The Company has its Corporate headquarters on its campus in Jacksonville, Florida, which it leases from its former affiliate, FIS. The majority of our branch offices are leased from third parties. See Note K to Notes to Consolidated Financial Statements.
Acquisitions among entities under common control such as the Asset Contribution are not considered business combinations and are to be accounted for at historical cost in accordance with Emerging Issues Task Force (“EITF”) 90-5, Exchanges of Ownership Interests between Enterprises under Common Control. Furthermore, the substance of the Asset Contribution and the 2006 Distribution and the Old FNF-FIS merger is effectively a reverse spin-off of FIS by Old FNF in accordance with EITF 02-11, Accounting for Reverse Spinoffs. Accordingly, the historical financial statements of Old FNF became those of FNF; however, the criteria to account for FIS as discontinued operations as prescribed by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets were not met. This is primarily due to our continuing involvement with and significant influence over FIS subsequent to the merger of Old FNF and FIS through common board members, common senior management and continuing business relationships. As a result, for periods prior to October 24, 2006, FIS continues to be included in our consolidated financial statements.
Beginning October 24, 2006, the date on which the Asset Contribution and the 2006 Distribution were completed, our financial results no longer include the results of FIS. The operations of FIS continue to be included in our results for periods prior to October 24, 2006. In addition, FIS’s financial results for 2006 include the results of operations of Certegy, Inc. (“Certegy”) since February 1, 2006, the date on which Certegy was acquired by FIS (see Note B of Notes to Consolidated Financial Statements).
additional minority interest expense related to the minority interest issued in FNT and FIS. (See Note A of the Notes to Consolidated Financial Statements).
Our financial results for the year ended December 31, 2003 include the results of our acquisition of ALLTEL Information Services, Inc. for the period from April 1, 2003, the acquisition date, through December 31, 2003, and include the results of operations of various other entities acquired on various dates during 2003.
Unaudited pro forma net earnings per share is calculated using the number of outstanding shares of Old FNF on a date prior to the distribution of FNF shares to Old FNF shareholders.
Investments as of December 31, 2006, 2005, 2004, 2003, and 2002 include securities pledged to secure trust deposits of $696.8 million, $656.0 million, $546.0 million, $448.1 million, and $474.9 million, respectively. Investments as of December 31, 2006 and 2005 include securities pledged relating to our securities lending program of $271.0 million and $138.7 million, respectively.
Cash and cash equivalents as of December 31, 2006, 2005, 2004, 2003, and 2002 include cash pledged to secure trust deposits of $228.5 million, $234.7 million, $195.2 million, $231.1 million, and $295.1 million, respectively. Cash and cash equivalents as of December 31, 2006 and 2005 include cash pledged relating to our securities lending program of $316.0 million and $143.4 million, respectively.
Includes title insurance premiums and escrow and other title related fees.
The quarter ended December 31, 2005 includes in net earnings approximately $100.0 million in additional income tax expense relating to the 2005 distribution to Old FNF shareholders of a 17.5% interest in FNT. (See Note A of Notes to Consolidated Financial Statements).
We are a holding company that is a provider, through our subsidiaries, of title insurance, specialty insurance, and claims management services. We are one of the nation’s largest title insurance companies through our title insurance underwriters, with an approximately 29.0% national market share. We also provide flood insurance, personal lines insurance, and home warranty insurance through our specialty insurance subsidiaries. We are also a leading provider of outsourced claims management services to large corporate and public sector entities through our minority-owned subsidiary, Sedgwick CMS (“Sedgwick”).
Prior to October 17, 2005, we were known as Fidelity National Title Group, Inc. (“FNT”) and were a wholly-owned subsidiary of another publicly traded company, also called Fidelity National Financial, Inc. (“Old FNF”). On October 17, 2005, Old FNF distributed to its shareholders a minority interest in FNT, making it a majority-owned, publicly traded company. On October 24, 2006, Old FNF transferred certain assets to us in return for the issuance of 45,265,956 shares of our common stock to Old FNF. Old FNF then distributed to its shareholders all of its shares of our common stock, making FNT a stand alone public company. Old FNF was then merged with and into another of its subsidiaries, Fidelity National Information Services, Inc. (“FIS”), after which we changed our name to Fidelity National Financial, Inc. (“FNF” or the “Company”). Under applicable accounting principles, following these transactions, Old FNF’s historical financial statements, with the exception of equity and earnings per share, became our historical financial statements, including the results of FIS through the date of our spin-off from Old FNF. Our historical equity has been derived from FNT’s historical equity and our historical basic and diluted earnings per share have been calculated using FNT’s basic and diluted weighted average shares outstanding.
Corporate and Other. The corporate and other segment consists of the operations of the FNF parent holding company, certain other unallocated corporate overhead expenses, and the Company’s share in the operations of certain equity investments, including Sedgwick and Fidelity National Real Estate Solutions.
Prior to October 24, 2006, through FIS, Old FNF provided industry leading data processing, payment and risk management services to financial institutions and retailers. Through October 23, 2006, the Company’s results also included the operations of FIS as a separate segment. This segment provided transaction processing services, consisting principally of technology solutions for banks and other financial institutions, credit and debit card services and check risk management and related services for retailers and others. This segment also provided lender processing services, consisting principally of technology solutions for mortgage lenders, selected mortgage origination services such as title agency and closing services, default management and mortgage information services. FIS’s credit and debit card services and check risk management services were added through its merger
with Certegy, Inc. (“Certegy”). This merger closed in February 2006 and as a result these businesses are not included in FIS’s financial information prior to the closing.
From October 24 through December 31, 2006, our expenses included $17.6 million paid to a subsidiary of FIS for the provision by FIS to us of IT infrastructure support, data center management and related IT support services and $3.1 million in software expenses relating to an agreement with a subsidiary of FIS.
Historically, the Company has provided corporate services to FIS. These corporate services include accounting, internal audit, treasury, payroll, human resources, tax, legal, purchasing, risk management, mergers and acquisitions and general management. From October 24 through December 31, 2006, our expenses were reduced by $1.5 million as a result of the provision of corporate services by us to FIS.
The title plant assets of several of our title insurance subsidiaries are managed or maintained by a subsidiary of FIS. The underlying title plant information and software continues to be owned by each of our title insurance underwriters, but FIS manages and updates the information in return for either (i) a management fee or (ii) the right to sell that information to title insurers, including title insurance underwriters that we own and other third party customers. In most cases, FIS is responsible for keeping the title plant assets current and fully functioning, for which we pay a fee to FIS based on our use of, or access to, the title plant. From October 24 through December 31, 2006, our expenses to FIS under these arrangements were $5.5 million. In addition, each of our applicable title insurance underwriters in turn receives a royalty on sales of access to its title plant assets. From October 24 through December 31, 2006, our revenues included title plant royalties of $0.4 million. We have entered into agreements with FIS that permit FIS and certain of its subsidiaries to access and use (but not to re-sell) the starters databases and back plant databases of our title insurance subsidiaries. Starters databases are our databases of previously issued
We also have certain license and cost sharing agreements with FIS, for which our expenses included $1.2 million from October 24 through December 31, 2006.
Through June 30, 2005, we leased equipment to a subsidiary of FIS. Revenue relating to these leases was $5.0 million and $8.4 million 2005 and 2004, respectively.
Our expenses included amounts paid to a subsidiary of FIS for the provision by FIS to us of IT infrastructure support, data center management and related IT support services. For 2006, 2005, and 2004, expenses incurred related to such FIS services totaled $82.8 million, $56.9 million, and $56.6 million, respectively. In addition, we incurred software expenses relating to an agreement with a subsidiary of FIS that approximated $12.2 million, $7.7 million, and $5.8 million in 2006, 2005, and 2004, respectively.
Because commercial real estate transactions tend to be driven more by supply and demand for commercial space and occupancy rates in a particular area rather than by macroeconomic events, our commercial real estate title insurance business can generate revenues which are not dependent on the industry cycles discussed above.
Because these factors can change dramatically, revenue levels in the title insurance industry can also change dramatically. For example, beginning in January 2001 and continuing through June of 2003, the Federal Reserve Board reduced interest rates by 550 basis points, bringing interest rates down to their lowest level in recent history, which significantly increased the volume of refinance activity. Recently, mortgage rates have increased as the Federal Reserve Board increased interest rates by 425 basis points since June 2004, resulting in decreases in
refinance activity. The decreased refinance activity is evidenced by the Mortgage Bankers Association’s (“MBA”) statistics showing that approximately 44.4% of new loan originations in 2006 were refinance transactions as compared with approximately 50.0% in 2005 and 52.8% in 2004. The ten-year treasury rate has increased from 4.2% in January 2004 to 4.7% at the end of 2006. According to the MBA, U.S. mortgage originations (including refinancings) were approximately $2.5 trillion, $3.0 trillion, and $2.8 trillion in 2006, 2005 and 2004, respectively. The MBA’s Mortgage Finance Forecast estimates a $2.39 trillion mortgage origination market for 2007, which would be a 5.0% decrease from 2006. The MBA further forecasts that the 5.0% decrease will result from purchase transactions declining from $1.40 billion in 2006 to $1.33 billion in 2007 or 4.8% and refinance transactions dropping from $1.11 billion to $1.06 billion or 5.2%. We expect that current interest rate levels and any future increase in interest rates will most likely result in lower levels of mortgage originations in 2007 than in 2006 or 2005.
Historically, real estate transactions have produced seasonal revenue levels for title insurers. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. The third calendar quarter has been typically the strongest in terms of revenue primarily due to a higher volume of home sales in the summer months and the fourth quarter is usually also strong due to commercial customers desiring to complete transactions by year-end. Significant changes in interest rates may alter these traditional seasonal patterns due to the effect the cost of financing has on the volume of real estate transactions.
Our specialty insurance business participates in the NFIP. We earn fees under that program for settling flood claims and administering the program. Our specialty insurance revenues in 2005 were significantly increased due to fee revenues we earned from settling claims related to the year’s major hurricanes, including Katrina, Rita and Wilma.
Our reserve for claim losses includes reserves for known claims (“PLR”) as well as for losses that have been incurred but not yet reported to us (“IBNR”), net of recoupments. We reserve for each known claim based on our review of the estimated amount of the claim and the costs required to settle the claim. Reserves for IBNR claims are estimates that are established at the time the premium revenue is recognized and are based upon historical experience and other factors, including industry trends, claim loss history, legal environment, geographic
considerations, and the types of policies written. We also reserve for losses arising from escrow, closing and disbursement functions due to fraud or operational error.
Using the above approach, our external actuaries develop a single point estimate of our incurred but not reported losses, rather than a range of reserves or a set of point estimates. The point estimate provided by our independent actuaries, combined with our known claim reserves, aggregated $1,232.5 million at December 31, 2006, as compared with our carried reserve of $1,154.9 million, a difference of $77.6 million, or 6.3%. Different professional judgment in four critical assumptions was the primary driver of the difference between the independent actuary’s point estimate and our carried reserve level: different weight given to a separate projection of individually significant losses (losses greater than $500,000); adjustments based on recent experience to realize emerging changes in refinance and home sale activity; cost reduction expectations with respect to unallocated loss adjustment expense (“ULAE”) reserves; and
greater anticipated loss and allocated loss adjustment expense savings resulting from claim administration improvements. In the independent actuary’s estimate, approximately one half of the effect of projecting significant losses separately was taken into consideration, whereas our management applied full weight to such analysis. Secondly, management placed moderately greater weight on the effects of home sale and refinancing assumptions in the 1995-1998 policy years. Thirdly, adjustments to the ULAE reserves were supported by management’s analysis of the true costs expected to be incurred in a claims run-off scenario. Finally, a significant increase in the number of claims administrators and claims administration process improvements are expected to result in a reduction in loss and allocated loss expense costs somewhat greater than that estimated by the external actuaries.
Our independent actuaries fulfill a function by providing information that is a part of the total information available to our management to set our reserves. Evaluation of this information is only one component of management’s evaluation process. While there can be no assurance as to the accuracy of loss reserve estimates, use of the reserve setting process described above has resulted in development of prior years’ loss reserves over the past three years, as shown in the table below, that has generally been within a narrow range.
The valuation of intangible assets such as software, purchased customer relationships and contracts involves significant estimates and assumptions concerning matters such as customer retention, future cash flows and discount rates. If any of these assumptions change, it could affect the carrying value of these assets. Purchased customer relationships are amortized over their estimated useful lives using an accelerated method which takes into consideration expected customer attrition rates over a ten-year period. Contractual relationships are generally amortized using the straight-line method over their contractual life. In 2005 and 2004, we determined that the carrying value of certain of our intangible assets may not be recoverable and recorded impairment charges of $9.3 million and $6.3 million, respectively, relating to the write-off of these assets. These impairments were recorded as other operating expenses in our 2005 and 2004 Consolidated Statements of Earnings. There were no impairment charges recorded relating to intangible assets during 2006.
Capitalized software development costs are accounted for in accordance with either SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (SFAS No. 86), or with SOP No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. After the technological feasibility of the software has been established (for SFAS No. 86 software), or at the beginning of application development (for SOP No. 98-1 software), software development costs, which include salaries and related payroll costs and costs of independent contractors incurred during development, are capitalized. Research and development costs incurred prior to the establishment of technological feasibility (for SFAS No. 86 software), or prior to application development (for SOP No. 98-1 software), are expensed as incurred. For software subject to the provisions of SFAS No. 86, software development costs are amortized on a product by product basis commencing on the date of general release of the products, generally the greater of (1) the straight line method over its estimated useful life, which ranges from three to seven years or (2) the ratio of current revenues to total anticipated revenue over its useful life. The cost of purchased software that is subject to the provisions of SOP No. 98-1 is amortized on a straight-line basis over its estimated useful life.
Fidelity National Title Group. Our direct title insurance premiums and escrow and other title-related fees are recognized as revenue at the time of closing of the related transaction as the earnings process is then considered complete, whereas premium revenues from agency operations and agency commissions include an accrual based on estimates using historical information of the volume of transactions that have closed in a particular period for which premiums have not yet been reported to us. The accrual for agency premiums is necessary because of the lag between the closing of these transactions and the reporting of these policies to us by the agent. During the second quarter of 2005, we re-evaluated our method of estimation for accruing agency title revenues and commissions and refined the method, which resulted in our recording approximately $50.0 million in additional agency revenue in the second quarter of 2005 than we would have under our prior method. The impact on net earnings of this adjustment was approximately $2.0 million. We are likely to continue to have changes to our accrual for agency revenue in the future, but as demonstrated by this second quarter adjustment, the impact on net earnings of changes in these accruals is very small.
Specialty Insurance Segment. Revenues from home warranty and personal lines insurance policies are recognized over the life of the policy, which is one year. Revenues and commissions related to the sale of flood insurance are recognized when the policy is reported.
The substantial majority of the revenues in this business were from outsourced data processing and application management arrangements. Revenues from these arrangements were recognized as services were performed in accordance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 104 (SAB No. 104), Revenue Recognition and related interpretations. SAB No. 104 sets forth guidance as to when revenue was realized or realizable and earned when all of the following criteria were met: (1) persuasive evidence of an arrangement existed; (2) delivery had occurred or services have been rendered; (3) the seller’s price to the buyer was fixed and determinable; and (4) collectability was reasonably assured. Revenues and costs related to implementation, conversion and programming services associated with FIS’s data processing and application management agreements during the
implementation phase were deferred and subsequently recognized using the straight-line method over the term of the related services agreement. At each reporting period, FIS evaluated these deferred contract costs for impairment.
If all of the services were software related services as determined under the American Institute of Certified Public Accountants’ Statement of Position (SOP) 97-2 (SOP No. 97-2), entitled Software Revenue Recognition, and SOP 98-9, entitled Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions, FIS applied these pronouncements and related interpretations to determine the appropriate units of accounting and how the arrangement consideration should be measured and allocated to the separate units.
FIS recognized software license and post-contract customer support fees as well as associated development, implementation, training, conversion and programming fees in accordance with SOP No. 97-2 and SOP No. 98-9. Initial license fees were recognized when a contract existed, the fee was fixed or determinable, software delivery had occurred and collection of the receivable was deemed probable, provided that vendor specific objective evidence, or VSOE, had been established for each element or for any undelivered elements. FIS determined the fair value of each element or the undelivered elements in multi element software arrangements based on VSOE. If the arrangement was subject to accounting under SOP No. 97-2, VSOE for each element was based on the price charged when the same element was sold separately, or in the case of post-contract customer support, when a stated renewal rate was provided to the customer. If evidence of fair value of all undelivered elements existed but evidence did not exist for one or more delivered elements, then revenue was recognized using the residual method. Under the residual method, the fair value of the undelivered elements was deferred and the remaining portion of the arrangement fee was recognized as revenue. If evidence of fair value did not exist for one or more undelivered elements of a contract, then all revenue was deferred until all elements were delivered or fair value was determined for all remaining undelivered elements. Revenue from post-contract customer support was recognized ratably over the term of the agreement. FIS recorded deferred revenue for all billings invoiced prior to revenue recognition.
In its default management businesses, FIS recognized revenues on services provided to assist customers through the default and foreclosure process, including property preservation and maintenance services (such as lock changes, window replacement, debris removal and lawn service), posting and publication of foreclosure and auction notices, title searches, document preparation and recording services, and referrals for legal and property brokerage services. Revenue derived from these services was recognized as the services were performed in accordance with SAB No. 104 as described above.
Year ended December 31, 2005. Our Consolidated Statements of Earnings for 2005 include a full year of results for the 2004 FIS acquisitions of Aurum Technology, Inc., Sanchez Computer Associates, Inc., KORDOBA Gesellschaft fur Bankensoftware mbH & Co. KG, Munich, and InterCept, Inc., and the 2004 FNT acquisition of American Pioneer Title Insurance Company (“APTIC”). 2005 results also include additional interest expense incurred due to $2.8 billion of borrowings incurred as part of the recapitalization of FIS, a $318.2 million gain on sale of a minority interest in FIS and additional minority interest expense relating to that transaction and to the 2005 distribution of a minority interest in FNT to shareholders of Old FNF.
In 2006, our mix of direct and agency title premiums stayed relatively consistent, with agency premiums making up 57.5% of total premiums compared with 54.3% in 2005 and 55.1% in 2004. During the second quarter of 2005, we reevaluated our method of estimation for accruing agency title revenues and commissions and refined the method which resulted in our recording approximately $50 million more in agency revenue in the second quarter of 2005 than we would have under our prior method. The impact on net earnings of this adjustment was approximately $2 million. A change in agency premiums has a much smaller effect on profitability than the same change in direct premiums would have because our margins as a percentage of premiums for agency business are significantly lower than the margins realized from our direct operations due to commissions paid to our agents and other costs related to the agency business.
Interest and investment income levels are primarily a function of securities markets, interest rates and the amount of cash available for investment. Interest and investment income in 2006 was $208.3 million compared with $145.0 million in 2005 and $70.7 million in 2004. Average invested assets increased 8.0% to $5,088.9 million in 2006, and 30.1% to $4,711.4 million in 2005 from $3,622.0 million in 2004. The tax equivalent yield in 2006, excluding realized gains and losses, was 4.8% as compared with 3.8% in 2005 and 2.6% in 2004.
Net realized gains and losses for 2006, 2005 and 2004 were $18.6 million, $41.1 million, and $37.0 million, respectively. Net realized gains in 2004 include $16.2 million relating to the investment in Covansys Corporation warrants at FIS.
Other income represents revenue generated by other smaller businesses included within our segments. Other income was $52.6 million in 2006, $49.0 million in 2005, and $48.7 million in 2004.
Our operating expenses consist primarily of personnel costs, other operating expenses, which in our title insurance business are incurred as orders are received and processed, and agent commissions, which are incurred as revenue is recognized. Title insurance premiums, escrow and other title related fees are generally recognized as income at the time the underlying transaction closes. As a result, direct title operations revenue lags approximately 45-60 days behind expenses and therefore gross margins may fluctuate. The changes in the market environment, mix of business between direct and agency operations and the contributions from our various business units have impacted margins and net earnings. We have implemented programs and have taken necessary actions to maintain expense levels consistent with revenue streams. However, a short time lag exists in reducing variable costs and certain fixed costs are incurred regardless of revenue levels.
Personnel costs include base salaries, commissions, benefits and bonuses paid to employees, and are one of our most significant operating expenses. Personnel costs totaled $3,225.3 million, $3,224.7 million, and $2,786.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. Personnel costs, as a percentage of total revenue, were 34.2% in 2006, compared with 33.4% in 2005 and 33.6% in 2004. Included in personnel costs for 2006, 2005 and 2004 is approximately $65.0 million, $34.1 million, and $21.5 million, respectively, in compensation expense relating to stock based compensation plans. Personnel costs attributable to FIS were $1,357.4 million, $1,276.6 million, and $1,073.4 million in 2006, 2005, and 2004, respectively. The increase in expense related to stock based compensation plans in 2006 is primarily due to an acceleration charge of $24.5 million recorded by FIS relating to performance based options. See Note M of Notes to Consolidated Financial Statements.
Depreciation and amortization expense was $460.8 million, $406.3 million, and $338.4 million in 2006, 2005, and 2004, respectively, with the increases in each year primarily due to FIS acquisitions.
Income tax expense as a percentage of earnings before income taxes for 2006, 2005 and 2004 was 37.2%, 35.6%, and 37.0%, respectively. The fluctuation in income tax expense as a percentage of earnings before income taxes is attributable to our estimate of ultimate income tax liability, and changes in the characteristics of net earnings year to year, such as the weighting of operating income versus investment income. The decrease in 2005 is partially attributable to the fact that no income taxes were provided for the gain on the issuance of subsidiary stock as Old FNF’s tax basis in its investment in FIS exceeded the book basis on the date of the sale and the payment of a $10 per share dividend on shares held by the FNF 401(k) Plan. This was partially offset by the approximately $100.0 million in tax expense recorded by Old FNF in connection with its 2005 distribution of a minority interest in FNT.
Title insurance premiums were $4,608.3 million in 2006, $4,949.0 million in 2005, and $4,718.2 million in 2004. The following table presents the percentages of title insurance premiums generated by our direct and agency operations:
Direct title premiums decreased from 2005 to 2006 with a decrease in closed order levels partially offset by an increase in average fee per file. Direct title premiums increased from 2004 to 2005 with an increase in average fee per file partially offset by a decrease in closed order levels. The average fee per file in our direct operations was $1,580, $1,487, and $1,324 in 2006, 2005, and 2004, respectively, reflecting a strong commercial market in 2006 and 2005 and continued appreciation in home prices in 2005 and 2004. The decrease in closed order levels in 2006 reflects a declining purchase market and a relatively stable refinance market. The decrease in closed order levels in 2005 reflects a weaker refinance market, partially offset by a strong, stable purchase market.
Agency premiums decreased $39.0 million in 2006 and increased $49.2 million in 2005. During the second quarter of 2005, we reevaluated our method of estimation for accruing agency title revenues and commissions and refined the method which resulted in our recording approximately $50.0 million more in agency revenue in the second quarter of 2005 than we would have under our prior method. The impact on net earnings of this adjustment was approximately $2.0 million. A change in agency premiums has a much smaller effect on profitability than the same change in direct premiums would have because our margins as a percentage of gross premiums for agency business are significantly lower than the margins realized from our direct operations due to commissions paid to our agents and other costs related to the agency business. Agency revenues from FIS title agency businesses were $95.5 million, $91.9 million, and $106.3 million in 2006, 2005, and 2004, respectively.
Trends in escrow and other title-related fees are primarily related to title insurance activity generated by our direct operations. Escrow and other title-related fees during the three-year period ended December 31, 2006, fluctuated in a pattern generally consistent with the fluctuation in direct title insurance premiums and order counts. Escrow and other title-related fees were $1,064.3 million, $1,162.3 million, and $1,039.8 million during 2006, 2005, and 2004, respectively.
Other income represents revenue generated by other smaller real-estate related businesses that are not directly title-related. Other income was $45.0 million, $41.8 million, and $43.5 million in 2006, 2005, and 2004, respectively.
Other operating expenses consist primarily of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums in lieu of franchise and other state taxes), postage and courier services, computer services, professional services, advertising expenses, general insurance, and trade and notes receivable allowances. Other operating expenses totaled $891.1 million, $920.9 million, and $849.4 million for the years ended December 31, 2006, 2005, and 2004, respectively. Other operating expenses as a percentage of direct title insurance premiums and escrow and other title-related fees were 30.2% in 2006, 27.5% in 2005, and 27.9% in 2004, with the increase in 2006 primarily due to declining order volumes, which resulted in revenue declines outpacing cost reductions.
The provision for claim losses includes an estimate of anticipated title and title-related claims and escrow losses. The estimate of anticipated title and title-related claims is accrued as a percentage of title premium revenue based on our historical loss experience and other relevant factors. We monitor our claims loss experience on a continual basis and adjust the provision for claim losses accordingly.
Interest expense for the years ended December 31, 2006, 2005, and 2004 was $12.2 million, $16.7 million, and $3.9 million, respectively. The decrease in 2006 relates primarily to a decrease in average borrowings due to the reclassification of certain debt into the corporate and other segment in 2006, and was partially offset by an increase in interest rates. The increase in 2005 relates primarily to an increase in average borrowings as compared to the prior year including $500 million in notes due to Old FNF and borrowings on a credit facility in 2005.
Income tax expense as a percentage of earnings before income taxes for 2006, 2005, and 2004 was 35.5%, 37.7%, and 36.6%, respectively. The fluctuation in income tax expense as a percentage of earnings before income taxes is attributable to our estimate of ultimate income tax liability, and changes in the characteristics of net earnings year to year, such as underwriting income versus investment income.
Revenues from specialty insurance were $410.2 million, $438.0 million, and $242.8 million in 2006, 2005 and 2004, respectively, and include revenues from the issuance of flood, home warranty and homeowners’ insurance policies. In our flood insurance business, we provide coverage under NFIP, the U.S. federal flood insurance program, and receive fees for assistance in settling claims. The decrease in revenues in 2006 as compared to 2005 was primarily the result of a decrease in revenues generated by the processing of flood claims due to the large volume of claims processed in 2005 related to three hurricanes, Katrina, Wilma, and Rita, partially offset by organic growth in our homeowners’ insurance business. The increase in revenues in 2005 as compared with 2004 was primarily the result of the significant revenues generated by the processing of flood claims relating to the 2005 hurricane season that were recorded in the fourth quarter of 2005 and organic growth of these business lines in 2005.
Other operating expenses in the specialty insurance segment were $144.7 million, $135.3 million, and $127.9 million in 2006, 2005 and 2004, respectively. The increases in 2006 and 2005 were due to an increase in premiums written in our homeowners’ insurance business.
The corporate and other segment is primarily comprised of the operations of our parent holding company and smaller entities not included in our operating subsidiaries. It generated $145.3 million in net income in 2005, largely due to the gain on sale of subsidiary securities in connection with the sale of a minority interest in FIS, offset by income tax and by minority interest expense related to the distribution of a minority interest in FNT.
Personnel costs were $1,357.4 million, $1,276.6 million, and $1,073.4 million in 2006, 2005 and 2004, respectively. As a percentage of revenues, personnel costs were 41.3%, 46.0%, and 45.8% in 2006, 2005 and 2004, respectively. The $80.8 million increase in 2006 was primarily due to the 2006 merger with Certegy and the inclusion of a $24.5 million expense relating to performance based options granted at FIS in March 2005 for which the performance criteria were met during the first quarter of 2006, partially offset by the exclusion of FIS from our results of operations after the closing of the SEDA. The $203.2 million increase in 2005 as compared to 2004 was primarily related to an increase of $179.3 million in our financial institution processing and mortgage loan processing businesses which resulted from a full year’s activity being included for our 2004 acquisitions in this area. Personnel costs relating to mortgage origination and default management services were relatively steady in 2005 and 2004, while there was an $18.7 million increase in our personnel costs relating to our information services businesses.
Depreciation and amortization expenses were $343.6 million, $299.6 million, and $238.4 million in 2006, 2005 and 2004, respectively. The increase in 2006 was primarily due to the merger with Certegy, and was partially offset by the exclusion of FIS from our results of operations after the closing of the SEDA. The increase in 2005 primarily relates to amortization of computer software and other intangible assets acquired over the past three year period.
Interest expense was $154.2 million, $126.8 million, and $4.5 million in 2006, 2005 and 2004, respectively. The increase in 2006 is primarily due to increased borrowings of $2.8 billion relating to the recapitalization transaction in March 2005 and $250 million relating to the merger with Certegy, partially offset by the exclusion of FIS from our results of operations after the closing of the SEDA. The increase in 2005 relates primarily to interest expense incurred on the $2.8 billion of borrowings relating to the recapitalization transaction in March of 2005.
Income tax expense as a percentage of earnings before income taxes for 2006, 2005, and 2004 was 37.0%. 37.2%, and 37.6%, respectively. Through March 9, 2005, FIS was included in FNF’s consolidated tax return, but on that date, it became a separate entity for tax purposes. The provision for income taxes is calculated as though FIS were a stand-alone taxpaying entity during the annual periods presented. The fluctuation in income tax expense as a percentage of earnings before income taxes is attributable to our estimate of ultimate income tax liability and changes in its components from year to year.
Cash Requirements. Our cash requirements include operating expenses, taxes, payments of interest and principal on our debt, capital expenditures, business acquisitions, and dividends on our common stock. We intend to pay an annual dividend of $1.20 per share on our common stock, payable quarterly, or an aggregate of approximately $265 million per year, although the declaration of any future dividends is at the discretion of our board of directors. We believe that all anticipated cash requirements for current operations will be met from internally generated funds, through cash dividends from subsidiaries, cash generated by investment securities and borrowings on existing credit facilities. Our short-term and long-term liquidity requirements are monitored regularly to ensure that we can meet our cash requirements. We forecast the needs of all of our subsidiaries and periodically review their short-term and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying these projections.
The New Credit Agreement contains affirmative, negative and financial covenants customary for financings of this type, including, among other things, limits on the creation of liens, sales of assets, the incurrence of indebtedness, restricted payments, transactions with affiliates, and certain amendments. The New Credit Agreement requires us to maintain certain financial ratios and levels of capitalization. The New Credit Agreement also includes customary events of default for facilities of this type (with customary grace periods, as applicable) and
In connection with the 2005 distribution of FNT stock by Old FNF, we issued two $250 million intercompany notes payable to Old FNF (the “Mirror Notes”), with terms that mirrored Old FNF’s existing $250 million 7.30% public debentures due in August 2011 and $250 million 5.25% public debentures due in March 2013. Following issuance of the Mirror Notes, we filed a Registration Statement on Form S-4, pursuant to which we offered to exchange the outstanding Old FNF notes for notes we would issue having substantially the same terms and deliver the Old FNF notes received to Old FNF to reduce our debt under the Mirror Notes. On January 17, 2006, the offers expired, with $241.3 million aggregate principal amount of the 7.30% notes due 2011 and the entire $250.0 million aggregate principal amount of the 5.25% notes due 2013 validly tendered and not withdrawn in the exchange offers. Following the completion of the exchange offers, we issued a new 7.30% Mirror Note due 2011 in the amount of $8.7 million, representing the principal amount of the portion of the original Mirror Notes that was not exchanged. On October 23, 2006, the remaining balance of these notes was redeemed and no balance remains at December 31, 2006. Interest on the Mirror Notes accrued from the last date on which interest on the corresponding FNF notes was paid and at the same rate.
During the second quarter of 2005, we began lending fixed maturity and equity securities to financial institutions in short-term security lending transactions. Our security lending policy requires that the cash received as collateral be 102% or more of the fair value of the loaned securities. These short-term security lending arrangements increase investment income with minimal risk. At December 31, 2006, we had security loans outstanding with a fair value of $316.0 million included in accounts payable and accrued liabilities and we held cash in the same amount as collateral for the loaned securities.
Seasonality. Historically, real estate transactions have produced seasonal revenue levels for title insurers. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. The third calendar quarter has been typically the strongest in terms of revenue primarily due to a higher volume of home sales in the summer months and the fourth calendar quarter is usually also strong due to commercial entities desiring to complete transactions by year-end. Significant changes in interest rates may alter these traditional seasonal patterns due to the effect the cost of financing has on the volume of real estate transactions.
As of December 31, 2006 we had title insurance reserves of $1,154.9 million. The amounts and timing of these obligations are estimated and are not set contractually. Nonetheless, based on historical title insurance claim experience, we anticipate the above payment patterns. While we believe that historical loss payments are a
reasonable source for projecting future claim payments, there is significant inherent uncertainty in this payment pattern estimate because of the potential impact of changes in:
Equity Investments. Our equity investments are in public companies whose security prices are subject to significant volatility. Should the fair value of these investments fall below our cost bases and/or the financial condition or prospects of these companies deteriorate, we may determine in a future period that this decline in fair value is other-than-temporary, requiring that an impairment loss be recognized in the period such a determination is made.
liabilities associated with the assets leased to us. This is because the assets leased by us will not exceed 50% of the total fair value of the lessor’s assets excluding any assets that should be excluded from such calculation under FIN 46, nor did the lessor finance 95% or more of the leased balance with non-recourse debt, target equity or similar funding.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (Topic 1N), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). This SAB addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, the SAB allows registrants to record that effect as a cumulative effect adjustment to beginning-of-year retained earnings. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. Management has analyzed the effects of SAB 108 and determined that there are no adjustments required to be made to the Company’s statements of financial condition or results of operations pursuant to SAB 108.
In our opinion, management’s assessment that Fidelity National Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Fidelity National Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related Consolidated Statements of Earnings, Comprehensive Earnings, Stockholders’ Equity and Cash Flows for each of the years in the three-year period ended December 31, 2006, and our report dated March 1, 2007 expressed an unqualified opinion on those consolidated financial statements.
Net of income tax expense (benefit) of $7.9 million, $11.1 million, and $17.8 million for 2006, 2005 and 2004, respectively.
Net of income tax benefit of $4.0 million, $(2.0) million, and $(6.9) million for 2006, 2005 and 2004, respectively.
The Company made a reclassification adjustment to the Consolidated Statements of Earnings, included within this Annual Report on Form 10-K, with regard to the presentation of interest and investment income and other operating expenses. This adjustment was necessary to properly reflect certain credits earned as a reduction of other operating expenses as opposed to an increase in investment income. The adjustment resulted in a reduction of interest and investment income of $14.4 million in 2005, and $0.2 million in 2004.
Fidelity National Financial, Inc. is a holding company that is a provider, through its subsidiaries, of title insurance, specialty insurance, and claims management services. FNF is one of the nation’s largest title insurance companies through its title insurance underwriters, with an approximately 29.0% national market share. FNF also provides flood insurance, personal lines insurance, and home warranty insurance through its specialty insurance subsidiaries. Since February 1, 2006, when FNF closed its acquisition of a 40% interest in Sedgwick CMS (“Sedgwick”), the Company is also now a leading provider of outsourced claims management services to large corporate and public sector entities.
Fidelity National Title Group, Inc. This segment consists of the operations of FNF’s title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - which together issued approximately 29.0% of all title insurance policies issued nationally during 2005. This segment provides core title insurance and escrow and other title related services including collection and trust activities, trustee’s sales guarantees, recordings and reconveyances. The Company’s principal title insurance subsidiaries consist of Fidelity National Title Insurance Company, Chicago Title Insurance Company, Chicago Title Insurance Company of Oregon, Ticor Title Insurance Company, Ticor Title Insurance Company of Florida, Security Union Title Insurance Company and Alamo Title Insurance. The Company’s principal underwritten title company subsidiaries, essentially wholly-owned title agencies, consist of Fidelity National Title Company, Fidelity National Title Company of California, Chicago Title Company and Ticor Title Company of California, formerly American Title Company.
Other long-term investments consist primarily of equity investments accounted for under the equity method of accounting.
Capitalized software includes software acquired in business acquisitions, purchased software and internally developed capitalized software. Purchased software is recorded at cost and amortized using the straight-line method over a 3-year period and software acquired in a business acquisition is recorded at its fair value upon acquisition and amortized using straight-line and accelerated methods over its estimated useful life, generally 5 to 10 years. Capitalized computer software development costs are accounted for in accordance with either SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (“SFAS No. 86”), or with American Institute of Certified Public Accountants’ Statement of Position (“SOP”) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). After the technological feasibility of the software has been established (for SFAS No. 86 software), or at the beginning of application development (for SOP No. 98-1 software), software development costs, which include salaries and related payroll costs and costs of independent contractors incurred during development, are capitalized. Research and development costs incurred prior to the establishment of technological feasibility (for SFAS No. 86 software), or prior to application development (for SOP No. 98-1 software), of a product are expensed as incurred and are not significant. The cost of internally developed computer software that is subject to the provisions of SFAS 86 is amortized on a product-by-product basis commencing on the date of general release of the products, generally the greater of (1) the straight-line method over its estimated useful life, which ranges from three to ten years or (2) the ratio of current revenues to total anticipated revenue over its useful life. The cost of purchased software that is subject to the provisions of SOP No. 98-1 is amortized on a straight-line basis over its estimated useful life.
The Company has other intangible assets, not including software, which consist primarily of customer relationships and contracts and trademarks which are generally recorded in connection with acquisitions at their fair value. SFAS No. 142 requires that intangible assets with estimable lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 144. Customer relationships are amortized over their estimated useful lives using an accelerated method which takes into consideration expected customer attrition rates over a ten-year period. Contractual relationships are generally amortized over their contractual life. Trademarks are considered intangible assets with indefinite lives and are reviewed for impairment at least annually in accordance with SFAS No. 142.
In the event that the Company’s arrangements with its customers include more than one product or service, the Company determines whether the individual elements can be recognized separately in accordance with the provisions of EITF No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 addresses the determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the arrangement consideration should be measured and allocated to the separate units of accounting. If all of the products and services are software related products and services as determined under the provisions of SOP 97-2 (“SOP No. 97-2”), entitled Software Revenue Recognition, and SOP 98-9, entitled
Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions, the Company applies these pronouncements and related interpretations to determine the appropriate units of accounting and how the arrangement consideration should be measured and allocated to the separate units of accounting.
The Company recognizes software license and maintenance fees as well as associated development, implementation, training, conversion and programming fees in accordance with SOP No. 97-2 and SOP No. 98-9. Initial license fees are recognized when a contract exists, the fee is fixed or determinable, software delivery has occurred and collection of the receivable is deemed probable, provided that vendor-specific objective evidence, or VSOE, has been established for each element or for the undelivered elements. The Company determines the fair value of each element or the undelivered elements in multi-element software arrangements based on VSOE. If the arrangement is subject to accounting under SOP No. 97-2, VSOE for each element is based on the price charged when the same element is sold separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of fair value does not exist for one or more undelivered elements of a contract, then all revenue is deferred until all elements are delivered or fair value is determined for all remaining undelivered elements. Revenue from maintenance and support is recognized ratably over the term of the agreement. The Company records deferred revenue for maintenance amounts invoiced prior to revenue recognition.
With respect to a small percentage of revenues, the Company uses contract accounting, as required by SOP No. 97-2, when the arrangement with the customer includes significant customization, modification, or production of software. For elements accounted for under contract accounting, revenue is recognized in accordance with SOP 81-1, Accounting for Performance of Construction Type and Certain Production-Type Contracts, using the percentage-of-completion method since reasonably dependable estimates of revenues and contract hours applicable to various elements of a contract can be made. Revenues in excess of billings on these agreements are recorded as unbilled receivables and are included in accounts receivable. Billings in excess of revenue recognized on these agreements are recorded as deferred revenue until revenue recognition criteria are met. Changes in estimates for revenues, costs and profits are recognized in the period in which they are determinable. When the Company’s estimate indicates that the entire contract will be performed at a loss, a provision for the entire loss is recorded in that accounting period.
Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net earnings available to common stockholders plus the impact of assumed conversions of dilutive potential securities. The Company has granted certain options, warrants and restricted stock which have been treated as common share equivalents for purposes of calculating diluted earnings per share.
An FIS subsidiary acts as the title agent in the issuance of title insurance policies by a title insurance underwriter owned by us and in connection with certain trustee sales guarantees, a form of title insurance issued as part of the foreclosure process. As a result, FNF’s title insurance subsidiaries pay commissions on title insurance policies sold through FIS. For the period from October 24 through December 31, 2006, these FIS operations generated $22.4 million of revenues for FNF, which the Company recorded as agency title premiums and FNF paid FIS commissions at the rate of 88% of premiums generated, equal to $19.5 million.
From October 24 through December 31, 2006, FNF’s expenses included $17.6 million paid to a subsidiary of FIS for the provision by FIS to us of IT infrastructure support, data center management and related IT support services and $3.1 million in software expenses relating to an agreement with a subsidiary of FIS.
The title plant assets of several of FNF’s title insurance subsidiaries are managed or maintained by a subsidiary of FIS. The underlying title plant information and software continues to be owned by each of FNF’s title insurance underwriters, but FIS manages and updates the information in return for either (i) a management fee or (ii) the right to sell that information to title insurers, including title insurance underwriters that FNF owns and other third party customers. In most cases, FIS is responsible for keeping the title plant assets current and fully functioning, for which FNF pays a fee to FIS based on its use of, or access to, the title plant. From October 24 through December 31, 2006, FNF’s expenses to FIS under these arrangements were $5.5 million. In addition, each of FNF’s applicable title insurance underwriters in turn receives a royalty on sales of access to its title plant assets. From October 24 through December 31, 2006, FNF’s revenues included title plant royalties of $0.4 million. FNF has entered into agreements with FIS that permit FIS and certain of its subsidiaries to access and use (but not to re-sell) the starters databases and back plant databases of FNF’s title insurance subsidiaries. Starters databases are FNF’s databases of previously issued title policies and back plant databases contain historical records relating to title that are not regularly updated. Each of FNF’s applicable title insurance subsidiaries receives a fee for any access to or use of its starters and back plant databases by FIS. FNF also does business with additional entities within FIS that provide real estate
FNF’s expenses from October 24 through December 31, 2006 included expenses for a lease of office space to FNF for its corporate headquarters and business operations in the amount of $1.8 million and were reduced by $0.1 million for the lease of an aircraft to FIS.
The Company believes the amounts earned by it or charged to it under each of the foregoing arrangements are fair and reasonable. Although the commission rate paid on the title insurance premiums written by the FIS title agencies was set without negotiation, the Company believes the commissions earned are consistent with the average rate that would be available to a third party title agent given the amount and the geographic distribution of the business produced and the low risk of loss profile of the business placed. In connection with the title plant management and maintenance services provided by FIS, the Company believes that the fees charged to it by FIS are at approximately the same rates that FIS and other similar vendors charge unaffiliated title insurers. The IT infrastructure support and data center management services provided to the Company by FIS are priced within the range of prices that FIS offers to its unaffiliated third party customers for the same types of services. However, the amounts the Company earned or were charged under these arrangements were not negotiated at arm’s length, and may not represent the terms that might have been obtained from an unrelated third party.
FIS accounts for derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), as amended. FIS engaged in hedging activities relating to its variable rate debt through the use of interest rate swaps. FIS designated these interest rate swaps as cash flow hedges. The estimated fair value of the cash flow hedges were recorded as an asset or liability and, prior to October 24, 2006, were included in the Consolidated Balance Sheets in prepaid expenses and other assets or accounts payable and accrued liabilities and as a component of accumulated other comprehensive earnings, net of deferred taxes. The amount included in accumulated other comprehensive earnings was reclassified into interest expense as a yield adjustment as interest expense on the debt was recognized. FIS’s cash flow hedges were highly effective and there was no impact on earnings due to hedge ineffectiveness. It was the policy of FIS to execute such instruments with credit-worthy banks and not to enter into derivative financial instruments for speculative purposes.
From September 2004 through October 2006, FIS also owned warrants to purchase additional shares relating to its investment in Covansys Corporation (“Covansys”). From September 2004 until March 25, 2005, FIS accounted for the warrants under SFAS No. 133 as the warrants were considered derivative instruments. At the date of the Covansys acquisition, the warrants were recorded at fair value aggregating $23.5 million. During the first quarter of 2005, FIS recorded a loss of $4.4 million on the decrease in fair value of the warrants through March 25, 2005 which was reflected in the Consolidated Statements of Earnings in realized gains and losses. On March 25, 2005, the terms of the warrants were amended such that the accounting for the investment in the warrants was then governed by the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and changes in the fair value of the warrants were recorded in other comprehensive earnings. During 2004, FIS did not engage in any hedging activities and thus recorded all derivative financial instruments at fair value in the Consolidated Balance Sheets and all changes in fair value were recognized in realized gains and losses in the Consolidated Statements of Earnings. During 2004, FIS’s derivative financial instruments were limited to the investment in warrants to purchase common stock of Covansys and certain put and call options relating to the minority interest in certain majority-owned subsidiaries.
The functional currency for the foreign operations of the Company is either the U.S. Dollar or the local currency. For foreign operations where the local currency is the functional currency, the translation of foreign currencies into U.S. Dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The unrealized gains and losses resulting from the translation are included in accumulated other comprehensive earnings in the Consolidated Statements of Stockholders’ Equity and are excluded from net earnings. Gains or losses resulting from foreign currency transactions are included in realized gains and losses and are insignificant in 2006, 2005 and 2004.
Certain reclassifications have been made in the 2005 and 2004 Consolidated Financial Statements to conform to the classifications used in 2006.
The results of operations and financial position of the entities acquired during any year are included in the Consolidated Financial Statements from and after the date of acquisition. Based on the Company’s valuation, any differences between the fair value of the identifiable assets and liabilities and the purchase price paid are recorded as goodwill. There were no significant acquisitions in 2006 except for the acquisition of Certegy Inc. (“Certegy”) by FIS. (See “FIS Acquisitions” below.) All significant acquisitions in 2005 and 2004 were attributable to FIS and are no longer included in our Consolidated Financial Statements after the closing of the SEDA.
On March 22, 2004, the Company acquired American Pioneer Title Insurance Company (“APTIC”) for $115.2 million in cash. APTIC is a 45-state licensed title insurance underwriter with significant agency operations and computerized title plant assets in Florida. APTIC was subsequently renamed Ticor Title Insurance Company of Florida and operates under the Company’s Ticor Title brand.
Generally accepted accounting principles in the U.S. require that one of the two companies in the transaction be designated as the acquirer for accounting purposes. FIS was designated as the accounting acquirer because immediately after the merger its shareholders held more than 50% of the common stock of the combined company. As a result, the merger was accounted for as a reverse acquisition under the purchase method of accounting. Under this accounting treatment, FIS was considered the acquiring entity and Certegy was considered the acquired entity for financial reporting purposes.
On September 30, 2004, the Company acquired a 74.9% interest in KORDOBA Gesellschaft fur Bankensoftware mbH & Co. KG, Munich (“Kordoba”), a provider of core processing software and outsourcing solutions to the German banking market, from Siemens Business Services GmbH & Co. OHG. The acquisition price was $123.6 million in cash. The Company recorded the Kordoba acquisition based on its proportional share of the fair value of the assets acquired and liabilities assumed on the purchase date. On September 30, 2005, the Company purchased the remaining 25.1% of Kordoba that it did not already own for $39.7 million.
The assets acquired and liabilities assumed in the Kordoba acquisition were as follows (dollars in thousands):
The change in unrealized gains (losses) on fixed maturities for the years ended December 31, 2006, 2005, and 2004 was $16.5 million, $(44.4) million, and $(27.1) million, respectively.
The following table presents certain information regarding contractual maturities of the Company’s fixed maturity securities at December 31, 2006:
During the second quarter of 2005, the Company began lending fixed maturity and equity securities to financial institutions in short-term security lending transactions. The Company’s security lending policy requires that the cash received as collateral be 102% or more of the fair value of the loaned securities. These short-term security lending arrangements increase investment income with minimal risk. At December 31, 2006 and 2005, the Company had short-term security loans outstanding with values of $305.3 million and $138.7 million, respectively,
During the years ended December 31, 2006, 2005 and 2004, gross realized gains on sales of fixed maturity securities considered available for sale were $1.2 million, $4.9 million, and $8.9 million, respectively; gross realized losses were $1.2 million, $1.4 million, and $0.2 million, respectively. Gross proceeds from the sale of fixed maturity securities considered available for sale amounted to $2,476.9 million, $2,539.3 million, and $2,305.8 million during the years ended December 31, 2006, 2005 and 2004, respectively.
A substantial portion of the Company’s unrealized losses greater than twelve months relate to its holdings of debt securities. Unrealized losses relating to U.S. government, state and political subdivision and fixed maturity corporate holdings were primarily caused by interest rate increases. Since the decline in fair value of these investments is attributable to changes in interest rates and not credit quality, and the Company has the intent and ability to hold these securities, the Company does not consider these investments other-than-temporarily impaired. The unrealized losses relating to equity securities were caused by market changes that the Company considers to be temporary. During 2006 and 2005, the Company incurred impairment charges relating to investments that it determined to be other than temporarily impaired, which resulted in charges of $9.1 million and $8.3 million, respectively.
Property and equipment at December 31, 2006 does not include any property and equipment of FIS. Property and equipment at December 31, 2005 includes property and equipment of FIS of $215.0 million, net of accumulated depreciation, which is made up of $9.2 million of land, $99.2 million of buildings, $36.4 million of leasehold improvements, $278.1 million of furniture, fixtures, and equipment, and $(207.8) million in accumulated depreciation. See “Old FNF Asset Contribution and Stock Distribution” in Note A.
Accounts payable and accrued liabilities at December 31, 2006 does not include any accounts payable and accrued liabilities of FIS. Accounts payable and accrued liabilities at December 31, 2005 includes accounts payable and other liabilities of FIS of $371.4 million, made up of $117.4 million of salaries and incentives, $46.5 million of accrued benefits, $43.6 million of trade accounts payable, and $163.9 million in other accrued liabilities. See “Old FNF Asset Contribution and Stock Distribution” in Note A.
The New Credit Agreement contains affirmative, negative and financial covenants customary for financings of this type, including, among other things, limits on the creation of liens, sales of assets, the incurrence of indebtedness, restricted payments, transactions with affiliates, and certain amendments. The New Credit Agreement requires the Company to maintain certain financial ratios and levels of capitalization. The New Credit Agreement also includes customary events of default for facilities of this type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default, the interest rate on all outstanding obligations will be increased and payments of all outstanding loans may be accelerated and/or the lenders’ commitments may be terminated. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the New Credit Agreement shall automatically become immediately due and payable, and the lenders’ commitments will automatically terminate.
On January 17, 2006, $241.3 million aggregate principal amount of the Old FNF 7.30% notes due 2011 and the entire $250.0 million aggregate principal amount of the Old FNF 5.25% notes due 2013 were validly exchanged for FNF notes. The remaining principal amount of $8.7 million of the Old FNF 7.30% notes has been validly redeemed and cancelled.
Management believes that based on its historical pattern of taxable income, the Company will produce sufficient income in the future to realize its deferred tax assets. The net deferred tax liability at December 31, 2005 includes a net liability of $72.7 million attributable to the operations of FIS.
In 2006, the Company transferred $8.5 million in reserves to FIS in connection with the distribution of FIS. The Company assumed the outstanding reserve for claim losses of Service Link and APTIC in connection with their acquisitions in 2005 and 2004, respectively.
A class action in Texas alleges that the Company overcharged for recording fees in Arizona, California, Colorado, Oklahoma and Texas. The suit seeks to recover the recording fees for the class that was overcharged, interest and attorney’s fees. The suit was filed in the United States District Court for the Western District of Texas, San Antonio Division on March 24, 2006. Similar suits are pending in Indiana, Kansas, and Missouri. The Company intends to vigorously defend these actions.
A class action in New Mexico alleges the Company has engaged in anti-competitive price fixing in New Mexico. The suit seeks an injunction against price fixing and writs issued to the State regulators mandating the law be interpreted to provide a competitive market, compensatory damages, punitive damages, statutory damages, interest and attorney’s fees for the injured class. The suit was filed in State Court in Santa Fe, New Mexico on April 27, 2006. The Company intends to vigorously defend this action.
Two class actions filed in Illinois allege the Company has paid attorneys to refer business to the Company by paying them for core title services in conjunction with orders when the attorneys, in fact, did not perform any core title services and the payments were to steer business to the Company. The suits seek compensatory damages, attorney’s fees and injunctive relief to terminate the practice. The suit was filed in state court in Chicago, Illinois on May 11, 2006. The Company intends to vigorously defend these actions.
Two class actions, one in Michigan and one in Ohio, allege the Company has violated RESPA by engaging in affiliated business arrangements in violation of RESPA. The suits seek to recover three times the title charges, interest and attorney’s fees. The Company intends to vigorously defend these actions.
A class action in Washington alleges that the Company has violated state law by making prohibited payments for the referral of business, thereby increasing the cost of title insurance to consumers. The suit seeks compensatory damages, and attorney’s fees. The Company intends to vigorously defend this action.
In 2006, the Company and its subsidiaries settled all allegations of wrongdoing arising from a wide-ranging review of the title insurance industry by the New York State Attorney General (the “NYAG”). Under the terms of the settlement, the Company paid a $2 million fine and were required to reduce premiums by 15% on owner’s policies under $1 million. Rate hearings will be conducted by the New York State Insurance Department (the “NYSID”) in 2007 where all rates will be considered industry-wide. The settlement clarifies practices considered wrongful under New York law by the NYAG and the NYSID, and the Company has agreed not to engage in those practices. The Company will take steps to assure that consumers are aware of the filed rates for premiums on title insurance products and that the products are correctly rated. The settlement also resolves all issues raised by the market conduct investigation of the Company and its subsidiaries by the NYSID except the issues of rating errors found by the NYSID. As part of the settlement, the Company and its subsidiaries denied any wrongdoing. Neither the fines nor the 15% rate reduction are expected to have a material impact on the Company’s earnings. The Company cooperated fully with the NYAG and NYSID inquiries into these matters and will continue to cooperate with the NYSID.
Further, in 2006, U.S. Representative Oxley, the Chairman of the House Financial Services Committee, asked the Government Accountability Office (the GAO) to investigate the title insurance industry. Representative Oxley stated that the Committee is concerned about payments that certain title insurers have made to developers, lenders and real estate agents for referrals of title insurance business. Representative Oxley asked the GAO to examine, among other things, the foregoing relationships and the levels of pricing and competition in the title insurance industry. A congressional hearing was held regarding title insurance practices on April 27, 2006. The GAO’s report is expected in the spring of 2007. The Company is unable to predict the outcome of this inquiry or whether it will adversely affect its business or results of operations.
In addition, the Florida Office of Insurance Regulation (the “OIR”) has recently released three studies of the title insurance industry which purport to demonstrate that title insurance rates in Florida are too high and that the Florida title insurance industry is overwhelmingly dominated by five firms, which includes us. The studies recommend tying premium rates to loss ratios thereby making the rates a reflection of the actual risks born by the insurer. The OIR is presently developing a rule to establish and govern the annual collection of statistical data and has said that it will use the information gathered to begin a full review of the title insurance rates charged in Florida.
As a condition to the 2006 Distribution, Old FNF received a ruling from the Internal Revenue Service and an opinion from a nationally recognized accounting firm, together to the effect that the 2006 Distribution would be tax free for both Old FNF and the stockholders of Old FNF under Section 355 and related provisions of the Internal Revenue Code. Although a private letter ruling from the Internal Revenue Service generally is binding on the Internal Revenue Service, if the factual representations or assumptions made in the letter ruling are untrue or incomplete in any respect, then the ruling may not be relied upon. The accounting firm’s opinion is based on, among other things, certain assumptions and representations as to factual matters made by Old FNF and FNT, which, if incorrect or inaccurate in any respect, could prevent those opinions from being relied upon. The opinion is not binding on the Internal Revenue Service or the courts, and the Internal Revenue Service or the courts may not agree with the opinion.
Rent expense incurred under operating leases during the years ended December 31, 2006, 2005 and 2004, was $224.4 million, $208.3 million, and $197.3 million, respectively.
On June 29, 2004, Old FNF entered into an off-balance sheet financing arrangement (commonly referred to as a “synthetic lease”). The owner/lessor in this arrangement acquired land and various real property improvements associated with new construction of an office building in Jacksonville, Florida, that are part of FNF’s corporate campus and headquarters. The lease expires on June 28, 2011, with renewal subject to consent of the lessor and the lenders. The lessor is a third-party limited liability company. The synthetic lease facility provides for amounts up to $75.0 million. As of December 31, 2006, the full $75.0 million had been drawn on the facility to finance land costs and related fees and expenses. The leases include guarantees by us of up to 86.7% of the outstanding lease balance, and options to purchase the facilities at the outstanding lease balance. The guarantee becomes effective if the Company declines to purchase the facilities at the end of the lease and also declines to renew the lease. The lessor financed the acquisition of the facilities through funding provided by third-party financial institutions. The Company has no affiliation or relationship with the lessor or any of its employees, directors or affiliates, and transactions with the lessor are limited to the operating lease agreements and the associated rent expense that have
been included in other operating expenses in the Consolidated Statements of Earnings after the end of the construction period.
The Company’s insurance subsidiaries, including title insurers, property and casualty insurers, underwritten title companies and insurance agencies, are subject to extensive regulation under applicable state laws. Each of the insurance underwriters is subject to a holding company act in its state of domicile which regulates, among other matters, the ability to pay dividends and enter into transactions with affiliates. The laws of most states in which the Company transacts business establish supervisory agencies with broad administrative powers relating to issuing and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, accounting practices, financial practices, establishing reserve and capital and surplus as regards policyholders (“capital and surplus”) requirements, defining suitable investments for reserves and capital and surplus and approving rate schedules.
Since we are governed by both state and federal governments and the applicable insurance laws and regulations are constantly subject to change, it is not possible to predict the potential effects on our insurance operations, particularly our Fidelity National Title Group segment, of any laws or regulations that may become more restrictive in the future or if new restrictive laws will be enacted. See Note K for a description of certain recent regulatory developments in California and other states.
Pursuant to statutory accounting requirements of the various states in which the Company’s insurers are domiciled, these insurers must defer a portion of premiums earned as an unearned premium reserve for the protection of policyholders and must maintain qualified assets in an amount equal to the statutory requirements. The level of unearned premium reserve required to be maintained at any time is determined by statutory formula based upon either the age, number of policies and dollar amount of policy liabilities underwritten, or the age and dollar amount of statutory premiums written. As of December 31, 2006, the combined statutory unearned premium reserve required and reported for the Company’s title insurers was $1,398.3 million. In addition to statutory unearned premium reserves, each of our insurers maintains surplus funds for policyholder protection and business operations.
Each of the Company’s insurance subsidiaries is regulated by the insurance regulatory authority in its respective state of domicile, as well as that of each state in which it is licensed. The insurance commissioners of their respective states of domicile are the primary regulators of the Company’s title insurance subsidiaries. Each of the insurers is subject to periodic regulatory financial examination by regulatory authorities, and certain of these examinations are currently ongoing.
The Company’s insurance subsidiaries are subject to regulations that restrict their ability to pay dividends or make other distributions of cash or property to their immediate parent company without prior approval from the Department of Insurance of their respective states of domicile. As of December 31, 2006, $1,995.5 million of the Company’s net assets are restricted from dividend payments without prior approval from the Departments of Insurance. During 2007, the Company’s title insurers can pay or make distributions to the Company of approximately $264.8 million, without prior approval.
The combined statutory capital and surplus of the Company’s title insurers was $860.3 million and $852.2 million as of December 31, 2006 and 2005, respectively. The combined statutory net earnings of the Company’s title insurance subsidiaries were $413.8 million and $400.4 million for the years ended December 31, 2006 and 2005, respectively.
The Company’s underwritten title companies are also subject to certain regulation by insurance regulatory or banking authorities, primarily relating to minimum net worth. Minimum net worth of $7.5 million, $2.5 million, $3.0 million and $0.4 million is required for Fidelity National Title Company, Fidelity National Title Company of California, Chicago Title Company and Ticor Title Company of California, respectively. All of the Company’s underwritten title companies are in compliance with all of their respective minimum net worth requirements at December 31, 2006.
In connection with the 2005 distribution of FNT stock by Old FNF, the Company established the FNT 2005 Omnibus Incentive Plan (the “Omnibus Plan”) authorizing the issuance of up to 8 million shares of common stock,
On October 24, 2006, as part of the closing of the SEDA and spin-off from Old FNF, the Company granted options and restricted stock to replace Old FNF options and Old FNF restricted stock to its employees. The Company issued approximately 10.0 million options with a weighted average strike price of $10.47 per share to replace 5.0 million outstanding Old FNF options granted out of the historical FNF plans in an intrinsic value swap. The Company also issued approximately 0.7 million shares of restricted stock to employees as part of the distribution and to replace Old FNF restricted stock. During 2006, at the closing of the SEDA the Company also granted 790,000 shares of restricted stock to certain executive officers and the board of directors. Subsequent to the closing of the SEDA, the Company also granted 754,500 shares of restricted stock to other officers and employees and 2,116,500 options to other officers and employees.
A detail of Old FNF option activity from December 31, 2003 through the closing of the SEDA transaction on October 24, 2006 is as follows:
Upon payment of the $10.00 special dividend in the first quarter of 2005 and the FNT distribution in the fourth quarter of 2005, the Company’s outstanding stock options were equitably adjusted to take into account the payment of the $10.00 special dividend and $4.06 adjustment relating to the FNT distribution in respect of each share of the Company’s common stock. The purpose of the adjustment was to keep the intrinsic value of the options after the dividend the same as the intrinsic value of the options before the dividend, which was accomplished by dividing the exercise price of each option, and multiplying the number of shares subject to each option, by a ratio obtained by dividing the market price of a share of common stock before giving effect to the dividend by the market price after giving effect to the dividend.
Restricted stock transactions under the Omnibus Plan in 2006 were as follows:
During the first quarter of 2006, the Company began accounting for stock based compensation under the provisions of SFAS No. 123R issued in December 2004 under the modified prospective method. Previous to this adoption, the Company had adopted the fair value recognition provisions of SFAS No. 123, for stock-based
employee compensation in 2003. Under the fair value method of accounting, compensation cost is measured based on the fair value of the award at the grant date and recognized over the service period. In 2003, the Company elected to use the prospective method of transition, as permitted by Statement of Financial Accounting Standards No. 148, “Accounting for Stock- Based Compensation - Transition and Disclosure” (“SFAS No. 148”). Under the fair value method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. Prior year financial statements were not restated. The adoption of SFAS 123R using the modified prospective method did not have a material impact on the Company’s financial position or results of operations for 2006 as all options that were previously accounted for under the intrinsic value method were fully vested as of December 31, 2005. During 2006, 2005 and 2004, the Company recorded stock-based compensation expense of $65.0 million, $34.1 million and $21.5 million, respectively, in connection with grants of restricted stock and stock options which is included in personnel costs in the reported financial results. During the third quarter of 2006 the compensation committee approved the immediate vesting of stock options and restricted stock shares previously granted to a director who retired from the board of directors in the third quarter. Stock based compensation expense for 2006 includes a $0.3 million charge for this acceleration of vesting. Also in 2006, stock based compensation expense included $24.5 million in expense relating to performance based options at FIS for which the performance and market based criteria were met during the first quarter.
Pro forma information regarding net earnings and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for all of its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions:
For purposes of pro forma disclosures, the estimated fair value of the options is amortized into expense over the options’ vesting period. For the year ended December 31, 2006, there was no difference between net earnings as reported and pro forma net earnings as calculated pursuant to SFAS 123 because, as of January 1, 2006, all stock-based compensation awards that were granted prior to our adoption of SFAS 123 were fully vested. The following
table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to all outstanding and unvested awards in 2005 and 2004:
At December 31, 2006, the total unrecognized compensation cost related to non-vested stock option grants and restricted stock grants was $74.6 million, which is expected to be recognized in pre-tax income over a weighted average period of 1.9 years.
Under Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions” (“SFAS No. 87”), the measurement date shall be as of the date of the financial statements, or if used consistently from year to year, as of a date not more than three months prior to that date. The Company’s measurement date is December 31.
The components of net periodic expense included in the results of operations for 2006, 2005 and 2004 are as follows:
The components of amounts recognized in other comprehensive income, showing separately the net transition asset or obligation, the net gain or loss and the net prior service cost or credit, are as shown below, on both a before tax and net of tax basis.
The Company’s funding policy is to contribute annually at least the minimum required contribution under the Employee Retirement Income Security Act (ERISA). Contributions are intended to provide not only for benefits accrued to date, but also for those expected to be earned in the future. In 2006 and 2005, the Company made contributions of $12.1 million and $24.3 million, respectively. The Company is not required to make a contribution to the pension plan in 2007. The Company intends to contribute amounts sufficient to avoid payment of the PBGC variable premium in 2007.
The accrued cost of the accumulated postretirement benefit obligation included in the Company’s Consolidated Balance Sheets at December 31, 2006, 2005 and 2004 is as follows:
Pursuant to the required implementation of SFAS 158 for this fiscal year end, the liability recorded on the Company’s balance sheet at December 31, 2006 is equal to the funded status. Adoption SFAS 158 resulted in a $5.8 million increase accounts payable and accrued liabilities and $3.6 million in other accumulated comprehensive loss.
The Company’s postretirement health care and life insurance costs included in the results of operations for 2006, 2005 and 2004 are as follows:
As of and for the year ended December 31, 2006 (dollars in thousands):
As of and for the year ended December 31, 2004 (dollars in thousands):
This segment consists of the operation of FNF’s title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - which together issued approximately 29.0% of all title insurance policies issued nationally during 2005. This segment provides core title insurance and escrow and other title related services including collection and trust activities, trustee’s sales guarantees, recordings and reconveyances.
This segment, consisting of FNF’s various non-title insurance subsidiaries, issues flood, home warranty, homeowners, automobile, and certain niche person lines insurance policies.
Through October 24, 2006, this segment consisted of the operations of Old FNF’s majority owned subsidiary, FIS, which provided transaction processing services, consisting principally of technology solutions for banks and other financial institutions, credit and debit card services and check risk management and related services for retailers and others. FIS also provided lender processing services, consisting principally of technology solutions for mortgage lenders, selected mortgage origination services such as title agency and closing services, default management and mortgage information services. FIS’s credit and debit card services and check risk management services were added through its merger with Certegy, which closed on February 1, 2006. As a result of that merger, for periods prior to February 1, 2006, these businesses are not included in the financial information in this report. Included in this segment for the years ended December 31, 2005 and 2004 is $9.3 million and $6.3 million, respectively, of pre-tax expenses relating to asset impairment charges pursuant to SFAS No. 144.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (Topic 1N), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). This SAB addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, the SAB allows registrants to record that effect as a cumulative effect adjustment to beginning-of-year retained earnings. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006. Management has analyzed the effects of SAB 108 and determined that there are no adjustments required to be made to the Company’s statements of financial condition or results of operations pursuant to SAB 108.