has numerous other leases for its branch offices and subsidiaries throughout the states in which it operates. In addition, it owns several properties which in aggregate are not material to its business taken as a whole.
On February 25, 1993 the Company's Board of Directors declared a three-for-two split of its common stock to all shareholders of record on April 15, 1993. Accordingly, all common share, per common share and stock option data have been restated to reflect the stock split.
Overview -Lawyers Title Corporation reported improved earnings in 1996 compared to 1995 which had been a significant improvement over 1994. The Company's primary business is the insurance of titles to real property which is greatly influenced by the real estate economy. Underlying economic factors adversely affected 1994 results due to upward pressures on mortgage loan interest rates as the Federal Reserve responded to inflationary fears. Mortgage interest rates averaged 7.8% in 1996, 8.0% in 1995 and 8.4% in 1994. Housing starts were 1.5 million, 1.35 million and 1.4 million in 1996, 1995 and 1994, respectively. Resales of existing homes were at 4.1 million, 3.8 million and 4.0 million in 1996, 1995 and 1994, respectively.
Premiums and related fees are determined both by competition and by state regulation. Operating revenues from direct title operations are recognized at the time real estate transactions close, which is generally 60 to 90 days after the opening of a title order. Operating revenues from agents are recognized when the issuance of a policy is reported to the Company by an agent. Although agents generally report the issuance of policies on a monthly basis, heightened levels of real estate activity may slow this reporting process. This typically results in delays of 30 to 60 days from the closing of real estate transactions until the recognition of revenues from agents.
The Company's principal variable expense is commissions paid to independent agents. The Company regularly reviews the profitability of its agency revenues; contracting in unprofitable markets and expanding where acceptable levels of profitability are available. The Company continually monitors its operating margin, which is the percentage of operating revenues less salaries and employee benefits, agency commissions and other expenses to operating revenues.
Claims - Generally, title insurance claim rates are lower than for other types of insurance because title insurance policies insure against prior events affecting the quality of real estate titles, rather than against unforeseen, and therefore less predictable, future events. A provision is made for estimated future claim payments at the time revenue is recognized. Both the Company's experience and industry data indicate that claims activity continues through 20 years after the policy is issued. Management uses actuarial techniques to estimate future claims by analyzing past claim payment patterns. Management has continued to emphasize and strengthen claims prevention and product quality programs.
In the fourth quarter of 1996 the Company made a change from reporting policy and contract claims on a discounted to an undiscounted basis. This change was made to conform with industry practice and because it is considered preferable by rating agencies and investment analysts. The effect of the change for 1996 was to increase the provision for policy and contract claims by $76 million and decrease net income by $49 million and net income per share by $5.51.
Seasonality - Historically, real estate activity has been generally slower in the winter months with volumes showing significant improvements in the spring and summer months. The percentage of title orders closed to title orders opened
Comparison of Years Ended December 31, 1996, December 31, 1995 and December 31, 1994
Operating Revenues - Revenues from operations improved 19.3% to $557.8 million in 1996 compared to $467.4 million in 1995. This 1995 level was a 4.0% reduction from the 1994 amount.
The volume of orders for title insurance opened in Company offices increased 14.2% in 1996 compared to 1995 after improving 16.2% between 1994 and 1995. Exclusive of recent acquisitions, orders in 1995 would have fallen 9.9% compared to 1994.
Expenses - Salaries and Employee Benefits: Personnel related expenses are a significant portion of total operating expenses in the title insurance industry. These expenses require management through the often rapidly changing conditions in the real estate economy. Salaries and employee benefits increased 18.2% in 1996 compared to 1995. This increase was largely tied to higher business volumes which necessitated increased staffing levels to meet customer service demands, incentive increases and normal merit raises. Salaries and employee benefits increased 8.4% in 1995 over 1994. In the fourth quarter of 1994, in response to a severe fall in order counts, a special staff and salary reduction program was implemented that lasted through the second quarter of 1995. As an offset to these reductions, staffing levels increased between 1994 and 1995 due to
the Company's acquisition program. Operating revenue net of agents' commissions improved on a per employee basis in both 1996 and 1995 compared to the prior year.
Income Taxes - The Company pays U.S. federal and state income taxes based on laws in the jurisdictions in which it operates. The effective tax rates reflected in the income statement for 1996, 1995 and 1994 differ from the U.S. federal statutory rate principally due to non-taxable interest, dividend deductions, travel and entertainment and company-owned life insurance.
At December 31, 1996 the Company had recorded deferred tax assets of $32.2 million related primarily to policy and contract claims and employee benefit plans. Substantially all of this deferred tax asset balance could be realized in the future through the reversal of existing temporary taxable differences. Accordingly, it is more likely than not that the income tax benefits will be realized for all the temporary deductible differences existing at December 31, 1996.
Net Income - Net income was $36.5 million in 1996, $17.1 million in 1995 and $6.8 million in 1994. Earnings per share were $4.11, $1.92 and $0.80 in 1996, 1995 and 1994, respectively. The increase in 1996 over 1995 was due to favorable results from operations and capital gains attributable to a shift in the Company's investment portfolio discussed under Investment Income.
Liquidity and Capital Resources - Cash provided by operating activities was $33.2 million for 1996, $22.0 million for 1995 and $6.4 million for 1994. The Company believes that it can meet both its short- and long-term capital needs. In addition to $95.6 million of cash and invested cash on hand at December 31, 1996, the Company has no long-term debt and maintains a $35.0 million working capital line of credit of which $34.0 million was unused at December 31, 1996.
Forward-Looking and Cautionary Statements - The Company and its representatives may from time to time make written or oral forward- looking statements, including statements contained in the Company's filings with the Securities and Exchange Commission and in its reports to shareholders. In connection with the "safe harbor" provision of the Private Securities Litigation Reform Act of 1995, the Company is hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statements made by or on behalf of the Company; any such statement is qualified by reference to the following cautionary statements.
The title insurance business is characterized by low profit margins due to the high cost of producing title evidence whereas premium revenues are subject to regulatory and competitive restraints. The amount of title insurance business available is influenced by housing starts, housing resales and commercial real estate transactions. Real estate activity levels have historically been cyclical and are influenced by such factors as interest rates and the health of the overall economy. The value of the Company's investment portfolio is subject to fluctuation based on similar factors. The title insurance industry may be exposed to substantial claims, such as claims of Indian tribes. The industry is regulated by state laws which require the maintenance of minimum levels of capital and surplus and which restrict the amount of dividends which may be paid without prior regulatory approval. Developments in any of these areas, which are more fully described elsewhere in Parts I and II hereof, each of which is incorporated into this section by reference, could cause the Company's results to differ materially from results that have been or may be projected by or on behalf of the Company. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward- looking statement that may be made from time to time by or on behalf of the Company.