In September 1999, the Company moved its executive offices to one of the newly constructed office buildings at MacArthur Place in Santa Ana, California. The Orange County branch and certain other operations of the Company's title insurance segment moved into the two other buildings constructed on the site later in 1999. The three new buildings are in a campus environment and total approximately 210,000 square feet. The Company continues to own the two adjacent buildings in Santa Ana, California, which previously housed its executive offices. That location, comprising approximately 105,000 square feet of floor space, continues as the home of the company's trust and banking division. In addition, there are plans to move certain other divisions into that complex as their existing leases expire. The Company also owns an 18,000 square foot building located across the street from that complex. This building is currently used primarily for storage.
The Company's title insurance subsidiary, First American, and its subsidiaries, own or lease buildings or office space in more than 400 locations throughout the United States and Canada, principally for their respective title operations.
The Company's real estate information subsidiary, First American Real Estate Information Services, Inc. ("FAREISI"), houses its national operations in a leased 231,000 square foot office building in Dallas, Texas. FAREISI's corporate headquarters are housed in a leased office building located in St. Petersburg, Florida. In 1999, the Company completed the construction of two office buildings in Poway, California. The two buildings total approximately 152,000 square feet and are located on a 17 acre parcel of land. The buildings are occupied by various divisions of FAREISI. In addition, FAREISI and its subsidiaries lease office space in more than 75 locations throughout the United States, principally for their respective operations.
The selected consolidated financial data for the Company for the five-year period ended December 31, 1999, has been derived from the audited Consolidated Financial Statements. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, "Item 1 - Business - Acquisitions," and "
Real estate information operating revenues decreased 8.8% in 1999 from 1998 and increased 83.8% in 1998 over 1997. These fluctuations were primarily attributable to the same factors affecting title insurance mentioned above, as well as acquisition activity. In addition, the decrease in 1999 from 1998 was also due to a $22.7 million reduction in tax service operating revenues attributable to the change in revenue recognition policy. Operating revenues of $19.3 million and $141.0 million were contributed by new acquisitions in 1999 and 1998, respectively.
Consumer information operating revenues increased 19.7% in 1999 over 1998 and 35.6% in 1998 over 1997. These increases were primarily attributable to an increased awareness and acceptance of this business segment's products, increased market share and acquisition activity. Operating revenues of $8.1 million and $3.5 million were contributed by new acquisitions in 1999 and 1998, respectively.
The premium split between underwriter and agents is in accordance with their respective agency contracts and can vary from region to region due to divergencies in real estate closing practices, as well as rating structures. As a result, the percentage of title premiums retained by agents may vary due to the geographical mix of revenues from agency operations.
Title insurance other operating expenses (principally direct operations) increased 6.6% in 1999 over 1998 and 24.0% in 1998 over 1997. The increase in 1999 over 1998 was primarily due to $9.7 million of costs associated with new acquisitions, Y2K expenses of $5.8 million, a $2.5 million charge resulting from a previously announced fine imposed by the California insurance commissioner, approximately $2.0 million in impaired asset write-offs, and general price-level increases, offset in part by a reduction in certain incremental costs associated with the decline in title order volume. The increase in 1998 over 1997 was primarily attributable to an increase in the incremental costs associated with the increased order volume, marginal price-level increases, Y2K costs and acquisition activity.
Real estate information other operating expenses decreased 1.5% in 1999 from 1998 and increased 73% in 1998 over 1997. The decrease in 1999 from 1998 was primarily due to a reduction in costs resulting from the Company's cost- containment programs initiated in response to the decline in business volume, offset in part by $6.9 million of costs associated with new acquisitions and Y2K expenses of $19.0 million. The increase in 1998 over 1997 was primarily attributable to costs incurred servicing the increased business activity, as well as $60.6 million of other operating costs relating to new acquisitions, offset in part by cost-containment programs.
Corporate other operating expenses increased 98.9% in 1999 over 1998 and 36.2% in 1998 over 1997. The increase in 1999 over 1998 was primarily attributable to $10.8 million of nonrecurring merger-related charges incurred in the NAIG acquisition. The increase in 1998 over 1997 was primarily due to increased costs associated with supporting the overall growth of the Company's businesses.
The provision for title insurance losses, expressed as a percentage of title insurance operating revenues, was 3.1% in 1999, 3.3% in 1998 and 3.6% in 1997. These decreases reflect ongoing improvement in title insurance claims experience. The provision for consumer information losses principally reflects home warranty claims, and to a lesser extent, property and casualty insurance claims. The provision for home warranty claims, expressed as a percentage of home warranty operating revenues, was 49.8% in 1999, 56.2% in 1998 and 58.3% in 1997. This decreasing trend reflects the relative change in the average number of claims per contract experienced during these periods. The provision for property and casualty insurance losses expressed as a percentage of property and casualty insurance operating revenues approximated 32.5% for the three-year period ended December 31, 1999.
Premium taxes - A summary by pertinent segment of the Company's premium taxes is as follows:
Insurers are generally not subject to state income or franchise taxes. However, in lieu thereof, a "premium" tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of operating revenues. The Company's underwritten title company (noninsurance) subsidiaries are subject to state income tax and do not pay premium tax. Accordingly, the Company's total tax burden at the state level is composed of a combination of premium taxes and state income taxes. Premium taxes attributable to title insurance operations, as a percentage of title insurance operating revenues, were approximately 1% for the three- year period ended December 31, 1999.
The Company's profit margins vary according to a number of factors, including the volume, composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. For example, in title insurance operations, commercial transactions tend to generate higher revenues and greater profit margins than
The increase in net corporate expenses in 1999 over 1998 was primarily due to an investment gain of $32.4 million recognized in 1998 relating to the joint venture agreement with Experian; and in 1999, $10.8 million of nonrecurring merger-related charges incurred in the NAIG acquisition; and decreased equity in earnings of unconsolidated subsidiaries. The decrease in net corporate expenses in 1998 from 1997 was primarily attributable to the investment gain of $32.4 million mentioned above.
Net income - Net income and per share information are summarized as follows:
property and equipment, proceeds in 1998 from the issuance of senior debentures and proceeds in 1997 from the issuance of mandatorily redeemable preferred securities. The net effect of all activities on total cash and cash equivalents was a decrease of $31.3 million for 1999, an increase of $197.9 million for 1998 and an increase of $8.3 million for 1997.
On July 2, 1999, the Company increased its lines of credit to $175.0 million. Pursuant to the terms of the credit agreements, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt-to-capitalization ratios. The lines of credit are currently unused.
Notes and contracts payable, as a percentage of total capitalization, was 16.4%, as of December 31, 1999, as compared with 13% as of the prior year end. This increase was primarily attributable to debt incurred in connection with company acquisitions, offset, in part, by an increase in the capital base primarily due to shares issued in connection with company acquisitions and net income for the period. Notes and contracts payable are more fully described in Note 8 to the consolidated financial statements.
Pursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to the Company in 2000 from its insurance subsidiaries is $133.1 million. Such restrictions have not had, nor are they expected to have, an impact on the Company's ability to meet its cash obligations.
During the latter part of 1999, the Company successfully completed its Y2K plan. The plan, which was created with the help of an outside consulting firm in January 1997, was completed at a total cost of $40.0 million.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of The First American Financial Corporation and its subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
The First American Financial Corporation (the Company), through its subsidiaries, is engaged in the business of providing business information and related products and services. The Company's three primary business segments are title insurance and services, real estate information and services and consumer information and services. The title insurance segment issues residential and commercial title insurance policies, and provides escrow services, equity loan services, tax-deferred exchanges and other related products. The real estate information segment provides tax monitoring, mortgage credit reporting, property data services, flood certification, field inspection services, appraisal services, mortgage loan servicing systems and mortgage document preparation. The consumer information segment provides home warranties, property and casualty insurance, resident screening, pre-employment screening, specialized credit reporting, automotive insurance tracking, investment advisory and trust and thrift services.
Other long-term investments consist primarily of investments in affiliates, which are accounted for under the equity method of accounting, and notes receivable, which are carried at the lower of cost or fair value less costs to sell.
Goodwill recognized in business combinations is amortized over its estimated useful life ranging from 20 to 40 years. Other intangibles, which include customer lists and covenants not to compete are amortized over their estimated useful lives, ranging from three to 20 years. The Company periodically evaluates the amortization period assigned to each intangible asset to ensure that there have not been any events or circumstances that warrant revised estimates of useful lives.
The Company provides for claims losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per claim is calculated using the average of the most recent 12 months of claims experience.
Title insurance - Title premiums on policies issued directly by the Company are recognized on the effective date of the title policy and escrow fees are recorded upon close of the escrow. Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent.
Real estate information - In December 1999, the Company adopted Staff Accounting Bulletin No. 101 (SAB), "Revenue Recognition in Financial Statements." The SAB, which became effective January 1, 1999, applies to the Company's tax service operations and requires the deferral of the tax service fee and the recognition of that fee as revenue ratably over the expected service period. The amortization rates applied to recognize the revenues assume a 10-year contract life and are adjusted to reflect prepayments. The Company 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. Accordingly, the Company may adjust the rates to reflect current trends. SAB No. 101 finalizes a series of changes instituted by the Securities and Exchange Commission concerning revenue recognition policies. As a result of adopting the SAB, in 1999, the Company reported a charge of $55.6 million, net of income taxes and minority interests, as a cumulative change in accounting principle, reduced net income by $10.9 million, or $.16 per diluted share and restated its quarterly information. Assuming the SAB had been adopted on January 1, 1997, pro forma net income and net income per diluted share for 1998 and 1997 would have been $188.3 million, or $3.00, and $59.8 million, or $1.02, respectively.
The Company's title insurance subsidiary, First American Title Insurance Company, maintained statutory capital and surplus of $394.2 million and $301.6 million at December 31, 1999 and 1998, respectively. Statutory net income for the years ended December 31, 1999, 1998 and 1997 was $71.2 million, $137.3 million and $35.9 million, respectively.
Real estate loans are secured by properties located in California. The average yield on the Company's loan portfolio was 10% for the years ended December 31, 1999 and 1998. Average yields are affected by amortization of discounts on loans purchased from other institutions, prepayment penalties recorded as income, loan fees amortized to income and the market interest rates charged by thrift and loan institutions.
The above amounts are net of valuation reserves of $4.9 million and $12.3 million at December 31, 1999 and 1998, respectively.
December 31 (in thousands except percentages) 1999 1998 - ---------------------------------------------------------------------- Passbook accounts $11,117 $12,502 - ---------------------------------------------------------------------- Certificate accounts: Less than one year 51,976 33,980 One to five years 17,750 20,922 - ---------------------------------------------------------------------- 69,726 54,902 - ---------------------------------------------------------------------- $80,843 $67,404 - ---------------------------------------------------------------------- Annualized interest rates: Passbook accounts 4%-5% 4%-5% Certificate accounts 5%-8% 5%-8%
The carrying value of the passbook accounts approximates fair value due to the short-term nature of this liability. The fair value of investment certificate accounts was $69.5 million and $55.4 million at December 31, 1999 and 1998, respectively, and was estimated based on the discounted value of future cash flows using a discount rate approximating current market for similar liabilities.
December 31 (in thousands) 1999 1998 1997 - ---------------------------------------------------------------------------- Balance at beginning of year $272,921 $254,058 $247,443 - ---------------------------------------------------------------------------- Provision related to: Current year 122,311 121,118 92,009 Prior years (6,093) 3,060 4,796 - ---------------------------------------------------------------------------- 116,218 124,178 96,805 - ---------------------------------------------------------------------------- Payments related to: Current year 58,915 52,164 43,226 Prior years 54,029 46,359 41,901 - ---------------------------------------------------------------------------- 112,944 98,523 85,127 - ---------------------------------------------------------------------------- Other (2,471) (6,792) (5,063) - ---------------------------------------------------------------------------- Balance at end of year $273,724 $272,921 $254,058 - ----------------------------------------------------------------------------
(in thousands) 1999 1998 - ------------------------------------------------------------------------------ 7.55% senior debentures, due April, 2028 $ 99,486 $ 99,468 Secured notes payable pursuant to amended credit agreement - 2,040
Trust deed notes with maturities through 2007, secured by land and buildings with a net book value of $3,437, average rate of 10.5% 3,022 3,952
Other notes and contracts payable with maturities through 2007, average rate of 7.5% 94,307 38,006 - ------------------------------------------------------------------------------ $196,815 $143,466 - ------------------------------------------------------------------------------
In April 1999, the Company paid off the fixed-rate indebtedness portion of the 1997 amended credit agreement. The $75.0 million line of credit established under the amended credit agreement remained in effect. In July 1999, the Company entered into a new credit agreement that provided for an additional $100.0 million line of credit. Under the terms of the credit agreements, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt-to-capitalization ratios. Both lines of credit expire in July 2002 and were unused at December 31, 1999.
(in thousands) 1999 1998 1997 - ---------------------------------------------------------------------------- Current: Federal $51,237 $101,238 $28,491 State 7,183 12,520 4,075 - ---------------------------------------------------------------------------- 58,420 113,758 32,566 - ---------------------------------------------------------------------------- Deferred: Federal 3,260 13,584 9,600 State 620 1,170 770 3,880 14,754 10,370 - ---------------------------------------------------------------------------- $62,300 $128,512 $42,936 - ----------------------------------------------------------------------------
(in thousands) 1999 1998 - ---------------------------------------------------------------------------- Deferred tax assets: Deferred revenue $ 67,540 $25,952 Employee benefits 24,892 14,407 Bad debt reserves 7,291 7,412 Acquisition reserve 114 520 State taxes 872 2,262 Other 3,938 6,235 - ---------------------------------------------------------------------------- 104,647 56,788 - ----------------------------------------------------------------------------
(in thousands) 1999 1998 1997 - ------------------------------------------------------------------------------ Expense: Service Cost $ 23,726 $14,863 $10,550 Interest Cost 15,376 13,067 11,178 Actual Return on Plan Assets (11,751) (9,196) (7,421) Amortization of net transition obligation 309 309 309 Amortization of prior service cost 143 143 143 Amortization of net loss 1,746 1,408 945 - ------------------------------------------------------------------------------ $ 29,549 $20,594 $15,704 - ------------------------------------------------------------------------------
The rate of increase in future compensation levels for the plans of 4.5% and the weighted average discount rates of 7.5% and 6.75% were used in determining the actuarial present value of the projected benefit obligation at December 31, 1999 and 1998, respectively. The majority of pension plan assets are invested in U.S. government securities, time deposits and common stocks with projected long-term rates of return of 9%.
The Company also has a Stock Bonus Plan (the Plan) for key employees pursuant to which 154,000, 186,000 and 258,000 common shares were issued in 1999, 1998 and 1997, respectively, resulting in a charge to operations of $3.4 million, $2.7 million and $2.2 million, respectively. The Plan, as amended December 9, 1992, provides that a total of up to 1,350,000 common shares may be awarded in any one year.
Effective January 1, 1995, the Company adopted The First American Financial Corporation 401(k) Savings Plan (The Savings Plan), which is available to substantially all employees. The Savings Plan allows for employee-elective contributions up to the maximum deductible amount as determined by the Internal Revenue Code. The Company makes contributions to The Savings Plan based on profitability, as well as contributions of the participants.
On April 24, 1996, the Company implemented The First American Financial Corporation 1996 Stock Option Plan (the Stock Option Plan). Under the Stock Option Plan, options are granted to certain employees to purchase the Company's common stock at a price no less than the market value of the shares on the date of the grant. The maximum number of shares that may be subject to options is 11,625,000. Currently outstanding options become exercisable one to five years, and expire 10 years, from the grant date. On April 24, 1997, the Company implemented The First American Financial Corporation 1997 Directors' Stock Plan (the Directors' Plan). The Directors' Plan is similar to the employees' Stock Option Plan, except that the maximum number of shares that may be subject to options is 1,800,000 and the maximum number of shares that may be purchased pursuant to options granted shall not exceed 6,750 shares during any 12-consecutive-month period.
(in thousands, except per share amounts) 1999 1998 1997 - ---------------------------------------------------------------------------- Net income: As reported $33,003 $201,527 $67,765 Pro forma $21,790 $183,845 $66,533
Earnings per share: As reported Basic .51 $ 3.35 $ 1.19 Diluted .50 $ 3.21 $ 1.16
The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1999, 1998 and 1997, respectively; dividend yield of 1.5%, 1% and 1.2%; expected volatility of 39.6%, 36% and 38.1%; risk-free interest rate of 5.8%, 5.7% and 6.3%; and expected life of seven years.
The Company leases certain office facilities, automobiles and equipment under operating leases, which, for the most part, are renewable. The majority of these leases also provide that the Company will pay insurance and taxes. In December 1999, the Company entered into a sale-leaseback agreement with regard to certain furniture and equipment with a net book value of $65.7 million. Proceeds from the sale amounted to $80.1 million and a gain of $14.4 million has been included in deferred revenue and will be amortized over the life of the lease. Under the agreement, the Company agreed to lease the equipment for five years with minimum annual lease payments of $15.2 million. At the end of the term of the lease, the Company has the option to acquire the equipment or return it to the lessor.
(in thousands) Year - ------------------------------------------------------------ 2000 $114,880 2001 93,747 2002 77,027 2003 60,037 2004 46,901 Later Years 67,915 - ------------------------------------------------------------ $460,507 - ------------------------------------------------------------
The change in other unrealized gains (losses) on debt and equity securities includes reclassification adjustments of $3.7 million, $1.2 million and $0.4 million of net realized gains for the years ended December 31, 1999, 1998 and 1997, respectively.
On May 19, 1999, The People of the State of California, Kathleen Connell, Controller of the State of California, and Chuck Quackenbush, Insurance Commissioner of the State of California, filed a class action suit in the Sacramento Superior Court. The action seeks to certify as a class of defendants all "title insurers", all "underwritten title companies" and all "controlled escrow companies" (as those terms are defined in the California Insurance Code) -------------- and all "independent escrow companies" (as the term is defined in the California Financial Code) doing business in the State of California from 1970 to the - -------------- present who (i) hold dormant, unclaimed escrow funds; (ii) charged California home buyers and other escrow customers $10.00 or more for delivery services or administrative fees; (iii) charged California home buyers and other escrow customers reconveyance fees and/or (iv) earned interest (or its equivalent) from financial institutions on customers' deposited escrow funds.
In February 2000, the Company entered into an administrative settlement with the California Department of Insurance (DOI), whereby the DOI released the Company from any further claim of liability as to the Company's receipt of earnings credits or any alleged overcharges for various miscellaneous escrow fee items, such as courier, Federal Express or wire service fees. The DOI further agreed to direct the attorney general to dismiss it as a plaintiff from the action brought by the State of California. In the settlement with the DOI, the Company agreed to (i) make a contribution to a consumer education fund and (ii) accept a new regulation to be promulgated by the DOI, whereby earnings credit programs will be authorized and regulated by the DOI and rate filings will be required for escrow fees including several specified miscellaneous fee items.
Included in other operating expenses for the 12 months ended December 31, 1999, were merger-related charges of $10.8 million, $7.0 million after tax, or 10 cents per diluted share. These nonrecurring charges include severance payments, lease terminations and consulting services. Combined and separate results of the Company and NAIG during the periods preceding the acquisitions were as follows:
During the year ended December 31, 1999, the Company acquired 25 companies. The purchase method of accounting was used for 24 of the acquisitions and the pooling-of-interests method was used for one.
The 24 acquisitions accounted for under the purchase method of accounting were individually not material and are included in the following business segments; 20 in the title insurance segment, three in the real estate information services segment and one in the consumer information segment. Their aggregate purchase price was $71.8 million in cash, $53.5 million in notes and 1,119,321 shares of the Company's common stock. The purchase price for each was allocated to the assets acquired and liabilities assumed based on estimated fair values and approximately $110.7 million in goodwill was recorded. Goodwill is being amortized on a straight-line basis over its estimated useful
The Company's operations include three reportable segments: title insurance and services, real estate information and services and consumer information and services. The title insurance segment issues policies, which are insured statements of the condition of title to real property, and provides other related services. The real estate information property and casualty insurance segment provides to lender customers the status of tax payments on real property securing their loans, mortgage credit information derived from at least two credit bureau sources, flood zone determination reports that provide information on whether or not a property is in a special flood hazard area, as well as other real estate-related information services. The consumer information segment provides home warranties, which protect homeowners against defects in home fixtures; automotive tracking services; resident screening; pre-employment screening; property and casualty insurance; trust and banking services; investment advisory and other related services.
In December, 1999, the Company adopted Staff Accounting Bulletin No. 101 (SAB), "Revenue Recognition in Financial Statements", which became effective January 1, 1999. In conformity with the SAB the Company has restated its results for the first three quarters of 1999. See Note 1 to the consolidated financial statements for further discussion.
All financial results presented include the effect of the 1999 acquisition of NAIG accounted for under the pooling of interests method of accounting.
Column A Column B Column C Column D -------- -------- -------- --------
Deferred Policy Claims Deferred Segment Acquisition Costs Reserves Revenues ------- ----------------- -------- --------
Title Insurance $ 248,723,000 Real Estate Information 17,857,000 $ 83,801,000 Consumer Information 7,590,000 6,341,000 35,401,000 Corporate ----------- ------------- ------------- Total $ 7,590,000 $ 272,921,000 $ 119,202,000 =========== ============= =============
Note A - Amount represents accounts written off, net of recoveries. Note B - Amount represents net $7,955,000 in purchase accounting adjustments, $11,251,000 related to the disposition of a subsidiary and $6,093,000 from the reserve for assets acquired in connection with claim settlements. Note C - Amount represents claim payments, net of recoveries. Note D - Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset.
Note A - Amount represents accounts written off, net of recoveries. Note B - Amount represents $45,000 in purchase accounting adjustments, net of a reclassification of $4,678,000 to the reserve for assets acquired in connection with claim settlements. Note C - Amount represents claim payments, net of recoveries. Note D - Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E - Amount represents elimination of reserve in connection with the expiration of the related temporary differences.