The Company owns its Corporate headquarters on its campus in Jacksonville, Florida. The majority of our branch offices are leased from third parties. See Note K to Notes to Consolidated Financial Statements.
As of December 31, 2005, we leased office and storage space as follows:
Our financial results for the year ended December 31, 2004 include the results of various entities acquired on various dates during 2004, as discussed in “Business - Recent Developments” and Note B of Notes to Consolidated Financial Statements.
Cash and cash equivalents as of December 31, 2005, 2004, 2003, 2002 and 2001 include cash pledged to secure trust deposits of $234.7 million, $195.2 million, $231.1 million, $295.1 million and $367.9 million, respectively. Cash and cash equivalents as of December 31, 2005 include cash pledged relating to our securities lending program of $143.4 million.
We are a holding company that is a provider of outsourced products and services to a variety of industries. During 2005, we completed certain strategic initiatives, including contributing our title operations to a newly formed subsidiary, Fidelity National Title Group, Inc. (“FNT”) (NYSE:FNT) which in turn became a majority-owned, publicly traded company; selling a minority interest in our subsidiary Fidelity National Information Services Inc. (FIS); and agreeing to merge FIS with a separate publicly traded company, Certegy Inc. (“Certegy”). Certegy is now known as Fidelity National Information Services, Inc. (“FIS”) (NYSE:FIS). Through FNT, we are the United States’ largest title insurance company, with approximately 30.5% national market share. Through FIS, we provide industry leading data processing, payment and risk management services to financial institutions and retailers. Through our other wholly-owned subsidiaries, we are a leading provider of specialty insurance products, including flood insurance, homeowners insurance and home warranty insurance. Since February 1, 2006 when we closed our acquisition of a 40% interest in Sedgwick CMS (“Sedgwick”), we are now a provider of outsourced insurance claims management services to large corporate and public sector entities.
Fidelity National Title Group, Inc. This segment consists of the operations of our majority owned subsidiary, FNT. FNT’s title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - together issued approximately 30.5% of all title insurance policies issued nationally during 2005. FNT provides core title insurance and escrow and other title related services including collection and trust activities, trustee’s sales guarantees, recordings and reconveyances.
Fidelity National Information Services, Inc. This segment consists of the operations of our majority owned subsidiary, FIS. FIS provides transaction processing services, consisting principally of technology solutions for banks and other financial institutions, credit and debit card services and check risk management and related services for retailers and others. FIS also provides lender processing services, consisting principally of technology solutions for mortgage lenders, selected mortgage origination services such as title agency and closing services, default management and mortgage information services. FIS’s credit and debit card services and check risk management services were added through our merger with Certegy. This merger closed in February 2006 and as a result these businesses are not included in the historical financial information in this report.
Specialty Insurance. The specialty insurance segment, consisting of our various non-title insurance subsidiaries, issues flood, home warranty, homeowners, automobile and certain niche personal lines insurance policies.
Corporate and Other. The corporate and other segment consists of the operations of the parent holding company and certain other unallocated corporate overhead expenses.
Historically, real estate transactions have produced seasonal revenue levels for title insurers. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. Recently, the third calendar quarter has been typically the strongest in terms of revenue primarily due to a higher volume of home sales in the summer months and the fourth quarter is usually also strong due to commercial customers desiring to complete transactions by year-end. Significant changes in interest rates may alter these traditional seasonal patterns due to the effect the cost of financing has on the volume of real estate transactions.
In the financial institution processing business, increases in deposit and lending transactions can positively affect our business and thus the condition of the overall economy can have an effect on growth. While this business generally is not significantly affected by the cyclicality of real estate transactions, our ability to expand its mortgage loan processing business is correlated to the total number of mortgage loans outstanding.
activity. This trend continued through the first six months of 2003. The increasing refinance activity, coupled with record levels of residential resale and new home sales, resulted in an exceptionally strong business climate for FIS’s mortgage origination services in 2003. Declines in refinancings since 2003 have adversely affected our revenues in 2004 and 2005 from mortgage origination services. For further information, see the discussion above under “- Fidelity National Title Group.”
In contrast to the loan origination business, FIS believes that a higher interest rate environment may increase the volume of consumer defaults and thus favorably affect FIS’s Default Management Services business, which provides services relating to residential mortgage loans in default. The overall strength of the economy also affects default revenues.
Our reserve for claim losses includes reserves for known claims (“PLR”) as well as for losses that have been incurred but not yet reported to us (“IBNR”), net of recoupments. We reserve for each known claim based on our review of the estimated amount of the claim and the costs required to settle the claim. Reserves for IBNR claims are estimates that are established at the time the premium revenue is recognized and are based upon historical experience and other factors, including industry trends, claim loss history, legal
We continually update loss reserve estimates by utilizing both internal and external resources. Management performs a detailed study of loss reserves based upon the latest available information at the end of each quarter and year. In addition, an independent actuarial consulting firm assists us in analyzing our historic loss experience and developing statistical models to project ultimate loss expectancy. The actuaries prepare a formal analysis of our reserves at December 31 each year. Management examines both the quantitative and qualitative data provided by both the independent actuaries and internal sources such as our legal, claims, and underwriting departments to ultimately arrive at our best reserve estimate. Regardless of technique, all methods involve significant judgment and assumptions. Management strives to improve its loss reserve estimation process by enhancing its ability to analyze loss development patterns and we continually look for ways to identify new trends to reduce the uncertainty of our loss exposure. However, adjustments may be required as experience develops unexpectedly, new information becomes known, new loss patterns emerge, or as other contributing factors are considered and incorporated into the analysis.
In our reserve setting process, our independent actuaries fulfill a function, which is to provide information that is utilized as part of the overall mix of information that our management uses to set our reserves, but this is only one component of management’s evaluation process. While there can be no assurance as to the precision of loss reserve estimates, as shown in the table below, our development on prior years’ loss reserves over the past three years has generally been within a narrow range, using the reserve setting processes described above.
The valuation of intangible assets such as software, purchased customer relationships and contracts involves significant estimates and assumptions concerning matters such as customer retention, future cash flows and discount rates. If any of these assumptions change, it could affect the carrying value of these assets. Purchased customer relationships are amortized over their estimated useful lives using an accelerated method which takes into consideration expected customer attrition rates over a ten-year period. Contractual relationships are generally amortized using the straight-line method over their contractual life. In 2005 and 2004, we determined that the carrying value of certain of our intangible assets may not be recoverable and recorded impairment charges of $9.3 million and $6.3 million, respectively relating to the write-off of these assets, respectively. These impairments were recorded as other operating expenses in our 2005 and 2004 Consolidated Statements of Earnings.
Capitalized software development costs are accounted for in accordance with either SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (SFAS No. 86), or with SOP No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. After the technological feasibility of the software has been established (for SFAS No. 86 software), or at the beginning of application development (for SOP No. 98-1 software), software development costs, which include salaries and related payroll costs and costs of independent contractors incurred during development, are capitalized. Research and development costs incurred prior to the establishment of technological feasibility (for SFAS No. 86 software), or prior to application development (for SOP No. 98-1 software), are expensed
FIS recognizes revenues relating to bank processing services and mortgage processing services along with software licensing and software related services. Several of FIS’s contracts include a software license and one or more of the following services: data processing, development, implementation, conversion, training, programming, post-contract customer support and application management. In some cases, these services are offered in combination with one another and in other cases FIS offers them individually. Revenues from bank and mortgage processing services are typically volume based depending on factors such as the number of accounts processed, transactions processed and computer resources utilized.
The substantial majority of the revenues in this business are from outsourced data processing and application management arrangements. Revenues from these arrangements are recognized as services are performed in accordance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 104 (SAB No. 104), Revenue Recognition and related interpretations. SAB No. 104 sets forth guidance as to when revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectability is reasonably assured. Revenues and costs related to implementation, conversion and programming services associated with FIS’s data processing and application management agreements during the implementation phase are deferred and subsequently recognized using the straight-line method over the term of the related services agreement. At each reporting period, FIS evaluates these deferred contract costs for impairment.
If all of the services are software related services as determined under the American Institute of Certified Public Accountants’ Statement of Position (SOP) 97-2 (SOP No. 97-2), entitled Software Revenue Recognition, and SOP 98-9, entitled Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions, FIS applies these pronouncements and related interpretations to determine the appropriate units of accounting and how the arrangement consideration should be measured and allocated to the separate units.
In its information services businesses, FIS records revenue from providing data or data related services. These services principally include appraisal and valuation services, property records information, real estate tax services, borrower credit and flood zone information and multiple listing software and services. Revenue derived from these services is recognized as the services are performed in accordance with SAB No. 104 as described above.
FIS’s flood and tax units provide various services including life of loan-monitoring services. Revenue for life of loan services is deferred and recognized ratably over the estimated average life of the loan service period, which is determined based on FIS’s historical experience. FIS evaluates its historical experience on a periodic basis, and adjusts the estimated life of the loan service period prospectively. Revenue derived from software and service arrangements included in this segment is recognized in accordance with SOP No. 97-2 as discussed above. Revenues from other services in this segment are recognized as the services are performed in accordance with SAB No. 104 as described above.
Year ended December 31, 2005. Our Consolidated Statements of Earnings for 2005 include a full year of results for the 2004 FIS acquisitions of Aurum, Sanchez, Kordoba and InterCept and the 2004 FNT acquisition of APTIC. 2005 results also include additional interest expense incurred due to $2.8 billion of borrowings incurred as part of the recapitalization of FIS, a gain on sale of minority interest in FIS and additional minority interest expense relating to that transaction and to the FNT distribution.
Total revenue in 2005 increased $1,372.9 million to $9,668.9 million, an increase of 16.6% over 2004. Total revenue in 2004 increased $580.8 million to $8,296.0 million, an increase of 7.5% over 2003. The increase in revenue in 2005 is attributable to a full year of results from our 2004 acquisitions by FIS, increased title revenues, and an increase in revenues from our specialty insurance group attributable to growth and substantial flood claim processing revenues recorded in the fourth quarter of 2005. Also included in this revenue growth was a net $318.2 million non-operating gain on the issuance of subsidiary stock relating to the sale of a minority interest in FIS. The increase in revenue in 2004 is primarily attributable to a full year of results from the 2003 acquisitions of FI and Webtone, along with the 2004 acquisitions of Aurum, Sanchez, Kordoba and InterCept by FIS, and an increase in the specialty insurance segment relating to significant organic growth, offset in part by a reduction in realized gains and losses.
Includes premiums reported by FNT and the portion of title premiums FIS reports as commissions in its mortgage origination business in connection with the policies issued by FNT with respect to which FIS acts as title agent.
Title insurance premiums, including those attributable to FNT and FIS, were $4,945.0 million in 2005, $4,739.3 million in 2004 and $4,738.3 million in 2003. Direct title premiums increased from 2004 to 2005 and decreased from 2003 to 2004 while agency title premiums increased during both periods. The increase in direct title premiums in 2005 as compared to 2004 is primarily due to an increase in fee per file as the number of orders decreased in the same period. The decrease in direct title premiums in 2004 as compared to 2003 is primarily due to a reduction in refinancing activity experienced in 2004 as compared with 2003 and was partially offset by an increase in the average fee per file. The fee per file tends to increase as mortgage interest
In 2005, our mix of direct and agency title premiums stayed relatively consistent, with agency premiums making up 54.3% of total premiums compared with 55.1% in 2004. Agency premiums made up 49.3% of total premiums in 2003. During the second quarter of 2005, we reevaluated our method of estimation for accruing agency title revenues and commissions and refined the method which resulted in our recording approximately $50 million in additional agency revenue in the second quarter of 2005 than we would have under our prior method. The impact on net earnings of this adjustment was approximately $2 million. A change in agency premiums has a much smaller effect on profitability than the same change in direct premiums would have because our margins as a percentage of premiums for agency business are significantly lower than the margins realized from our direct operations due to commissions paid to our agents and other costs related to the agency business. Agency premiums increased in 2004 by $273.0 million, of which $193.5 million was attributed to our acquisition of APTIC in March 2004. The remainder of the increase can be attributed to our agents’ mix of business being different from our direct operations and the agency business not fluctuating as much in relation to the refinancing environment.
Trends in escrow and other title related fees are primarily related to title insurance activity generated by our direct operations. Escrow and other title related fees during the three-year period ended December 31, 2005, fluctuated in a pattern generally consistent with the fluctuation in direct title insurance premiums and order counts. Escrow and other title related fees were $1,157.0 million, $1,042.2 million and $1,056.4 million, respectively, during 2005, 2004 and 2003.
Our operating expenses consist primarily of personnel costs, other operating expenses, which in our title insurance business are incurred as orders are received and processed, and agent commissions, which are incurred as revenue is recognized. Title insurance premiums, escrow and other title related fees are generally recognized as income at the time the underlying transaction closes. As a result, direct title operations revenue lags approximately 45-60 days behind expenses and therefore gross margins may fluctuate. The changes in the market environment, mix of business between direct and agency operations and the contributions from our various business units have impacted margins and net earnings. We have implemented programs and have taken necessary actions to maintain expense levels consistent with revenue streams. However, a short time lag exists in reducing variable costs and certain fixed costs are incurred regardless of revenue levels. We have taken significant measures to maintain appropriate personnel levels and costs relative to the volume and mix of business while maintaining customer service standards and quality controls. Beginning during the second half of 2003, as open orders on refinance transactions declined with the increase in mortgage interest rates, we began reducing personnel costs with the reduction of approximately 22% of the title and escrow workforce from July to December of 2003. We maintained personnel at appropriate levels during 2005 and 2004, including a reduction of approximately 8% of the title and escrow workforce in the fourth quarter of 2005, and will continue to monitor prevailing market conditions and adjust personnel costs in accordance with activity.
Personnel costs include base salaries, commissions, benefits and bonuses paid to employees, and are one of our most significant operating expenses. Personnel costs totaled $3,224.7 million, $2,786.3 million and $2,465.0 million for the years ended December 31, 2005, 2004 and 2002, respectively. Personnel costs, as a percentage of total revenue, were 33.4% in 2005, compared with 33.6% in 2004 and 32.0% in 2003. The increase in personnel costs as a percentage of total revenue in 2005 and 2004 as compared to 2003 can be attributed primarily to the incremental personnel costs as we grew FIS through acquisition as much of its business requires many programmers and other personnel with an information technology background who generally have high average salaries. Also included in personnel costs for 2005, 2004 and 2003 is approximately $34.1 million, $21.8 million and $6.2 million in compensation expense relating to stock based compensation plans, respectively. See Note M of Notes to Consolidated Financial Statements.
We assumed Service Link’s outstanding reserve of $1.0 million for claim losses in connection with its acquisition in 2005. We assumed APTIC’s outstanding reserve for claim losses in connection with its acquisition in 2004. We assumed LSI’s and ANFI’s outstanding reserve for claim losses in connection with their acquisitions in 2003.
The unfavorable title loss provision amounts in 2005 reflect a higher estimated loss for the 2005 policy year as well as higher than expected incurred losses and payment levels on previously issued policies. The title loss provision in 2004 reflects a higher estimated loss for the 2004 policy year offset in part by a favorable adjustment from previous policy years. The unfavorable development during 2003 reflects higher than expected payment levels on previously issued policies.
Income tax expense as a percentage of earnings before income taxes for 2005, 2004 and 2003 was 35.6%, 37.0% and 38.0%, respectively. The fluctuation in income tax expense as a percentage of earnings before income taxes is attributable to our estimate of ultimate income tax liability, and changes in the characteristics of net earnings year to year, such as the acquisition of FI and operating income versus investment income. The decrease in 2005 is partially attributable to the fact that no income taxes were provided for the gain on the issuance of subsidiary stock as our tax basis in our investment in FIS exceeded the book basis on the date of the sale. This was offset by the approximately $100.0 million in tax expense recorded in connection with the FNT distribution. The decrease in 2004 is due to a change in state income tax apportionment.
Minority interest expense for 2005, 2004 and 2003 was $70.4 million, $5.0 million and $19.0 million, respectively. The increase in minority interest expense in 2005 relates to recording minority interest expense on the earnings of FIS since the March 9, 2005 sale of a 25% minority interest and recording minority interest on the earnings of FNT since the October 17, 2005 distribution to our shareholders. The decrease in minority
interest expense in 2004 is primarily due to our acquisition of the minority interest of FNIS, which we acquired in 2003.
Interest and investment income levels are primarily a function of securities markets, interest rates and the amount of cash available for investment. Interest and investment income in 2005 was $118.1 million, compared with $64.9 million in 2004 and $56.7 million in 2003. The increase in interest and investment income in 2005 is primarily due to an increase in the short-term investment and fixed income asset base and an increase in interest rates. Average invested assets were $3,732.6 million, $3,226.2 million and $2,811.5 million in 2005, 2004, and 2003, respectively. The tax equivalent yield in 2005, excluding realized gains and losses, was 3.8%, as compared with 2.7% in 2004 and 2.5% in 2003.
Personnel costs include base salaries, commissions, benefits and bonuses paid to employees, and are one of our most significant operating expenses. Personnel costs totaled $1,897.9 million, $1,680.8 million, and $1,692.9 million for the years ended December 31, 2005, 2004, and 2003, respectively. Personnel costs, as a percentage of direct title insurance premiums and escrow and other title-related fees, were 56.6% in 2005, compared with 55.2% in 2004 and 53.5% in 2003. The increase in personnel costs as a percentage of related revenue in 2005 is primarily due to a recent trend in salary increases relating to increased competition for top employees and the strong real estate environment. The increase in personnel costs as a percentage of related revenue in 2004 as compared to 2003 is attributable to the lag in reducing personnel to the appropriate level based on activity.
Interest expense for the years ended December 31, 2005, 2004, and 2003 was $16.7 million, $3.9 million, and $4.6 million, respectively. The increase in 2005 relates primarily to an increase in average borrowings as compared to the prior year including the $500 million in notes due to FNF and borrowings on the Credit Facility in 2005.
Income tax expense as a percentage of earnings before income taxes for 2005, 2004, and 2003 was 37.7%, 36.6%, and 37.3%, respectively. The fluctuation in income tax expense as a percentage of earnings before
income taxes is attributable to our estimate of ultimate income tax liability, and changes in the characteristics of net earnings year to year, such as underwriting income versus investment income.
Personnel costs were $40.5 million, $28.8 million and $19.8 million in 2005, 2004 and 2003, respectively. As a percentage of total specialty insurance revenues, personnel costs were 9.2%, 11.9% and 14.4% in 2005, 2004 and 2003, respectively. The decrease as a percentage of revenues in 2005 and 2004 is primarily the result of organic growth of the business lines, which has not required a proportionate increase in personnel.
Claim loss expense was $124.1 million, $51.3 million and $31.4 million in 2005, 2004 and 2003, respectively. As a percentage of premiums earned the claim loss provision was 65.8%, 43.0% and 50.5% in 2005, 2004 and 2003, respectively. The substantial increase in 2005 was primarily the result of increased claims incurred due to three hurricanes, Katrina, Rita and Wilma.
The corporate and other segment is primarily comprised of the operations of our parent holding company and smaller entities not included in our operating subsidiaries. It generated $145.3 million in net income in 2005, largely due to the gain on sale of subsidiary securities in connection with the sale of a minority interest in FIS, offset by related income tax and by minority interest expense.
In connection with the distribution of FNT stock, FNT issued two $250 million intercompany notes payable to us, with terms that mirrored our existing $250 million 7.30% public debentures due in August 2011 and $250 million 5.25% public debentures due in March 2013. Interest on each mirror note accrues from the last date on which interest on our corresponding notes was paid and at the same rate. The mirror notes mature on the maturity dates of our corresponding notes. Upon any acceleration of maturity of our notes, whether upon redemption or an event of default of our notes, FNT must repay the corresponding mirror note. Following the issuance of the intercompany notes, FNT filed a Registration Statement on Form S-4, pursuant to which FNT offered to accept the outstanding FNF notes in exchange for new FNT notes issued having substantially the same terms. On January 18, 2006, FNT completed these exchange offers and received $241.3 million in aggregate principal amount of our 7.30% Notes due August 15, 2011, and the entire $250.0 million in aggregate principal amount of our 5.25% Notes due March 15, 2013. The notes received by FNT in the exchange were subsequently delivered to us in partial redemption of the 7.30% Mirror Note due August 15, 2011, and in full redemption of the 5.25% Mirror Note due March 15, 2013. In order to reflect the partial redemption of the 7.30% Mirror Note due August 15, 2011, the original note has been replaced with an identical Mirror Note with a principal balance of $8.7 million, which reflects the unredeemed portion of the original Mirror Note. Interest on each mirror note has been accrued from the last date on which interest on the corresponding FNF notes was paid and at the same rate. The remaining mirror notes mature on the maturity dates of the corresponding notes. FNT may seek to acquire some or all of the 7.30% FNF notes remaining outstanding, through purchases in the open market, privately negotiated purchases or otherwise. In the event that any such notes are acquired, we anticipate that FNT would deliver the notes to us in further redemption of the remaining 7.30% Mirror Note due August 15, 2011.
On March 9, 2005, we completed a recapitalization plan of FIS. FIS entered into $3.2 billion in senior credit facilities consisting of a $800.0 million Term Loan A facility, a $2.0 billion Term Loan B facility (collectively, the “Term Loan Facilities”) and a $400.0 million revolving credit facility (“Revolver”) with a consortium of lenders led by Bank of America. FIS fully drew upon the entire $2.8 billion in Term Loan Facilities to consummate the recapitalization. FIS used proceeds from the loans to repay the outstanding principal and interest on a $2.7 billion note it previously paid as a dividend to us. We in turn used these funds to pay $1.8 billion as a special cash dividend of $10.00 per share to our shareholders and $400 million to pay down our existing credit facility. The remainder will be used for general corporate purposes. Revolving credit borrowings and Term A Loans bear interest at a floating rate, which will be, at the borrowers’ option, either
The new credit facilities contain affirmative, negative, and financial covenants customary for financings of this type, including, among other things, limits on the creation of liens, limits on the incurrence of indebtedness, restrictions on investments and dispositions, limitations on dividends and other restricted payments and capital expenditures, a minimum interest coverage ratio, and a maximum secured leverage ratio.
On March 9, 2005, FIS used proceeds from the Term Loans to repay all outstanding principal and interest on a $2.7 billion principal amount promissory note that it distributed to FNF as a dividend on March 8, 2005. On March 9, 2005, FIS also completed its minority interest sale, in which it issued common shares representing a 25% interest in FIS to an investor group for $500 million. FIS used the proceeds of that issuance and the remaining Term Loan proceeds to retire its former revolving credit facility, as described below, and pay expenses relating to the recapitalization and the minority interest sale. These expenses totaled $79.2 million, and included certain fees and expenses of the investor group totaling approximately $45.7 million. The remaining proceeds from the Term Loans and minority interest sale were retained to use for general corporate purposes.
Following the recapitalization, FIS is highly leveraged. As of December 31, 2005, it is paying interest on the term loan facilities at a rate of one month LIBOR plus 1.50% to 1.75% (5.86 - 6.11%). At that rate, the annual interest on the remaining $1,854.0 million of debt not swapped into a fixed rate obligation as described below would be $112.8 million. A one percent increase in the LIBOR rate would increase its annual debt service on this portion of the Term Loan Facilities by $18.8 million. The credit rating assigned to the Term Loan Facilities and Revolver by Standard & Poor’s is currently BB.
On April 11, 2005, FIS entered into interest rate swap agreements which have effectively fixed the interest rate at approximately 6.1% through April 2008 on $350 million of the Term Loan B Facility and at approximately 5.9% through April 2007 on an additional $350.0 million of the Term Loan B Facility. The estimated fair value of the cash flow hedges results in an asset of the Company of $5.2 million as of December 31, 2005, which is included in the accompanying consolidated balance sheet in prepaid expenses and other assets and as a component of accumulated other comprehensive earnings, net of deferred taxes.
On November 8, 2004, FIS entered into a new credit agreement providing for a $500.0 million, 5-year revolving credit facility due November 8, 2009. The facility provided an option to increase the size of the credit facility an additional $100.0 million. This credit agreement bore interest at a variable rate based on leverage and was unsecured. The interest rate under the new credit agreement during the time it was outstanding was LIBOR plus 0.50%. In addition, FIS was required to pay a 0.15% commitment fee on the entire facility. On November 8, 2004, FIS drew down approximately $410 million to fund the acquisition of InterCept. On March 9, 2005, FIS repaid this facility with a portion of the net proceeds from our sale of a minority interest in FIS to a group of investors and terminated the agreement.
Seasonality. Historically, real estate transactions have produced seasonal revenue levels for title insurers. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. Recently, the third calendar quarter has been typically the strongest in terms of revenue primarily due to a higher volume of home sales in the summer months and the fourth calendar quarter is usually also strong due to commercial entities desiring to complete transactions by year-end. Significant changes in interest rates may alter these traditional seasonal patterns due to the effect the cost of financing has on the volume of real estate transactions.
As of December 31, 2005 we had title insurance reserves of $1,063.9 million. The amounts and timing of these obligations are estimated and are not set contractually. Nonetheless, based on historical title insurance claim experience, we anticipate the above payment patterns. While we believe that historical loss payments are a reasonable source for projecting future claim payments, there is significant inherent uncertainty in this payment pattern estimate because of the potential impact of changes in:
In addition to the amounts shown in the table, at December 31, 2005, we held claim reserves of $45.4 million in respect of our specialty insurance reserves. Because of uncertainty with respect to the precise payout pattern of these reserves, and their small size, we have not allocated them to the periods shown, although we would expect the substantial majority of these amounts to be paid in 2006. In addition, the above tables do not reflect long-term contractual obligations of Certegy, which merged with FIS after December 31, 2005. Certegy’s long-term contractual obligations totaled $528.0 million as of December 31, 2005.
Additional Minimum Pension Liability Adjustment. Discount rates that are used in determining our December 31, 2005 projected benefit obligation and 2005 net periodic pension costs were based on prevailing interest rates as of December 31, 2005. Similar to prior years, we considered investment grade corporate bond yields at that date as an appropriate basis in determining the discount rate. A decrease in the discount rate used at December 31, 2005 resulted in an additional minimum pension liability adjustment. As such, we recorded a net-of-tax charge of $6.8 million to accumulated other comprehensive loss in 2005 in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions”.
Off-Balance Sheet Arrangements. Other than facility and equipment leasing arrangements, we do not engage in off-balance sheet financing activities. On June 29, 2004 we entered into an off-balance sheet financing arrangement (commonly referred to as a “synthetic lease”). The owner/lessor in this arrangement acquired land and various real property improvements associated with new construction of an office building in Jacksonville, Florida that will be part of our corporate campus and headquarters. The lease expires on September 28, 2011, with renewal subject to consent of the lessor and the lenders. The lessor is a third-party limited liability company. The synthetic lease facility provides for amounts up to $75.0 million. As of December 31, 2005, approximately $40.8 million had been drawn on the facility to finance land costs and related fees and expenses. The leases include guarantees by us of up to 85.0% of the outstanding lease balance, and options to purchase the facilities at the outstanding lease balance. The guarantee becomes effective if we decline to purchase the facilities at the end of the lease and also decline to renew the lease. The lessor financed the acquisition of the facilities through funding provided by third-party financial institutions. We have no
affiliation or relationship with the lessor or any of its employees, directors or affiliates, and our transactions with the lessor are limited to the operating lease agreements and the associated rent expense that will be included in other operating expenses in the Consolidated Statements of Earnings after the end of the construction period.
We do not believe the lessor is a variable interest entity, as defined in FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46”). In addition, we have verified that even if the lessor was determined to be a variable interest entity, we would not have to consolidate the lessor nor the assets and liabilities associated with the assets leased to us. This is because the assets leased by us will not exceed 50% of the total fair value of the lessor’s assets excluding any assets that should be excluded from such calculation under FIN 46, nor did the lessor finance 95% or more of the leased balance with non-recourse debt, target equity or similar funding.
In conducting our operations, we routinely hold customers’ assets in escrow, pending completion of real estate transactions. Certain of these amounts are maintained in segregated bank accounts and have not been included in the Consolidated Balance Sheets. As a result of holding these customers’ assets in escrow, we have ongoing programs for realizing economic benefits during the year through favorable borrowing and vendor arrangements with various banks. There were no investments or loans outstanding as of December 31, 2005 related to these arrangements.
In December 2004, the FASB issued FASB Statement No. 123R (“SFAS No. 123R”), “Share-Based Payment”, which requires that compensation cost relating to share-based payments be recognized in our financial statements. We are implementing this standard effective January 1, 2006. During 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003. We elected to use the prospective method of transition, as permitted by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”). Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. SFAS No. 123R does not allow for the prospective method, but requires the recording of expense relating to the vesting of all unvested options beginning January 1, 2006. Since we adopted SFAS No. 123 in 2003, the impact of recording additional expense in 2006 under SFAS No. 123R relating to options granted prior to January 1, 2003 is insignificant.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Fidelity National Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fidelity National Financial, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
In our opinion, management’s assessment that Fidelity National Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Fidelity National Financial, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2005 and 2004, 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, 2005, and our report dated March 13, 2006 expressed an unqualified opinion on those consolidated financial statements.
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, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
Net of income tax expense (benefit) of $(0.5) million, $0.7 million and $(0.3) million for 2005, 2004 and 2003, respectively.
Net of income tax benefit of $(2.0) million, $(6.9) million and $(6.4) million in 2005, 2004 and 2003, respectively.
Fidelity National Financial, Inc. (the “Company” or “FNF”) is a holding company that is a provider of outsourced products and services to a variety of industries. During 2005, FNF completed certain strategic initiatives, including contributing its title operations into a newly formed subsidiary, Fidelity National Title Group, Inc. (“FNT”) (NYSE:FNT) which in turn became a majority-owned, publicly traded company; selling a minority interest in its subsidiary Fidelity National Information Services Inc. (“FIS”); and agreeing to merge FIS with a separate publicly traded company, Certegy Inc. (“Certegy”). Certegy is now known as Fidelity National Information Services, Inc. (NYSE:FIS). Through FNT, FNF is the United States’ largest title insurance company, with approximately 30.5% national market share. Through FIS, FNF provides industry leading data processing, payment and risk management services to financial institutions and retailers. Through its other wholly-owned subsidiaries, FNF is a leading provider of specialty insurance products, including flood insurance, homeowners insurance and home warranty insurance. Since February 1, 2006 when FNF closed its acquisition of a 40% interest in Sedgwick CMS (“Sedgwick”), FNF is now a provider of outsourced insurance claims management services to large corporate and public sector entities.
Fidelity National Title Group, Inc. This segment consists of the operation of FNF’s majority owned subsidiary, FNT. FNT’s title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - together issued approximately 30.5% of all title insurance policies issued nationally during 2004. FNT provides core title insurance and escrow and other title related services including collection and trust activities, trustee’s sales guarantees, recordings and reconveyances.
Corporate and Other. The corporate and other segment consists of the operations of the FNF parent holding company and certain other unallocated corporate overhead expenses.
The recapitalization of FIS was completed on March 9, 2005 through $2.8 billion in borrowings under new senior credit facilities consisting of an $800 million Term Loan A facility, a $2.0 billion Term Loan B facility (collectively, the “Term Loan Facilities”) and an undrawn $400 million revolving credit facility (“ the Revolver”). FIS fully drew upon the entire $2.8 billion in Term Loan Facilities while the Revolver remained undrawn at the closing. The current interest rate on both the Term Loan Facilities and the Revolver is LIBOR plus 1.50% to 1.75%. Bank of America, JP Morgan Chase, Wachovia Bank, Deutsche Bank and Bear Stearns led a consortium of lenders providing the new senior credit facilities.
Goodwill represents the excess of cost over fair value of identifiable net assets acquired and assumed in a business combination. SFAS No. 142, Goodwill and Intangible Assets (“SFAS No. 142”) provides that goodwill and other intangible assets with indefinite useful lives should not be amortized, but shall be tested for
impairment annually, or more frequently if circumstances indicate potential impairment, through a comparison of fair value to its carrying amount. The Company measures for impairment on an annual basis.
Amortization expense relating to computer software was $110.7 million, $85.9 million and $39.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.
In the state of Illinois, a trust company is permitted to commingle and invest customers’ assets with those of the Company, pending completion of real estate transactions. Accordingly, the Company’s Consolidated Balance Sheets reflect a secured trust deposit liability of $882.6 million and $735.3 million at December 31, 2005 and 2004, respectively, representing customers’ assets held by us and corresponding assets including cash and investments pledged as security for those trust balances.
The substantial majority of the revenues in this business are from outsourced data processing and application management arrangements. Revenues from these arrangements are recognized as services are performed in accordance with SEC Staff Accounting Bulletin No. 104 (SAB No. 104), “Revenue Recognition” and related interpretations. SAB No. 104 sets forth guidance as to when revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectibility is reasonably assured. Revenue and deferred costs related to implementation, conversion and programming services associated with the Company’s data processing and application management agreements are deferred during the implementation phase and subsequently recognized using the straight-line method over the term of the related agreement. The Company evaluates these deferred costs for impairment in the event any indications of impairment exist.
In the event that the Company’s arrangements with its customers include more than one product or service, the Company determines whether the individual elements can be recognized separately in accordance with the provisions of Financial Accounting Standards Board (FASB) Emerging Issues Task Force No. 00-21 (EITF 00-21), “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses the determination of whether an arrangement involving more than one deliverable contains more than one unit of accounting and how the arrangement consideration should be measured and allocated to the separate units of accounting.
With respect to a small percentage of revenues, the Company uses contract accounting, as required by SOP NO. 97-2, when the arrangement with the customer includes significant customization, modification, or production of software. For elements accounted for under contract accounting, revenue is recognized in accordance with SOP 81-1, Accounting for Performance of Construction Type and Certain Production-Type Contracts, using the percentage-of-completion method since reasonably dependable estimates of revenues and contract hours applicable to various elements of a contract can be made. Revenues in excess of billings on these agreements are recorded as unbilled receivables and are included in accounts receivable. Billings in excess of revenue recognized on these agreements are recorded as deferred revenue until revenue recognition criteria are met. Changes in estimates for revenues, costs and profits are recognized in the period in which they are determinable. When the Company’s estimate indicates that the entire contract will be performed at a loss, a provision for the entire loss is recorded in that accounting period.
The Company records revenue from providing data or data-related services. These services principally include appraisal and valuation services, property records information, real estate tax services, borrower credit and flood zone information and multiple listing software and services. Revenue derived from these services is recognized as the services are performed in accordance with SAB No. 104 as described above.
The Company also owns warrants to purchase additional shares relating to its investment in Covansys Corporation (“Covansys”). From September 2004 until March 25, 2005, the Company accounted for the warrants under SFAS No. 133 as the warrants were considered derivative instruments. At the date of the Covansys acquisition, the warrants were recorded at fair value aggregating $23.5 million. During the first quarter of 2005, the Company recorded a loss of $4.4 million on the decrease in fair value of the warrants through March 25, 2005 which is reflected in the Consolidated Statement of Earnings in realized gains and losses. On March 25, 2005, the terms of the warrants were amended such that the accounting for the investment in the warrants is now governed by the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, and changes in the fair value of the warrants are recorded in other comprehensive earnings. During 2004, the Company did not engage in any hedging activities and thus recorded all derivative financial instruments at fair value in the Consolidated Balance Sheet and all changes in
The functional currency for the foreign operations of the Company is either the U.S. Dollar or the local currency. For foreign operations where the local currency is the functional currency, the translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The unrealized gains and losses resulting from the translation are included in accumulated other comprehensive earnings in the Consolidated Statement of Stockholders’ Equity and are excluded from net earnings. Gains or losses resulting from foreign currency transactions are included in realized gains and losses and are insignificant in 2005, 2004 and 2003.
Certain reclassifications have been made in the 2004 and 2003 Consolidated Financial Statements to conform to the classifications used in 2005.
The results of operations and financial position of the entities acquired during any year are included in the Consolidated Financial Statements from and after the date of acquisition. Based on the Company’s valuation, any differences between the fair value of the identifiable assets and liabilities and the purchase price paid are recorded as goodwill. There were no significant acquisitions in 2005.
On March 11, 2004, the Company acquired Aurum Technology, Inc. (“Aurum”) for $306.4 million, comprised of $185.0 million in cash and the issuance of 3,144,390 shares of the Company’s common stock valued using the average closing prices over the five day period beginning two days before and ending two days after the valuation date, which was $121.4 million. Aurum is a provider of outsourced and in-house information technology solutions for the community bank and credit union markets.
On September 30, 2004, FNF acquired a 74.9% interest in KORDOBA Gesellschaft fur Bankensoftware mbH & Co. KG, Munich (“Kordoba”), a provider of core processing software and outsourcing solutions to
Selected unaudited pro forma results of operations for the years ended December 31, 2005 and 2004, assuming the above acquisitions had occurred as of January 1, 2004, and using actual general and administrative expenses prior to the acquisition, are set forth below(dollars in thousand except per share data):
The Company allocated the purchase price as follows: $450.7 million to goodwill; $348.0 million to other intangible assets, namely acquired customer relationship intangibles; and $95.0 million to capitalized software. The Company is amortizing the other intangible assets using an accelerated method which takes into consideration expected customer attrition rates over a 10-year period. The acquired software is amortized over a ten-year period using an accelerated method that contemplates the period of expected economic benefit and future enhancements to the underlying software. Under the terms of the stock purchase agreement, the Company made a joint election with ALLTEL to treat the acquisition as a sale of assets in accordance with
Section 338 (h) (10) of the Internal Revenue Code, which resulted in the revaluation of the assets acquired to fair value. As such, the fair value assignable to the historical assets, as well as intangible assets and goodwill, is deductible for federal and state income tax purposes.
The assets acquired and liabilities assumed in the FIS acquisition were as follows (dollars in thousands):
On September 30, 2003, the Company acquired the outstanding minority interest of Fidelity National Information Solutions, Inc. (“FNIS”), its majority-owned real estate information services public subsidiary that provides property data and real-estate related services, whereby FNIS became a wholly-owned subsidiary of the Company. In the acquisition, each share of FNIS common stock (other than FNIS common stock the Company already owned) was exchanged for 0.83 shares of the Company’s common stock. The Company issued 14,292,858 shares of its common stock to FNIS stockholders in the acquisition. The Company has allocated $154.8 million of the purchase price to goodwill and $88.9 million of the purchase price to other intangible assets and capitalized software.
On August 1, 2005, the Company acquired Service Link, L.P. (“Service Link”) a national provider of centralized mortgage and residential real estate title and closing services to major financial institutions and institutional lenders. The acquisition price was approximately $110.2 million in cash. The Company recorded approximately $76.2 million in goodwill and approximately $33.6 million in other amortizable intangible assets relating to this transaction.
On September 15, 2004, the Company acquired 11 million shares of common stock and warrants to purchase four million additional shares of Covansys, a publicly traded U.S.-based provider of application management and offshore outsourcing services with India based operations, for $121.0 million in cash. The
Company owns approximately 29% of Covansys and accounts for the investment in common stock using the equity method of accounting and, until March 25, 2005, accounted for the warrants pursuant to SFAS No. 133 (See Note A to Notes of Consolidated Financial Statements).
On July 2, 2004, the Company acquired 100% of Geotrac, Inc. (“Geotrac”), a flood zone monitoring services provider, for $40.0 million in cash.
On April 7, 2004, the Company acquired Bankware, a provider of check imaging solutions for financial institutions, for $55.7 million in cash.
The change in unrealized gains (losses) on fixed maturities for the years ended December 31, 2005, 2004, and 2003 was $(44.4) million, $(27.1) million and $(22.4) million, respectively.
The following table presents certain information regarding contractual maturities of the Company’s fixed maturity securities at December 31, 2005:
Equity securities at December 31, 2005 and 2004 consisted of investments in various industry groups at a cost basis of $222.5 million and $128.8 million and fair value of $210.2 million and $135.5 million. There were no significant investments in banks, trust and insurance companies at December 31, 2005 or 2004.
During the second quarter of 2005, the Company began lending fixed maturity and equity securities to financial institutions in short-term security lending transactions. The Company’s security lending policy requires that the cash received as collateral be 102% or more of the fair value of the loaned securities. These short-term security lending arrangements increase investment income with minimal risk. At December 31, 2005, the Company had security loans outstanding with a fair value of $138.7 million included in accounts payable and accrued liabilities and the Company held cash in the amount of $143.4 million as collateral for the loaned securities.
Net realized gains amounted to $372.1 million, $37.0 million and $106.4 million for the years ended December 31, 2005, 2004 and 2003, respectively. Included in 2004 were gains related to the Company’s investment in Covansys warrants of $16.2 million. Included in 2003 net realized gains is a $51.7 million realized gain as a result of InterActive Corp’s acquisition of Lending Tree Inc. and the subsequent sale of the Company’s InterActive Corp common stock and a realized gain of $25.0 million on the sale of New Century Financial Corporation common stock.
During the years ended December 31, 2005, 2004 and 2003, gross realized gains on sales of fixed maturity securities considered available for sale were $4.9 million, $8.9 million and $18.5 million, respectively; gross realized losses were $1.4 million, $0.2 million and $2.2 million, respectively. Gross proceeds from the sale of fixed maturity securities considered available for sale amounted to $2,978.9 million, $2,305.8 million and $1,451.7 million during the years ended December 31, 2005, 2004 and 2003, respectively.
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2005 and 2004 were as follows:
A substantial portion of the Company’s unrealized losses relate to its holdings of debt securities. Unrealized losses relating to U.S. government, state and political subdivision and fixed maturity corporate holdings were primarily caused by interest rate increases. Since the decline in fair value of these investments is attributable to changes in interest rates and not credit quality, and the Company has the intent and ability to hold these securities, the Company does not consider these investments other-than-temporarily impaired. The unrealized losses relating to equity securities were caused by market changes that the Company considers to be temporary. During 2005 and 2004, the Company incurred impairment charges relating to investments that it determined to be other than temporarily impaired, which resulted in charges of $8.3 million and $8.0 million, respectively.
Amortization expense for amortizable intangible assets which consist primarily of customer relationships was $145.7 million, $124.1 million and $115.4 million for the years ended December 31, 2005, 2004 and 2003,
On November 8, 2004, the Company through FIS entered into a new credit agreement providing for a $500.0 million, 5-year revolving credit facility due November 8, 2009. On March 9, 2005, the Company paid down this facility and terminated the agreement.
On October 17, 2005, the Company entered into a new Credit Agreement, dated as of October 17, 2005, with Bank of America, N.A. as Administrative Agent and Swing Line Lender, and the other financial institutions party thereto (the “Credit Agreement”). This Credit Agreement replaced the Company’s prior $700.0 million, 5-year revolving credit facility which was due November 4, 2008.
The Credit Agreement contains certain affirmative and negative covenants customary for financings of this type, including, among other things, limits on the creation of liens, sales of assets and the incurrence of indebtedness, restrictions on investments and limitations on restricted payments and transactions with affiliates. The Credit Agreement also contains customary financial covenants regarding net worth, fixed charge coverage, total debt to total capitalization and a minimum unencumbered cash balance. The Credit Agreement includes customary events of default for facilities of this type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default, the interest rate on all outstanding obligations will be increased and payments of all outstanding loans may be accelerated and/or the lenders’ commitments may be terminated. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the Credit Agreement shall automatically become immediately due and payable, and the lenders’ commitments will automatically terminate. The Credit Agreement also requires a pledge of subsidiary stock at certain below investment grade credit ratings.
Agreement shall automatically become immediately due and payable, and the lenders’ commitments will automatically terminate.
On August 20, 2001, the Company completed a public offering of $250.0 million aggregate principal amount of 7.3% notes due August 15, 2011. The notes were priced at 99.597% of par to yield 7.358% annual interest. As such, the Company recorded a discount of $1.0 million, which is netted against the $250.0 million aggregate principal amount of notes. The discount is amortized to interest expense over 10 years, the term of the notes. The Company received net proceeds of $247.0 million, after expenses, which were used to pay down a portion of the $450.0 million, 6-year term loan facility under our prior credit agreement.
On March 9, 2005, Fidelity National Information Solutions, Inc. and Fidelity National Tax Service, Inc., (collectively the “borrowers”), both direct subsidiaries of FIS and indirect subsidiaries of the Company, entered into a Credit Agreement, dated as of March 9, 2005, with Bank of America, as Administrative Agent and other financial institutions (the “FIS Credit Agreement”). The Company is not a party nor a guarantor to this agreement.
The FIS Credit Agreement provides for a $800 million six-year term facility (“Term A Loans”), a $2.0 billion eight-year term facility (“Term B Loans”) and a $400 million revolving credit facility maturing on the sixth anniversary of the closing date. The term facilities were fully drawn on the closing date while the revolving credit facility was undrawn on the closing date. FIS has provided an unconditional guarantee of the full and punctual payment of the borrowers’ obligations under the FIS Credit Agreement and related loan documents.
performance of the borrowers. The Term B Loans bear interest at either the British Bankers Association LIBOR plus 1.75% per annum or, at the borrowers’ option, a base rate plus 0.75% per annum.
Tax benefits of $34.8 million, $36.1 million and $18.9 million associated with the exercise of employee stock options and the vesting of restricted stock grants were allocated to stockholders’ equity for the years ended December 31, 2005, 2004 and 2003, respectively.
Additionally, the Company has received inquiries from regulators about its business involvement with title insurance agencies affiliated with builders, realtors and other traditional sources of title insurance business, some of which the Company participated in forming as joint ventures with its subsidiaries. These inquiries have focused on whether the placement of title insurance with the Company through these affiliated agencies is proper or an improper form of referral payment. Like most other title insurers, the Company participates in these affiliated business arrangements in a number of states. The Company recently entered into a settlement with the Florida Department of Financial Services under which it agreed to refund approximately $3 million in premiums received though these types of agencies in Florida and pay a fine of $1 million. The other pending inquiries are at an early stage and as a result the Company can give no assurance as to their likely outcome.
Further, U.S. Representative Oxley, the Chairman of the House Financial Services Committee, recently asked the Government Accountability Office (the “GAO”) to investigate the title insurance industry. Representative Oxley stated that the Committee is concerned about payments that certain title insurers have made to developers, lenders and real estate agents for referrals of title insurance business. Representative Oxley asked the GAO to examine, among other things, the foregoing relationships and the levels of pricing and competition in the title insurance industry. The Company is unable to predict the outcome of this inquiry or whether it will adversely affect the Company’s business or results of operations.
Finally, the California Department of Insurance has begun to examine levels of pricing and competition in the title insurance industry in California, with a view to determining whether prices are too high and if so, implementing rate reductions. New York, Colorado, Florida, Nevada, and Texas insurance regulators have also announced similar inquiries (or other reviews of title insurance rates) and other states could follow. At this stage, the Company is unable to predict what the outcome will be of this or any similar review.
The Company and its subsidiaries, FIS and Fidelity Information Services, Inc. (“FI”), together with certain of its employees, were named on March 6, 2006 as defendants in a civil lawsuit brought by Grace & Digital Information Technology Co., Ltd. (“Grace”), a Chinese company that formerly acted as a sales agent for Alltel Information Services (“AI”), the predecessor to Fidelity Information Services, in China.
Grace originally filed a lawsuit in December 2004 in state court in Monterey County, California, alleging that FIS breached the sales agency agreement between Grace and FI by failing to pay Grace commissions on certain contracts in 2001 and 2003. However, the 2001 contracts were never completed and the 2003 contracts, as to which Grace provided no assistance, were for a different project and were executed one and one-half years after FI terminated the sales agency agreement with Grace. In addition to its breach of contract claim, Grace also alleged that FNF violated the Foreign Corrupt Practices Act (FCPA) in its dealings with a bank customer in China. FNF denied Grace’s allegations in this California lawsuit.
In December 2005, the Monterey County court dismissed the lawsuit on the grounds of inconvenient forum. On March 6, 2006, Grace filed a new lawsuit in the United States District Court for the Middle District of Florida arising from the same transaction, and added an additional allegation to its complaint that FNF violated the Racketeer Influenced and Corrupt Organizations Act (RICO) in its dealings with the same bank customer. FNF and its subsidiaries intend to defend this case vigorously. On March 6, 2006, FNF filed its motion to dismiss this lawsuit and denied Grace’s underlying allegations.
FNF and its counsel have investigated these allegations and, based on the results and extent of the investigations completed to date, FNF does not believe that there have been any violations of the FCPA or RICO, or that the ultimate disposition of these allegations or the lawsuit will have a material adverse impact on FNF’s or any of its subsidiaries’ financial position, results of operations or cash flows. FNF is fully cooperating with the Securities and Exchange Commission and the U.S. Department of Justice in connection with their inquiry into these allegations.
In conducting its operations, the Company routinely holds customers’ assets in escrow, pending completion of real estate transactions. Certain of these 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 our customers, which amounted to $12.0 billion at December 31, 2005. As a result of holding these customers’ assets in escrow, the Company has ongoing programs for realizing economic benefits during the year through favorable borrowing and vendor arrangements with various banks. There were no investments or loans outstanding as of December 31, 2005 and 2004 related to these arrangements.
The Company leases certain of its premises and equipment under leases which expire at various dates. Several of these agreements include escalation clauses and provide for purchase and renewal options for periods ranging from one to five years.
The Company’s insurance subsidiaries, including title insurers, underwritten title companies and insurance agencies, are subject to extensive regulation under applicable state laws. Each of the insurance underwriters is subject to a holding company act in its state of domicile which regulates, among other matters, the ability to pay dividends and enter into transactions with affiliates. The laws of most states in which the Company transacts business establish supervisory agencies with broad administrative powers relating to: issuing and revoking licenses to transact business; regulating trade practices; licensing agents; approving policy forms; prescribing accounting principles and financial practices; establishing reserve and capital and surplus as regards policyholders (“capital and surplus”) requirements; defining suitable investments and approving rate schedules.
The Company’s title insurers are regulated by the insurance regulatory authority in their respective state of domicile, as well as that of each state in which it is licensed. The insurance commissioners of their respective states of domicile regulate the Company’s title insurance subsidiaries. Regulatory financial examinations are conducted generally by regulatory authorities at three-year intervals, and certain of these examinations are currently ongoing.
Pursuant to statutory requirements of the various states in which the Company’s title insurers are domiciled, such insurers must maintain certain levels of minimum capital and surplus. Each of the Company’s title underwriters has complied with the minimum statutory requirements as of December 31, 2005.
On April 24, 2002, the Company’s Board of Directors approved a three-year stock repurchase program. Purchases were made by the Company from time to time in the open market, in block purchases or in privately negotiated transactions. For the year ended December 31, 2003, the Company repurchased 1,775,400 shares of common stock for $45.4 million, or an average price of $25.60. In the fourth quarter of 2003, the Company retired 989,450 of these shares held as treasury stock, totaling $27.3 million. As a result of the increased cash dividend per share, the Company decided to suspend this stock repurchase program effective July 23, 2003; however, effective December 18, 2003, the stock repurchase program was reinstated. From January 1, 2004 through December 31, 2005, the Company repurchased a total of 430,500 shares of common stock for $16.5 million, or an average price of $38.33. Additionally, on December 13, 2004, the Company entered into an agreement to repurchase 2,530,346 shares of Company common stock from Willis
Stein & Partners (“Willis Stein”) and J.P. Morgan Chase, as escrow agent for the former stockholder of Aurum. The Company acquired Aurum in March 2004. The purchase price per share of $44.35 was a discount to the closing price of the Company’s common stock on December 13, 2004. During 2005, the Company did not purchase any shares of common stock under this plan. On April 6, 2005, the Company acquired 2,250,000 shares at a purchase price of $31.50 per share of Company’s common stock from ALLTEL, Inc. that they had acquired as part of the Company’s purchase of Fidelity Information Services in 2003 and classified these as treasury shares.
The Company offers its employees the opportunity to participate in the Fidelity National Financial, Inc. 401(k) Profit Sharing Plan (“401(k) Plan”), a qualified voluntary contributory savings plan, which is available to substantially all Fidelity employees. Eligible employees may contribute up to 40% of their pretax annual compensation, up to the amount allowed pursuant to the Internal Revenue Code. The Company matches 50% of each dollar of employee contribution up to six percent of the employee’s total compensation. The Company’s cost for the 401(k) Plan for the years ended December 31, 2005, 2004 and 2003 was $40.0 million, $33.5 million and $28.0 million, respectively.
The Company’s 1993 Stock Plan (“1993 Plan”) expired in June 2003. Options generally had a term of 10 years from the date of grant and were exercisable subject to the terms and conditions set by the Board of Directors. The per share option price was determined at the date of grant, provided that the price for incentive stock options shall not be less than 100% of their market value or award stock shares. A total of 1,089,401 stock options were outstanding as of December 31, 2005. No further awards may be granted under this plan.
In connection with the 1998 acquisition of FNF Capital, Inc. (formerly known as “Granite”), which was accounted for as a pooling-of-interests, the Company assumed 1,140,855 options outstanding under Granite’s existing stock option plan (“Granite Plan”), of which 24,524 stock options were outstanding as of December 31, 2005. The Granite Plan provides that qualified stock options be granted at an exercise price equal to fair market value on the date of the grant with a term not to exceed 10 years. The Granite Plan provides that non-qualified stock options be granted at an exercise price not less than 85% of the fair market value on the date of grant with a term not to exceed 10 years.
During 1998, stockholders approved the adoption of the 1998 Stock Incentive Plan (“1998 Plan”). The 1998 Plan authorizes up to 9,985,828 shares of common stock for issuance under the terms of the 1998 Plan. As of December 31, 2005, there were 7,759,226 options outstanding under this plan. The 1998 Plan provides for grants of “incentive stock options” as defined in Section 422 of the Internal Revenue Code of 1986, as amended, non-qualified stock options and rights to purchase shares of common stock (“Purchase Rights”). The term of options may not exceed 10 years from the date of grant (five 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), and the right to exercise such options shall vest equally over three years. 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 option 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 Board of Directors.
amounting to $4.6 million to the exercise price. Pursuant to the terms of the 2001 Plan, there are no future exercise price decreases to options granted under this Plan in 2003 and beyond. In 2002, options were granted at an exercise price of $11.41 to key employees of the Company who applied deferred bonuses expensed in 2001 amounting to $5.7 million to the exercise price. The exercise price of these options decreases approximately $.35 per year through 2007 and $.22 per year from 2008 through 2013, at which time the exercise price will be $8.33.
In connection with the acquisition of ANFI, the Company assumed 988,389 options outstanding under ANFI’s existing option plans: the American National Financial, Inc. 1999 Stock Option Plan and the American National Financial, Inc. 1998 Stock Incentive Plan. The options granted under these plans generally had a term of 10 years. As of December 31, 2005, there were 448,200 options outstanding under these plans.
In connection with the acquisition of Sanchez, the Company assumed 1,024,588 options outstanding under Sanchez’ 1995 Stock Incentive Plan. The option granted under this plan generally had a term of 8 years. As of December 31, 2005, there were 550,554 options outstanding under this plan.
In connection with the acquisition of InterCept, the Company assumed 1,708,155 options outstanding under InterCept’s existing option plans - 2002 InterCept Stock Option Plan, 1996 InterCept Stock Option Plan, 1994 InterCept Option Plan and the Boggs InterCept Stock Option Plan. The options granted under these plans were fully vested prior to the acquisition and the majority of them had a remaining term of 90 days which expired on February 7, 2005. As of December 31, 2005, there were 363,030 options outstanding under this plan.
Beginning in 2005, FNT and FIS also both issue stock options and restricted stock through their own plans. The awards outstanding under these plans impact the Company’s diluted earnings per share based on the impact they would have on earnings available to the Company if the options and awards were exercised
The following table summarizes information related to stock options outstanding and exercisable as of December 31, 2005:
The following table sets forth the funded status of the Pension Plan as of December 31, 2005, 2004 and 2003:
The expected long term rate of return on plan assets was 8.5% in 2005 and 2004, derived using the plan’s asset mix, historical returns by asset category, expectations for future capital market performance, and the fund’s past experience. Both the plan’s investment policy and the expected long-term rate of return assumption are reviewed periodically. The Company’s strategy is to focus on a one to three-year investment horizon, maintaining equity securities at 65% of total assets while maintaining an average duration in debt securities, extending that duration as interest rates rise and maintaining cash funds at appropriate levels relating to the current economic environment.
In 2004, the Company also assumed pension plans relating to its acquisition of Kordoba. These plans cover benefits for retirees in Germany and amount to a liability of approximately $23.7 and $18.0 million at December 31, 2005 and 2004, respectively. Net pension expense recorded relating to this plan was $5.9 million and $2.9 million in 2005 and 2004, respectively. In addition, the net pension liability includes an minimum liability adjustment of $4.7 million which is included in accumulated other comprehensive earnings (losses) in 2005. Benefit payments were $0.1 million in 2005. Projected benefit payments relating to this plan are $0.3 million, $0.5 million, $0.6 million, $0.7 million and $0.7 million in 2006, 2007, 2008, 2009 and 2010, respectively and $6.2 million in 2011-2015.
The accrued cost of the accumulated postretirement benefit obligation included in the Company’s Consolidated Balance Sheets at December 31, 2005, 2004 and 2003 is as follows:
The Company’s postretirement health care and life insurance costs included in the results of operations for 2005, 2004 and 2003 are as follows:
During the fourth quarter of 2005, the Company restructured its business segments to more accurately reflect a change in the Company’s current operating structure. Accordingly previously reported segment information has been restated to be consistent with the current presentation.
others. FIS also provides lender processing services, consisting principally of technology solutions for mortgage lenders, selected mortgage origination services such as title agency and closing services, default management and mortgage information services. FIS’s credit and debit card services and check risk management services were added through our merger with Certegy, which closed on February 1, 2006 (See Note R). As a result of that merger, these businesses are not included in the historical financial information in this report. Included in this segment for the year ended December 31, 2005, 2004 and 2003 is $9.3 million, $6.3 million and $5.9 million, respectively of pre-tax expenses relating to asset impairment charges pursuant to SFAS No. 144.
The corporate and other segment consists of the operations of the FNF parent holding company and certain other unallocated corporate overhead expenses. Included in the corporate and other segment for the year ended December 31, 2003 is $1.6 million in pre-tax expenses relating to the relocation of the Company’s Corporate headquarters to Jacksonville, Florida, pursuant to SFAS No. 146.
On January 31, 2006, the Company, along with our equity partners, THL and Evercore Capital Partners, completed an acquisition of Sedgwick CMS, a leading provider of outsourced insurance claims management services to large corporate and public sector entities headquartered in Memphis, Tennessee. Subsequent to the closing, we now hold a 40% interest in Sedgwick.