revenue. Pre-tax margins for the current three and nine-month periods of 2008 were 7.1% and 12.6%, respectively, down from 15.9% and 17.1% margins for the prior year three and nine-month periods (excluding the impact of the gain recognized in connection with the acquisition of CoreLogic Systems, Inc.). The lower revenues, combined with the high level of fixed costs, primarily drove the decrease year over year; the impact of these items was offset by the impact of the cost cutting initiatives implemented by management. If the results of the segment’s second lien product operations were excluded, margins for the three and nine-month periods ended September 30, 2008 would have been 8.6% and 13.7%, respectively, as compared to 16.7% and 17.1% in the comparable prior periods.

Risk Mitigation and Business Solutions

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Operating revenues

   $ 186,459     $ 219,341     $ (32,882 )   (15.0 )   $ 587,014     $ 652,291     $ (65,277 )   (10.0 )

Investment and other income

     1,994       1,367       627     45.9       7,527       7,637       (110 )   (1.4 )

Net realized investment (losses) gains

     (389 )     (321 )     (68 )   (21.2 )     (6,214 )     (443 )     (5,771 )   (1,302.7 )
                                                            
     188,064       220,387       (32,323 )   (14.7 )     588,327       659,485       (71,158 )   (10.8 )
                                                            

Expenses

                

Salaries and other personnel costs

     58,984       67,842       (8,858 )   (13.1 )     192,777       207,634       (14,857 )   (7.2 )

Other operating expenses

     94,903       105,934       (11,031 )   (10.4 )     294,999       325,670       (30,671 )   (9.4 )

Provision for policy losses and other claims

     —         10       (10 )   (100.0 )     —         10       (10 )   (100.0 )

Depreciation and amortization

     12,171       10,861       1,310     12.1       33,958       32,040       1,918     6.0  

Interest

     640       2,945       (2,305 )   (78.3 )     2,140       9,269       (7,129 )   (76.9 )
                                                            
     166,698       187,592       (20,894 )   (11.1 )     523,874       574,623       (50,749 )   (8.8 )
                                                            

Income (loss) before income taxes and minority interests

   $ 21,366     $ 32,795       (11,429 )   (34.8 )   $ 64,453     $ 84,862       (20,409 )   (24.0 )
                                                            

Margins

     11.4 %     14.9 %     (3.5 )%   (23.7 )     11.0 %     12.9 %     (1.9 )%   (14.9 )
                                                            

 

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Risk mitigation and business solutions operating revenues were $186.5 million and $587.0 million for the three and nine months ended September 30, 2008, respectively, decreases of $32.9 million, or 15.0%, and $65.3 million, or 10.0%, when compared with the same periods of the prior year. Acquisitions generated $1.8 million and $4.5 million of operating revenues for the three and nine-month periods and growth in the investigative and litigation support services contributed to the increases as well. These increases were partially offset by the disposition of the US SEARCH.com business in the fourth quarter 2007 and several other business lines in 2008, combined with a general downturn in demand for the credit, data and employment-based products.

Risk mitigation and business solutions investment and other income totaled $2.0 million and $7.5 million for the three and nine months ended September 30, 2008, respectively. Risk mitigation and business solutions investment and other income totaled $1.4 million and $7.6 million for the three and nine months ended September 30, 2007, respectively.

Risk mitigation and business solutions net realized investment losses totaled $0.4 million and $6.2 million for the three and nine months ended September 30, 2008, respectively. Risk mitigation and business solutions had net realized investment losses of $0.3 million and $0.4 million for the prior year three and nine-month period.

Risk mitigation and business solutions salaries and other personnel costs were $59.0 million and $192.8 million for the three and nine months ended September 30, 2008, decreases of $8.9 million, or 13.1%, and $14.9 million, or 7.2%, for the three and nine months ended September 30, 2008, respectively, when compared with the same periods of the prior year. Acquisition activity contributed $0.6 million and $1.7 million of costs for the three and nine months ended September 30, 2008, respectively, and there was severance expense of $1.7 million and $2.7 million in the three and nine-month periods ended September 30, 2008; acquisition related increases were offset by a decrease in salaries and other personnel costs due to the reduction in production volumes in 2008, lower share-based compensation in 2008 and the $8.0 million of severance included in the 2007 results related to the resignation of the former chief executive officer.

Risk mitigation and business solutions other operating expenses were $94.9 million and $295.0 million for the three and nine months ended September 30, 2008, decreases of $11.0 million, or 10.4%, and $30.7 million, or 9.4%, respectively, when compared with the same periods of the prior year. Acquisition activity contributed $0.5 million and $1.5 million of costs. These decreases were primarily due to the reduction in production volumes in 2008, lower information technology costs and other expense reductions. The decreases noted were partially offset by $2.8 million and $4.5 million of restructuring expenses in the three and nine-month periods ended September 30, 2008.

Many of the expenses incurred by the risk mitigation and business solutions segment are variable in nature and therefore generally decrease as revenues decrease. Most of the revenues for the risk mitigation and business solutions segment are unaffected by real estate activity, with the exception of the mortgage credit business, which is dependent on real estate activity. Pre-tax margins for the current three and nine-month periods were 11.4% and 11.0%, respectively, compared with 14.9% and 12.9% for the prior year three and nine-month periods.

 

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Corporate

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Investment and other (losses) income

   $ 315     $ 1,380     $ (1,065 )   (77.2 )   $ 2,561     $ (3,686 )   $ 6,247     169.5  

Gain on stock issued by a subsidiary

     —         123       (123 )   (100.0 )     1,325       9,426       (8,101 )   (85.9 )

Net realized investment (losses) gains

     1,428       (974 )     2,402     246.6       (1,547 )     (21,652 )     20,105     92.9  
                                                            
     1,743       529       1,214     229.0       2,339       (15,912 )     18,251     114.7  
                                                            

Expenses

                

Salaries and other personnel costs

     9,682       21,611       (11,929 )   (55.2 )     32,708       61,233       (28,525 )   (46.6 )

Other operating expenses

     8,646       9,114       (468 )   (5.1 )     26,083       30,744       (4,661 )   (15.2 )

Depreciation and amortization

     3,470       4,361       (891 )   (20.4 )     11,224       13,394       (2,170 )   (16.2 )

Interest

     13,744       10,164       3,580     35.2       37,852       26,397       11,455     43.4  
                                                            
     35,542       45,250       (9,708 )   (21.5 )     107,867       131,768       (23,901 )   (18.1 )
                                                            

Income (loss) before income taxes and minority interests

   $ (33,799 )   $ (44,721 )   $ 10,922     24.4     $ (105,528 )   $ (147,680 )   $ 42,152     28.5  
                                                            

Net realized investment losses for the prior year nine-month period included a $15.8 million impairment loss related to the valuation of an unconsolidated affiliate.

Corporate total salaries and other personnel costs and other operating expenses totaled $18.3 million and $58.8 million for the three and nine months ended September 30, 2008, respectively, decreases of $12.4 million, or 40.3%, and $33.2 million, or 36.1%, when compared with the same periods of the prior year. These decreases were primarily due to changes in technology initiatives, salary reductions, employee reductions, decreased employee benefit and retirement costs, and the impact of other corporate-wide cost saving initiatives that have been implemented by the Company.

Interest expense was $13.7 million and $37.9 million for the three and nine months ended September 30, 2008, respectively, increases of $3.6 million, or 35.2%, and $11.5 million, or 43.4%, when compared with the same periods of the prior year. Interest expense includes interest associated with inter-company notes issued to the home warranty business (a component of the specialty insurance segment) and the title insurance business. These amounts totaled $2.9 million and $6.1 million for the three and nine months ended September 30, 2008, respectively, and $0.7 million and $2.2 million for the three and nine months ended September 30, 2007, respectively. Excluding inter-company interest expense, corporate interest expense increased relative to the prior periods due to incremental draws on the Company’s credit facility. The inter-company interest expense at the corporate level and related interest income which is included in the title insurance and specialty insurance segments are eliminated in the consolidated financial statements.

 

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Eliminations

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in thousands except percentages)

   2008     2007     $ Change     % Change     2008     2007     $ Change     % Change  

Revenues

                

Operating revenues

   $ (29,797 )   $ (23,477 )   $ (6,320 )   (26.9 )   $ (78,637 )   $ (79,396 )   $ 759     1.0  

Investment and other income

     (2,856 )     (713 )     (2,143 )   (300.6 )     (6,087 )     (2,176 )     (3,911 )   (179.7 )
                                                            
     (32,653 )     (24,190 )     (8,463 )   (35.0 )     (84,724 )     (81,572 )     (3,152 )   (3.9 )
                                                            

Expenses

                

Other operating expenses

     (29,797 )     (23,477 )     (6,320 )   (26.9 )     (78,637 )     (79,396 )     759     1.0  

Interest expense

     (2,856 )     (713 )     (2,143 )   (300.6 )     (6,087 )     (2,176 )     (3,911 )   (179.7 )
                                                            
     (32,653 )     (24,190 )     (8,463 )   (35.0 )     (84,724 )     (81,572 )     (3,152 )   (3.9 )
                                                            

Income (loss) before income taxes and minority interests

   $ —       $ —       $ —       —       $ —       $ —       $ —       —    
                                                            

Eliminations represent revenues and related expenses associated with inter-segment sales of services and products, as well as interest expense and related interest income associated with inter-company notes which are eliminated in the consolidated financial statements.

INCOME TAXES

The effective income tax rate (income tax expense as a percentage of pretax income before minority interest expense) was 35.8% for the nine months ended September 30, 2008, and 29.3% for the same period of the prior year. The increase in the effective rate was primarily attributable to changes in the ratio of permanent differences to income before income taxes and minority interests and the effect of interest and penalties recognized for the nine months ended September 30, 2008, relating to FIN 48. A large portion of the Company’s minority interest expense is attributable to a limited liability company subsidiary, which for tax purposes, is treated as a partnership. Accordingly, no income taxes have been provided for that portion of the minority interest expense. The change in the quarter in the liability for income taxes associated with uncertain tax positions, the net amount that favorably affects the effective tax rate and the change in the amount accrued for interest and penalties primarily relates to a foreign transfer pricing matter impacted by recent administrative and judicial developments. The Company continues to monitor the realizability of recognized, impairment and unrecognized losses recorded through September 30, 2008. The Company believes it is more likely than not that the tax benefits associated with those losses will be realized. However, this determination is a judgment and could be impacted by further market fluctuations.

MINORITY INTERESTS

Minority interest expense was $10.2 million and $45.5 million for the three and nine months ended September 30, 2008, respectively, decreases of $9.8 million and $37.5 million when compared with $20.0 million and $83.0 million for comparable periods of the prior year. The prior year nine-month period included the minority interest portion of a $77.1 million realized gain recognized by the Company’s joint venture with Experian. This gain resulted from the combination of the Company’s Real Estate Services division with CoreLogic Systems, Inc.

NET (LOSS) INCOME

Net loss for the three months ended September 30, 2008 was $8.3 million, or $0.09 per diluted share. Net income for the nine months ended September 30, 2008 was $40.6 million, or $0.44 per diluted share, respectively. Net income for the three and nine months ended September 30, 2007, was $46.6 million, or $0.49 per diluted share, and $64.4 million, or $0.66 per diluted share, respectively.

 

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LIQUIDITY AND CAPITAL RESOURCES

Total cash and cash equivalents decreased $336.9 million for the nine months ended September 30, 2008, and $319.0 million for the nine months ended September 30, 2007. The decrease for the current year period was due primarily to an increase in deposits with banks, net purchases of debt and equity securities, cash paid for acquisitions and capital expenditures. The uses were offset by cash provided from operations, an increase in demand deposits and net borrowings. The decrease for the prior year period was primarily due to purchases of debt securities, cash paid for acquisitions, capital expenditures and the net change in demand deposits.

Notes and contracts payable as a percentage of total capitalization were 22.4% and 21.6% at September 30, 2008 and at December 31, 2007, respectively.

In both June and July 2008, the Company borrowed $70.0 million on its credit facility to fund a portion of the $200.5 million transfer of assets to First American Title Insurance Company (“FATICO”), its wholly owned title insurance subsidiary. The Company has $160.0 million of borrowing capacity available on its $500.0 million committed credit facility due 2012.

The Company has a share repurchase program with a total amount authorized under the program, as amended, of $800.0 million, of which $360.4 million remains available. Between inception of the program and September 30, 2008, the Company had repurchased and retired approximately 10.5 million of its Common shares for a total purchase price of $439.6 million. The Company has not repurchased any shares in the current nine-month period.

Management believes that all of its anticipated operating cash requirements for the immediate future will be met from internally generated funds.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The Company’s primary exposure to market risk relates to interest rate risk associated with certain financial instruments. Although the Company monitors its risk associated with fluctuations in interest rates, it does not currently use derivative financial instruments on any significant scale to hedge these risks.

The Company is also subject to equity price risk as related to its equity securities, but such risk is immaterial.

Although the Company is subject to foreign currency exchange rate risk as a result of its operations in certain foreign countries, the foreign exchange exposure related to these operations, in the aggregate, is not material to the Company’s financial condition or results of operations, and therefore, such risk is immaterial.

As the overall composition of the Company’s investment portfolio and nature of the items invested in has not changed substantially since December, 31, 2007, management believes that there have been no material changes in the Company’s market risks since the filing of its Form 10-K for the year ended December 31, 2007.

 

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company’s chief executive officer and chief financial officer have concluded that, as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q, the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, were effective, based on the evaluation of these controls and procedures required by Rule 13a-15(b) thereunder.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2008, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II: OTHER INFORMATION

 

Item 1. Legal Proceedings.

The Company and its subsidiaries have been named in various lawsuits, most of which relate to their title insurance operations. In cases where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on facts known to the Company. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (SFAS 5), the Company maintained a reserve for these lawsuits totaling $63.7 million at September 30, 2008. Actual losses may materially differ from the amounts recorded. The Company does not believe that the ultimate resolution of these cases, either individually or in the aggregate, will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

The Company’s title insurance, property and casualty insurance, home warranty, thrift, trust and investment advisory businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of the Company’s operations. These audits or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry and title insurance customer acquisition and retention practices. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure based on facts known to the Company. In accordance with SFAS 5, the Company maintained a reserve for these matters totaling $2.4 million at September 30, 2008. While the ultimate disposition of each such audit or investigation is not yet determinable, the Company does not believe that individually or in the aggregate, they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These audits or investigations could result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

 

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The Company also is involved in numerous ongoing routine legal and regulatory proceedings related to its operations. While the ultimate disposition of each proceeding is not determinable, the Company does not believe that any of such proceedings, individually or in the aggregate, will have a material adverse effect on its financial condition, results of operations or cash flows.

 

Item 1A. Risk Factors.

The Company has added the risk factor set forth below. You should carefully consider the risk factors set forth in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, as updated in Part II, Item 1A of the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2008 and June 30, 2008, respectively, and as further updated hereby, as well as the other information contained in the Company’s Annual Report, as updated or modified in subsequent filings. The Company faces risks other than those listed in the Annual Report, as updated, including those that are unknown and others of which the Company may be aware but, at present, considers immaterial. Because of the factors set forth in Part I, Item 1A of the Company’s Annual Report, as updated, as well as other variables affecting the Company’s financial condition, results of operations or cash flows, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

17. Failures at financial institutions at which the Company deposits funds could adversely affect the Company

The Company deposits substantial funds in financial institutions. These funds include amounts owned by third parties, such as escrow deposits. Should one or more of the financial institutions at which the Company maintains deposits fail, there is no guarantee that the Company would recover the funds it has deposited, whether through Federal Deposit Insurance Corporation coverage or otherwise. In the event of any such failure, the Company also could be held liable for the funds owned by third parties. Such events could be disruptive to the Company’s business and could adversely affect the Company’s liquidity, results of operations and financial condition.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

The following table describes purchases by the Company of the Company’s Common shares which settled during each period set forth in the table. Prices in column (b) include commissions. Purchases described in column (c) were made pursuant to the share repurchase program initially announced by the Company on May 18, 2004, which was amended to add additional amounts to the repurchase authorization on May 19, 2005, June 26, 2006, and January 15, 2008. The amounts in column (d) reflect the effect of these amendments. Under this plan, which has no expiration date, the Company may repurchase up to $800 million of the Company’s issued and outstanding Common shares. As of September 30, 2008, the Company repurchased $439.6 million (including commissions) of its shares and had the authority to repurchase an additional $360.4 million (including commissions).

 

     (a)
Total
Number of
Shares
Purchased
   (b)
Average
Price Paid
per Share
   (c)
Total Number
of Shares
Purchased as Part
of Publicly
Announced Plans
or Programs
   (d)
Maximum
Approximate Dollar
Value of Shares that May
Yet Be Purchased Under
the Plans or Programs

Period

           

July1 to July 31, 2008

   —      —      —      $ 360,369,939

August 1 to August 31, 2008

   —      —      —      $ 360,369,939

September 1 to September 30, 2008

   —      —      —      $ 360,369,939
                     

Total

   —      —      —      $ 360,369,939
                     

 

Item 6. Exhibits.

See Exhibit Index.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

THE FIRST AMERICAN CORPORATION
(Registrant)

/s/ Parker S. Kennedy

Parker S. Kennedy
Chairman and Chief Executive Officer

/s/ Max O. Valdes

Max O. Valdes
Chief Financial Officer

Date: October 30, 2008

 

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EXHIBIT INDEX

 

Exhibit No.

  

Description

  

Location

10(a)    Arrangement regarding bonus plan for named executive officers, approved July 29, 2008.    Incorporated by reference herein to the description contained in the Current Report on Form 8-K dated July 29, 2008.
10(b)    Employment Agreement, dated September 12, 2008, between First American Title Insurance Company and Curt G. Johnson.    Attached.
(31)(a)    Certification by Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.    Attached.
(31)(b)    Certification by Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.    Attached.
(32)(a)    Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.    Attached.
(32)(b)    Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.    Attached.