UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
For the Quarterly Period Ended September 30, 2004
OR
For the transition period from _______________ to _______________
Commission File Number: 0-11774
INVESTORS TITLE COMPANY(Exact name of registrant as specified in its charter)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of September 30, 2004, there were 2,855,744 outstanding shares of common stock of Investors Title Company, including 367,014 shares held by Investors Title Insurance Company, a wholly owned subsidiary of Investors Title Company.
See notes to consolidated financial statements.
1
2
3
4
Notes to Consolidated Financial StatementsSeptember 30, 2004(Unaudited)
Note 1 - Basis of Presentation
Reference should be made to the “Notes to Consolidated Financial Statements” of Investors Title Company’s (the “Company”) Annual Report to Shareholders for the year ended December 31, 2003 for a complete description of the Company’s significant accounting policies. There were no material changes in the significant accounting policies during the nine months ended September 30, 2004.
Principles of Consolidation – The accompanying unaudited condensed consolidated financial statements include the accounts and operations of Investors Title Company and its subsidiaries (Investors Title Insurance Company, Northeast Investors Title Insurance Company, Investors Title Exchange Corporation, Investors Title Accommodation Corporation, Investors Title Management Services, Inc., Investors Title Commercial Agency, LLC, Investors Capital Management Company, and Investors Trust Company), and have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted. All intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows in the accompanying unaudited consolidated financial statements have been included. All such adjustments are of a normal recurring nature. Operating results for the three and nine month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.
Use of Estimates and Assumptions – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reclassification– Certain 2003 amounts have been reclassified to conform to 2004 classifications.
5
Earnings Per Share – Basic net income per share information is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share is computed using the weighted average number of shares of common and dilutive potential common shares outstanding during the period.
Stock-Based Compensation – The Company accounts for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which states that, for fixed plans, no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the Company’s common stock on the grant date. In the event that stock options are granted with an exercise price below the estimated fair value of the Company’s common stock at the grant date, the difference between the fair value of the Company’s common stock and the exercise price of the stock option is recorded as deferred compensation. Deferred compensation is amortized to compensation expense over the vesting period of the stock option. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment to FASB Statement No. 123, which together require compensation expense to be disclosed based on the fair value of the options granted at the date of the grant.
Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method required by SFAS No. 123, the Company’s net income and diluted net income per common share would have been the pro forma amounts indicated in the following table:
6
Recent Accounting Pronouncements – Emerging Issue Task Force (“EITF”) Issue 03-16: In March 2004, the EITF reached a final consensus on Issue 03-16, “Accounting for Investments in Limited Liability Companies.” EITF 03-16 requires investors in limited liability corporations that have specific ownership accounts to follow the equity method of accounting for investments that are more than minor as prescribed in Statement Of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures” and EITF Topic No. D-46, “Accounting for Limited Partnership Investments.” EITF 03-16 was effective for quarters beginning after June 15, 2004. The adoption of this standard did not have a material impact on the Company’s results of operations, financial condition or liquidity.
Note 2 - Reserves for Claims
Transactions in the reserves for claims for the nine months ended September 30, 2004 and the year ended December 31, 2003 were as follows:
The total reserve for all reported and unreported losses the Company incurred through September 30, 2004 is represented by the reserve for claims. The Company’s reserves for unpaid losses and loss adjustment expenses are established using estimated amounts required to settle claims for which notice has been received (reported) and the amount estimated to be required to satisfy incurred claims of policyholders which may be reported in the future. Despite the variability of such estimates, management believes that the reserves are adequate to cover claim losses which might result from pending and future claims. The Company continually reviews and adjusts its reserve estimates to reflect its loss experience and any new information that becomes available. Adjustments resulting from such reviews may be significant.
Claims and losses paid are charged to the reserves for claims. Although claims losses are typically paid in cash, occasionally claims are settled by purchasing the interest of the insured or the claimant in the real property. When this event occurs, the Company carries assets at the lower of cost or estimated realizable value, net of any indebtedness on the property.
Note 3 - Comprehensive Income
Comprehensive income for the three months ended September 30, 2004 and 2003 was $3,235,700 and $2,784,755, respectively. Comprehensive income for the nine months ended September 30, 2004 and 2003 was $7,713,227 and $9,050,867, respectively. Other comprehensive income is comprised solely of unrealized gains or losses on the Company’s available-for-sale securities.
7
Note 4 - Earnings Per Common Share
Employee stock options are considered outstanding for the diluted earnings per common share calculation and are computed using the treasury stock method. The total increase in the weighted average shares outstanding related to these equivalent shares was 114,374 and 125,621 for the three months ended September 30, 2004 and 2003, respectively, and 121,268 and 117,854 for the nine months ended September 30, 2004 and 2003, respectively. Options to purchase 250,506 and 274,241 shares of common stock were outstanding as of September 30, 2004 and 2003, respectively. Of the total options outstanding, 3,700 and 0 options were not included in the computation of diluted earnings per share for the three months ended September 30, 2004 and 2003, respectively; and 3,700 and 36,350 options were not included in the computation of diluted earnings per share for the nine months ended September 30, 2004 and 2003, respectively, because the options’ exercise prices were greater than the average market price of the common shares.
Note 5 - Segment Information
Consistent with SFAS No. 131, the Company has aggregated its operating segments into two reportable segments: 1) title insurance services; and 2) tax-free exchange services.
8
Note 6 – Commitments and Contingencies
The Company and its subsidiaries are involved in various legal proceedings that are incidental to their business. In the Company’s opinion, based on the present status of these proceedings, any potential liability of the Company or its subsidiaries with respect to these legal proceedings will not, in the aggregate, be material to the Company’s consolidated financial condition or operations.
On November 17, 2003, Investors Title Insurance Company entered into employment agreements with key executives that provide for the continuation of certain employee benefits upon retirement. The executive employee benefits include health insurance, dental insurance, vision insurance and life insurance. The plan is unfunded. The following sets forth the net periodic benefits cost for the executive benefits for the three and nine months ended September 30, 2004:
9
The Company’s 2003 Form 10-K and 2003 Annual Report to Shareholders should be read in conjunction with the following discussion since they contain important information for evaluating the Company’s operating results and financial condition.
Title Insurance: Investors Title Company (the “Company”) engages primarily in two segments of business. Its main business activity is the issuance of title insurance through two subsidiaries, Investors Title Insurance Company (“ITIC”) and Northeast Investors Title Insurance Company (“NE-ITIC”) and settlement-related services. Through ITIC and NE-ITIC, the Company underwrites land title insurance for owners and mortgagees as a primary insurer and as a reinsurer for other title insurance companies. ITIC delivers title insurance coverage principally through branch offices and issuing agents and NE-ITIC delivers title insurance through issuing agents. Title insurance protects against loss or damage resulting from defects that affect the title to real property. The policies issued are the standard American Land Title Association approved forms.
There are two basic types of title insurance policies - one for the mortgage lender and one for the real estate owner. A lender often requires property owners to purchase title insurance to protect its position as a holder of a mortgage loan, but the lender’s title insurance policy does not protect the property owner. The property owner has to purchase a separate owner’s title insurance policy to protect his investment. When real property is conveyed from one party to another, occasionally there is a hidden defect in the title or a mistake in a prior deed, will or mortgage that may give a third party a claim against such property. If a claim is made against real property, title insurance provides a corporate guarantee against insured defects, pays all legal expenses to eliminate any title defects, pays any claims arising from errors in title examination and recording, and pays any losses arising from hidden defects in title and defects that are not of record. Title insurance provides an assurance that the insurance holder’s ownership and use of such property will be defended promptly against claims, at no cost, whether or not the claim is valid.
The Company’s profitability in the land title insurance industry is affected by a number of factors, including the cost and availability of mortgage funds, the level of real estate and mortgage refinance activity, the cost of real estate, consumer confidence, employment levels, family income levels and general economic conditions. Generally, real estate activity declines as a result of higher interest rates or an economic downturn, thus leading to a corresponding decline in title insurance premiums written and the revenues and profitability of the Company. The cyclical nature of the land title insurance industry has historically caused fluctuations in revenues and profitability and it is expected to continue to do so in the future.
Volume is also a key factor in the Company’s profitability because the Company has certain significant fixed costs such as personnel and occupancy expenses associated with processing and issuing a title insurance policy. Most of these costs do not necessarily increase or decrease depending on the size and type of the policy issued.
10
During 2004, premiums have declined principally due to the decline in refinancing activity, as a result of increased interest rates, which is expected to continue throughout the rest of the year, partially offset by a rate increase in North Carolina for insured closing services. As always, the Company has been monitoring and managing its operating expenses in light of the expected decline in title insurance revenues.
The Company strives to offset the cyclical nature of the real estate market by expanding into new markets primarily by continuing to develop agency relationships and improving market penetration with existing offices and agents. In order to maintain and improve profits, the Company endeavors to identify opportunities to refine operating procedures and implement programs designed to reduce expenses.
Exchange Services: The Company’s second segment provides tax-free exchange services through its subsidiaries, Investors Title Exchange Corporation (“ITEC”) and Investors Title Accommodation Corporation (“ITAC”). ITEC serves as a qualified intermediary in §1031 like-kind exchanges of real or personal property. In its role as qualified intermediary, ITEC coordinates the exchange aspects of the real estate transaction with the closing agents. ITEC’s duties include drafting standard exchange documents, holding the exchange funds between the sale of the old property and the purchase of the new property, and accepting the formal identification of the replacement property within the required identification period. ITAC serves as exchange accommodation titleholder in reverse exchanges. As exchange accommodation titleholder, ITAC offers a vehicle for accommodating a reverse exchange when the taxpayer must acquire replacement property before selling the relinquished property. Factors that influence the title insurance industry will also generally affect the exchange services industry.
New Services: Investors Trust Company (“INTC”), wholly owned by the Company, was chartered on February 17, 2004 by the North Carolina Commissioner of Banks. INTC serves clients throughout North Carolina and neighboring states by providing professional portfolio management services along with trust services. Activities of this company are not currently significant.
For the quarter ended September 30, 2004, net premiums written decreased 22% to $18,334,559, total revenues decreased 19% to $20,503,324 and net income decreased 1% to $2,927,864, all compared with the same quarter in 2003. Both net income per basic and diluted common share decreased 1%, to $1.17 and $1.12, respectively, as compared with the same quarter in 2003. For the quarter ended September 30, 2004, the title insurance segment’s operating revenues decreased 23% compared with the third quarter of 2003, while the exchange services segment’s operating revenues increased 143% for the quarter ended September 30, 2004, compared with the same quarter in 2003.
For the nine months ended September 30, 2004, net premiums written decreased 17% to $54,965,967, total revenues decreased 15% to $60,601,380 and net income decreased 7% to $8,029,863, all compared with the same period in 2003. Both net income per basic and diluted common share decreased 7%, to $3.21 and $3.06 as compared with the same nine-month period ended September 30, 2003. For the nine months ended September 30, 2004, the title insurance segment’s operating revenues decreased 18% compared with the same period in 2003, while the exchange services segment’s operating revenues increased 124% for the nine months ended September 30, 2004 compared with the same period in 2003.
11
Operating revenues: Revenues were primarily impacted by the decline in premiums written due to lower levels of mortgage refinancing compared with the prior year period as a result of increased interest rates. According to the Freddie Mac Weekly Mortgage Rate Survey, the monthly average 30-year fixed mortgage interest rates increased to an average of 5.87% for the nine months ended September 30, 2004, compared with an average of 5.79% for the nine months ended September 30, 2003. The volume of business decreased in the first three quarters of 2004, as the number of policies and commitments issued for the nine months declined to 220,329, a decrease of 32% compared with 324,417 in the same period in 2003.
Shown below is a schedule of premiums written for the three and nine months ended September 30, 2004 and 2003 in all states in which the Company’s two insurance subsidiaries, ITIC and NE-ITIC, currently underwrite insurance:
12
The decline in total premiums written was due primarily to lower mortgage refinancing activity compared with the same period in 2003. Premiums written in Nebraska, Pennsylvania, Minnesota and New York were also impacted by declining business in individual agencies in those states. Year to date premiums in North Carolina, the Company’s largest market, were positively impacted by approximately $5.38 million related to the rate increase filed on October 1, 2003 for insured closing services. The increase in Florida is due primarily to the increase in agent business.
Shown below is a breakdown of net premiums from branch offices and issuing agents for the three and nine months ended September 30:
Net premiums written from branch operations decreased 5% for the three months ended September 30, 2004 as compared with the same period in the prior year. For the nine months ended September 30, 2004, net premiums written from branch operations increased 4% as compared with the same period in the prior year. Of the Company’s 29 branch locations that underwrite title insurance policies, 27 are located in North Carolina and, as a result, branch net premiums written primarily represent North Carolina business. The increase in branch premiums relative to total premiums has increased primarily due to the rate increase filed in North Carolina.
Agency net premiums decreased 32% for the three months ended September 30, 2004 as compared with the same period in the prior year. For the nine months ended September 30, 2004, agency net premiums decreased 29% as compared with the same prior year period. The majority of the decrease in agency net premiums written in the third quarter 2004 and for the nine-month period ended September 30, 2004 can be attributed to the general decline in business due to the slowdown in refinancing activity as a result of increased interest rates.
The decrease in other revenues was primarily attributed to a decline in settlement-related services.
The increase in exchange services revenue for the three and nine months ended September 30, 2004 was due to both an increase in the volume of transactions resulting from increased demand for qualified intermediary services, as well as an increase in fees. The Company believes that this line of business will continue to grow for the reminder of 2004, although not necessarily at the same rate.
Operating Expenses: Total operating expenses decreased 23% and 17% for the three and nine month periods ended September 30, 2004, respectively, compared with the same periods in 2003. This was due primarily to a decrease in commission expense as a result of decreased business from agent sources. A summary by segment of the Company’s operating expenses, net of intersegment eliminations, is as follows for the three and nine months ended September 30:
13
Commissions to agents decreased 33% for the three months ended September 30, 2004 when compared with the same quarter in 2003. Commissions to agents decreased 30% for the nine months ended September 30, 2004 when compared with the same period in 2003. Commissions decreased due to the decline in premiums written from agency operations.
The provision for claims as a percentage of net premiums written was 11.2% for the nine months ended September 30, 2004, and for the same period in 2003.
Total salaries, employee benefits and payroll taxes as a percentage of total revenues were 20% and 16% for the nine months ended September 30, 2004 and 2003, respectively. The increase in these costs was attributed to several factors, including $513,000 for certain employee benefits associated with key executive employment agreements entered into in late 2003, and additional personnel costs related to staff hired by the newly formed Investors Trust Company and the regulated investment advisory, and various staff additions and salary adjustments made during the first nine months of 2004. These increases were partially offset by a reduction in health insurance expense in the third quarter of 2004 due to favorable claims experience. The title insurance segment’s total salaries, employee benefits and payroll taxes accounted for 89% and 93% of the total consolidated amount for the nine months ended September 30, 2004 and 2003, respectively.
Professional fees for the nine months ended September 30, 2004 increased primarily due to the costs associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002, along with an increase in various other professional and legal fees.
Provision for Income Taxes: The provision for income taxes was approximately 34% of income before income taxes for the three months ended September 30, 2004 and 2003. For the nine months ended September 30, 2004 and 2003, the provision for income taxes was 33.6% and 32.4%, respectively, of income before income taxes.
Cash flows: Net cash provided by operating activities for the nine months ended September 30, 2004 was $10,425,377 compared with $10,195,277 for the same nine-month period of 2003. The slight net increase is primarily the result of a decrease in receivables and other assets, offset in part by a decrease in provision for claims, a decrease in the provision for losses on premiums receivable and increased net claim payments. Cash flow from operations has been the source of financing for additions to the investment portfolio and expanding operations.
14
Payment of dividends: The Company’s ability to pay dividends to its shareholders and operating expenses is dependent on funds received from the insurance subsidiaries, which are subject to regulation in the states in which they do business. These regulations, among other things, require prior regulatory approval of the payment of dividends and other intercompany transfers. The Company believes, however, that amounts available for transfer from the insurance subsidiaries are adequate to meet the Company’s operating needs.
Liquidity:Management believes that funds generated from operations will enable the Company to adequately meet its cash needs and is unaware of any trend or occurrence that is likely to result in adverse liquidity changes. In addition to operational liquidity, the Company maintains a high degree of liquidity within its investment portfolio in the form of short-term investments and other readily marketable securities.
Capital Expenditures: During 2004, the Company has plans for various capital improvement projects, including an upgrade of certain electronic data processing systems. For the nine months ended September 30, 2004, the Company purchased electronic data processing equipment totaling approximately $876,000. Other property additions were approximately $251,000. The Company anticipates additional capital expenditures of approximately $150,000 during the remainder of 2004 in connection with these capital improvement projects.
Off-Balance Sheet Arrangements and Contractual Obligations: It is not the general practice of the Company to enter into off-balance sheet arrangements nor is it the policy of the Company to issue guarantees to third parties. Off-balance sheet arrangements are generally limited to the future payments under noncancelable operating leases and payments due under various agreements with third-party service providers and obligations pursuant to certain executive employment agreements.
The following table summarizes the Company’s future estimated cash payments under existing contractual obligations at September 30, 2004, including payments due by period:
15
The total reserve for all reported and unreported losses the Company incurred through September 30, 2004 is represented by the reserve for claims. Information regarding the claims reserve can be found in Note 2 to the consolidated financial statements of this Form 10-Q. Further information on contractual obligations related to the reserves for claims can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission.
Equity Investments: The Company’s equity investments are in public companies whose security prices are subject to volatility. Should the fair value of these investments fall below the Company’s cost bases and the financial condition or prospects of these companies deteriorate, the Company may determine in a future period that this decline in fair value is other than temporary, requiring that an impairment loss be recognized.
In March 2004, the Emerging Issues Task Force (“EITF”) released EITF Issue 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The Issue provides guidance for determining whether an investment is other-than-temporarily impaired and requires certain disclosures with respect to these investments. The recognition and measurement guidance for other-than-temporary impairment has been delayed by the issuance of FASB Staff Position EITF 03-1-1 on September 30, 2004. The adoption of this standard is not expected to have a material impact on the Company’s results of operations, financial condition or liquidity.
This Quarterly Report on Form 10-Q, as well as information included in future filings by the Company with the Securities and Exchange Commission (“SEC”) and information contained in written material, press releases and oral statements issued by or on behalf of the Company, contains, or may contain, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that reflect management’s current outlook for future periods. These statements may be identified by the use of words such as “plan,” “expect,” “aim,” “believe,” “project,” “anticipate,” “intend,” “estimate,” “will,” “should,” “could” and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including statements about the Company’s strategy for growth, product and service development, market position, claims, expenditures and financial results, are forward-looking statements. Forward-looking statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Actual future results and trends may differ materially from historical results or those projected in any such forward-looking statements depending on a variety of factors, including, but not limited to, the following: (1) the demand for title insurance will vary due to factors such as the cost and availability of mortgage funds, the level of real estate and mortgage refinance activity, the cost of real estate, consumer confidence, employment levels, family income levels and general economic conditions; (2) losses from claims may be greater than anticipated such that reserves for possible claims are inadequate; (3) unanticipated adverse changes in securities markets could result in material losses on the Company’s investments; (4) the Company’s dependence on key management personnel, the loss of whom could have a material adverse effect on the Company’s business; (5) the Company’s ability to develop and offer products and services that meet changing industry standards in a timely and cost-effective manner; (6) the costs of producing title evidence are relatively high, whereas premium revenues are subject to regulatory and competitive restraints; and (7) state statutes require the Company’s insurance subsidiaries to maintain minimum levels of capital and surplus and restrict the amount of dividends that the insurance subsidiaries may pay to the Company without prior regulatory approval. Other risks and uncertainties may be described from time to time in the Company’s other reports and filings with the SEC.
16
No material changes in the Company’s market risk or market strategy occurred since December 31, 2003. A detailed discussion of market risk is provided in the Company’s 2003 Annual Report on Form 10-K for the period ended December 31, 2003.
The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Act”) was recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. An evaluation was performed under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) under the Act. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2004.
During the quarter ended September 30, 2004, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
17
18
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed in its behalf by the undersigned hereunto duly authorized.
Dated: November 12, 2004
19