The majority of the branch offices of the Company are leased from third parties. The remainder are owned by the Company or leased from partnerships in which the Company has an interest or leased from affiliates.
As of December 31, 1998, the Company leased office and storage spaces as follows:
should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein:
- --------------- (1) During 1994, the Company recognized a $2.4 million extraordinary gain, net of related income taxes of $1.3 million, related to the early retirement of $48 million maturity value of the Company's Liquid Yield Option Notes (the "LYONs").
(3) The Company acquired Nations Title Inc. and its wholly-owned subsidiaries Nations Title, Nations New York and National on April 1, 1996. See Management's Discussion and Analysis of Financial Condition and Results of Operations. The selected financial data above includes the balance sheet accounts of Nations Title Inc. and subsidiaries at December 31, 1998, 1997 and 1996 and the results of its operations for the years ended December 31, 1998, 1997 and for the nine-month period ended December 31, 1996.
(4) The selected financial data above includes the balance sheet accounts and results of operations of ATC as a wholly-owned subsidiary as of December 31, 1996, 1995 and 1994 and for the six-month period ended June 30, 1997 and for the years ended December 31, 1996, 1995 and 1994, and ATC's activities as an agent for the six-month period ended December 31, 1997 and for the year ended December 31, 1998.
On July 3, 1997, the Company converted an outstanding note balance in conjunction with the exercise of warrants into a 51% ownership interest of National Alliance Marketing Group ("National Alliance"). The Company acquired the outstanding minority interest in National Alliance on August 14, 1998. The selected financial data above includes the Company's interest in the balance sheet accounts of National Alliance at December 31, 1998 and 1997 and the Company's interest in the results of operations for the year ended December 31, 1998 and for the period from July 3, 1997 through December 31, 1997.
(5) The Company acquired Granite Financial, Inc. and subsidiaries ("Granite") on February 26, 1998. This acquisition has been accounted for as a pooling-of-interests. The selected financial data above includes the balance sheet accounts of Granite at December 31, 1998, 1997 and 1996 and the results of its operations for the years ended December 31, 1998, 1997 and 1996. Granite's financial position and results of operations for the years ended December 31, 1995 and prior were insignificant, and as such, the selected financial data above has not been restated for prior years.
(6) The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") on May 14, 1998. This transaction has been accounted for as a reverse merger of Micro General into the Company. The selected financial data above includes the balance sheet accounts of Micro General at December 31, 1998 and the results of its operations for the period from May 14, 1998 through December 31, 1998.
(8) Percentage return on average equity is net earnings for the period divided by the simple average of total stockholders' equity as of the beginning and end of each year presented.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments" and Note B of Notes to Consolidated Financial Statements.
The following table sets forth certain financial and other data for the years indicated:
- --------------- (1) Percentage return on average equity is net earnings for the period divided by the simple average of total stockholders' equity as of the beginning and end of each year presented.
Title insurance revenue is closely related to the level of real estate activity and the average price of real estate sales. Real estate sales are directly affected by the availability of funds to finance purchases, i.e., mortgage interest rates. Other factors affecting real estate activity include demand, family income levels and general economic conditions. While the level of sales activity was relatively depressed in certain geographical areas during the period 1991 through mid-1993, lower mortgage interest rates beginning in the latter part of 1991 triggered an increase in refinancing activity which continued at then record levels through 1993 and into the first quarter of 1994. During 1994 and early 1995, steady interest rate increases caused by actions taken by the Federal Reserve Board resulted in a significant decline in refinancing transactions and a stagnation in residential resales and new home sales. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a favorable effect on the level of real estate activity, including refinancing transactions, new home sales and resales. The overall economic environment, stable mortgage interest rates and strength in the real estate market, especially in California and on the West Coast, contributed to very positive conditions for the industry throughout 1996, 1997 and 1998. It is impossible to predict in what future direction interest rates and the real estate market may move or fluctuate.
During 1995 and prior, the majority of the Company's total title-related revenue was generated from direct operations. The Company traditionally focused on direct operations because it retains the entire premium from each transaction and is better able to generate additional revenues by promoting and cross- selling other title-related services. In 1996, the Company continued the implementation of its strategy to become a leading national title underwriter by expanding into other markets and diversifying its premium revenue base to a more balanced mix of direct and agency operations.
On April 1, 1996, the Company completed its acquisition of the Nations Title Inc. group of companies. The acquisition positioned Fidelity National Financial, Inc. as the nation's fourth largest title insurance underwriter. Nations Title Inc. and its three wholly-owned underwriting subsidiaries, Nations Title Insurance
Company (which was subsequently merged into Fidelity Title), Nations Title Insurance of New York Inc. and National Title Insurance of New York Inc., expanded the Company's national agency network and increased its market share in the more traditional agency driven states. The Nations Title Inc. acquisition resulted in additional agency business and a shift in the mix of business from direct to agency during 1996. The revenue and expense information presented in Management's Discussion and Analysis of Financial Condition and Results of Operations includes the Nations Title Inc. group's results of operations for the nine-month period ended December 31, 1996 and for the years ended December 31, 1997 and 1998. In 1996, the total title-related revenue (excluding interest and investment income and non-title-related other fees and revenue) generated by agency operations increased to 41.3% from 32.4% in 1995.
Also, during 1996 and 1997, the Company acquired certain ancillary service companies in various separate transactions. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. The acquired ancillary service companies have been bundled with other existing lender services to form Fidelity National Lender Express Network ("FLEXNet"). FLEXNet provides a complete range of real estate transactional services, leading to a broader base of services provided and increased other fees and revenue.
The following table sets forth information regarding title-related revenue derived from direct and agency operations:
The Company's strategies are to (i) maximize operating profits by increasing its share of the title insurance business in the markets it serves; (ii) effectively manage operating expenses through the real estate cycle; (iii) minimize net claim payments and (iv) continue to implement a value-added acquisition and diversification strategy. The Company intends to execute these strategies by continuing to implement the following elements:
Total revenue in 1998 increased 49.3% to $1,288.5 million from $863.1 million in 1997. Revenue in 1997 of $863.1 million reflected a 17.5% increase from 1996 revenue of $734.8. The increases in total revenue are primarily the result of strength in the Company's core title and real estate related operations, which were positively impacted by favorable market conditions leading to an increase in real estate activity. The increased real estate activity, combined with acquisitions of ancillary service companies and the integration of those service operations into the Company's core businesses, also contributed to the increased revenues. Results of operations in 1997 also include a full year of operations of Nations, which was acquired in April 1996.
Title insurance premiums, increased by 47.8% to $910.3 million in 1998 from $616.1 million in 1997. In 1997, title premiums increased by 11.4% to $616.1 million from $552.8 million in 1996. The increases in title premiums reflect the favorable real estate market and a significant increase in title premiums from agency operations resulting primarily from the Nations Title Inc. acquisition in 1996. Prior to the acquisition of the Nations Title Inc. group of companies, which was completed on April 1, 1996, the Company generated the majority of its title premiums from its network of direct operations as opposed to agency relationships, the latter being more common in the title industry. The acquisition of the Nations group of companies increased
Other fees and revenue trend closely with the level and mix of business, as well as the performance of certain of the Company's title-related subsidiaries. During 1996 and 1997, the Company acquired certain ancillary service companies in various separate transactions. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. The Company's strategy in making the ancillary service company acquisitions was to acquire previously existing entities in businesses it believed to be complementary to its core title and escrow businesses. Further, the Company sought to acquire companies with strong management and efficient operations in order to provide for a seamless transition from their being stand-alone operations to being subsidiaries of the Company and to prevent any disruption of the acquired companies' businesses, while minimizing integration costs. The integration of the ancillary service companies continues as expected and integration related costs have been negligible. The acquired ancillary service companies have been bundled with other existing lender services to form Fidelity National Lender Express Network ("FLEXNet"). Utilizing its extensive network of direct operations as its primary distribution channel and FLEXNet as the platform to provide a comprehensive network of real estate related services, the Company has made a concerted effort to develop the ancillary service contribution to title and real estate related revenue. The Company has been able to leverage its core title and escrow businesses, national presence and proprietary technology in successfully expanding the market presence of its ancillary service businesses. FLEXNet provides a complete range of real estate transactional services, leading to increased other fees and revenues in 1998 as compared to 1997 and in 1997 compared to 1996. 1998 other fees and revenue were $208.3 million, an increase of $83.2 million, or 66.4%, over 1997 other fees and revenue of $125.1 million. In 1997, other fees and revenue increased $33.5 million, or 36.6%, to $125.1 million from $91.6 million in 1996. The year over year increases are primarily attributable to the growth of the ancillary service businesses.
Interest and investment income levels are primarily a function of securities markets, interest rates and the amount of cash available for investment. 1998 investment income increased $3.8 million, or 10.6%, to $39.6 million compared to $35.8 million in 1997. Average invested assets, excluding real estate, increased 28.6% to $482.5 million in 1998 from $375.1 million in 1997, while the tax equivalent yield remained at 5.5%. The increase in investment income in 1998 over 1997 is primarily the result of an increase in interest and dividend income generated by the increased invested asset base. Net realized gains from the sale of investment securities and other assets in 1998 were $17.2 million compared to $16.8 million in 1997. Included in 1998 net realized gains is a gain from the conversion of the Company's investment in Data Tree Corporation of approximately $9.7 million. The Company shifted the emphasis in its fixed income portfolio from taxable to non-taxable securities during 1997. During 1997, interest and investment income increased 86.2% to $35.8 million from $19.2 million in 1996. Average invested assets, excluding real estate, increased $71.2 million, or 23.4%, to $375.1 million in 1997 from $303.9 million in 1996. The difference in investment income is primarily attributable to increased capital gains in 1997 compared to 1996. During 1997, the Company recognized $16.8 million of capital gains compared to $2.5 million of capital gains recorded in 1996. The primary components of 1997 capital gains, prior to applicable income taxes, are the following: $10.4 million in
The Company's operating expenses primarily consist of personnel costs and other operating expenses which are incurred as orders are received and processed. Title insurance premiums, escrow fees and other fees and revenue are generally recognized as income at the time the underlying transaction closes. Certain other fees and revenue are recognized over the period the related services are provided. As a result, revenue lags approximately 60-90 days behind expenses and therefore gross margins may fluctuate.
The 1996 addition of Nations Title Inc. title premiums, which are primarily agency-related, has provided a balance between direct operation and agency revenue. In previous periods the majority of title premiums and
total revenue were generated by direct operations, which resulted in higher personnel costs and other operating expenses.
The provision for claim losses includes an estimate of anticipated title claims and major claims. The estimate of anticipated title claims is accrued as a percentage of title premium revenue based on the Company's historical loss experience and other relevant factors. The Company monitors its claims experience on a continual basis and adjusts the provision for claim losses accordingly. Based on Company loss development studies, the Company believes that as a result of its underwriting and claims handling practices, as well as the refinancing business of prior years, the Company will maintain the trend of favorable claim loss experience. Based on this information, in 1998, 1997 and 1996, the Company recorded a provision for claim losses of 7.0% of title insurance premiums prior to major claim expense, net of recoupments and prior to the impact of premium rates and Company loss experience in the state of Texas. Premiums in Texas are all-inclusive and include a closing fee in addition to a risk-related premium, which differs from similar coverage in other states, while loss experience is comparable. As a result, the provision for claim losses in Texas is much lower than in states that do not have all-inclusive premiums. These factors resulted in a net provision for claim losses of 6.5%, 6.7% and 6.6% in 1998, 1997 and 1996, respectively.
Interest expense is incurred by the Company in financing its capital asset purchases, lease originations, certain acquisitions and certain general corporate purposes. Interest expense consists of interest related to the Company's outstanding debt and the amortization of original issue discount and debt issuance costs related to the Liquid Yield Option Notes due 2009 ("LYONs") issued in February 1994. Interest expense on non-LYONs debt totalled $12.8 million, $7.0 million and $6.4 million for the years 1998, 1997 and 1996, respectively. The LYONs-related component of interest expense amounted to $4.2 million, $5.3 million and $5.2 million for 1998, 1997 and 1996, respectively. Included in 1998 interest expense is $4.7 million of interest relating to the settlement of an Internal Revenue Service examination for the tax years 1990 through 1994. Excluding the interest expense related to the tax examination, the fluctuation in interest expense can be attributed to an increase in non-LYONs debt outstanding offset by more favorable interest rates in 1998 than 1997, and improved rates in 1997 compared to 1996. See "Extraordinary Item" and "Recent Developments."
Income tax expense for 1998, 1997 and 1996, as a percentage of earnings before income taxes, including the extraordinary losses in 1997 was 39.7%, 42.8% and 39.4%, respectively. See "Extraordinary Item." The fluctuations in income tax expense as a percentage of earnings before income taxes, including the extraordinary item, are attributable to the effect of state income taxes on the Company's wholly-owned underwritten title companies and ancillary service companies; a change in the amount and characteristics of net income, operating income versus investment income; and the tax treatment of certain items. See Note I of Notes to Consolidated Financial Statements for additional information regarding income taxes.
In February 1994, the Company issued zero coupon, convertible subordinated Liquid Yield Option Notes due February 2009 at an interest rate of 5.5% with a principal amount at maturity of $235,750,000. Net proceeds to the Company were approximately $101,000,000. The proceeds were used for investment and general corporate purposes, including the repurchase of treasury shares. The amount of LYONs outstanding on December 31, 1998 was $124,113,000 of maturity value. On January 13, 1999, the Company announced that it was going to redeem, pursuant to the terms of the indenture, its outstanding Liquid Yield Option Notes
SEASONALITY. Historically, the greatest volume of residential resale activity has occurred in the spring and summer months. However, events during the past five years, including numerous actions taken by the Federal Reserve Board, have caused unusual fluctuations in real estate activity, particularly in the seasonal pattern of resale and refinance activity. The Company cannot predict whether the historical pattern of resale and refinance activity will continue to be affected by such outside factors.
On July 22, 1997, the Company purchased 1,000,000 shares of common stock of GB Foods Corporation, now known as Santa Barbara Restaurant Group ("SBRG"), which represented approximately 15.5% of the outstanding common stock of SBRG for a purchase price of $5.0 million. Additionally, the Company purchased warrants to acquire an additional 3,500,000 shares of SBRG at various prices ranging from $5.00 - $7.50 for a purchase price of $800,000; 1,500,000 warrants exercisable at $5.00 per share, 1,000,000 warrants exercisable at $7.00 per share and 1,000,000 warrants exercisable at $7.50 per share. In conjunction with the common stock purchase, the Company gained control of three seats on the SBRG Board of Directors. During 1998, the Company exercised 1,000,000 of the $5.00 warrants in conjunction with an acquisition by SBRG in order to provide SBRG additional capital. In addition, on December 31, 1998, the Company exchanged certain investments in restaurant common stocks with a combined value of $9.45 million for an additional 2,478,000 shares of SBRG. The Company now owns approximately 31.1% of SBRG. The Company's investment in SBRG is accounted for under the equity method. See Note C of Notes to Consolidated Financial Statements.
On October 17, 1997, the Company in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs). The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock (the "Exchange Shares"). The Company also paid Merrill Lynch the excess of a base price of $19.53 per Exchange Share over the actual sales price (less $0.05 per share in commissions) realized by Merrill Lynch for sales of up to 607,881 Exchange Shares. The Company also paid Merrill Lynch, for each day, an amount in cash to be determined by multiplying the Net Carry Amount (number of Exchange Shares multiplied by $19.53) by the Applicable Rate (LIBOR plus 2.50%). The Company's payment obligations were subject to reduction for dividends on Exchange Shares received by Merrill Lynch during the period. The Company paid the foregoing amounts to Merrill Lynch in cash of approximately $790,000 on November 7, 1997. The purchase of the LYONs increased stockholders' equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. Additionally, an extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, was recorded in the fourth quarter of 1997. The maturity value of LYONs outstanding at December 31, 1998 was approximately $124,113,000.
The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") for 4.6 million shares of Micro General common stock, valued at $1,297,000, on May 14, 1998. ACS provides small to medium size businesses within the real estate industry with software, systems integration and communication services including telecommunications hardware, long distance reselling, computer hardware and system software reselling, consulting services, technical services, internet services, electronic commerce and title and escrow software applications. ACS will continue to provide the above listed services to the Company at preferred customer rates. This transaction has been accounted for as a reverse merger of Micro General into the Company. The Company currently owns 70.6% of Micro General Corporation. See Note B of Notes to Consolidated Financial Statements.
The Company's Board of Directors declared a cash dividend of $.07 per share on March 17, 1999, which will be payable on May 28, 1999 to stockholders of record on April 9, 1999.
On March 17, 1999, the Company's Board of Directors approved an increase to the number of shares of outstanding Company common stock authorized for purchase under the Company's previously announced purchase program. The new authorization will permit the Company to purchase up to 4.0 million shares. Through March 25, 1999, the Company has purchased 1,202,050 shares at an average purchase price of $16.61 per share totalling $19,960,000. Purchases may be made from time to time by the Company in the open market or in block purchases or in privately negotiated transactions depending on market conditions and other factors.
statement, but requires that an enterprise display an amount representing total comprehensive earnings for the period covered by that financial statement. SFAS 130 requires an enterprise to (a) classify items of other comprehensive earnings by their nature in a financial statement and (b) display the accumulated balance of other comprehensive earnings separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS 130 became effective for fiscal years beginning after December 15, 1997. The adoption of SFAS 130 has not had a material impact on the Company's financial reporting.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of SFAS 133 is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this statement. The Company does not believe the adoption of SFAS 133 will have a material impact on its financial reporting.
We have audited the Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related Consolidated Statements of Earnings, Comprehensive Earnings, Stockholders' Equity and Cash Flows for each of the years in the three-year period ended December 31, 1998. These Consolidated Financial Statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these Consolidated Financial Statements based on our audits.
In our opinion, the Consolidated Financial Statements referred to above present fairly, in all material respects, the consolidated financial position of Fidelity National Financial, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998 in conformity with generally accepted accounting principles.
KPMG LLP Los Angeles, California February 17, 1999, except as to Note Q to the Consolidated Financial Statements, which is as of March 25, 1999
- --------------- (1) Net of income tax expense (benefit) of ($1,059), $15,214, and $5,070 for 1998, 1997 and 1996, respectively.
(2) Net of income tax expense of $6,824, $7,207, and $975 for 1998, 1997 and 1996, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Fidelity National Financial, Inc., through its principal subsidiaries (collectively, the "Company"), is one of the largest national underwriters engaged in the business of issuing title insurance policies and performing other real estate related services such as escrow, collection and trust activities, real estate information and technology services, trustee sale guarantees, credit reporting, attorney services, flood certification, tax monitoring, home warranty insurance, reconveyances, recordings, foreclosure publishing and posting services and exchange intermediary services in connection with real estate transactions. Title insurance services are provided through the Company's direct operations and otherwise through independent title insurance agents who issue title policies on behalf of the underwriting subsidiaries. Title insurance is generally accepted as the most efficient means of determining title to, and the priority of interests in, real estate in nearly all parts of the United States. Today, virtually all real property mortgage lenders require their borrowers to obtain a title insurance policy at the time a mortgage loan is made or to allow the sale of loans in the secondary market.
Fidelity Title was the parent company of Fidelity National Title Insurance Company of Tennessee ("Fidelity Tennessee"), Fidelity National Title Insurance Company of California ("Fidelity California") and Nations Title Insurance Company ("Nations Title"). Fidelity Tennessee, Fidelity California and Nations Title were merged into Fidelity Title on December 31, 1998, August 7, 1997 and December 29, 1997, respectively. Fidelity New York is the parent company of Nations Title Insurance of New York Inc. ("Nations New York") and National Title Insurance of New York Inc. ("National"). Fidelity National Title Insurance Company of Pennsylvania ("Fidelity Pennsylvania") was merged into Fidelity New York as of April 11, 1997, which in turn, was the parent company of American Title Insurance Company ("ATIC"), which was merged into Fidelity Pennsylvania as of November 21, 1996.
On February 26, 1998, the Company, in exchange for approximately 5.0 million shares of Company common stock plus cash in lieu of fractional shares, acquired the common stock of Granite Financial, Inc. and subsidiaries. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $26.08 on February 26, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Granite.
Granite previously reported its results of operations based on a fiscal year ended June 30. Granite's fiscal year has been converted to a calendar year in order to conform to that of the Company.
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income on a trade date basis. Unrealized gains or losses on bonds and common stocks which are classified as available for sale, net of applicable deferred income taxes (benefits), are excluded from income and credited or charged directly to a separate component of stockholders' equity. If any unrealized losses on bond or common stocks are deemed other than temporary, such unrealized losses are recognized as realized losses.
Leases and residual interests in securitizations includes direct financing leases, direct financing leases assigned to lender and residual interests in securitizations. See Note D.
Gains or losses resulting from sales of leases are recognized in the accompanying Consolidated Statements of Earnings at the date of sale and are based on the difference between the selling price of the sales and the carrying value of the related leases sold. Nonrefundable fees and direct costs associated with the origination of leases are deferred and recognized when the leases are sold.
On January 1, 1997, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"). Under SFAS 125, a transfer of financial assets in which control is surrendered is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. Liabilities and derivatives incurred or obtained by the transfer of financial assets are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the transferred assets must be measured by allocating the previous carrying value between the asset sold and the interest retained, if any, based on their relative fair values at the date of transfer.
Residual interests in securitizations ("Residuals") of lease receivables in trust are recorded as a result of the sale of lease receivables through securitization. The securitizations are generally structured as follows: First, the Company sells a portfolio of lease receivables to a special purpose entity ("SPE") which has been established for the limited purpose of buying and reselling the Company's lease receivables. Next, the SPE transfers the same lease receivables to a Trust (the "Trust"), and the Trust in turn issues interest-bearing asset-backed securities (the "Bonds and Certificates") generally in an amount equal to the aggregate initial principal balance of the lease receivables, multiplied by an advance rate. The Company typically sells these lease receivables at face value and with limited recourse relating to defaulted loans, prepayments and certain representations and warranties provided by the Company to the Trust. One or more investors purchase these Bonds and Certificates and the proceeds from the sale of the Bonds and Certificates are used as consideration to purchase the lease receivables from the Company.
The excess of the cash received by the Company over the allocated cost of the lease receivables sold less transaction costs, equals the net gain on sale recorded by the Company.
Leases are collateralized by the equipment under lease, and lessees generally are required to personally guarantee lease payments. The Company's risk of loss is partially mitigated by recovering collateral and enforcing guarantees. However, the resale value of leased equipment generally declines at a rate greater than the principal of the lease. As a result, full recovery on defaulted leases is not usually possible.
Lease acquisition costs consist of broker bonuses and commissions paid upon the origination of the lease contracts. The costs are included in direct financing leases and are amortized to expense over the life of the related lease contracts on the interest method.
The fair values of financial instruments presented in the applicable notes to the Company's Consolidated Financial Statements are estimates of the fair values at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessarily indicative of amounts the Company could realize or settle currently. The Company does not necessarily intend to dispose of or liquidate such instruments prior to maturity. See Notes C, D, E and H.
The Company's reserve for claim losses includes known claims as well as losses the Company expects to incur, net of recoupments. Each known claim is reserved for on the basis of a review by the Company as to the estimated amount of the claim and the costs required to settle the claim. Reserves for claims which are incurred but not reported are provided for at the time premium revenue is recognized based on historical loss experience and other factors, including industry averages, claim loss history, current legal environment, geographic considerations and type of policy written. The occurrence of a significant major claim (those greater than $500,000) in any given period could have a material adverse effect on the Company's financial condition and results of operations for such period. See Note J.
Title insurance premiums, escrow fees and certain other fees and revenue are recognized as revenue at the time of closing of the related transaction as the earnings process is considered complete. Certain other fees and revenue are recognized over the period the related services are provided. Title insurance commissions earned by the Company's agents are recognized as an expense concurrently with premium recognition. Other fees and revenue includes revenue derived from Granite's operations, as well as non-title related revenue from other subsidiaries and other title-related revenue not included in title insurance premiums or escrow fees.
On December 11, 1996, the Company declared a 10% stock dividend to shareholders of record on December 23, 1996, distributed January 7, 1997. The Company declared a 10% stock dividend on December 17, 1997 to shareholders of record on December 29, 1997, distributed January 14, 1998. On December 13, 1998, the Company declared a 10% stock dividend to shareholders of record on December 28, 1998, distributed January 12, 1999. The par value of the additional shares of common stock issued in connection with the stock dividends was credited to common stock and a like amount charged to retained earnings as of December 31, 1998, 1997 and 1996, respectively. Fractional shares were paid in cash.
Basic earnings per share is computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during the period. Dilutive earnings per share is calculated by dividing net earnings available to common shareholders plus the impact of assumed conversions of dilutive potential securities. The Company has granted certain options and warrants which have been treated as common share equivalents for purposes of calculating diluted earnings per share. The Liquid Yield Option Notes ("LYONs") are considered other dilutive securities for purposes of calculating diluted earnings per share to the extent that they are not antidilutive.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the National Alliance acquisition were as follows (dollars in thousands):
On March 31, 1997, Granite acquired the assets and liabilities of Global Finance & Leasing, Inc. ("Global"), a micro-ticket leasing company, for a purchase price of $2.3 million in cash. The acquisition
On August 22, 1997, the Company acquired the common stock of First Title Corporation ("First Title"), a title company with fourteen offices throughout the southeastern United States. First Title has been merged into a subsidiary of the Company. First Title was acquired for $4.7 million; payable in 80% common stock of the Company (278,738 shares or $3.8 million) and 20% cash (approximately $900,000). This transaction has been accounted for as a purchase.
Also on October 9, 1997, the Company acquired the common stock of Express Network, Inc. ("ENI"), a provider of attorney services such as courier, messenger, courthouse filing, process serving, investigation and reprographics. ENI provides services to legal firms in Los Angeles, Orange County, San Diego, Riverside and San Francisco, California. The purchase price for ENI was $10.55 million; subject to certain purchase price adjustments based on the combined equity of ENI and CRI, its affiliate, payable in 50% common stock of the Company (332,374 shares or $5.275 million) and 50% cash (approximately $5.275 million). Approximately $2.8 million of the cash portion of the purchase price will be paid in equal installments over a four-year period. This transaction has been accounted for as a purchase.
On December 30, 1997, Granite completed the acquisition of 84% of the common stock of North Pacific Funding, Inc. dba C&W Leasing and its wholly-owned subsidiary CKC Corporation dba US Funding (collectively, "C&W Leasing"). The purchase price for this transaction was $5.1 million, in the form of notes payable to the former stockholders. This transaction has been accounted for as a purchase. The remaining 16% of the common stock of C&W Leasing was purchased on January 5, 1998 for additional consideration of $900,000 in promissory notes payable.
The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") for 4.6 million shares of Micro General common stock, valued at $1,297,000, on May 14, 1998. ACS provides small to medium size businesses within the real estate industry with software, systems integration and communication services including telecommunications hardware, long distance reselling, computer hardware and system software reselling, consulting services, technical services, internet services, electronic commerce and title and escrow software applications. ACS will continue to provide the above listed services to the Company at preferred customer rates. The Company currently owns 70.6% of Micro General Corporation. This transaction has been accounted for as a reverse merger of Micro General into the Company.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Micro General acquisition were as follows (dollars in thousands):
Additionally, on November 17, 1998, Micro General acquired LDExchange.com, Inc. ("LDX"), for a purchase price of $3.1 million, payable $1.1 million in cash and $2.0 million in Micro General common stock (1,000,000 shares). LDX is a facilities based, wholesale carrier providing international telecommunication services.
Selected unaudited pro forma combined results of operations for the years ended December 31, 1998, 1997 and 1996, assuming the National Alliance (51%), Brazoria, Global, SFR, First Title, ICS, CRI, ENI, CCD and C&W Leasing acquisitions occurred on January 1, 1997 and 1996, and assuming the Micro General,
The change in unrealized gains and losses on equity securities for the years ended December 31, 1998, 1997 and 1996 was ($23,443,000), $12,756,000 and $15,214,000, respectively.
Granite's direct financing leases at December 31, 1998 and 1997 consist of the following:
At December 31, 1998, the weighted average implicit rate of interest is approximately 13.0%.
The carrying value of the direct financing leases at December 31, 1998 and 1997 approximated fair value because of the short-term period that these leases are held before sale or securitization or, in certain cases, because the interest rate approximates current market rates. The fair value of the direct financing leases assigned to lender at December 31, 1998 and 1997 approximated the carrying value because the interest rate on the related Class A Term Note approximates current market rates.
The Company has completed six securitization facilities that provide for aggregate funding limits of approximately $354,000,000. Two of the securitization facilities, GF Funding IV and GF Funding V, are revolving facilities.
In April 1996, the Company's wholly-owned subsidiary, GF Funding I, issued $21,689,000 of 6.33% Class A Lease-Backed Term Note ("GFI Note") due November 20, 2001 in a private placement. The GFI Note is collateralized by (i) payments to be made under leases contributed by Granite Financial, LLC to GF Funding I, (ii) all of GF Funding I's rights and interest in the leased equipment, (iii) a cash collateral account (which generally does not increase the overall level of credit enhancement, but rather accommodates changes that may occur from time to time in the form of credit enhancement from excess implicit principal balance of lease receivables to cash) and (iv) a financial guaranty insurance policy. Under the terms of the insurance policy, the monthly payments of interest and final payment of principal and maturity are unconditionally guaranteed. As this securitization was completed through the issuance of a debt security prior to the adoption of SFAS 125, the transaction is accounted for as a collateralized borrowing. Accordingly, the underlying lease assets, recorded as direct financing leases assigned to lender, and the related limited recourse note payable are reflected in the consolidated balance sheet. The underlying assets are comprised of the Company's net investment in the leases of $5,818,000 and $11,902,000 as of December 31, 1998 and 1997, respectively. The related limited recourse note payable was $5,930,000 and $11,719,000 as of December 31, 1998 and 1997, respectively. See Note H.
In November 1996, GF Funding II was formed to establish the Company's second securitization facility. The facility provided for the issuance of up to $65 million in aggregate principal amount of Class A Lease-Backed Certificates due June 20, 2003 (the "1996 Certificates") in a private placement. For purposes of computing interest, the 1996 Certificates are issued in two tranches, consisting of the Floating Rate Tranche and the Fixed Rate Tranche. The principal amount of the Floating Rate Tranche will generally convert to the Fixed Rate Tranche on a quarterly basis. The Floating Rate Tranche bears interest at an annual rate equal to the LIBOR Rate, as adjusted from time to time, plus .50%. The Fixed Rate Tranche bears interest at an annual rate equal to the Treasury Rate, as adjusted form time to time, plus .70%. The annual interest rate on each tranche is subject to a maximum annual rate of 10%. The 1996 Certificates represent an undivided interest in a trust estate created by GF Funding II comprised of (i) payments to be made under leases contributed to GF Funding II, (ii) all of GF Funding II's right and interest in the leased equipment, (iii) a cash collateral account and (iv) a financial guaranty insurance policy. The securitization was fully funded in December 1997. The Company has recorded gains from the sales of leases with respect to this securitization of $5,656,000 and $864,000, respectively, during the years ended December 31, 1997 and 1996.
funded in June 1997. The Company has recorded gains from the sales of leases with respect to this securitization of $1,670,000 during the year ended December 31, 1997.
In March 1998, GF Funding V was formed to establish the Company's fifth securitization facility. The facility provides for the issuance of up to $65 million in aggregate principal amount of Class A Lease-Backed Certificates due April 2005 (the "GFV Certificates") in a private placement. For purposes of computing interest, the GFV Certificates are issued in Fixed Rate Tranches which bear interest at an annual rate equal to the Treasury Rate, as adjusted form time to time, plus 1.20%. The GFV Certificates represent an undivided interest in a trust estate created by GF Funding V comprised of (i) payments to be made under leases contributed to GF Funding V and (ii) all of GF V's rights and interest in the leased equipment. The Company is required to sell a minimum of $15,000,000 in leases to the securitization facility per quarter. The Company has recorded gains from the sales of leases with respect to this securitization of $2,817,000 during the year ended December 31, 1998.
The Company entered into agreements with certain financial institutions to sell, on an ongoing basis, certain leases either on a recourse or non-recourse basis. The purchase price of the leases is determined on a transaction by transaction basis. A gain on sale is recognized on the date of sale based upon the present value of the payments to be received under the lease. The Company retains servicing of all leases under the agreements. During the years ended December 31, 1998, 1997 and 1996, the Company recognized a net gain on sale of leases of $857,000, $1,559,000 and $1,483,000, respectively.
The allowance for doubtful receivables is primarily related to certain promissory notes at December 31, 1998 and 1997. Interest income is not recognized on the Company's non-performing notes receivable. There were no non-performing notes receivable at December 31, 1998.
At December 31, 1998 and 1997, the Company had financial interests ranging from 22% to 50% in three real estate partnerships which were accounted for under the equity method. These partnerships are involved in the ownership and management of commercial office buildings, retail facilities and have acquired specific parcels of real property for investment purposes. The Company, through Manchester Development Corporation ("Manchester"), a wholly-owned subsidiary, had a general partnership interest in one of the three real estate partnerships at December 31, 1998 and 1997.
Two of these partnerships, representing raw land investments, also have officers and directors of the Company as partners with ownership interests that are based on cash contributions. These two partnerships require that all of the partners, including the Company, make pro-rata capital contributions should the partnerships require additional funds to pay liabilities. The carrying value of the Company's interests in these partnerships totalled $1,214,000 and $1,208,000 at December 31, 1998 and 1997, respectively.
At December 31, 1998, the Company had a 92.5% interest in a real estate partnership which is consolidated with the Company. At December 31, 1997, the Company had a 92.5% and 76.3% interest in real estate partnerships consolidated with the Company.
Principal maturities, including accretion of original issue discount, are as follows (dollars in thousands):
Also included in notes payable in the Consolidated Balance Sheets as of December 31, 1998 and 1997 is the Class A Lease-Backed Term Note due 2001. See Note D. The amount due related to the GFI Class A Lease-Backed Term Note was $5,930,000 and $11,719,000 at December 31, 1998 and 1997, respectively. The GFI note bears interest at 6.33% and is due November 2001. The carrying value of the GFI Class A Lease-Backed term note approximates fair value at December 31, 1998 and 1997 due to the fact that the interest rate paid on the GFI Class A Lease-Backed Note approximates market rates.
Notes payable in the Consolidated Balance Sheet as of December 31, 1998 also includes the GFVI Class A Certificates in the amount of $7,878,000 and the Class B Certificates in the amount of $8,128,000. See Note D. The Class A and Class B Certificates bear interest at 6.20%, and are due in September 2005 and December 2005, respectively. The carrying value of the Class A and Class B Certificates approximates fair value at December 31, 1998 due to the fact that the interest rate paid on the Class A and Class B Certificates approximates market rates.
equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. Additionally, an extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, was recorded in the fourth quarter of 1997.
In conducting its operations, the Company routinely holds customers' assets in trust, pending completion of real estate transactions. Such amounts are maintained in segregated bank accounts and have not been included in the accompanying Consolidated Balance Sheets. The Company has a contingent liability relating to proper disposition of these balances for its customers which amounted to $532.2 million at December 31, 1998.
Rent expense incurred under operating leases during the years ended December 31, 1998, 1997 and 1996 was $32,609,000, $29,730,000 and $28,117,000, respectively. Included in rent expense for 1998, 1997 and 1996 is $485,000, $523,000 and $523,000, respectively paid to related parties.
Statutorily calculated net worth determines the maximum insurable amount under any single title insurance policy. As of January 1, 1999, the Company's self-imposed single policy maximum insurable amounts, which comply with all statutory limitations, for Fidelity Title, Fidelity New York and Alamo Title were $60.0 million, $90.0 million and $17.5 million, respectively. The self-imposed single policy maximum insurable amounts for Nations New York and National were $19.0 million and $5.0 million, respectively.
The combined statutory capital and surplus of the Insurance Subsidiaries was $164,953,000, $122,107,000 and $97,845,000 as of December 31, 1998, 1997 and 1996, respectively. The combined statutory earnings of the Insurance Subsidiaries were $37,771,000, $26,701,000 and $12,243,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Pursuant to statutory requirements of the various states in which the Insurance Subsidiaries are domiciled, they must maintain certain levels of minimum capital and surplus. Each of the Company's title underwriters have complied with the minimum statutory requirements as of December 31, 1998.
The UTCs are also subject to certain regulation by insurance regulatory or banking authorities, primarily relating to minimum net worth. Minimum net worth of $7.5 million and $2.5 million is required for Fidelity National Title Company ("FNTC") and Fidelity National Title Company of California ("FNCAL"), respectively. FNTC and FNCAL are in compliance with their respective minimum net worth requirements at December 31, 1998.
In 1992, stockholders approved the adoption of the 1991 Stock Option Plan ("1991 Option Plan"). Under the terms of the 1991 Option Plan, options may be granted to officers and key employees of the Company or any or all of its present or future subsidiaries. The number of shares reserved for issuance under the 1991 Option Plan and subsequent amendments is 1,953,000 shares of common stock, which may be newly issued or treasury shares. The per share option price is determined at the date of grant. The option price may be less than the fair market value of the common stock at the date of grant to reflect the application of the optionee's deferred bonus, if applicable. Options granted under the 1991 Option Plan shall be exercisable in such installments and for such periods as may be fixed at the time of grant, but in no event shall any stock options extend for a period in excess of 12 years from the date of grant.
This plan allows for exercise prices with a fixed discount from the quoted market price. 115,169 options were granted in 1996 at an exercise price of $9.39 to key employees of the Company who applied deferred bonuses expensed in 1995 amounting to $433,000 to the exercise price, reducing it to $5.64 if exercised within the first year of the grant. The exercise price of these options decreases approximately 5.0% per year through 2001 and $.16 per share from 2002 through 2007, at which time the exercise price will be $3.31. In 1997, 201,169 options were granted at an exercise price of $10.44 to key employees of the Company who applied deferred bonuses expensed in 1996 amounting to $876,000 to the exercise price, reducing it to $6.30 if exercised within the first year of the grant. The exercise price of these options decreases approximately 7% per year through 2002 and $.18 per share from 2003 through 2008, at which time the exercise price will be $3.74. In 1998, 388,123 options were granted at an exercise price of $24.26 to key employees of the Company who applied deferred bonuses expensed in 1997 amounting to $1,764,000 to the exercise price, reducing it to $19.72 if exercised within the first year of the grant. The exercise price of these options decreases approximately 7% per year through 2003 and $.20 per share from 2004 through 2009, at which time the exercise price will be $16.90. Additionally, the Company recorded compensation expense relating to the price decrease of $282,000, 194,000 and $111,000, for the years ended December 31, 1998, 1997 and 1996, respectively.
Purchase Rights may be granted to employees of the Company and its subsidiaries and affiliates, non-employee directors and officers, consultants and other service providers.
The Board of Directors, or a committee consisting of two or more members of the Board of Directors, will administer the 1998 Plan (the "Administrator"). The Administrator will have the full power and authority to interpret the 1998 Plan, select the recipients of options and Purchase Rights, determine and authorize the type, terms and conditions of, including vesting provisions, and the number of shares subject to, grants under the 1998 Plan, and adopt, amend and rescind rules relating to the 1998 Plan. The term of options may not exceed 10 years from the date of grant (5 years in the case of a person who owns or is deemed to own more than 10% of the total combined voting power of all classes of stock of the Company). The option exercise price for each share granted pursuant to an incentive stock option may not be less than 100% of the fair market value of a share of common stock at the time such options is granted (110% of fair market value in the case of an incentive stock option granted to a person who owns more than 10% of the combined voting power of all classes of stock of the Company). There is no minimum purchase price for shares of common stock purchased pursuant to a Purchase Right, and any such purchase price shall be determined by the Administrator. The maximum number of shares for which options or Purchase Rights may be granted to any one person during any one calendar year under the 1998 Plan is 300,000 and in no event shall the aggregate number of shares subject to incentive stock options exceed 1,000,000. The aggregate fair market value of the common stock (determined as of the date of grant) with respect to incentive stock options granted under the 1998 Plan or any other stock option plan of the Company that become exercisable for the first time by any optionee during any calendar year may not exceed $100,000.
A summary of the Company's stock option activity, and related information for the years ended December 31, 1998, 1997 and 1996 is as follows:
The weighted average remaining contractual life of the options outstanding at December 31, 1998 is 7.68 years.
The Company also offers the Fidelity National Financial, Inc. 401(k) Profit Sharing Plan, a qualified voluntary contributory savings plan, available to substantially all employees. Eligible employees may contribute up to 15% of their pretax annual compensation, up to the amount allowed pursuant to the Internal Revenue Code. The Company may elect to make matching contributions. The Company has historically not made matching contributions.
The following supplemental cash flow information is provided with respect to interest and tax payments, as well as certain non-cash investing and financing activities. See Notes B, H and I.
Granite approved contingent fundings of approximately $67,900,000 and $73,200,000 in leases at December 31, 1998 and 1997, respectively.
statements for interim periods in the second year of application. The adoption of SFAS 131 has not had a material impact on the Company's financial reporting.