In 2003, the Company recorded exit and termination costs, net of tax of $170 related to facility rationalization programs with an offset related to reductions in the Primis accruals established in 2002. Additionally, the Company recorded title plant impairments net of tax of $3,191.
In the fourth quarter of 2001, the Company reassessed the carrying value of intangibles and capitalized software which resulted in net of tax charges to earnings of $32,893. See Note 18 to the Consolidated Financial Statements.
Our Title Insurance segment is influenced by the level of real estate activity and the cost and availability of mortgage funds. Revenue for this segment results primarily from resales and refinancing of residential real estate and, to a lesser extent, from commercial transactions and the construction and sale of new housing. In addition, Title Insurance revenue is affected by the Company’s sales and marketing efforts and its strategic decisions based on the rate structure and claims environment in particular markets.
The Company’s profit margins are affected by several factors, including the volume of real estate and mortgage refinance activity, title policy type and amount. Volume is an important determinant of profitability because the Company, like any other real estate services company, has a significant level of fixed costs arising from personnel, occupancy costs and maintenance of title plants. The Company utilizes orders opened as a forward looking indicator of business volume. Because premiums are based on the face amount of the policy, larger policies generate higher premiums although expenses of issuance do not necessarily increase in proportion to policy size. Cancellations affect profitability because costs incurred both in opening and in processing orders typically are not offset by fees.
The Company’s largest expense is commissions paid to independent agents. The Company regularly reviews the profitability of its agents, adjusting commission levels or canceling certain agents where profitability objectives are not being met and expanding operations where acceptable levels of profitability are available. The Company continually monitors its operating expenses which are the sum of salaries and employee benefits, agency
commissions and other expenses (exclusive of interest, amortization and certain other items) as a percentage of operating revenues.
Generally title insurance claims rates are lower than other types of insurance because title insurance policies insure against prior events affecting the quality of real estate titles rather than against unforeseen, and therefore less predictable, future events. See “Critical Accounting Estimates - Policy and Contract Claims” for further discussion. In addition, the Company may be subject to claims and litigation other than in the ordinary course of business. For a discussion of pending legal proceedings, see “Item 3 - Legal Proceedings.”
A significant challenge facing management of the Title Insurance segment is management of the revenue reductions expected to occur due to the decline in refinancing activity. As a result, operating results for the years ended 2002 and 2003 should not be viewed as indicative of results for any future period. The Company has been reducing staffing levels in response to the reduction in refinance transactions. The Company expects to realize the full effect of expense savings from these staffing level reductions in 2004. Continuing staff reductions and expense management will be an ongoing focus for senior management.
Our Lender Services segment provides services to regional and national lending institutions which complement those offered in our title insurance business. These services consist primarily of real estate tax processing and flood certification services, mortgage credit reporting and default management services. With the exception of default management, the services provided by this segment are the result of businesses acquired by the Company during 2003. The Company expanded into the business of providing flood certification and real estate tax services to mortgage lenders by purchasing LERETA Corp. (“LERETA”), one of the largest, most advanced service companies in its industry, on October 1, 2003. The Company also entered the credit information business for the mortgage lending industry through its acquisition in August 2003 of INFO1 Holding Company, Inc.
Revenues in the mortgage credit reporting area and default management services are recognized when the report or service is delivered to the customer.
Centennial provides and purchases in bulk commercial real estate loans to businesses primarily in the Southern California marketplace and is dependent on the viability of businesses in the Southern California markets in which it operates. Deposits are solicited through the internet for both certificates of deposit and passbook savings accounts. As an industrial bank, Centennial does not accept demand deposits, such as checking accounts, that provide for payment to third parties. Centennial does not offer banking services such as credit cards or automated teller machines.
The Company’s assessment business is managed by the Company’s LandAmerica Assessment Corporation subsidiary that was acquired in 2002 and which is headquartered in California. This business provides due diligence services to commercial customers throughout the country. Revenue is recognized upon completion of the services to the customer.
The Company’s residential inspection services are run by the Company’s Inspectech subsidiary. This rapidly growing subsidiary is one of the largest providers of residential real estate inspections in the country. Its business is highly dependent on the real estate industry and the levels of residential home sales and refinancings. Inspectech charges a flat fee for each transaction which is generally collected at the time of service.
Policy and Contract Claims. A provision for estimated future claims payments is recorded at the time policy revenue is recorded. The Company’s payment experience as well as the industry’s extends for more than 20 years after the issuance of a policy. Due to the length of time over which claim payments are made and regularly occurring changes in underlying economic conditions, these estimates are subject to variability. As general economic conditions decline, claims experience has been shown to deteriorate, leading to increases in such losses as mechanics liens and defalcations. These factors tend to diminish as economic conditions improve. Loss provision rates are reviewed periodically and adjusted by management as experience develops or new information becomes known. In establishing loss provision rates, management considers historical experience, current economic conditions and the mix of business. The Company’s independent consulting actuaries perform projections of required reserves as considered necessary during the year and at year-end. These projections are compared to recorded reserves to evaluate the adequacy of such recorded reserves and any necessary adjustments are included in current operations. The impact of a 1% change in the loss rate on current year business volumes is as follows:
Purchase Accounting, Impairment of Goodwill and Long-Lived Assets. The Company, as a normal part of its business, acquires agencies and other title related operations. In addition, in 2003 the Company purchased three businesses which were outside its traditional business expertise but primarily focused in the real estate industry. As a result of these acquisitions, the Company assigned fair values to the assets and liabilities purchased and increased the amount of goodwill and other intangibles recorded on its balance sheet. The Company utilizes the services of an independent appraisal company to assist with the allocation of purchase price to acquired assets (including goodwill) and liabilities. On January 1, 2002 the Company adopted Financial Accounting Standards Board (“FASB”) Statements of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, No. 142, Goodwill and Other Intangible Assets and No. 144, Accounting for the Impairment or Disposal of Long-Lived Fixed Assets. SFAS No. 141 established new rules for accounting for business combinations and requires that all business combinations be accounted for using the purchase method. SFAS No. 142 eliminated the requirement to amortize goodwill and other identified indefinite life intangibles and instead requires that impairment testing be performed at least annually. SFAS No. 144 requires that long-lived assets (other than goodwill and indefinite life intangibles) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Determination of the amount, if any, of impairment associated with goodwill or other long-lived assets is subject to a number of individual criteria, each of which is difficult to value.
Deferred Tax Asset. Net deferred tax assets at December 31, 2003 and 2002 relate primarily to policy and contract claims, pension liability, deferred service arrangements, allowance for doubtful accounts and employee benefit plans. A valuation allowance is provided for deferred tax assets if it is more likely than not that some portion or all of the assets will not be realized. The most significant factor in this determination is the projected future timing and amounts of taxable income. The provision of a valuation allowance would reduce net income in the period recorded. Based upon our historical results of operations, the existing financial condition of the
Another significant assumption in valuing the pension liability is the discount rate. The discount rate utilized is based on rates on high quality fixed income debt instruments available at the end of each valuation period. The Company utilized a discount rate of 6.0% in determining its 2003 benefit obligations. Changing the discount rate or long-term rate of return would result in the following impact on the pension benefit liability:
As previously noted, real estate tax monitoring and flood certification fees received on new contracts entered into since the acquisition date are deferred and amortized over the estimated lives of the contracts to which they relate. The sum of amortization of the “initial deferred service obligation” and amortization related to fees accrued on new contracts represent the earned fee amount reported as revenue for the period.
Historically, residential real estate activity has been generally slower in the winter, when fewer families buy or sell homes, with increased volumes in the spring and summer. Residential refinancing activity is generally more uniform throughout the seasons, but is subject to interest rate variability. The Company’s Title Insurance segment typically reports its lowest revenues in the first quarter, with revenues increasing into the second quarter and through the third quarter. The fourth quarter customarily may be as strong as the third quarter, depending on the level of activity in the commercial real estate market. However, in 2002 and 2003 the Company’s fourth quarter revenues were stronger than the third quarter due to increased activity in the residential real estate market related to refinance activity.
The Company’s Lender Services segment has similar seasonal trending. However, due to the nature of the revenue deferrals made in this segment, as noted above, the impact on the Company’s results of operations will differ. In instances where the Company receives cash in advance for services for real estate tax payment and flood certification services, the revenue is deferred and amortized ratably over the anticipated life of the loan servicing. This ratable amortization has the impact of reducing the volatility in revenue related to this segment.
In the 2001 through 2003 period, the typical seasonality of the title insurance business was influenced by changes in the levels of refinancing activity. For additional information, see “Item 1 - Business - Cyclicality and Seasonality.”
Title Insurance - Operating revenues from direct title operations increased 25.4% in 2003 over 2002 and 13.6% in 2002 over 2001. The increase in 2003 was due to a 27.1% increase in the number of title policies issued by the Company’s direct operations offset by a slight decrease
in the premiums per policy issued. The decrease in the premium per policy issued is due to the large volume of refinancing activity in 2003, which resulted in a slightly lower premium per policy. The increase of 2002 over 2001 was due to a 15.6% increase in the number of policies issued offset by reductions in ancillary service revenues. Policies issued by the Company’s direct title operations were 1,112,000, 875,000 and 757,000 during 2003, 2002 and 2001 respectively. Average mortgage interest rates for 30-year fixed rate mortgages for 2003, 2002 and 2001 were 5.95%, 6.55% and 6.93%, respectively. The average premium per policy issued was $643 in 2003, $651 in 2002 and $643 in 2001. The fluctuations noted in issued policies and average revenues per policy issued were primarily attributable to the relative changes in real estate activity year-over-year, as mentioned above. Operating revenues from agency title operations increased by 34.3% in 2003 over 2002 and 26.6% in 2002 over 2001. These increases were primarily attributable to the same factors affecting direct title operations and by the inherent delay in the reporting of transactions by agents. As noted above, the timing of policy reporting, and therefore revenue reporting by agents, differs in various parts of the country.
Investment and Other Income. Investment and other income totaled $52.1 million, $51.7 million and $50.8 million in 2003, 2002 and 2001, respectively. The increase of $396,000, or .8%, in 2003 as compared to 2002 was primarily the result of lower yields on cash equivalents and the Company’s investment portfolio which was offset in large part by a larger investment portfolio. The increase of $902,000, or 1.8%, in 2002 as compared to 2001, was due to a larger investment portfolio partially offset by lower yields on cash equivalents and the Company’s investment portfolio. The Company’s investment portfolio consists primarily of fixed maturity securities.
Company’s fixed maturity securities as a result of the reduction of interest rates in the marketplace.
Salaries and Employee Benefits. A summary of the Company’s salaries and other personnel costs is as follows:
Title Insurance salaries and employee benefit costs increased $142.8 million, or 22.2%, in 2003 over 2002 and $71.2 million, or 12.4%, in 2002 over 2001. The increase of $142.8 million in 2003 over 2002 was primarily related to compensation increases associated with the increase in business volumes and increased commission expense for internal sales personnel. The Company also had an increase in its pension expense of approximately $3.0 million (see additional information in Note 12 to the Consolidated Financial Statements). Average Full Time Equivalent (FTE) counts for the year totaled 10,573 in 2003 versus 8,621 in 2002. Additionally, the Company had increased costs of approximately $8.0 million related to acquisitions in the current year. The increase of 2002 over 2001 is due to a $41.8 million increase in incentive compensation due to higher business volumes and increases in the Company’s contribution to health care benefit plans and its 401(k) match. The increase in incentive compensation is due to bonuses paid relative to the Company’s operating profits as well as operational efficiencies achieved. The increase in the Company’s 401(k) match is related to the Company’s discretionary matching component which changes in correlation to the Company’s operating results. The Company’s average FTE count was 8,621 in 2002 versus 8,365 in 2001.
Corporate and Other - Corporate and Other salary and benefit costs increased $3.8 million, or 8.2% in 2003 over 2002 and decreased $21.4 million in 2002 over 2001. The increase in salaries and benefit costs in 2003 over 2002 relate to increase in employees at the Company’s shared resources facility required due to growth in the Company’s infrastructure, primarily in the information technology area, an increase in incentive compensation as a result of the Company’s financial performance, as well as continued expansion of the Company’s other services (an increase of $6.4 million), offset by the termination of the business of Primis, Inc., the Company’s web-based provider of real estate services, of $11.3 million (see additional information under Exit and Termination Costs below). The decrease in 2002 over 2001 in Corporate and Other compensation expense relates to reduced personnel costs associated with the Primis business of $25.2 million, offset somewhat by $7.6 million in new businesses created by the residential inspection and commercial appraisal and assessment businesses. These businesses increased FTE headcount by 38 employees in 2002.
Agent Commissions. A summary of agent commissions and revenues related to the Title Insurance segment is as follows:
The commission rate paid to agents varies by geographic area in which the commission was paid and by individual agent agreement. The trend of increasing commission rates is attributable to increased competition for agents.
Exit and Termination Costs. The Company incurred exit and termination costs on a pre-tax basis of $0.3 million, $13.4 million and $1.7 million in 2003, 2002 and 2001, respectively.
In October 2000, the Company acquired Primis, Inc., a web-based provider of real-estate services. In 2001, the acceptance of Primis’ technology by our customer base proved to be much slower than anticipated, necessitating a fourth quarter non-cash writeoff of intangibles, including goodwill, acquired in the acquisition. In connection with the fourth quarter 2001 non-cash writeoff of $1.7 million, the Company incurred certain termination costs associated with facility and employee rationalization programs.
Finally, in 2003, the Company continued to rationalize and consolidate certain office space. The Company incurred charges of approximately $.8 million in the fourth quarter of 2003 related to its decision to consolidate office space in two markets.
Write-off of Capitalized Software and Intangibles. During the fourth quarter of 2001, the Company made a decision to scale back and write down prior investments in specific technology and appraisal business initiatives that resulted in two one-time charges. The first of these was a non-cash pre-tax charge of approximately $11.2 million resulting from the Company’s decision to stop development of TitleQuest, its back office title production software. The second was a one-time non-cash pre-tax charge of $40.2 million related to impairment of acquisition related intangibles that resulted from the Primis acquisition. As noted above, Primis experienced performance levels below forecast due to slower than anticipated acceptance of its technology by the Company’s customer base.
Additionally, in the fourth quarter of 2003, the Company identified 21 title plants with an aggregate book value of $4,932 that will not continue to be used or maintained. The Company took a charge to earnings to reflect the dimunition in value associated with these plants.
General, Administrative and Other. A summary of general, administrative and other expenses is as follows:
On January 1, 2002 the Company adopted SFAS No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Under these new rules, goodwill (and intangible
assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives.
In December 2002, FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation, SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No.148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The transition rules of this standard are not applicable since the Company continues to account for stock-based compensation under the guidance of APB Opinion 25. See Note 7 in the Notes to Consolidated Financial Statements for further discussion of the Company’s stock-based plans.
As noted above, the Company’s operating results and cash-flows are heavily dependent on the real estate market, particularly in the title insurance segment. While the Company has continued to diversify its product portfolio over the last several years, a significant downturn in the real estate market would adversely impact the Company’s cash-flows. The Company’s business is labor intensive and changes to the real estate market are monitored closely and staffing levels are adjusted accordingly. There is typically a lag between changes in the real estate market and changes in personnel levels resulting in higher personnel costs in periods where the real estate market declines in advance of headcount reductions. The Lender Services segment provides real estate tax payment and flood certification services for the life of loans for which it receives cash at loan closing. This revenue related to the long-term servicing is deferred and amortized over the life of the loan. Revenues, cash receipts and loans in the Company’s industrial bank subsidiary are not dependent on the real estate industry but are dependent on the ability of the bank to attract deposits and qualified commercial customers. The Company believes that its product diversification efforts along with its management of operating expenses and significant working capital position will enhance its ability to manage cash resources through declines in the real estate market.
The Company has acquired, or entered into agreements to acquire, several businesses. During 2003, the Company completed acquisitions of approximately $363.0 million. The 2003 purchases were funded through a mixture of cash, invested cash, investments and utilization of the Companies various credit facilities. The Company has entered into an agreement to purchase a title agency in the Southern California marketplace that is expected to close in the first half of 2004 for a purchase price of approximately $100.0 million. The Company will continue to selectively evaluate additional acquisitions should attractive candidates be identified.
Additionally, in the fourth quarter of 2003, the Company privately issued $115.0 million of its 3.125% Convertible Senior Debentures due 2033. The Company utilized the proceeds from this issue for general corporate purposes including financing on a long-term basis a portion of the purchase price of certain of the acquisitions noted above. The debentures are initially convertible into common stock at a conversion rate of 14.9162 shares per $1,000 principal amount of the debentures. For additional information see Part II, Item 5 “Recent Sales of Unregistered Securities”. In February 2004, the Company filed a registration statement on Form S-3 to register both the debentures and common stock associated with this transaction. The Company may elect to issue additional debt securities should the timing and interest yields prove to be attractive.
The Company’s debt, as a percentage of total capitalization, was 23.9% as of December 31, 2003 as compared to 17.9% as of December 31, 2002. This increase is due to the Company’s issuance of the Convertible Debentures as well as debt acquired primarily from the acquisition of Centennial. See additional information related to the Company’s debt obligations in Note 14 to the Consolidated Financial Statements.
During the first quarter of 2001, 2.2 million shares of the Company’s preferred stock were converted to 4.8 million shares of common stock. This conversion decreased the amount of preferred dividends paid by $7.7 million on an annual basis. The common shares issued upon conversion receive dividends at the same rate paid on all other outstanding common shares.
The Company included all purchase obligations in excess of $100,000 in value irrespective of their termination dates. These include annually renewable corporate insurance programs, payments required under software licensing agreements, vehicle leasing arrangements, annual line of credit availability fees and fees to certain joint venture partners. Purchase obligations not exceeding $100,000 were not material to the Company, either individually or in the aggregate.
The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. For investment securities, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Actual cash flows could differ from the expected amounts.
As a national provider of real estate transaction products and services, the Company participates in an industry that is subject to significant change, frequent new product and service introductions and evolving industry standards. In addition, alternatives to traditional title insurance, such as lien protection products, have emerged in recent years. The Company believes that its future success will depend on its ability to anticipate changes in technology and customer preferences and to offer products and services that meet evolving standards on a timely and cost-effective basis. The development and implementation of new products and services may require significant capital expenditures and other resources. There is a risk that customers may not accept the Company’s new product and service offerings and the Company may not successfully identify new product and service opportunities or develop and introduce new products and services in a timely and cost-effective manner. In addition, products and services that the Company’s competitors and other real estate industry participants develop or introduce may render certain of the Company’s products and services obsolete or noncompetitive. Advances in technology could also reduce the useful lives of the Company’s products, preventing the Company from recovering fully its investment in particular products and services. As a result, the inability of the Company to anticipate industry changes and to respond with competitive and
One of the Company’s business strategies is to expand its capabilities to manage the delivery of multiple services required in real estate transactions through a centralized source, and to significantly grow the volume of transactions that it manages. There is a risk that the Company’s transaction management services may fail to gain market acceptance, particularly from the large national mortgage originators. Furthermore, there are relatively low barriers to entry into the market for real estate transaction management, as opposed to the regulated title insurance business, which may result in a large number of competitors, including large national mortgage originators and others having substantially greater financial resources.
• prior approval of the acquisition and control of an insurance company or of any company controlling an insurance company
• regulation of certain transactions entered into by an insurance company with any of its affiliates
• restrictions on the size of risks that may be insured by a single company
These regulations may impede, or impose burdensome conditions on, rate increases or other actions that the Company might want to take to enhance its operating results. In addition, state regulatory examiners perform periodic examinations of insurance companies.
From time to time the Company is involved in litigation arising in the ordinary course of its business. In addition, the Company currently is and has been in the past been subject to claims and litigation not arising in the ordinary course of business from large classes of claimants seeking substantial damages. Material pending legal proceedings not arising in the ordinary course of business are disclosed in our filings with the Securities and Exchange Commission. See Part I, Item 3 “Legal Proceedings” set forth elsewhere in this report. An unfavorable outcome in any class action suit or similar litigation against the Company could have a material adverse effect on its financial position or results of operations.