The following information should be read in conjunction with the financial statements and related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Report.
- --------------- (1) Revenues for real estate information services include revenues in 1997 from PinTax subsequent to the PinTax Acquisition. Total expenses include expenses from PinTax subsequent to the PinTax Acquisition.
(3) Non-recurring expenses consist of $4.1 million in 1995 for Proposition 103 rebates and $1.0 million in 1994 for restructuring charges in connection with relocation of an operation.
summarizes premiums written net of cancellations after application of the reserve for return premiums during the periods indicated (in thousands):
The Company's strategy includes expanding its authorization to write premiums on a direct basis. At the present time, the Company generally retains the first $500,000 of each risk and reinsures the rest up to a maximum of $2.0 million per risk, pursuant to reinsurance arrangements. The Company also purchases catastrophic reinsurance, under which the Company is protected against an accumulation of losses arising out of any one event up to 95% of $12.5 million in excess of the initial $2.5 million of losses which the Company incurs. See "Business -- Insurance Operations -- Reinsurance" and Note 17 of Notes to Consolidated Financial Statements for a description of the Company's reinsurance arrangements. The Company remains primarily liable to its policyholders in the event any reinsurer is unable or will not fulfill the obligations assumed under reinsurance. As a result of the cost and availability of reinsurance, in the future the Company may elect to retain a higher portion of the risk historically ceded to reinsurers. If the Company were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by the Company. This increased exposure could have a material adverse effect on the Company's results of operations.
Effective January 1, 1999, National implemented a change to its revenue recognition accounting policy for real estate tax service contracts. The accounting policy was adopted prospectively and applies to all new loans serviced beginning January 1, 1999. Prior to January 1, 1999, National recognized revenues from real estate tax service contracts over the estimated duration of the contracts as the related servicing costs were estimated to occur. The majority of the servicing costs, approximately 64%, are incurred in the first tax processing cycle, with the remaining 36% incurred over the remaining service life of the contract. This policy results in recognition of approximately 65% of billings as revenue in the first year depending on the month that the contracts are added. The new policy provides for a more ratable recognition of revenues, reducing the amount of revenue and gross profit recognized at the inception of the contract and recognizing it over the expected service period. The amortization rates applied to recognize the revenues are based on a 10 year average contract life and are adjusted to reflect prepayments. The resulting rates by year are 41%, 21%, 13%, 8%, 6%, 4%, 3%, 2%, 1% and 1%. National periodically reviews its tax service contract portfolio to determine if there have been changes in contract lives and/or changes in the number and/or timing of prepayments.
In March 1998, Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides guidance on accounting by all nongovernmental entities for the costs of computer software developed or obtained for internal use and for determining whether computer software is for internal use. This SOP also provides guidance on when costs incurred for internal-use computer software are and are not capitalized. SOP 98-1 is effective for fiscal years beginning after December 15, 1998. The Company is not currently involved in significant software development projects and does not believe that SOP 98-1 will have a material impact on its financial statements in 1999.
In December 1997, Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3, Accounting by Insurance and Other Enterprises for Insurance-Related Assessments. This SOP provides guidance on accounting by insurance and other enterprises for insurance-related assessments. SOP 97-3 is effective for fiscal years beginning after December 15, 1998. The Company does not believe that SOP 97-3 will have a material impact on its financial statements.
YEAR ENDED DECEMBER 31, 1997 VERSUS YEAR ENDED DECEMBER 31, 1998
The dollar amounts referred to in this section comparing operating results for the year ended December 31, 1997 with December 31, 1998 are approximate amounts stated in millions and are based on the financial statements included elsewhere in this Report, which amounts are stated in thousands. All percentages referred to in this section comparing operating results for the year ended December 31, 1997 with December 31, 1998 are approximate percentages and are based only on dollar amounts set forth in the financial statements contained elsewhere in this Report, which amounts are stated in thousands.
Total revenue increased from $53.1 million in 1997 to $66.6 million in 1998, an increase of $13.5 million or 25.4%. Net premiums written decreased from $20.5 million in 1997 to $14.3 million in 1998, a decrease of $6.2 million or 30.3%. The decrease in net premiums written was principally due to the loss in the third and fourth quarters of 1997 of two hazard insurance tracking and outsourcing customers. There was no material price change related to the Company's insurance products in 1998.
Tracking fees increased from $7.5 million in 1997 to $12.3 million in 1998, an increase of $4.8 million or 63.7%. The increase was primarily due to the addition of new motor vehicle insurance tracking and outsourcing customers in 1998 and the growth in the motor vehicle lease portfolios of the Company's customers.
As a result of the above factors, income before provision for income taxes decreased from $4.7 million in 1997 to $3.6 million in 1998, a decrease of $1.1 million, or 22.8%.
Total revenue increased from $40.7 million in 1996 to $53.1 million in 1997, an increase of $12.4 million or 30.5%. Net premiums written increased from $12.6 million in 1996 to $20.5 million in 1997, an increase of $7.9 million or 62.7%. The increase in net premiums written was principally due to growth in loan portfolios of the Company's existing and former Hazard Insurance Tracking and Outsourcing Services clients. There was no material price change related to the Company's insurance products in 1997.
Real estate information services revenue (consisting of revenue from Pinnacle Data and PinTax) increased from $18.5 million in 1996 to $23.5 million in 1997, an increase of $5.0 million, or 27.0%. Approximately $2 million of the increase was the result of PinTax, which was acquired in September 1997. The remainder of the increase was the result of higher flood zone determination volumes from existing customers. The Company's overall price level for its real estate information services did not materially change in 1997.
Tracking fees increased from $5.5 million in 1996 to $7.5 million in 1997, an increase of $2.1 million or 37.7%. The increase was primarily due to higher volumes of motor vehicle leases tracked for new and existing Motor Vehicle Insurance Tracking and Outsourcing customers.
Personnel expenses increased from $18.9 million in 1996 to $23.1 million in 1997, an increase of $4.2 million, or 22.1%. The increase in personnel expenses was due to an increase in incentive compensation and staff additions in response to several factors, primarily an increase in the volume of flood zone determinations and loans tracked. To a lesser extent, the PinTax Acquisition contributed to additional personnel costs in 1997. Personnel expenses as a percent of total revenue decreased from 46.6% in 1996 to 43.6% in 1997.
interest or investment income. The principal assets of National are the stock of its Subsidiaries. National is, and for the foreseeable future will continue to be, dependent on the dividends from its Subsidiaries to meet its liquidity requirements, including debt service obligations. Dividends payable to National by GPIC are subject to certain regulatory restrictions, which are described below.
GPIC collects and invests premiums written in advance of the payments for associated claims. In the absence of a catastrophic loss, this timing difference between premium collection and claims payment, combined with investment income, normally provides short-term funds in excess of normal operating demands for cash. As of December 31, 1998, the Company had cash and short-term investments aggregating $9.3 million.
In connection with the PinTax Acquisition, PinTax paid to the sellers of ARTS (the "Sellers") in 1998 approximately $2.5 million of Additional Consideration. Of these amounts, approximately $1.5 million of Additional Consideration was paid in cash using the proceeds from the Term Facility. The remaining $1.0 million of Additional Consideration was paid in the form of an unsecured note to the Sellers (the "Purchaser Note"). The Purchaser Note bears simple interest of 8% per annum. Principal and interest are due in equal quarterly installments over the three (3) years ending May 2001, with the first installment due on June 18, 1998. As of December 31, 1998, the outstanding principal balance of the Purchaser Note was approximately $0.7 million.
announced as its prime lending rate. Collateral for the loan includes the outstanding capital stock of Pinnacle Data, which consists of 1,000 shares, along with all proceeds and products of Pinnacle Data. As of December 31, 1998, the outstanding principal balance of the Credit Facility was $2 million.
Industry and regulatory guidelines suggest that a property and casualty insurers' annual statutory net written premium should not exceed approximately three times its policyholders' surplus. The Company's surplus ratio is significantly lower than such guidelines. For the year ended December 31, 1998, the Company's net written premium to policyholder surplus ratio was .6 to 1. See "Business -- Insurance Operations -- Insurance Operating Ratios."
These factors, together with statements regarding certain risks and uncertainties contained in other parts of this Report, may affect the Company's operating results. Investors should read this section in connection with any forward-looking statement made in this Report, including, but not limited to, statements preceded or followed by the words "believes", "anticipates", "expects", "aware" or similar expressions as they relate to the Company or its management.
The Company derives a substantial portion of its total revenues from fees for Flood Zone Determination Services. These services are primarily provided to assist lenders in complying with federal laws which in many instances require lenders to determine whether property being financed is located in a federally-designated Special Flood Hazard Area ("SFHA") and if the property is located in an SFHA require borrowers to obtain flood insurance. Any significant change in federal legislation or secondary market requirements limiting these requirements on lenders or borrowers, or the development by competitors of significantly enhanced service or delivery systems could have a material adverse effect on the Company's business or operating results.
The Company's financial results can be significantly affected by a number of factors, including, but not limited to, the amount of net written premium and the rate of cancellation of insurance policies, the addition or loss of customers, changes in the number of loans or personal property leases being tracked for customers, increases or decreases in interest rates, and catastrophic loss events. For example, in 1992 GPIC incurred net losses relating to the Los Angeles riots and Hurricane Andrew of $612,000 and $527,000, respectively. In November 1993, GPIC received claims of approximately $650,000 from policyholders for losses arising out of the October and November 1993 series of fires in Southern California. The Company also received an assessment of $725,000 from the California Fair Plan Association, a mandatory insurance pool for certain California real estate, relating to losses from those fires. In addition, revenues from the Company's Flood Zone Determination Services and Real Estate Tax Services are directly related to the volume of mortgage loan originations, both new and refinanced, and any change in the level of such activity could have a material impact on the Company's performance.
The Company derives a significant amount of its revenues from insurance premiums and investment income. In the event that, for whatever reason, GPIC experiences abnormally high losses, purchases reinsurance from reinsurers who will not or cannot pay losses submitted, or other adverse developments occur, then any such event or combination of events could have a material adverse impact on the Company. In addition, insurance companies and others have often been sued under certain legal theories, such as bad faith handling or settlement of claims, which could subject GPIC to liability in excess of policy limits. An adverse outcome of any such lawsuit could have a material negative impact on the Company.
of December 31, 1998 concluded that the reserves (i) met the requirements of the insurance laws of California, (ii) were computed in accordance with accepted loss reserving standards and principles and (iii) make a reasonable provision for all unpaid loss and loss expense obligations of GPIC under the terms of its policies and agreements.
GPIC's business is partially dependent upon its ability to cede to reinsurers risks insured by GPIC. The amount, availability and cost of reinsurance are subject to prevailing market conditions, beyond the control of GPIC, which can affect GPIC's level of business and profitability. GPIC is ultimately liable for the reinsured risk if for any reason the reinsurers do not cover or will not pay GPIC for the losses of the insureds. As a result of the anticipated increased cost and more limited availability of reinsurance, in the future, GPIC may elect to retain a higher portion of the risk historically ceded to reinsurers. If GPIC were to retain a higher proportion of insured risks, it would increase its exposure to significant losses relating to properties insured by GPIC. This increased exposure could have a material adverse effect on the Company's results of operations. See "Business -- Insurance Operations -- Reinsurance."
Pinnacle Data indemnifies its customers for certain losses resulting from erroneous flood inquiry determinations, where a borrower was not properly advised whether the collateral was located in or out of an SFHA. PinTax indemnifies its customers for real estate late-payment penalties, interest on late-paid taxes and loss of tax payment discounts as a result of certain errors or omissions made by PinTax. PMSIS and Fastrac indemnify customers for certain errors and omissions made by either of them. The Company maintains insurance coverage in the maximum aggregate amount of $5 million for certain types of errors and omissions. The policy is on a claims made and occurrence basis. While to date the Company has experienced no significant losses related to errors or omissions and maintains reserves equal to its self insured retention for errors and omissions losses, there can be no assurance such reserves will prove adequate in the future or that the Company's insurance will avert adverse impacts as a result of any errors or omissions.
The Company's delivery and upgrade of products and services to its customers is dependent upon, among other factors, the Company's ability to attract and retain key analytical and management professionals, including skilled computer programmers and systems analysts. Businesses located in San Francisco, San Mateo, Contra Costa and Santa Clara counties of California, and in other areas in which the company maintains facilities, are experiencing a tightening of the labor market, which may result in one or more of the following: an increase in personnel costs, a delay in service installations and a reduction in customer service. The Company is unable to predict when the conditions in the local labor market will change.
The Company has considered the potential impact of the year 2000 on its information technology and non-information technology systems. The "Year 2000" problem relates to the fact that many computer systems will be affected in some way by the rollover of the two-digit year value to "00." Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The "Year 2000" issue creates risk for the Company from unforeseen problems in its own computer and embedded systems and from third parties with whom the Company does business. Failure of the Company's and/or third parties' computer systems and/or failure to be Year 2000 compliant could have a material impact on the Company's ability to conduct its business.
The Company continues to address Year 2000 compliance issues with respect to various networking systems within the Company, which include but are not limited to various hardware and related software, such as bridges, routers, gateways, hubs, switches, modems, security systems, and their respective operating systems. Most such hardware and software has been obtained from third party vendors, and the Company is working with many of these third party vendors to obtain software upgrades to make such hardware and software Year 2000 compliant. The Company does not anticipate that it will be required to replace any material amount of hardware or acquire any material amount of software to achieve Year 2000 compliance of such hardware and software. All such hardware and software are expected to be Year 2000 compliant by the end of the second quarter of 1999.
The Company is aware of issues concerning Year 2000 compliance with non-information technology systems and has commenced a program to address those issues. The full range of such issues is expected to be identified by the end of the second quarter of 1999 and the Company expects to take such action as is necessary, provided the action is within the Company's direct control, to make such non-information technology systems Year 2000 compliant by the end of the third quarter of 1999. Such non-information technology systems include such things as mail metering systems, office security systems, heating, ventilating and air conditioning systems and building elevators.
The Company has surveyed certain of its customers to determine the status of their Year 2000 compliance programs. A number of the Company's customers interface electronically with the Company. Therefore, it is critical that such customers' interfaces are Year 2000 compliant in order for such customers to be able to continue to interface with the Company after December 31, 1999. The Company completed such survey in the fourth quarter of 1998 and no significant or material Year 2000 problems were identified. The majority of the Company's customers are in the financial institutions industry. The regulatory agencies that regulate financial institutions have been closely monitoring financial institutions regarding Year 2000 compliance. The Company believes the financial institutions industry is considered to be a leader with respect to Year 2000 preparation efforts.
The Company is also surveying certain of its major vendors to determine the status of their Year 2000 compliance programs. Such vendors include, without limitation, public utilities, software vendors, computer hardware manufacturers and distributors, and office supply companies. To the extent vendors respond to the Company's Year 2000 compliance questionnaire, the Company expects such survey to be complete by the end of the second quarter of 1999. If such vendors are found by the Company to be likely to be non-Year 2000 compliant by December 31, 1999, the Company will take reasonable action to replace such vendors with Year 2000 compliant vendors.
Given the current state of the Company's internal preparedness for Year 2000, the Company believes that the risk of problems arising because of internal Year 2000 problems is minimal and any such problems are not anticipated to have any material effect on the Company. However, the Company believes that it is not possible to determine with complete certainty that all Year 2000 problems affecting the Company have been identified or corrected. The number of devices that could be affected and the interactions among these devises are simply too numerous. In addition, one cannot accurately predict how many external Year 2000 problem related failures will occur or the severity, duration or financial consequences of these perhaps inevitable external failures. For instance, failure of public utilities would likely prevent the Company from operating in the location of such failure and/or communicate and/or transact business with others. Likewise if the Company's customers and, in the case of PinTax, the taxing authorities from which it receives tax information are not Year 2000 compliant or if they suffer business interruptions because of external Year 2000 problems, the Company could be adversely impacted and such impact could be substantial. Therefore, the Company considers it possible that the Company or its clients could suffer a significant number of operational inconveniences and inefficiencies that may divert management's time and attention, and other financial and human resources, from the ordinary business activities, and a lesser number of serious systems failures that may require significant efforts by the Company or its clients to prevent or alleviate material business disruptions.
The Company has a disaster recovery plan, which is intended for use in connection with extraordinary events such as natural disasters. However, it could be implemented in the case of certain Year 2000 failures such as a public utilities failure. The disaster recovery plan contemplates the operation of certain critical portions of the Company from remote locations for certain limited periods of time. The Company has tested its information technology systems at such remote locations in order to determine that they would be
This information is incorporated hereby by reference to the financial statements listed in Item 14 of Part IV of this Report.