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 and the Company’s property and casualty insurance division. 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.
Overview-The majority of the revenues in the Company’s title insurance and real estate information segments, which today constitute 92% of the total revenue base, depend in large part, upon the level of real estate activity and the cost and availability of mortgage funds. Revenues for these segments result primarily from resales and refinancings of residential real estate and, to a lesser extent, from commercial transactions and the construction and sale of new housing. The remaining 8% of the Company’s total revenue base comes from the consumer information segment, which is isolated from the volatility of real estate transactions. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, changes in interest rates, as well as other economic factors, can cause fluctuations in the traditional pattern of real estate activity.
In 2001, mortgage interest rates decreased to levels comparable to rates experienced in 1998. Refinance activity reached record levels and the demand for residential resale and new home sales continued to be very strong. All four quarters of 2001 compared favorably with the respective quarters of 2000. Closed order counts reached record levels resulting in record operating revenues of $3.66 billion. Income before income taxes and minority interests was $329.5 million, net income was $167.3 million, and diluted earnings per share were $2.27. Equity surpassed the $1.1 billion mark at December 31, 2001.
Investment and other income-Investment and other income increased $31.0 million in 2001 over 2000 and $4.8 million in 2000 over 1999. The increase in 2001 over 2000 was primarily due to a $23.4 million increase in equity in earnings of unconsolidated affiliates, $3.8 million in increased interest income and a $2.5 million increase in realized investment gains. The increase in 2000 over 1999 was primarily due to a 4.6% increase in the average investment portfolio balance, investment gains totaling $5.7 million relating to the joint venture agreements with LandAmerica Financial Group, Inc, and Transamerica Corporation (see Note 18 to the consolidated financial statements) and $2.5 million of interest income contributed by a new acquisition in the United Kingdom, offset in part by a $4.3 million realized investment loss and reduced equity in earnings of unconsolidated affiliates. See Note 8 to the consolidated financial statements for additional information.
The Company’s title insurance segment (primarily direct operations) is labor intensive; accordingly, a major variable expense component is salaries and other personnel costs. This expense component is affected by two competing factors: the need to monitor personnel changes to match corresponding or anticipated new orders, and the need to provide quality service. In addition, this segment’s growth in operations that specialize in builder and lender business has created ongoing fixed costs required to service accounts.
Title insurance personnel expenses increased 23.9% in 2001 over 2000 and decreased 1.1% in 2000 from 1999. The increase in 2001 over 2000 was primarily due to: an increase in staff in the production area, where the title company experienced a 50.5% increase in total order volume; increased commissions associated with the increase in closed orders; $3.0 million in severance related to the consolidation of certain back-office functions; and costs associated with new acquisitions; offset in part by cost-containment measures. The decrease in 2000 from 1999 was primarily due to staff reductions in the production area (which reflects the decrease in total order volume), the restructuring of the Company’s principal pension plan and the consolidation of certain administrative functions within the title company’s regional structure, offset in part by personnel costs associated with new acquisitions. The restructuring of the Company’s pension plan contributed $11.8 million to the decrease in title personnel expenses (see Note 11 to the consolidated financial statements). Personnel expenses associated with new acquisitions totaled $15.6 million for 2001 and $36.6 million for 2000. The Company’s direct title operations opened 1,930,300, 1,240,700 and 1,334,100 orders in 2001, 2000 and 1999, respectively, representing an increase of 55.6% in 2001 over 2000 and a decrease of 7.0% in 2000 from 1999. From an efficiency standpoint, personnel costs as a percentage of net operating revenues were 52.9% in 2001, 56.6% in 2000 and 56.9% in 1999.
Real estate information personnel expenses increased 12.7% in 2001 over 2000 and stayed relatively constant in 2000 when compared with 1999. The increase in 2001 over 2000 was primarily due to personnel costs (primarily bonuses, commissions, overtime pay and temporary help) associated with the significant increase in business volume, as well as costs associated with new acquisitions, offset in part by cost-containment programs. Personnel expenses in 2000 remained relatively flat when compared with 1999, primarily as a result of staff reductions and the restructuring of the Company’s principal pension plan, offset by personnel costs associated with new acquisitions. The restructuring of the Company’s pension plan reduced personnel expenses in 2000 by $3.0 million when compared with 1999. Personnel costs associated with new acquisitions were $3.2 million for 2001 and $15.1 million for 2000. From an efficiency standpoint, personnel costs as a percentage of net operating revenues were 36.1% in 2001, 41.5% in 2000 and 40.2% in 1999.
Consumer information other operating expenses increased 16.8% in 2001 over 2000 and 12.3% in 2000 over 1999. These increases were primarily attributable to costs incurred servicing the increased business volume, as well as acquisition activity. Contributing to the increase for 2001 were $3.6 million of costs incurred to exit the lender-placed homeowner’s insurance business at the Company’s property and casualty insurance division. Other operating expenses associated with new acquisitions were $11.8 million in 2001 and $4.1 million in 2000.
Corporate other operating expenses remained relatively constant in 2001 compared with 2000 and decreased 67.7% in 2000 from 1999. The decrease in 2000 from 1999 was primarily due to $10.8 million of nonrecurring, merger-related charges incurred in the NAIG acquisition in 1999 and Y2K costs incurred in 1999.
Depreciation and amortization-Depreciation and amortization, as well as capital expenditures, are summarized in Note 19 to the consolidated financial statements.
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 1.0% for 2001, 2000 and 1999, respectively.
Income before income taxes, minority interests and cumulative effect of a change in accounting principle-A summary by segment is as follows:
Minority interests-Minority interests in net income of consolidated subsidiaries increased $27.8 million in 2001 over 2000 and decreased $2.1 million in 2000 from 1999. These fluctuations were primarily due to the relative changes in the operating results of the Company’s joint venture with Experian.
Net income-Net income and per share information are summarized as follows:
Cash provided by operating activities amounted to $388.2 million, $141.4 million and $173.2 million for 2001, 2000 and 1999, respectively, after net claim payments of $153.4 million, $135.4 million and $119.3 million, respectively. The principal nonoperating uses of cash and cash equivalents for the three-year period ended December 31, 2001, were for capital expenditures, additions to the investment portfolio, company acquisitions in 2000 and 1999, dividends and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were proceeds from the issuance of the Company’s $210.0 million senior convertible debentures (see Note 7 to the consolidated financial statements), proceeds from the sales and maturities of certain investments, and proceeds in 2000 and 1999 from the sale-leaseback of certain property and equipment. The net effect of all activities on total cash and cash equivalents was an increase of $344.3 million for 2001 and decreases of $49.1 million and $31.3 million for 2000 and 1999, respectively.
Pursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to the Company in 2002 from its insurance subsidiaries is $197.7 million. Such restrictions have not had, nor are they expected to have, an impact on the Company’s ability to meet its cash obligations (see Note 2 to the consolidated financial statements).
The First American 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, 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 database services, flood certification, default management services, mortgage loan servicing systems, mortgage document preparation and other real estate related services. The consumer information segment provides home warranties, property and casualty insurance, resident screening, pre-employment screening, substance abuse management and testing, specialized credit reporting, automotive insurance tracking and other services, investment advisory and trust and thrift services.
Equity securities are carried at fair value and consist primarily of investments in marketable common stocks of corporate entities in which the Company’s ownership does not exceed 20.0%.
Effective January 1, 1999, the Company adopted Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). SOP 98-1 requires the Company to capitalize interest costs incurred and certain payroll-related costs of employees directly associated with developing software, in addition to incremental payments to third parties. The adoption of SOP 98-1 did not have a material effect on the Company’s financial condition or results of operations.
Title plants and other indexes are carried at original cost. The costs of daily maintenance (updating) of these plants and other indexes are charged to expense as incurred. Because properly maintained title plants and other indexes have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation.
In connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property or judgment liens. These assets, sometimes referred to as “salvage assets,” are carried at the lower of cost or fair value less costs to sell and are included in “Other assets” in the Company’s consolidated balance sheets. The balance for these assets was $29.4 million and $27.8 million at December 31, 2001 and 2000, respectively.
On July 20, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (“SFAS 141”). This statement addresses financial accounting and reporting for business combinations and supercedes Accounting Principal Board (“APB”) Opinion No. 16, “Business Combinations.” All business combinations in the scope of SFAS 141 are to be accounted for using the purchase method of accounting. The provisions of SFAS 141 apply to all business combinations initiated or closed after June 30, 2001. Management of the Company anticipates that the adoption of SFAS 141 will not have a material effect on the Company’s financial condition or results of operations.
accounting and reporting for goodwill and other intangibles and supercedes APB Opinion No. 17, “Intangible Assets.” SFAS 142 addresses how goodwill and other intangible assets should be accounted for in the financial statements. Goodwill and intangible assets that have indefinite lives will not be amortized, but rather will be tested at least annually for impairment. Intangible assets that have finite lives will continue to be amortized over their useful lives. The provisions of SFAS 142 are required to be applied starting with fiscal years beginning after December 15, 2001, and apply to all goodwill and other intangible assets recognized in the financial statements at that date. Goodwill and intangible assets acquired after June 30, 2001, were subject immediately to nonamortization and amortization provisions of SFAS 142. Management is in the process of assessing the impact of implementing the impairment provision of SFAS 142 on the Company’s financial condition or results of operations. Management estimates that the adoption of the nonamortization provision of SFAS 142 will increase income before income taxes and minority interests in 2002 by $18.0 million, or $0.17 per diluted share, excluding the effects of impairment, if any.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans receivable are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral-dependent.
To the extent that the undiscounted cash flows related to other long-lived assets are less than the assets’ carrying value, the carrying value of such assets is reduced to the assets’ fair value.
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.
shares outstanding is increased to include the number of additional common shares that would have been outstanding if potential dilutive common shares had been issued.
Investments carried at $18.1 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2001.
The National Association of Insurance Commissioners has established certain new statutory accounting practices, which became effective January 1, 2001. Adoption of the new practices did not have a material impact on the Company’s statutory financial condition or results of operations.
The fair value of loans receivable was $104.3 million and $94.6 million at December 31, 2001 and 2000, respectively, and was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality.
The aggregate annual maturities for loans receivable in each of the five years after December 31, 2001, are as follows:
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 $77.0 million and $69.9 million at December 31, 2001 and 2000, respectively, and was estimated based on the discounted value of future cash flows using a discount rate approximating current market for similar liabilities.
NOTE 6. Reserve for Known and Incurred But Not Reported Claims:
In October 2001, the Company entered into a credit agreement that provides for a $200.0 million line of credit. This agreement supercedes the Company’s prior credit agreements that were due to expire in July 2002. Under the terms of the credit agreement, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt-to-capitalization ratios. The line of credit remains in effect until October 2006 and was unused at December 31, 2001.
The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 2001, are as follows:
For the year 2001, domestic and foreign pretax income from continuing operations was $278.3 million and $6.5 million, respectively.
The exercise of stock options represents a tax benefit and has been reflected as a reduction of taxes payable and an increase to the additional paid-in capital account. The benefits recorded were $2.6 million, $1.0 million and $0.7 million for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company’s potential dilutive shares are stock options and convertible debt. Stock options are reflected in diluted earnings per share by application of the treasury-stock method and convertible debt is reflected in diluted earnings per share by application of the if-converted method. A reconciliation of net income and weighted average shares outstanding is as follows:
The Company has pension and other retirement benefit plans covering substantially all employees. The Company’s principal pension plan is a noncontributory, qualified, defined benefit plan with benefits based on the employee’s years of service and the highest five consecutive years’ compensation during the last ten years of employment. The Company’s policy is to fund all accrued pension costs. Contributions are intended to provide not only for benefits attributable to past service, but also for those benefits expected to be earned in the future. The Company also has nonqualified, unfunded supplemental benefit plans covering certain key management personnel. Benefits under these plans are intended to be funded with proceeds from life insurance policies purchased by the Company on the lives of the executives. In December 2000, the Company amended its principal pension plan and certain other retirement plans. The primary impact of the amendment was to reduce future benefits accrued by employees by limiting credit for pay increases through December 31, 2001, and by limiting credit for years of service through December 31, 2005. As a result of amending the plans, the Company reduced its pension expense in 2000 by $5.0 million, recognized a one-time benefit of $34.3 million and will record reduced employee benefit expense in subsequent years.
The rate of increase in future compensation levels for the plans of 4.5% and the weighted-average discount rates of 7.25% and 7.5%, respectively, were used in determining the actuarial present value of the projected benefit obligation at December 31, 2001 and 2000. The majority of pension plan assets are invested in U.S. government securities, time deposits and common stocks with a projected long-term rate of return of 10.0% at December 31, 2001 and 2000.
The Company’s principal profit sharing plan was amended effective January 1, 1995, to discontinue future contributions. The plan holds 5,089,000 and 5,393,000 shares of the Company’s common stock, representing 7.4% and 8.4% of the total shares outstanding at December 31, 2001 and 2000, respectively.
In December 2001, the Company established an employee stock purchase plan under which eligible employees may purchase common stock of the Company at 85% of the closing price on the last day of each month. There were 17,000 shares issued in connection with the plan in 2001. At December 31, 2001, there were 2,983,000 shares reserved for future issuances.
On April 24, 1996, the Company implemented The First American 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 in one to five years, and expire ten years from the grant date. On April 24, 1997, the Company implemented The First American 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 consecutive 12-month period.
In May 1999, in connection with the Company’s business combination with National Information Group (NAIG), which was accounted for under the pooling-of-interests method of accounting, the Company adjusted the outstanding NAIG stock options to substitute Common shares of the Company for the shares of NAIG that were issuable upon exercise of those options. At December 31, 2001, 72,293 Common shares of the Company were issuable pursuant to exercise of the remaining outstanding adjusted NAIG options with exercise prices ranging from $7.65 to $21.27.
Future minimum rental payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2001, are as follows:
Total rental expense for all operating leases and month-to-month rentals was $162.5 million, $144.7 million and $126.3 million for the years ended December 31, 2001, 2000 and 1999, respectively.
On April 22, 1997, the Company issued and sold $100.0 million of 8.5% trust preferred securities, due in 2012, through its wholly owned subsidiary, First American Capital Trust. In connection with the subsidiary’s
On May 19, 1999, the state of California, the controller and insurance commissioner of the state of California filed a class action suit in the state court in Sacramento. Initially, the action sought to certify as a class of defendants all title and escrow companies doing business in California from 1970 to the present, including certain of the Company’s subsidiaries. The plaintiffs allege that the defendants: failed to give unclaimed property to the state of California on a timely basis; charged California home buyers and other escrow customers fees for services that were never performed or which cost less than the amount charged; and devised and carried out schemes, known as earnings credits, with financial institutions to receive interest on escrow funds deposited by defendants with financial institutions in demand deposits.
Subsequent to the filing of this lawsuit, First American Title Insurance Company, a subsidiary of the Company, was named and served as a defendant in two private class actions in California courts. The allegations in those actions include some, but not all, of the allegations contained in the lawsuit discussed above. The private
Out of the 16 current-year acquisitions, the largest was Credit Management Solutions, Inc. (CMSI), a provider of credit automation software and services in a stock-for-stock transaction. As a result of the acquisition, CMSI shareholders received 0.2841 newly issued shares of the Company’s common stock for each CMSI share. The Company issued 2,272,542 shares of common stock. The purchase price was allocated to the assets acquired and liabilities assumed based on the estimated fair values and $46.9 million in goodwill was recorded. CMSI is included in the Company’s consumer information and services segment.
The 15 remaining acquisitions were individually not material and are included in the following business segments; 12 in the title insurance segment, 2 in the real estate information services segment and 1 in the consumer information segment. Their aggregate purchase price was $20.8 million in cash, $12.0 million in notes and 1,208,942 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 $50.3 million in goodwill was recorded. Goodwill is being amortized on a straight-line basis over its estimated useful life ranging from 20 to 30 years, except as impacted by SFAS No. 142. The operating results of these acquired companies were included in the Company’s consolidated financial statements from their respective acquisition dates.
Effective May 14, 1999, the Company completed its merger of National Information Group (NAIG). Under the terms of the definitive merger agreement, each of the NAIG shareholders received .67 of a share of the Company’s common stock for each NAIG common share they owned. To complete the merger, the Company issued 3,004,800 shares, in exchange for 100% of the outstanding common stock of NAIG. The information services provided by NAIG include outsourcing services, flood zone determination services, real estate tax tracking, hazard and motor vehicle insurance tracking, lender-placed insurance and flood insurance. This merger was accounted for under the pooling-of-interests method of accounting and, as a result, the Company has restated all previously reported results to reflect this merger. 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 $0.10 per diluted share. These nonrecurring charges include severance payments, lease terminations and consulting services.
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 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 home owners against defects in home fixtures; automotive insurance tracking and other services; resident screening; pre-employment screening; substance abuse management and testing; property and casualty insurance; trust and banking services; investment advisory and other related services.
The title insurance and real estate information segments operate through networks of offices nationwide. The Company provides its title services through both direct operations and agents throughout the United States. It also offers title services in Australia, the Bahama Islands, Canada, England, Guam, Ireland, Mexico, Puerto Rico, Scotland, South Korea, the U.S. Virgin Islands and other countries abroad. To date, the international title operations have not been material to the Company’s financial condition or results of operations. The consumer information segment provides home warranty services in 19 states throughout the United States. Trust, banking
Corporate consists primarily of unallocated interest expense, minority interests, equity in earnings of affiliated companies and personnel and other operating expenses associated with the Company’s Home Office facilities.
Amount represents net $1,000,000 in purchase accounting adjustments and $2,471,000 reclassification from the reserve for assets acquired in connection with claim settlements.