(4) 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") issued in February 1994. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Extraordinary Item."
(6) This estimate of direct operations market share is based upon the number of title recordings by the Company in the counties where the Company maintains direct operations and excludes title recordings by the Company's agents and excludes title recordings in eastern and southeastern states because such information is not available. The direct operations market share percentage has been weighted to give effect to the Company's related direct revenue in the applicable counties.
The Company's strategy of expanding into selected geographic markets through the acquisition of title insurance operations continued during the last three years. The Company's acquisition strategy includes the restructuring of acquired operations by focusing on direct operations in residential resale and refinance markets, enhancing sales and marketing efforts, minimizing net claim payments through stringent quality controls and effectively managing overhead costs.
Favorable mortgage interest rates in the latter part of 1991 through early 1994 triggered refinancing activity at record levels. Beginning in early 1994 through mid-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. Title orders and requests for title related services followed the market trend as expected. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a positive impact on the level of real estate activity. These factors have resulted in title premiums of $285.6 million, $369.3 million and $429.8 million, for 1995, 1994 and 1993, respectively. The difference in title insurance premiums between 1995 and 1994 of $83.7 million represents a decrease of 22.7%. Title insurance premiums decreased $60.5 million, or 14.1%, in 1994 from 1993.
The average fee per file increased to $790 in 1995 from $750 in 1994, which had previously increased from $710 in 1993. The increase can be attributed to the change in the mix of business from refinance to resale. As mortgage interest rates increased due to the actions taken by the Federal Reserve Board, the refinancing trend ended. Thus, title business that was generated was primarily related to new home sale or resale transactions, which typically charge higher fees than refinancing transactions. Fees generated from refinancing transactions are generally less than fees generated from resale transactions because the base rate charged on such a policy is usually lower. Furthermore, one policy is issued to a lender in a refinance transaction and two policies are issued in a resale transaction (buyer and lender).
Other fees and revenue remained relatively stable during the three year period ended December 31, 1995. During 1995, other fees and revenue decreased $2.4 million, or 4.0%, to $57.0 million from $59.4 million in 1994 and decreased $1.6 million, or 2.6%, to $59.4 million from $61.0 million in 1993. Other fees and revenue were generated at comparable levels in 1995 and 1994, primarily as a result of the type of business in 1995, which was primarily resale business, and the direct operation/agency business mix. See "Overview." Direct operations generate other fees and income. Thus, even in a year when overall title revenue may be down, the level of other fees and revenue can be maintained, depending on the direct operation/agency business mix. The consistency between years is primarily attributable to the nature of the revenues included and the current title insurance market environment which has shifted from a refinance to a resale oriented market. See "Recent Developments." In a resale transaction, other fees and revenues are greater than in a refinancing transaction.
In 1994, interest and investment income decreased 19.0%, or $2.8 million, to $11.9 million from $14.7 million in 1993. The tax adjusted yield increased only slightly, to 6.7% in 1994 compared to 6.6% in 1993, while average invested assets, excluding real estate, increased 41.2%, or $88.6 million, to $303.6 million in 1994 from $215.0 million in 1993. The difference in investment results is attributable to the net capital gain (loss) activity between the years. In 1994, the Company recognized $3.1 million of net capital losses. Included in this amount is $2.6 million of capital losses recognized in December 1994. During December 1994, the Company sold certain investments, totalling approximately $38.2 million, in order to reinvest the proceeds in higher yielding investment instruments and to fund the early retirement of the Company's LYONs at favorable market prices. See "Extraordinary Item." $4.2 million of capital gains realized on the sale of assets, primarily fixed maturity and equity securities, are included in interest and investment income for the 1993 year. See Note C of Notes to Consolidated Financial Statements.
Personnel costs include both base salaries and commissions paid to employees and are the most significant operating expense incurred by the Company. Personnel costs totalled $165.5 million, $182.0 million and $196.5 million for the years ended December 31, 1995, 1994 and 1993, respectively. These costs generally fluctuate with the level of direct orders opened and closed, and with the fluctuation in revenue between direct and agency operations. See "Overview" and "Revenue." Personnel costs, as a percentage of total revenue, have increased to 40.4% in 1995 from 36.9% in 1994, which had previously increased from 34.1% in 1993. These increases in personnel costs as a percentage of total title revenue can be attributed to the fluctuating market conditions in the title insurance industry. The Company has taken significant measures to maintain appropriate personnel levels and costs relative to the volume of business and revenues, as indicated by the $16.5 million, or 9.1% reduction in personnel costs between 1995 and 1994, and the $14.5 million, or 7.4%, reduction in personnel costs in 1994 as compared to 1993. The Company will not, however, compromise its customer service standards or quality controls in responding to market conditions. The Company continues to
Other operating expenses primarily consist of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums and title related revenue in lieu of franchise and other state taxes), escrow losses, courier services, computer services, professional services, general insurance, trade and notes receivable allowances and depreciation. Other operating expenses increased as a percentage of total revenue to 30.2% in 1995 from 26.3% in 1994, which had previously increased from 23.6% in 1993. In response to market conditions, the Company implemented aggressive cost control programs in order to reduce operating expenses to levels consistent with the levels of title related revenue, however, certain fixed costs are incurred regardless of revenue levels, thus, resulting in the year over year percentage increases. The Company continues to be committed to these cost control measures. Total other operating expenses have decreased $5.5 million, or 4.3%, to $123.9 million in 1995 from $129.4 million in 1994. In 1994 operating expenses decreased $6.5 million, or 4.8%, from $135.9 million in 1993. See "Overview."
Interest expense is incurred by the Company in financing its capital asset purchases and certain of its acquisitions. 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 LYONs issued in February 1994. Interest expense on "non-LYONs" debt totaled $4.3 million, $3.8 million and $2.6 million for the years 1995, 1994 and 1993, respectively. The LYONs related component of interest expense amounted to $4.9 million and $4.8 million for 1995 and 1994, respectively. Interest expense increased in 1995 over 1994 primarily as a result of an increase in the average outstanding balance of a certain subsidiary's equipment outstanding debt and increases in the prime interest rate, to which certain of the interest rates paid by the Company are indexed. See "Recent Developments." Interest expense and amortization expense increased in 1994 over 1993 as a result of the LYONs offering and due to the $22.5 million of Senior Secured Notes issued in a private placement in March 1993, in connection with the acquisition of Fidelity New York (formerly Security Title and Guaranty Company) which were outstanding the entire period. See Note B of Notes to Consolidated Financial Statements. Furthermore, an increase in the average outstanding balance of a subsidiary's equipment line of credit and increasing interest rates also resulted in increased interest expense in 1994 over 1993.
Income tax expense for 1995, 1994 and 1993, as a percentage of earnings before income taxes, including the extraordinary loss in 1995 and extraordinary gain in 1994, was 16.9%, 24.2% and 30.9%, respectively. See "Extraordinary Item." The decrease in income tax expense as a percentage of earnings before income taxes, including the extraordinary item is attributable to a change in the mix of net income. In 1995 and 1994, investment income, including net capital gains (losses), represented the significant component of net income. In 1993, net income consisted of operating and investment income in relatively equal proportions. Based on the characteristics of the investment income, which includes a significant amount of tax exempt income, the
EXTRAORDINARY ITEM. In order to reduce interest expense incurred and interest rates paid, the Company prepaid the Senior Secured Notes (the "Senior Notes") issued in March 1993. Pursuant to the terms and conditions of the Senior Note Agreement, the Company provided for the Make Whole Provision, as defined, and related expenses in 1995. This amount, $1.25 million, before related income taxes, has been reflected as an extraordinary item in the Consolidated Statements of Earnings for the year ended December 31, 1995.
The short and long term liquidity requirements of the Company, Insurance Subsidiaries and UTCs are monitored regularly to match cash inflows with cash requirements. The Company, Insurance Subsidiaries and UTCs forecast their daily cash needs and periodically review their short and long term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying these projections.
In order to take advantage of investment market conditions, the Company's tax status and the interest rate environment, during the third quarter of 1995 the Company converted certain investments in tax-exempt fixed maturities to cash and cash equivalents. The Company is in the process of reinvesting these funds in taxable instruments.
general corporate purposes, including the repurchase of treasury shares. See Note G of Notes to Consolidated Financial Statements.
During 1993, the Company acquired from outside lenders substantially all of Manchester's outstanding indebtedness. Additionally, Manchester had not been released from its general partnership obligations under a separate debt agreement of a real estate partnership in which it sold its interest in 1991. The amount outstanding under this agreement totalled $931,000 at December 31, 1995. During 1994, the lender on this project agreed to release Manchester by substituting the buyer as the obligor. No such release has yet been executed. The Company does not believe that Manchester will require additional capital contributions from the Company that will materially impact liquidity, nor will Manchester's operations materially impact the Company's results of operations.
In the normal course of business certain of the Company's subsidiaries enter into off-balance sheet credit risk associated with certain aspects of its title insurance policies and Manchester's real estate activities. This credit risk is in the form of standby letters of credit and general partnership guarantees. The Company believes that this credit risk is adequately secured by either legal remedies associated with settlement procedures or the underlying real estate assets. See "Legal Proceedings" and Notes J and N of Notes to Consolidated Financial Statements.
Recent Accounting Pronouncements. In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115 ("Statement 115"), "Accounting for Certain Investments in Debt and Equity Securities." Statement 115 requires that investments be classified as "held to maturity," "available for sale" or "trading securities." Statement 115 defines investments in securities as "held to maturity" based upon a positive intent and ability to hold those securities to maturity. Investments held to maturity are reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and reported at fair value, with unrealized gains and losses included in operations. Debt and equity securities not classified as "held to maturity" or "trading securities" are classified as "available for sale" and recorded at fair value with unrealized gains and losses excluded from operations and reported as a separate component of stockholders' equity, net of related income tax effect. The Company adopted Statement 115 on January 1, 1994 and the impact on the results of operations and financial position was not material. In November 1995, the Financial Accounting Standards Board Emerging Issues Task Force granted all entities a one-time opportunity to reconsider their ability and intent to hold securities accounted for under Statement 115 as held to maturity. This allows entities to transfer securities from the held to maturity category without "tainting" their remaining held to maturity securities. The Board emphasized that this would be a one-time event. The Company has reassessed the appropriateness of the classifications of securities held and has chosen to reclassify its held to maturity portfolio to available for sale in 1995, in order to provide additional investment portfolio management flexibility. The fair value of the securities transferred from the held to maturity portfolio to the available for sale portfolio totalled $25.5 million and resulted in an unrealized gain of $459,000, before applicable income taxes.
RECENT DEVELOPMENTS. In February 1994, the Company issued zero coupon, convertible subordinated Liquid Yield Option Notes due February 2009 with a principal amount at maturity of $235,750,000 at an interest rate of 5.5%. 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.
On April 21, 1994, the Company acquired all of the capital stock of ACS Systems, Inc. ("ACS"). The adjusted purchase price was 209,370 shares of Company Common Stock ($2.7 million), and certain future considerations of $900,000. ACS is a computer software development company engaged in the development and marketing of trust, escrow and title related software. The transaction has been accounted for as a purchase.
On June 15, 1994, the Company provided to MacFarlane Partners L.P., a registered real estate investment advisor under the Investment Advisor Act of 1940, approximately $5.8 million to finance the acquisition of Mellon/McMahan Real Estate Advisors, Inc. ("Mellon/McMahan") from Mellon Bank N.A. This financing was structured as the purchase of an investment asset, subject to certain put options, acquired from Mellon/McMahan and a secured loan of approximately $3.8 million. In addition, the Company received an interest in MacFarlane Partners. In January 1996, the loan was repaid, and the remaining investment was disposed of for its approximate book value.
On June 14, 1995, the Company acquired certain assets of World Title Company ("World") for a purchase price to be determined based on the collection of certain accounts. In the case of trade accounts receivable acquired, the Company will retain certain percentages of amounts collected subsequent to the acquisition date and will remit the remaining amounts to the Department of Insurance of the State of California (the "Department"). The Company has also acquired the open title orders of World as of the purchase date. The Company will retain certain percentages of amounts collected on open title orders subsequent to the acquisition date and will remit the remaining amounts to the Department.
On August 19, 1995, the Company acquired the common stock of Southern California Title Company, an underwritten title company with operations in Los Angeles County in the state of California. Southern California Title Company was acquired for $2.1 million in cash. The acquired company operates as a subsidiary of the Company in Los Angeles County and is now known as Fidelity National Title Company. The acquisition has been accounted for as a purchase.
On September 14, 1995, the Company announced that it had executed a definitive agreement ("Agreement") with Nations Holding Group to acquire one hundred percent of Nations Title Inc., and its wholly owned subsidiaries Nations Title Insurance Company, Nations Title Insurance Company of New York and National Title Insurance Company of New York (collectively, "Nations Title Inc."), which is the eighth largest title insurer in the United States based on 1994 reported revenue of $297.0 million. Nations Title Inc. recorded revenue of $231.4 million in 1995. The acquisition of Nations Title Inc. is expected to close in the
On September 22, 1995, Fidelity National Financial, Inc. announced that it had reached agreement on the terms of a $35 million credit facility with a banking syndicate led by Chase Manhattan Bank N.A. The facility includes a $22 million term loan and a $13 million revolving credit facility. The $22 million term loan has been used to refinance higher rate indebtedness and for general corporate purposes. The $13 million revolving credit facility is available to fund a portion of the Nations Title Inc. acquisition. The Company is pleased with the level of confidence the banks have in Fidelity's long-term outlook and believes that the willingness of the banks to enter into this $35 million credit facility is an indication of Fidelity's overall financial strength. See Note G of Notes to Consolidated Financial Statements.
On February 14, 1996, the Company offered Giant Group, Ltd. ("Giant") stockholders the right to exchange all of their shares of common stock of Giant for shares of the Company's Common Stock. Giant sent the Company a letter on February 22, 1996, indicating that the Giant Board of Directors had rejected the offer.
The following briefly describes the significant accounting policies of Fidelity National Financial, Inc. ("Fidelity Financial") and its subsidiaries (collectively, the "Company") which have been followed in preparing the accompanying Consolidated Financial Statements.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly owned and majority owned subsidiaries. All material intercompany profits, transactions and balances have been eliminated. The Company's investments in non-majority owned partnerships are accounted for on the equity method.
Fixed maturity securities are purchased to support the investment strategies of the Company, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations and regulatory requirements. Prior to a reassessment of the investment strategy and subsequent reclassification of the held to maturity portfolio in 1995, the Company had the ability and intent to hold those fixed maturity securities which it had on deposit with regulatory authorities, and certain other fixed maturity securities, to maturity and carried them at amortized cost. See Note O. Those fixed maturity securities which may be sold prior to maturity to support the Company's investment strategies are carried at fair value and are classified as available for sale as of the balance sheet dates. Fair values for fixed maturity securities are principally a function of current interest rates and are based on quoted market prices. Care should be used in evaluating the significance of these estimated fair values.
Other long term investments, which consist of investments in limited partnership interests in investment funds, are carried at cost, which approximates fair value.
Short term investments, which consist primarily of securities purchased under agreements to resell, commercial paper and money market instruments, which have an original maturity of one year or less, are carried at amortized cost, which approximates fair value.
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 that are considered temporary, net of applicable deferred income taxes (benefits), are excluded from income and credited or charged directly to a separate component of stockholders' equity. The carrying value for investments in the held to maturity and available for sale categories is reduced to estimated realizable value if the decline in fair value is deemed other than temporary. Such reductions are recognized as realized losses.
Property and equipment are recorded at cost, less depreciation. Depreciation is computed primarily using the straight-line method based on the estimated useful lives of the related assets which range from three to fifty years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the applicable lease or the estimated useful lives of such assets.
If a loss is related to a policy issued by an independent agent, the Company may proceed against the independent agent pursuant to the terms of the agency agreement. In any event, the Company may proceed against third parties who are responsible for any loss under the title insurance policy, under rights of subrogation.
The terms of the Fidelity Pennsylvania (formerly Meridian Title Insurance Company) acquisition provided $31 million of additional claim loss protection for Fidelity Pennsylvania and ATIC policies issued on or before December 31, 1991. As part of the acquisition, Fidelity Pennsylvania paid its former parent company, Meridian Bank, a cash dividend of $11 million and Meridian Bank retained a $20 million investment in ATIC Redeemable Series A Preferred Stock ("ATIC Preferred Stock"). Under certain circumstances, Meridian Bank would be required to repay the Company some or all of the dividend and relinquish some or all of the redemption value of the ATIC Preferred Stock as reimbursement for excess claims incurred by Fidelity Pennsylvania and ATIC over the reserves established at December 31, 1991 for policies issued on or before December 31, 1991. On March 31, 1994, the Company purchased from Meridian Bank the ATIC Preferred Stock for $15.5 million, which represented a discount of approximately $6.2 million. As part of the agreement with Meridian Bank to purchase the ATIC Preferred Stock, the Company released Meridian Bank from its obligations to provide an additional $11 million in claims protection pursuant to the purchase agreement for Fidelity Pennsylvania and ATIC. The Company believes that the loss reserves for Fidelity Pennsylvania and ATIC, when combined with the $6.2 million reduction in the purchase price of the ATIC Preferred Stock, which has been added to reserves for claim losses, will be sufficient to meet pre-1992 policy claims. This $11 million, in addition to the $20 million of ATIC Preferred Stock, had been available as
On December 13, 1995, the Company declared a 10% stock dividend, to shareholders of record on January 15, 1996, distributed February 2, 1996. The par value of the additional shares of Common Stock issued in connection with the stock dividend was credited to common stock and a like amount charged to retained earnings as of December 31, 1995. Fractional shares were paid in cash.
All data with respect to earnings per share, dividends per share and share information, including price per share where applicable, in the following Notes to Consolidated Financial Statements have been retroactively adjusted to reflect the stock dividends and splits.
of $900,000. ACS is a computer software development company engaged in the development and marketing of trust, escrow and title related software. The transaction has been accounted for as a purchase.
The 1994 ACS results of operations were not material to the Consolidated Financial Statements.
On March 8, 1995, the Company acquired the common stock of Western Title Company of Washington, an underwritten title company with operations in King County (Seattle) and Snohomish County (Everett) in the state of Washington. Western Title Company of Washington was acquired from its selling shareholder for $3.2 million in cash. In addition, the Company also has an option to purchase a title plant in Pierce County (Tacoma), Washington. The Company will operate as a subsidiary of Fidelity in King and Snohomish counties under the name Fidelity National Title Company of Washington. The acquisition has been accounted for as a purchase.
The assets acquired, including cost in excess of assets acquired, and liabilities assumed in the acquisition of Fidelity National Title Company of Washington were as follows (dollars in thousands):
was acquired from WTC as part of the World Tax transaction. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of assets acquired, and liabilities assumed in the acquisition of Fidelity Tax were as follows (dollars in thousands):
On August 19, 1995, the Company acquired the common stock of Southern California Title Company, an underwritten title company with operations in Los Angeles County in the state of California. Southern California Title Company was acquired for $2.1 million in cash. The acquired company operates as a subsidiary of the Company in Los Angeles County, and is now known as Fidelity National Title Company. This transaction has been accounted for as a purchase.
On September 14, 1995, the Company announced that it had executed a definitive agreement ("Agreement") with Nations Holding Group to acquire one hundred percent of Nations Title Inc., and its wholly owned subsidiaries Nations Title Insurance Company, Nations Title Insurance Company of New York and National Title Insurance Company of New York (collectively, "Nations Title Inc."), which is the eighth largest title insurer in the United States based on 1994 reported revenue. The acquisition of Nations Title Inc. is expected to close in the first quarter of 1996, following final determination of the purchase price. The Company believes that the combination of its direct operations and Nations' strong agency network will provide a balance to Fidelity's title premium revenue between direct and agency, as well as hedge against future market downturns. Once assimilated, this acquisition should increase the Company's operating efficiencies and produce certain economies of scale, resulting in increased profits and enhancing its balance sheet. The Nations acquisition will significantly increase market share in areas where Fidelity National Financial, Inc. and subsidiaries have a limited presence, particularly in those areas where business in primarily agent driven, as well as in states where the Company currently has a strong position, while increasing its presence in the key title insurance states.
Under the terms of the Agreement, Fidelity National Financial, Inc. will acquire one hundred percent of the outstanding stock of Nations Title Inc. from its sole shareholder, Nations Holding Group, for a purchase price of $21 million in cash and 176,000 shares of Fidelity National Financial, Inc. Common Stock, subject to certain purchase price adjustments as defined in the Agreement.
The changes in unrealized gains (losses) on fixed maturities for the years ended December 31, 1995, 1994 and 1993 were $13,025,000, $(16,574,000) and $5,067,000, respectively.
Fixed maturity securities valued at approximately $10,569,000 and $10,977,000 were on deposit with various governmental authorities at December 31, 1995 and 1994, respectively, as required by law.
Equity securities at December 31, 1995 and 1994 consist of investments in various industry groups as follows:
During the years ended December 31, 1995, 1994 and 1993, gross realized gains on sales of fixed maturity securities considered available for sale were $1,700,000, $248,000 and $2,226,000, respectively, and gross realized losses were $1,331,000, $3,057,000 and $149,000, respectively. See Note O. Gross proceeds from the sale of fixed maturity securities considered available for sale amounted to $188,902,000, $101,323,000 and $77,371,000, during the years ended December 31, 1995, 1994 and 1993, respectively.
During the years ended December 31, 1995, 1994 and 1993, gross realized gains on sales of equity securities considered available for sale were $5,111,000, $634,000 and $2,409,000, respectively, and gross realized losses were $457,000, $132,000 and $266,000, respectively. Gross proceeds from the sale of equity securities amounted to $25,622,000, $11,112,000 and $14,042,000, during the years ended December 31, 1995, 1994 and 1993, respectively.
Included in other long term investments at December 31, 1994 are the Company's interests in two limited partnership investment funds, each totalling $7.5 million, which are carried at cost, which approximates fair value.
Summarized combined financial information of the unconsolidated partnerships is as follows:
During 1993, the Company acquired from outside lenders substantially all of Manchester's outstanding indebtedness. Additionally, Manchester had not been released from its general partnership obligations under a separate debt agreement of a real estate partnership in which it sold its interest in 1991. During 1994, the lender on this project agreed to release Manchester by substituting the buyer as the obligor. No such release has yet been executed. The amounts outstanding under this debt agreement approximated $931,000 and $946,000 at December 31, 1995 and 1994, respectively. See Notes J and N.
The Company has entered into an interest rate swap agreement concurrent with the funding of the Credit Agreement, dated as of September 21, 1995, which is principally used by the Company in the management of interest rate exposure. The interest rate swap agreement is accounted for on the accrual basis. Income and expense are recorded in the same category as that arising from the related debt. Amounts to be paid or received under interest rate swap agreements are recognized as interest income or expense in the periods in which they accrue. The interest rate swap agreement has not had a material impact on the Consolidated Financial Statements. See Note N.
In February 1994, the Company issued zero coupon, convertible subordinated LYONs 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. See Note K.
Short-term borrowings approximate their fair value. The fair value of the Company's fixed rate and variable rate notes payable is estimated using discounted cash flow analyses based on current market interest rates and comparison of interest rates being paid to the Company's current incremental borrowing rates for similar types of borrowing arrangements. The LYONs fair value is calculated based on quoted market prices.
Total income tax expense for the years ended December 31, 1995 and 1994 were allocated as follows:
Based upon the Company's current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the benefit of its existing deferred tax assets. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. However, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years. Certain tax planning or other strategies could be implemented, if necessary, to supplement income from operations to fully realize recorded tax benefits.
In April 1991, the Company renewed the employment agreement with its Chief Executive Officer whereby he is to receive a base annual salary. Cash or other bonuses may be paid to him at the discretion of the Compensation Committee of the Board of Directors. The agreement expires in March 1996, and allows the Company to terminate its Chief Executive Officer without termination payments.
In the ordinary course of business, the Company is involved in various pending and threatened litigation matters related to its operations, some of which include claims for punitive or exemplary damages.
In December 1995, Giant Group, Ltd. ("Giant") instituted an action in the United States District Court for the Central District of California against the Company, the Company's Chief Executive Officer and others. Giant alleges that defendants have engaged in various unlawful activities, including trading on non-public confidential and/or inside information, misappropriating confidential and proprietary information from Giant and its affiliate Rally's Hamburgers, Inc. and violating the disclosure requirements of Section 13(d) of the Securities Exchange Act of 1934. On January 3, 1996, Giant filed a First Amended Complaint to its Federal action which adds to Giants' prior allegations. Among other things, Giant alleges that the defendants plan to gain control of Rally's assets by forcing Rally's into bankruptcy. On January 16, 1996, Fidelity and Mr. Foley answered the First Amended Complaint and filed counterclaims against Giant and all of its directors. Fidelity and Mr. Foley deny that they engaged in any unlawful activities, including, among other things, trading on non-public confidential and proprietary information from Giant or Rally's, or violating the disclosure requirements of Section 13(d) of the Securities Exchange Act of 1934. In their counterclaims Fidelity and Mr. Foley seek certain declaratory relief, injunctive relief and monetary damages with respect to certain of the counterclaims. On February 16, 1996, Fidelity and Mr. Foley filed a First Amended Counterclaim against Giant and each of its directors. The Company believes that Giant's allegations are totally without merit and intends to defend the action and pursue their counterclaims vigorously. The Company has made an offer to
purchase Giant and already owns 14.8% of Giant's outstanding common stock. Giant declined the offer and Fidelity has announced that it intends to offer a slate of directors at Giant's next annual meeting.
Management believes that no other actions depart from customary litigation incidental to the insurance business of the Company and that resolution of all such litigation will not have a material adverse effect on the Company.
Rent expense incurred under operating leases during the years ended December 31, 1995, 1994 and 1993 was $21,388,000, $24,795,000 and $21,317,000, respectively. Included in rent expense for 1995, 1994 and 1993 is $523,000, $772,000 and $710,000, respectively, paid to Folco, the Company's Chief Executive Officer and Folco Mission Valley Partners.
The Company sold 1,402,500 shares of its Common Stock, including 149,600 treasury shares, in connection with an offering which became effective April 29, 1993. In connection with the offering, certain selling stockholders sold 1,485,000 shares of the Company's Common Stock, including 1,237,500 shares sold by Meridian Bancorp, Inc. (parent company of Meridian Bank). Proceeds of the offering were $17,827,000, net of expenses of $467,000.
On March 31, 1994, the Company announced that its Board of Directors authorized the repurchase in the open market of up to 1.1 million shares of the Company's Common Stock, or a comparable amount of the Company's LYONs, which are convertible into 21.095 shares of Common Stock per $1,000 maturity amount of LYONs. On June 14, 1994, the Company's Board of Directors authorized the additional repurchase of up to 1.1 million shares of the Company's Common Stock or a comparable amount of the Company's LYONs. A third authorization to repurchase an additional 3.3 million shares of the Company's Common Stock or a comparable amount of the Company's LYONs was announced on August 11, 1994. On March 9, 1995, the Company announced that the Board of Directors authorized the additional repurchase of up to 2.2 million shares of the Company's Common Stock or comparable amount of LYONs. As of December 31, 1995, the Company had repurchased 5,168,853 shares of its Common Stock for an aggregate price of $56.3 million, or $10.89 per share. Additionally, as of December 31, 1995, the Company had repurchased $48 million in maturity amount of LYONs for an aggregate price of $17.6 million. The repurchase of the LYONs resulted in
an extraordinary gain of $2.4 million which is net of related income taxes, unamortized debt issuance costs and amortized original issue discount, and is reflected in the 1994 Consolidated Statement of Earnings.
The Insurance Subsidiaries are regulated by the insurance commissioners of their respective states of domicile. Regulatory examinations usually occur at three year intervals. Examinations have been completed for Fidelity Title and Fidelity California as of and for the three year period ended December 31, 1993.
The Department of Insurance of the State of Florida has recently completed a triennial examination of ATIC as of and for the three year period ended December 31, 1994. The Company recently received a preliminary report of examination. The preliminary report, as forwarded to the Company by the Department of Insurance of the State of Florida, indicates that the examiners are proposing adjustments that could materially impact the statutory capital and surplus of ATIC. These adjustments have not been included in the 1995 Statutory Annual Statement as filed with insurance regulatory authorities. Certain of these proposed adjustments have been considered in the calculation of dividend capability, statutory surplus and statutory income (loss) reported below. In addition, since early 1995, the Company has effectively discontinued issuing ATIC insurance policies. Further, ATIC has recently entered into a voluntary consent order with the Department of Insurance of the State of Florida agreeing voluntarily to cease writing all new insurance
The Insurance Subsidiaries are subject to regulations that restrict their ability to pay dividends or make other distributions of cash or property to their immediate parent company without prior approval from the Department of Insurance of their respective states of domicile. In the case of Fidelity Title, the total amount of dividends or distributions made in any twelve month period may not exceed the lesser of 10% of the surplus as regards policyholders as of the last day of the preceding year or the net investment income for the twelve month period ending the last day of the preceding year. In the case of Fidelity California, Fidelity Tennessee and Fidelity Pennsylvania, the total amount of dividends made in any twelve month period may not exceed the greater of 10% of the surplus as regards policyholders as of the last day of the preceding year or net income for the twelve month period ending the last day of the preceding year. In the case of ATIC, the total amount of dividends or distributions made in any twelve month period may not exceed 10% of the total of statutory unassigned funds plus the preceding year's statutory net income. In the case of Fidelity New York, the total amount of dividends and distributions is limited to surplus as regards policyholders, excluding capital stock, less fifty percent of statutory premium reserve as of the last day of the preceding year and capital contributions received in the latest five year period. As of January 1, 1996, Fidelity Title could pay dividends or make other distributions to the Company of $3,016,000. As of January 1, 1996, Fidelity California and Fidelity Tennessee could pay dividends or make distributions to Fidelity Title of $1,072,000 and $623,000, respectively. As of January 1, 1996, Fidelity Pennsylvania could pay dividends or make other distributions to the Company of $2,193,000. ATIC and Fidelity New York do not have any dividend capability as of January 1, 1996.
In 1987, stockholders also approved the adoption of a Stock Option Plan ("1987 Option Plan"). Under the terms of the 1987 Option Plan, the Company may grant stock options to certain key employees and non-employee directors or officers. The number of shares issuable under the 1987 Option Plan is 1,361,250 shares of Common Stock at not less than fair market value on the date of grant. Employees are eligible to receive incentive stock options or non-qualified stock options, and non-employee directors are eligible to receive non-qualified stock options. Options available to directors or officers may not exceed one-half of the aggregate number of shares available for grant. All options granted become exercisable at the discretion of the Board of Directors and expire five to eleven years from the date of grant. Options that lapse or are canceled prior to exercise are added to the shares authorized for future grants. The 1987 Option Plan, which may be terminated at the discretion of the Board of Directors, expires December 31, 1996 with respect to incentive stock options, and December 31, 1997, with respect to non-qualified stock options. See table below.
In 1992, the 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 1,952,500 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 10 years from the date of grant.
(1) There were 437,246 options granted in 1993. These options were granted at an exercise price of $12.73 to key employees of the Company who applied deferred bonuses expensed in 1992 amounting to $1,325,000 to the exercise price reducing it to $9.70 per share if exercised within the first year of grant. This is a non-variable plan that allows for exercise prices with a fixed discount from the quoted market price. The exercise price of these options decreases approximately 2.3% per year through 1998 and $.09 per share from 1999 through 2005 at which time the exercise price will be $8.09. 283,201 options were granted in 1994 at an exercise price of $12.62 to key employees of the Company who applied deferred bonuses expensed in 1993 amounting to $1,287,000 to the exercise price reducing it to $8.07 per share if exercised within the first year of grant. The exercise price of these options decreases approximately 3.3% per year through 1999 and $.14 per share from 2000 through 2006 at which time the exercise price will be $6.00. 50,990 options were granted in 1995 at an exercise price of $9.32 to key employees of the Company who applied deferred bonuses expensed in 1994 amounting to $236,773 to the exercise price, reducing it to $4.77 if exercised within the first year of the grant. The exercise price of these options decreases approximately 7.0% per year through 2000 and $.20 per share from 2001 through 2007, at which time the exercise price will be $1.95.
The Company generates a significant amount of title insurance premiums in California and Texas, 43.6% and 10.1% in 1995, 37.9% and 10.7% in 1994 and 45.5% and 9.0% in 1993, respectively.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments, trade receivables, notes receivable and financial instruments used in hedging activities.
Concentrations of credit risk with respect to trade receivables are limited because a large number of geographically diverse customers make up the Company's customer base, thus spreading the trade risk. The Company controls credit risk through monitoring procedures.
During 1993, the Company acquired from outside lenders substantially all of Manchester's outstanding indebtedness. Additionally, Manchester had not been released from its general partnership obligations under a separate debt agreement of a real estate partnership in which it sold its interest in 1991. The amount outstanding under this agreement totalled $931,000 and $946,000 at December 31, 1995 and 1994, respectively. During 1994, the lender on this project agreed to release Manchester by substituting the buyer as the obligor. No such release has yet been executed. The Company does not believe that Manchester will require additional capital contributions from the Company that will materially impact liquidity, nor will Manchester's operations materially impact the Company's results of operations.
Statement of Financial Accounting Standards No. 123 ("Statement 123"), "Accounting for Stock-Based Compensation", was issued by the Financial Accounting Standards Board in October 1995. Statement 123 applies to all transactions in which an entity acquires goods or services by issuing instruments or by incurring liabilities where the payment amounts are based on the entity's common stock price, except for employee stock ownership plans ("ESOPs"). Statement 123 covers transactions with employees and non-employees and is applicable to both public and non-public entities. Statement 123 establishes a new method of accounting for stock-based compensation arrangements with employees. The new method is a fair value method rather than the intrinsic value method that is contained in Accounting Pronouncements Board Opinion No. 25 ("Opinion 25"). However, the Statement does not require an entity to adopt the new fair value based method for purposes of preparing its basic financial statements. Entities are allowed (1) to continue to use the Opinion 25 method or (2) to adopt the Statement 123 fair value based method. Once the fair value based
method is adopted, an entity cannot change back to the Opinion 25 method. Also, the selected method applies to all of an entity's compensation plans and transactions. The Statement 123 fair value based method will result in higher compensation cost than the Opinion 25 intrinsic value based method for fixed stock option compensation plans and will result in a different compensation cost for variable stock option compensation plans. Sometimes the amount will be higher and sometimes the amount will be lower. Also, many employee stock purchase plans that are considered noncompensatory under Opinion 25 will be compensatory and result in the recognition of compensation costs under the fair value based method. For entities not adopting the Statement 123 fair value based method, the Statement creates a unique financial reporting situation. It requires entities that retain the Opinion 25 method for preparing their basic financial statements to display in the footnotes pro forma net income and earnings per share information as if the fair value based method had been adopted. Thus, these entities are required to account for employee compensation arrangements by two different methods and must present two separate measures of results of operations. Statement 123 is effective for fiscal years beginning after December 15, 1995. The Company intends to continue using the Opinion 25 method when accounting for stock based compensation in its basic financial statements upon adoption of Statement 123. The Company will choose the pro forma disclosure method.