As of December 31, 2006, we leased office and storage space as follows:
The information set forth below should be read in conjunction with the consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K. Certain reclassifications have been made to the prior year amounts to conform with the 2006 presentation.
Our financial results for the year ended December 31, 2005 include in revenue and net earnings a $318.2 million gain on sale relating to the issuance of subsidiary stock, approximately $100.0 million in additional income tax expense relating to the distribution to our shareholders of a 17.5% interest of FNT and
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 Note B of Notes to Consolidated Financial Statements.
Our historical basic and diluted earnings per share have been calculated using FNT’s basic and diluted weighted average shares outstanding.
The quarter ended March 31, 2005 includes in revenue and net earnings a $318.2 million gain on sale relating to the issuance of subsidiary securities. (See Note A of Notes to Consolidated Financial Statements).
The quarter ended December 31, 2006 includes the operations of FIS only through October 23, 2006. (See Note A of Notes to Consolidated Financial Statements).
Fidelity National Title Group. This segment consists of the operation of FNF’s title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - which together issued approximately 29.0% of all title insurance policies issued nationally during 2005. This segment provides core title insurance and escrow and other title related services including collection and trust activities, trustee’s sales guarantees, recordings and reconveyances.
title policies and back plant databases contain historical records relating to title that are not regularly updated. Each of our applicable title insurance subsidiaries receives a fee for any access to or use of its starters and back plant databases by FIS. We also do business with additional entities within FIS that provide real estate information to our operations, for which we recorded expenses of $2.4 million from October 24, through December 31, 2006.
Our expenses from October 24 through December 31, 2006 included expenses for a lease of office space to us for our corporate headquarters and business operations in the amount of $1.8 million and were reduced by $1.0 million for a lease of office space to FIS and by $0.1 million for the lease of an aircraft to FIS.
We pay amounts to a subsidiary of FIS for capitalized software development and for title plant construction. During the period from October 24, 2006 through December 31, 2006, these amounts included capitalized software development costs of $1.9 million and capitalized title plant construction costs of $2.7 million.
For 2006, 2005, and 2004, we recognized revenues of $95.5 million, $91.9 million, and $106.3 million, respectively, for agency title premiums sold by an FIS subsidiary acting as title agent and our title insurance
subsidiaries paid commissions associated with these title premiums to FIS in the amounts of $83.9 million, $80.9 million, and $93.6 million, respectively.
For the years ended December 31, 2006, 2005, and 2004, our expenses were reduced by $9.5 million, $29.0 million, and $75.1 million, respectively, related to the provision of corporate services to FIS from us.
For 2006, 2005, and 2004, our expenses to FIS for management and maintenance of our title plant assets were $28.9 million, $29.9 million, and $28.9 million, respectively. For the years ended December 31, 2006, 2005 and 2004, the revenues from royalties on sales of access to our title plant assets, which were first recorded in November of 2004, were $2.5 million, $3.0 million and $0.3 million, respectively. Expenses for payments to FIS for real estate information provided to our operations were $12.7 million, $10.9 million, and $9.9 million in 2006, 2005, and 2004, respectively.
Allocations for the lease of office space to us for our corporate headquarters and business operations in the amounts of $5.1 million, $3.8 million, and $2.8 million were recorded in 2006, 2005, and 2004, respectively. In addition, our expenses were reduced by $1.0 million for a lease of office space to FIS and by $0.5 million in 2006 for the lease of an aircraft by us to FIS.
The accounting estimates described below are those we consider critical in preparing our Consolidated Financial Statements. Management is required to make estimates and assumptions that can affect the reported amounts of assets and liabilities and disclosures with respect to contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates. See Note A of Notes to the Consolidated Financial Statements for a more detailed description of the significant accounting policies that have been followed in preparing our Consolidated Financial Statements.
Predicting ultimate loss exposure is predicated on evaluating past experience and adjusting for changes in current development and trends. Our independent actuaries’ work includes two principal steps. First, they use an actuarial technique known as the loss development method to calculate loss development factors for the Company. The loss development factors forecast ultimate losses for each policy year based on historic emergence patterns of the Company. Older policy year experience is applied to newer policy years to project future development. When new trends surface, the loss development factors are adjusted to incorporate the more recent development phenomena. Changes in homeownership patterns, increased property turnover rates, and a boom in refinance transactions all are examples of events that reduce the tail exposure of the loss pattern and warrant these adjustments.
The table below presents our loss development experience for the past three years. As can be seen in the table, the variability in loss estimates over the past three years has ranged from favorable development in an amount equal to 0.4% of title premiums to adverse development of 0.9% of title premiums with the average being unfavorable development of 0.4% over the three year period. To illustrate the effect of changes in reserve estimates, the effect on pretax earnings of a further + or − 0.4% change in estimates is presented in the last line of the table.
0.4% has been selected as an example; actual variability could be greater or less.
Additionally, for our specialty insurance businesses, we have claims reserves of $65.8 million and $45.4 million as of December 31, 2006 and 2005.
Valuation of Investments. We regularly review our investment portfolio for factors that may indicate that a decline in fair value of an investment is other-than-temporary. Some factors considered in evaluating whether or not a
decline in fair value is other-than-temporary include: (i) our ability and intent to retain the investment for a period of time sufficient to allow for a recovery in value; (ii) the duration and extent to which the fair value has been less than cost; and (iii) the financial condition and prospects of the issuer. Such reviews are inherently uncertain and the value of the investment may not fully recover or may decline in future periods resulting in a realized loss. Investments are selected for analysis whenever an unrealized loss is greater than a certain threshold that we determine based on the size of our portfolio. Fixed maturity investments that have unrealized losses caused by interest rate movements are not at risk as we have the ability and intent to hold them to maturity. Unrealized losses on investments in equity securities and fixed maturity instruments that are susceptible to credit related declines are evaluated based on the aforementioned factors. Currently available market data is considered and estimates are made as to the duration and prospects for recovery, and the ability to retain the investment until such recovery takes place. These estimates are revisited quarterly and any material degradation in the prospect for recovery will be considered in the other than temporary impairment analysis. We believe that our monitoring and analysis has allowed for the proper recognition of other than temporary impairments over the past three year period. Any change in estimate in this area will have an impact on the results of operations of the period in which a charge is taken. During 2006, 2005, and 2004, we recorded other than temporary impairments totaling $9.1 million, $8.3 million and $8.0 million, respectively.
Goodwill. We have made acquisitions in the past that have resulted in a significant amount of goodwill. As of December 31, 2006 and 2005, goodwill was $1,154.3 million and $2,873.9 million, respectively. The majority of our goodwill as of December 31, 2006 relates to goodwill recorded in connection with the Chicago Title merger in 2000. The decrease in goodwill from December 31, 2005 relates primarily to the distribution of FIS’s goodwill. (See Note A of the Notes to Consolidated Financial Statements.)The process of determining whether or not an asset, such as goodwill, is impaired or recoverable relies on projections of future cash flows, operating results and market conditions. While we believe that our estimates of future cash flows are reasonable, these estimates are not guarantees of future performance and are subject to risks and uncertainties that may cause actual results to differ from what is assumed in our impairment tests. In evaluating the recoverability of goodwill, we perform an annual goodwill impairment test based on an analysis of the discounted future cash flows generated by the underlying assets. We have completed our annual goodwill impairment tests in each of the past three years and have determined that we have a fair value in excess of our carrying value. Such analyses are particularly sensitive to changes in estimates of future cash flows and discount rates. Changes to these estimates might result in material changes in fair value and determination of the recoverability of goodwill which may result in charges against earnings and a reduction in the carrying value of our goodwill.
Fidelity National Information Services, Inc. Through October 24, 2006, we recognized revenues relating to processing services, software licensing and software related services, mortgage origination services, default management services and data and information services. We provided some services to customers as part of an integrated offering through multiple businesses. The revenues for services provided under these multiple element arrangements were recognized in accordance with Financial Accounting Standards Board (“FASB”) EITF Issue No. 00-21, Revenue Arrangements and Multiple Deliverables (“EITF 00-21”).
FIS recognized revenues relating to bank processing services and mortgage processing services along with software licensing and software related services. Several of FIS’s contracts included 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 were offered in combination with one another and in other cases FIS offered them individually. Revenues from bank and mortgage processing services were typically volume based depending on factors such as the number of accounts processed, transactions processed and computer resources utilized.
In the event that FIS’s arrangements with its customers included more than one service, FIS determined whether the individual revenue elements could be recognized separately in accordance with EITF 00-21. 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, FIS used contract accounting, as required by SOP No. 97-2, when the arrangement with the customer included significant customization, modification, or production of software. For elements accounted for under contract accounting, revenue was 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 could be made. Revenues in excess of billings on these agreements were recorded as unbilled receivables and were included in trade receivables. Billings in excess of revenue recognized on these agreements were recorded as deferred revenue until revenue recognition criteria were met. Changes in estimates for revenues, costs and profits were recognized in the period in which they were determinable. When FIS’s estimates indicated that the entire contract would be performed at a loss, a provision for the entire loss was recorded in that accounting period.
In its information services businesses, FIS recorded revenue from providing data or data related services. These services principally included 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 was recognized as the services were performed in accordance with SAB No. 104 as described above.
FIS’s flood and tax units provided various services including life of loan-monitoring services. Revenue for life of loan services was deferred and recognized ratably over the estimated average life of the loan service period, which was determined based on FIS’s historical experience. FIS evaluated its historical experience on a periodic basis, and adjusted the estimated life of the loan service period prospectively. Revenue derived from software and service arrangements included in this segment was recognized in accordance with SOP No. 97-2 as discussed above. Revenues from other services in this segment were recognized as the services were performed in accordance with SAB No. 104 as described above.
Accounting for Income Taxes. This process involves estimating actual current tax expense together with assessing temporary differences resulting from differing recognition of items for income tax and accounting purposes. These differences result in deferred income tax assets and liabilities, which are included within the consolidated balance sheet. We must then assess the likelihood that deferred income tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, establish a valuation allowance. To the extent FNF establishes a valuation allowance or increases this allowance in a period, it must reflect this increase as an expense within income tax expense in the statement of earnings. Determination of the income tax expense requires estimates and can involve complex issues that may require an extended period to resolve. Further, changes in the geographic mix of revenues or in the estimated level of annual pre-tax income can cause the overall effective income tax rate to vary from period to period.
Year ended December 31, 2006. Beginning October 24, 2006, with the closing of the SEDA, our Consolidated Statements of Earnings no longer include the results of FIS. The operations of FIS continue to be included in our Consolidated Financial Statements for periods prior to October 24, 2006. (See Note A of the Notes to Consolidated Financial Statements for a description of the accounting treatment of the Asset Contribution and 2006 Distribution). In addition, our Consolidated Statements of Earnings for 2006 include the results of operations of Certegy, Inc. (“Certegy”), which was acquired by FIS on February 1, 2006, as discussed in Note B of Notes to Consolidated Financial Statements. This acquisition may affect the comparability of our 2006 and 2005 results of operations, particularly with respect to FIS in which the operating results of Certegy are included since its merger date.
Includes premiums reported by us and, for periods prior to October 24, 2006, the portion of title premiums FIS reported as commissions in its mortgage origination business in connection with the policies issued by us with respect to which FIS acted as title agent.
Title insurance premiums were $4,606.2 million in 2006, $4,945.0 million in 2005, and $4,739.3 million in 2004. Both direct and agency title premiums decreased from 2005 to 2006 and increased from 2004 to 2005. The decrease in direct title premiums from 2005 to 2006 is primarily due to a decrease in the number of orders, partially offset by an increase in average fee per file. The increase in direct title premiums in 2005 as compared to 2004 is primarily due to an increase in the average fee per file, partially offset by a decrease in the number of orders. The average fee per file in our direct operations was $1,428 in 2006, compared to $1,356 in 2005, and $1,212 in 2004, reflecting a strong commercial market in 2006 and 2005 and continued appreciation in home prices through 2005 and 2004. The decrease in closed order levels in 2006 reflects a declining purchase market and a relatively stable
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, 2006, fluctuated in a pattern generally consistent with the fluctuation in direct title insurance premiums and order counts. Escrow and other title related fees were $1,061.5 million, $1,157.0 million, and $1,042.2 million during 2006, 2005 and 2004, respectively.
Other operating expenses consist primarily of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums in lieu of franchise and other state taxes), postage and courier services, computer services, professional services, advertising expenses, general insurance, and trade and notes receivable allowances. Other operating expenses as a percentage of total revenue were 22.0% in 2006, 17.6% in 2005, and 19.3% in 2004. The fluctuation in other operating expenses as a percentage of total revenue is in part due to the inclusion in revenues of the gain on issuance of subsidiary stock in 2005. Excluding this gain, other operating expenses were 18.2% of revenues in 2005. The additional increase in other operating expenses as a percentage of total revenue in 2006 as compared to 2005 was primarily due to the lack of variability of some of these expenses, which limits our ability to reduce them as revenues decrease. Expenses attributable to FIS were $1,115.2 million, $751.3 million, and $719.8 million in 2006, 2005, and 2004, respectively.
The provision for claim losses includes an estimate of anticipated title and title related claims and specialty insurance claims. The estimate of anticipated title and title related claims is accrued as a percentage of title premium revenue based on our historical loss experience and other relevant factors. We monitor our claims loss experience on a continual basis and adjust the provision for claim losses accordingly. The provision for claim losses was $486.3 million, $480.6 million, and $311.9 million for 2006, 2005, and 2004, respectively. For analysis of the title insurance loss reserve and specialty insurance loss reserve, see their respective segment results of operations.
Interest expense for the years ended December 31, 2006, 2005 and 2004 was $210.0 million, $172.3 million, and $47.2 million, respectively. The increase in interest expense in 2006 is primarily due to increases in interest rates and average borrowings, and was partially offset by the consolidation of FIS for a full year in 2005 compared to 2006, which includes FIS activity only through the closing of the SEDA. The increase in interest expense in 2005 is attributable to $2.8 billion in borrowings relating to the recapitalization of FIS in the first quarter of 2005. Excluding interest expense attributable to FIS, interest expense was $55.8 million, $45.5 million, and $42.7 million in 2006, 2005, and 2004, respectively.
Minority interest expense for 2006, 2005 and 2004 was $154.6 million, $70.4 million, and $5.0 million, respectively. The increases in minority interest expense in 2006 and 2005 each relate primarily 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 minority interest distribution to Old FNF shareholders.
Total revenue in 2006 decreased $402.2 million to $5,899.3 million, a decrease of 6.4%, compared to 2005, with decreases in direct and agency title premiums and escrow and other title-related fees. Total revenue in 2005
increased $412.3 million, or 7.0%, to $6,301.5 million from $5,889.2 million in 2004 with increases in direct and agency title premiums and escrow and other title-related fees.
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 2006 was $167.0 million, compared with $111.6 million in 2005 and $64.7 million in 2004. The increases in interest and investment income in 2006 and 2005 were primarily due to increases in the short-term investment and fixed income asset base and increases in interest rates in both periods. Average invested assets were $4,009.4 million, $3,732.6 million, and $3,226.2 million in 2006, 2005, and 2004, respectively. The tax equivalent yield in 2006, excluding realized gains and losses, was 4.1%, as compared with 3.8% in 2005 and 2.7% in 2004.
Net realized gains and losses for 2006, 2005, and 2004 were $14.6 million, $36.8 million, and $22.9 million, respectively.
Our operating expenses consist primarily of personnel costs and other operating expenses, which are incurred as orders are received and processed, and agent commissions which are incurred as revenue is recognized. Title
Personnel costs include base salaries, commissions, benefits and bonuses paid to employees, and are one of our most significant operating expenses. Personnel costs totaled $1,789.8 million, $1,897.9 million, and $1,680.8 million for the years ended December 31, 2006, 2005, and 2004, respectively. Personnel costs, as a percentage of direct title insurance premiums and escrow and other title-related fees, were 60.7% in 2006, 56.6% in 2005, and 55.2% in 2004. The increase in personnel costs as a percentage of related revenue in 2006 was primarily due to increased salary and benefit costs due to competition. The increase in personnel costs as a percentage of related revenue in 2005 is primarily due to declining order volumes resulting in revenue declines outpacing personnel cost reductions as well as salary increases relating to increased competition and a strong real estate environment during that period. Average annualized personnel cost per employee decreased slightly, reflecting decreases in variable personnel costs such as overtime, commissions and bonuses, partially offset by increases in fixed personnel costs caused by the increased competition. Average employee count decreased to 18,352 in 2006 from 19,302 in 2005.
In 2006, we transferred $8.5 million in reserves to FIS in connection with the distribution of FIS. We assumed the outstanding reserve for claim losses of Service Link and APTIC in connection with their acquisitions in 2005 and 2004, respectively.
Claim loss expense was $140.6 million, $124.1 million, and $51.3 million in 2006, 2005 and 2004, respectively. In 2005, the Company experienced increased homeowners insurance claims as a result of Hurricanes Katrina, Rita, and Wilma. In addition, reserves were increased for apparent development trends of prior accident years. The 2006 provision reflects positive development in this reserve. As a percentage of premiums earned the claim loss provision was 62.7%, 65.8%, and 43.0% in 2006, 2005 and 2004, respectively, with the increase in 2005.
The Company’s consolidated results of operations include FIS’ results of operations through October 23, 2006. Thus, while a full year of activity is presented for 2005 and 2004, the 2006 results of operations only include activity until October 24, 2006, the closing date of the SEDA.
Total operating revenues for FIS were $3,289.1 million, $2,776.2 million, and $2,345.6 million in 2006, 2005 and 2004, respectively. The increase in revenues in 2006 of $512.9 million as compared to 2005 is primarily due to the inclusion of revenues from Certegy following the February 2006 merger, and was partially offset by the exclusion of FIS from our results of operations after the closing of the SEDA. The increase in revenue in 2005 of $430.6 million as compared to 2004 is primarily attributable to an increase of $355.2 million, or 28.0%, from our financial institution processing and mortgage loan processing businesses which is the result of including a full year of results for the 2004 acquisitions of Aurum, Sanchez, Kordoba, and InterCept. The 2004 acquisitions of Aurum, Sanchez, Kordoba and InterCept and other smaller acquisitions contributed $301.1 million of the increase in 2005 compared with 2004. Revenues from information services businesses increased $122.8 million in 2005, as compared to 2004, primarily due to organic growth of these businesses. These increases were partially offset by a $24.3 million decrease in revenues in the mortgage origination and default management businesses in 2005 as compared to 2004.
Other operating expenses consist primarily of data processing costs, professional fees, facilities expenses, postage and courier services, computer services, advertising expenses, general insurance, and trade and notes receivable allowances. Other operating expenses were $1,115.2 million, $751.3 million, and $719.8 million in 2006, 2005 and 2004, respectively. The increase in 2006 was primarily due to the merger with Certegy, partially offset by the exclusion of FIS from our results of operations after the closing of the SEDA. The increase in 2005 as compared to 2004 included an increase in data processing costs of approximately $35.0 million which primarily related to our financial institution processing and mortgage loan processing businesses. As a percentage of revenues, other operating costs were 33.9%, 27.1%, and 30.7% in 2006, 2005 and 2004, respectively.
Our two significant sources of internally generated funds are dividends and other payments from our subsidiaries. As a holding company, we receive cash from our subsidiaries in the form of dividends and as reimbursement for operating and other administrative expenses we incur. The reimbursements are paid within the guidelines of management agreements among us and our subsidiaries. Our insurance subsidiaries are restricted by state regulation in their ability to pay dividends and make distributions. Each state of domicile regulates the extent to which our title underwriters can pay dividends or make other distributions to us. As of December 31, 2006, $2.0 billion of our net assets were restricted from dividend payments without prior approval from the relevant departments of insurance. During 2007, our first tier title subsidiaries can pay or make distributions to us of approximately $264.8 million without prior regulatory approval. Our underwritten title companies and non-title insurance subsidiaries collect revenue and pay operating expenses. However, they are not regulated to the same extent as our insurance subsidiaries.
Capital Expenditures. Total capital expenditures for property and equipment were $145.4 million, $149.9 million, and $134.3 million in 2006, 2005, and 2004, respectively and included FIS expenditures of $87.7 million, $79.6 million, and $72.9 million, respectively. Total capital expenditures for software were $180.9 million, $166.1 million, and $94.9 million in 2006, 2005, and 2004, respectively, and were primarily comprised of FIS expenditures.
Financing. Effective October 24, 2006, we entered into a credit agreement (the “New Credit Agreement”) with Bank of America, N.A. as Administrative Agent and Swing Line Lender, and the other financial institutions party thereto. The New Credit Agreement, which replaced our previous credit agreement, provides for an $800 million unsecured revolving credit facility maturing on the fifth anniversary of the closing date. We have the option to increase the size of the credit facility by an additional $300 million, subject to certain requirements. Amounts under the revolving credit facility may be borrowed, repaid and reborrowed by the borrower thereunder from time to time until the maturity of the revolving credit facility. Voluntary prepayment of the revolving credit facility under the New Credit Agreement is permitted at any time without fee upon proper notice and subject to a minimum dollar requirement. Revolving loans under the credit facility bear interest at a variable rate based on either (i) the higher of (a) a rate per annum equal to one-half of one percent in excess of the Federal Reserve’s Federal Funds rate, or (b) Bank of America’s “prime rate” or (ii) a rate per annum equal to the British Bankers Association London Interbank Offered Rate (“LIBOR”) rate plus a margin of between 0.23%-0.675%, depending on our then current senior unsecured long-term debt rating from the rating agencies. In addition, we will pay a commitment fee between .07%-.175% on the entire facility, also depending on our senior unsecured long-term debt rating.
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 New Credit Agreement shall automatically become immediately due and payable, and the lenders’ commitments will automatically terminate.
In addition to the foregoing financing arrangements of FNT, our historical financial statements reflect debt and interest expense of FNF and its other subsidiaries, principally FIS.
Contractual Obligations. Our long term contractual obligations generally include our loss reserves, our credit agreements and other debt facilities and operating lease payments on certain of our premises and equipment. As of December 31, 2006, our required annual payments relating to these contractual obligations were as follows:
In addition to the amounts shown in the table, at December 31, 2006, we held claim reserves of $65.8 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 2007.
Capital Stock Transactions. On October 25, 2006, our Board of Directors approved a three-year stock repurchase program under which we can repurchase up to 25 million shares of our common stock. We may make purchases from time to time in the open market, in block purchases or in privately negotiated transactions, depending on market conditions and other factors. None of our common stock was repurchased under this plan in 2006.
Additional Minimum Pension Liability Adjustment. We recorded a net-of-tax credit of $10.5 million to accumulated other comprehensive loss in 2006 in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions” for the change in our minimum pension liability.
Off-Balance Sheet Arrangements. We do not engage in off-balance sheet activities other than facility and equipment leasing arrangements. On June 29, 2004 Old FNF 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 is part of our corporate campus and headquarters. The lease expires on June 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, 2006, the full $75.0 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 86.7% 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 be required to consolidate the lessor or the assets and
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, 2006 related to these arrangements.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans” (“SFAS 158”). SFAS 158 requires entities to recognize on their balance sheets the funded status of pension and other postretirement benefit plans. Entities are required to recognize actuarial gains and losses, prior service cost, and any remaining transition amounts from the initial application of Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” and Statement of Financial Accounting Standards No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” when recognizing a plan’s funded status, with the offset to accumulated other comprehensive income. SFAS 158 will not change the amounts recognized in the income statement as net periodic benefit cost. All of the requirements of SFAS 158 are effective as of December 31, 2006 for calendar-year public companies, except for a requirement for fiscal-year-end measurements of plan assets and benefit obligations with which the Company is already in compliance. The Company has adopted SFAS 158. See Note M.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 requires an evaluation to determine the likelihood that an uncertain tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. If it is determined that it is more likely than not that an uncertain tax position will be sustained upon examination, the next step is to determine the amount to be recognized. FIN 48 prescribes recognition of the largest amount of tax benefit that is greater than 50 percent likely of being recognized upon ultimate settlement of an uncertain tax position. Such amounts are to be recognized as of the first financial reporting period during which the more-likely-than-not recognition threshold is met. Similarly, an amount that has previously been recognized will be reversed as of the first financial reporting period during which the more-likely-than-not recognition threshold is not met. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the impact on the Company’s statements of financial position and operations.
In December 2004, the FASB issued SFAS No. 123R, which requires that compensation cost relating to share-based payments be recognized in our financial statements. During 2003, we adopted the fair value recognition provision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), effective as of the beginning of 2003. Using the fair value method of accounting, compensation cost is measured based on the fair value of the award at the grant date and recognized over the service period. Upon
adoption of SFAS No. 123, 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”). Using this method, stock-based employee compensation cost has been 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 in the first quarter of 2006. The adoption of SFAS No. 123R on January 1, 2006 had no significant impact on our financial condition or results of operations due to the fact that all options accounted for using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, were fully vested at December 31, 2005. In accordance with the provisions of SFAS No. 123R, we have not restated our share-based compensation expense for the 2005 and 2004 periods presented.
Consolidated Statements of Comprehensive Earnings for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2006, 2005 and 2004
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, 2006, 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.
We have audited the accompanying Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2006 and 2005 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, 2006. These Consolidated Financial Statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these Consolidated Financial Statements based on our audits.
In our opinion, the Consolidated Financial Statements referred to above present fairly, in all material respects, the consolidated financial position of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of internal control over financial reporting of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 1, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
Net of income tax (benefit) expense of $15.2 million, $(12.9) million, and $5.7 million for 2006, 2005 and 2004, respectively.
Net of income tax expense (benefit) of $(0.1) million, $(0.5) million, and $0.7 million for 2006, 2005 and 2004, respectively.
The following describes the significant accounting policies of Fidelity National Financial, Inc. and its subsidiaries (collectively, the “Company” or “FNF”) which have been followed in preparing the accompanying Consolidated Financial Statements.
Prior to October 18, 2005, the Company was known as Fidelity National Title Group, Inc. (“FNT”) and was a wholly-owned subsidiary of another publicly traded company, also called Fidelity National Financial, Inc. (“Old FNF”). On October 18, 2005, Old FNF distributed to its shareholders a minority interest in FNT, making it a majority-owned, publicly traded company. On October 24, 2006, Old FNF transferred certain assets to FNT in return for the issuance of 45,265,956 shares of FNT common stock to Old FNF (the “Asset Contribution”). Old FNF then distributed to its shareholders all of its shares of FNT common stock, making FNT a stand alone publicly traded company (the “2006 Distribution”). Old FNF was then merged with and into another of its subsidiaries, Fidelity National Information Services, Inc. (“FIS”), after which FNT’s name was changed to Fidelity National Financial, Inc. Under applicable accounting principles, following these transactions, Old FNF’s historical financial statements, with the exception of equity and earnings per share, became FNF’s historical financial statements, including the results of FIS through the date of the Company’s spin-off from Old FNF. The Company’s historical equity has been derived from FNT’s historical equity and the Company’s historical basic and diluted earnings per share have been calculated using FNT’s basic and diluted weighted average shares outstanding.
Acquisitions among entities under common control such as the Asset Contribution are not considered business combinations and are to be accounted for at historical cost in accordance with Emerging Issues Task Force (“EITF”) Issue No. 90-5, Exchanges of Ownership Interests between Enterprises under Common Control. Furthermore, the substance of the Asset Contribution and the 2006 Distribution and the Old FNF-FIS merger is effectively a reverse spin-off of FIS by Old FNF in accordance with EITF Issue No. 02-11, Accounting for Reverse Spinoffs. Accordingly, the historical financial statements of Old FNF, with the exception of equity and earnings per share, became those of FNF; however, the criteria to account for FIS as discontinued operations as prescribed by Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”) were not met. This is primarily due to our continuing involvement with and significant influence over FIS subsequent to the merger of Old FNF and FIS through common board members, common senior management and continuing business relationships. As a result, for periods prior to October 24, 2006, FIS continues to be included in our consolidated financial statements.
Specialty Insurance. The specialty insurance segment, consisting of FNF’s various non-title insurance subsidiaries, issues flood, home warranty, homeowners, automobile and certain niche personal lines insurance policies.
Fidelity National Information Services, Inc. Prior to October 24, 2006, this segment consisted of the operations of FNF’s 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 its merger with Certegy, Inc. (“Certegy”). This merger closed in February 2006 and as a result these businesses are only included in the historical financial information in the financial statements from the merger until the 2006 Distribution.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All intercompany profits, transactions and balances have been eliminated. The Company’s investments in non-majority-owned partnerships and affiliates are accounted for on the equity method until such time that they become wholly or majority owned. Minority interest expense is recorded on the consolidated statement of earnings relating to majority owned subsidiaries and the appropriate minority interest liability is recorded on the Consolidated Balance Sheets in each period.
On June 25, 2006, the Company, then known as FNT, entered into a Securities Exchange and Distribution Agreement (the “SEDA”) with Old FNF, and Old FNF entered into a merger agreement with Fidelity National Information Services, Inc. (“FIS”) (both amended and restated as of September 18, 2006), providing for the elimination of Old FNF’s holding company structure, the sale of certain of Old FNF’s assets and liabilities to the Company in exchange for shares of our stock, and the distribution of Old FNF’s ownership stake in the Company to Old FNF shareholders. Pursuant to the SEDA, on October 24, 2006, the Company completed the acquisition of substantially all of the assets and liabilities of Old FNF (other than Old FNF’s interests in FIS and in FNF Capital Leasing, Inc., a small leasing subsidiary) in exchange for 45,265,956 shares of our Class A common stock in the
Asset Contribution. The assets transferred included Old FNF’s specialty insurance business, its interest in certain claims management operations, certain timber and real estate holdings and certain smaller operations, together with all cash and certain investment assets held by Old FNF as of October 24, 2006. In connection with the Asset Contribution, Old FNF converted all of the FNT Class B common stock held by Old FNF into FNT Class A common stock and distributed the shares acquired by Old FNF from the Company, together with the converted shares, to holders of record of Old FNF common stock as of October 17, 2006 in a tax-free distribution (the “2006 Distribution”). As a result of the 2006 Distribution, Old FNF no longer owns any of the Company’s common stock and the Company is now a stand alone public company with all of its approximately 220.7 million shares held by the public. Also, on November 9, 2006, Old FNF merged with and into FIS, after which the Company legally changed its name to Fidelity National Financial, Inc. As of November 10, 2006, the Company’s common stock is now traded on the New York Stock Exchange under the trading symbol FNF. Old FNF’s current chairman of the board and chief executive officer has assumed the same positions in FNF and the position of executive chairman of the board of FIS. Other key members of Old FNF’s senior management will also continue their involvement in both FNF and FIS in executive capacities.
On October 17, 2005, Old FNF completed a pro rata distribution of shares representing 17.5% of the outstanding common stock of FNT to Old FNF’s shareholders. This distribution completed a restructuring that resulted in FNT becoming the parent company of Old FNF’s title insurance businesses. From the time of the distribution until October 24, 2006 (see “Old FNF Asset Contribution and Stock Distribution” above), FNT was a majority-owned subsidiary of FNF and a separate registrant reporting its results on a stand-alone basis. During that time, Old FNF continued to consolidate FNT in its results, and recorded minority interest liabilities and expense relating to the 17.5% minority interest. This restructuring was a taxable transaction to Old FNF and its shareholders. Old FNF recognized income tax expense of approximately $100 million in the fourth quarter of 2005 relating to this restructuring.
Equity securities are considered to be available for sale and carried at fair value as of the balance sheet dates. Fair values are based on quoted market prices.
The carrying values reported in the Consolidated Balance Sheets for trade and notes receivables approximate their fair value. Included in trade receivables at December 31, 2005 are unbilled receivables totaling $97.4 million.
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.
At December 31, 2006, capitalized software costs were $142.2 million, less accumulated amortization of $58.7 million. At December 31, 2005, capitalized software costs were $780.6 million, less accumulated amortization of $250.3 million and included FIS capitalized software costs of $660.9 million, less accumulated amortization of $208.9 million.
Amortization expense relating to computer software was $127.4 million, $110.7 million, and $85.9 million for the years ended December 31, 2006, 2005 and 2004, respectively, primarily related to amortization expense recorded by FIS in each period.
During 2005 and 2004, in accordance with SFAS No. 144, the Company determined that the carrying value of certain of its intangible assets, software and license fees may not be recoverable and recorded impairment expense of $9.3 million and $6.3 million, respectively, relating to the impairment of these assets. These expense amounts
were included in other operating expenses in the Consolidated Statements of Earnings for the years ended December 31, 2005 and 2004. There was no such expense recorded in 2006.
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 $905.5 million and $882.6 million at December 31, 2006 and 2005, respectively, representing customers’ assets held by us and corresponding assets including cash and investments pledged as security for those trust balances.
In a limited number of situations, the Company limits its maximum loss exposure by reinsuring certain risks with other insurers. The Company also earns a small amount of additional income, which is reflected in the Company’s direct premiums, by assuming reinsurance for certain risks of other insurers. The Company also cedes a portion of certain policy and other liabilities under agent fidelity, excess of loss and case-by-case reinsurance agreements. Reinsurance agreements provide that in the event of a loss (including costs, attorneys’ fees and expenses) exceeding the retained amounts, the reinsurer is liable for the excess amount assumed. However, the ceding company remains primarily liable in the event the reinsurer does not meet its contractual obligations.
Fidelity National Title Group. Direct title insurance premiums and escrow and other title related fees are recognized as revenue at the time of closing of the related transaction as the earnings process is considered complete, whereas premium revenues from agency operations and agency commissions include an accrual based on estimates of the volume of transactions that have closed in a particular period for which premiums have not yet been reported to us. The accrual for agency premiums is necessary because of the lag between the closing of these transactions and the reporting of these policies to us by the agent.
Fidelity National Information Services, Inc. In this segment, the Company earns revenues from processing services, software licensing and software related services and data and information services.
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.
The Company’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 the Company’s historical experience. The Company 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 is recognized in accordance with SOP No. 97-2.
Options to purchase 2,297,140 shares and 2,206,500 shares of the Company’s common stock for the years ended December 31, 2006 and 2005, respectively, were not included in the computation of diluted earnings per share because they were anti-dilutive.
Unaudited pro forma net earnings per share for the year ended December 31, 2004, has been calculated using the number of outstanding shares of FNF common stock as of a date prior to the distribution of FNF stock by Old FNF.
Beginning on October 24, 2006, the Company’s financial statements reflect transactions with FIS, which is a related party. Prior to October 24, 2006, these transactions were eliminated because FIS’ results of operations were included in our consolidated results.
A list of related party items included in revenues and expenses for the period from October 24 through December 31, 2006 is as follows:
Historically, the Company has provided corporate services to FIS. These corporate services include accounting, internal audit, treasury, payroll, human resources, tax, legal, purchasing, risk management, mergers and acquisitions and general management. From October 24 through December 31, 2006, FNF’s expenses were reduced by $1.5 million as a result of the provision of corporate services by the Company to FIS.
information to its operations, for which it recorded expenses of $2.4 million from October 24, through December 31, 2006.
FNF also has certain license and cost sharing agreements with FIS, for which FNF’s expenses included $1.2 million from October 24 through December 31, 2006.
FNF pays amounts to a subsidiary of FIS for capitalized software development and for title plant construction. During the period from October 24, 2006 through December 31, 2006, these amounts included capitalized software development costs of $1.9 million and capitalized title plant construction costs of $2.7 million.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), which requires that compensation cost relating to share-based payments be recognized in the Company’s consolidated financial statements. Effective as of the beginning of 2003, the Company adopted the fair value recognition provision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Using the fair value method of accounting, compensation cost is measured based on the fair value of the award at the grant date and recognized over the service period. Upon adoption of SFAS 123, the Company elected to use the prospective method of transition, as permitted by SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”). Using this method, stock-based employee compensation cost was 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 123R does not allow for the prospective method, but requires the recording of expense relating to the vesting of all unvested options beginning in the first quarter of 2006. The adoption of SFAS 123R on January 1, 2006 had no material impact on the Company’s income before income taxes, net income, cash flow from operations, cash flow from financing activities, or basic or diluted earnings per share in 2006 due to the fact that all options accounted for using the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” were fully vested as of December 31, 2005. In accordance with the provisions of SFAS 123R, share-based compensation expense for 2005 and 2004 has not been restated. Net earnings reflect stock-based compensation expense amounts of $65.0 million, $34.1 million, and $21.5 million for the years ended December 31, 2006, 2005, and 2004, which are included in personnel costs in the reported financial results of each period. Included in the 2006 amount is a $24.5 million charge related to the vesting of performance based options at FIS for which the vesting criteria was met during the first quarter and a $0.3 million charge for accelerated vesting, which was approved by the compensation committee, of stock options and restricted stock shares granted to a director who resigned from the board of directors in the third quarter of 2006.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized into expense over the options’ vesting period. For the year ended December 31, 2006, there was no difference between net earnings as reported and pro forma net earnings as calculated pursuant to SFAS 123 because, as of January 1, 2006, all stock-based compensation awards that were granted prior to our adoption of SFAS 123 were fully vested. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to all outstanding and unvested awards in 2005 and 2004:
The Company began purchasing equity interests in Cascade Timberlands LLC (“Cascade Timberlands”) in March 2006. As of December 31, 2006, the Company had acquired approximately 71% of Cascade Timberlands for $89.2 million. The primary assets of Cascade Timberlands are approximately 293,000 acres of productive timberlands located on the eastern side of the Cascade mountain range extending from Bend, Oregon south on State Highway 20 toward the California border. Cascade Timberlands was created by the secured creditors of Crown Pacific LP upon the conclusion of the bankruptcy case of Crown Pacific LP in December 2004.
On January 31, 2006, the Company, along with its equity partners, Thomas H. Lee Partners (“THL”) and Evercore Capital Partners, completed an acquisition of Sedgwick CMS Holdings, Inc. (“Sedgwick”). The Company acquired an approximately 40% interest in Sedgwick for approximately $126 million. Sedgwick, headquartered in Memphis, Tennessee, is a leading provider of outsourced insurance claims management services to large corporate and public sector entities. In September 2006, the Company invested an additional $6.8 million in Sedgwick, but maintained its 40% interest.
As a result of the 2006 Distribution, the results of operations of FIS acquisitions are not reflected in the Company’s financial statements for periods after October 23, 2006.
On September 14, 2005, the Company through Fidelity National Information Services, Inc. (“Former FIS”) entered into a definitive merger agreement with Certegy under which Former FIS and Certegy combined operations to form a single publicly traded company called Fidelity National Information Services, Inc. Certegy was a payment processing company headquartered in St. Petersburg, Florida. On January 26, 2006, Certegy’s shareholders approved the merger which was subsequently consummated on February 1, 2006.
based on their fair values as of February 1, 2006. Goodwill was recorded based on the amount that the purchase price exceeds the fair value of the net assets acquired. The purchase price allocation was as follows (in millions):
Also, the merger triggered the performance criteria relating to FIS’s stock option grant made in March 2005 and these awards vested when the trading value of the Company’s stock remained above $31.27 for 45 days following the Merger. As a result, the Company recorded a charge of $24.5 million in the first nine months of 2006.
On November 8, 2004, the Company acquired all of the outstanding stock of InterCept, Inc. (“InterCept”) for $18.90 per share. The total purchase price was $419.4 million and was paid by $407.3 million of cash with the remaining purchase price relating to the issuance of Company options for vested InterCept options. InterCept provides both outsourced and in-house, fully integrated core banking solutions for community banks, including loan and deposit processing and general ledger and financial accounting operations. InterCept also operates significant item processing and check imaging operations, providing imaging for customer statements, clearing and settlement, reconciliation and automated exception processing in both outsourced and in-house relationships for customers.
The assets acquired and liabilities assumed in the InterCept acquisition were as follows (dollars in thousands):
The assets acquired and liabilities assumed in the Aurum acquisition were as follows (dollars in thousands):
On April 14, 2004, the Company acquired Sanchez Computer Associates, Inc. (“Sanchez”) for $183.7 million, comprised of $88.1 million in cash and the issuance of 2,267,290 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 approximately $88.1 million with the remaining purchase price of $7.5 million relating to the issuance of the Company’s stock options for vested Sanchez stock options. Sanchez develops and markets scalable and integrated software and services that provide banking, customer integration, outsourcing and wealth management solutions to financial institutions in several countries.
The assets acquired and liabilities assumed in the Sanchez acquisition were as follows (dollars in thousands):
The carrying amounts and fair values of the Company’s fixed maturity securities at December 31, 2006 and 2005 are as follows:
Fixed maturity securities valued at approximately $115.5 million and $109.7 million were on deposit with various governmental authorities at December 31, 2006 and 2005, respectively, as required by law.
Equity securities at December 31, 2006 and 2005 consisted of investments in various industry groups at a cost basis of $216.7 million and $222.5 million, respectively, and fair value of $207.3 million and $210.2 million, respectively. There were no significant investments in banks, trust and insurance companies at December 31, 2006 or 2005.
The change in unrealized gains (losses) on equity securities for the years ended December 31, 2006, 2005 and 2004 was $3.0 million, $(19.0) million, and $(6.0) million, respectively.
included in accounts payable and accrued liabilities and the Company held cash in the same amounts as collateral for the loaned securities.
Net realized gains amounted to $18.6 million, $359.3 million, and $37.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. Included in 2005 was a $318.2 million gain on the sale of a minority interest in FIS. Included in 2004 were gains related to the Company’s investment in Covansys warrants of $16.2 million
During the years ended December 31, 2006, 2005 and 2004, gross realized gains on sales of equity securities considered available for sale were $49.3 million, $57.1 million, and $65.8 million, respectively; and gross realized losses were $29.4 million, $30.5 million, and $52.3 million, respectively. Gross proceeds from the sale of equity securities amounted to $807.3 million, $648.5 million, and $723.9 million during the years ended December 31, 2006, 2005 and 2004, respectively.
Net 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, 2006 and 2005 were as follows:
Other intangible assets at December 31, 2006 does not include any intangible assets of FIS. Other intangible assets at December 31, 2005 includes FIS other intangible assets of $536.1 million, net of accumulated amortization, which is made up of $783.7 million in customer relationships and contracts, $45.1 million in other, and $(292.7) million in accumulated amortization. See “Old FNF Asset Contribution and Stock Distribution” in Note A.
Amortization expense for amortizable intangible assets which consist primarily of customer relationships was $162.0 million, $145.7 million, and $124.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. Other represents non-amortizable intangible assets such as trademarks and licenses. Estimated amortization expense for the next five years for assets owned at December 31, 2006, is $21.3 million in 2007, $16.5 million in 2008, $11.9 million in 2009, $9.5 million in 2010 and $6.7 million in 2011.
The carrying value of the Company’s notes payable was approximately $6.9 million lower than its estimated fair value at December 31, 2006. At December 31, 2005, the carrying value of the Company’s outstanding notes payable was approximately $22.5 million lower than its estimated fair value. The fair value of the Company’s unsecured notes payable is based on established market prices for the securities on December 31, 2006 and 2005. The fair value of the Company’s remaining fixed rate and variable rate notes payable is estimated using discounted cash flow analyses based on current market interest rates and comparison of interest rates being paid to the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
On October 17, 2005, the Company entered into a Credit Agreement with Bank of America, N.A. as Administrative Agent and Swing Line Lender, and the other financial institutions party thereto (the “FNT Credit Agreement”). The FNT Credit Agreement was repaid and terminated on October 24, 2006.
Effective October 24, 2006, the Company entered into a new credit agreement (the “New Credit Agreement”) with Bank of America, N.A. as Administrative Agent and Swing Line Lender, and other financial institutions party thereto. The New Credit Agreement provides for an $800 million unsecured revolving credit facility maturing on the fifth anniversary of the closing date. The Company has the option to increase the size of the credit facility by an additional $300 million, subject to certain requirements. Amounts under the revolving credit facility may be borrowed, repaid and reborrowed by the borrower thereunder from time to time until the maturity of the revolving credit facility. Voluntary prepayment of the revolving credit facility under the New Credit Agreement is permitted at any time without fee upon proper notice and subject to a minimum dollar requirement. Revolving loans under the credit facility bear interest at a variable rate based on either (i) the higher of (a) a rate per annum equal to one-half of one percent in excess of the Federal Reserve’s Federal Funds rate, or (b) Bank of America’s “prime rate” or (ii) a rate per annum equal to LIBOR plus a margin of between 0.23%-0.675%, depending on the Company’s then current senior unsecured long-term debt rating from the rating agencies. In addition, the Company will pay a commitment fee between 0.07%-0.175% on the entire facility, also depending on the Company’s senior unsecured long-term debt rating.
Principal maturities of notes payable at December 31, 2006, are as follows (dollars in thousands):
The aggregate amounts above include income tax expense attributable to FIS operations of $118.4 million, $111.1 million, and $116.5 million for the years ended December 31, 2006, 2005, and 2004, respectively.
Total income tax expense for the years ended December 31 was allocated as follows (in thousands):
A reconciliation of the federal statutory rate to the Company’s effective tax rate is as follows:
The significant components of deferred tax assets and liabilities at December 31, 2006 and 2005 consist of the following:
Tax benefits of $81.8 million, $34.8 million, and $36.1 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, 2006, 2005 and 2004, respectively.
The Internal Revenue Service selected the Company to participate in a new pilot program (Compliance Assurance Program or CAP) that is a real-time audit for 2005 and future tax years. In November 2006, the Internal Revenue Service completed its examination of the Company’s tax returns for years 2002 through 2005, resulting in no significant adjustments to the Company’s previously filed tax positions; any additional payments or refunds for prior year returns did not adversely affect the Company’s financial position or results of operations. Currently, the only year that the Company has open for IRS audit is 2006. The implementation of FIN 48 will have no material impact on the financial statements.
In the ordinary course of business, we are involved in various pending and threatened litigation matters related to our operations, some of which include claims for punitive or exemplary damages. We believe that no actions, other than those listed below, depart from customary litigation incidental to our business. As background to the disclosure below, please note the following:
These matters raise difficult and complicated factual and legal issues and are subject to many uncertainties and complexities, including but not limited to the underlying facts of each matter, novel legal issues, variations between jurisdictions in which matters are being litigated, differences in applicable laws and judicial interpretations, the length of time before many of these matters might be resolved by settlement or through litigation and, in some cases, the timing of their resolutions relative to other similar cases brought against other companies, the fact that many of these matters are putative class actions in which a class has not
For the reasons specified above, it is not possible to make meaningful estimates of the amount or range of loss that could result from these matters at this time. We review these matters on an on-going basis and follow the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies” when making accrual and disclosure decisions. When assessing reasonably possible and probable outcomes, we base our decision on our assessment of the ultimate outcome following all appeals.
In the opinion of our management, while some of these matters may be material to our operating results for any particular period if an unfavorable outcome results, none will have a material adverse effect on our overall financial condition.
Several class actions are pending in Alabama, Connecticut, Florida, Ohio, New Mexico, New Hampshire, Pennsylvania and Washington alleging improper premiums were charged for title insurance. The cases allege that the named defendant companies failed to provide notice of premium discounts to consumers refinancing their mortgages, and failed to give discounts in refinancing transactions in violation of the filed rates. The actions seek refunds of the premiums charged and punitive damages. The Company intends to vigorously defend the actions.
A class action in California alleges that the Company violated the Real Estate Settlement Procedures Act (“RESPA”) and state law by giving favorable discounts or rates to builders and developers for escrow fees and requiring purchasers to use Chicago Title Insurance Company for escrow services. The action seeks refunds of the premiums charged and additional damages. The Company intends to vigorously defend this action.
Canadian lawyers who have traditionally played a role in real property transactions in Canada allege that the Company’s practices in processing residential mortgages are the unauthorized practice of law. Their Law Societies have demanded an end to the practice, and have begun investigations into those practices. In several provinces, bills have been filed that ostensibly would affect the way we do business. 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. In Missouri, a class action is pending alleging that certain acts performed by the Company in closing real estate transactions are the unlawful practice of law. The Company intends to vigorously defend this action.
None of the cases described above includes a statement as to the dollar amount of damages demanded. Instead, each of the cases includes a demand in an amount to be proved at trial. Two of the Ohio cases state that the damages per class member are less than the jurisdictional limit for removal to federal court.
The National Association of Insurance Commissioners and various state insurance regulators have been investigating so called “captive reinsurance” agreements since 2004. The investigations have focused on arrangements in which title insurers would write title insurance generated by realtors, developers and lenders and cede a portion of the premiums to a reinsurance company affiliate of the entity that generated the business. The U.S. Department of Housing and Urban Development (“HUD”) also has made formal or informal inquiries of the Company regarding these matters. The Company has been cooperating and intends to continue to cooperate with all ongoing investigations. The Company has discontinued all captive reinsurance arrangements. The total amount of premiums the Company ceded to reinsurers was approximately $10 million over the existence of these agreements. The Company has settled most of the accusations of wrongdoing that arose from these investigations by discontinuing the practice and paying fines. Some investigations are continuing. The Company anticipates they will be settled in a similar manner.
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 has settled the accusations of wrongdoing that arose from some of these investigations by discontinuing the practice and paying fines. Other investigations are continuing. The Company anticipates they will be settled in a similar manner.
back so that in effect, premiums are charged on the basis of real property values from the year 2000. Title insurers would be required to reduce their rates to a level below their 2000 rates, with the amount of the reduction determined by a formula adjusting for real estate appreciation and inflation. Although FNF is continuing to evaluate the effect that these regulations would have on its business and its financial results, FNF is concerned that the reduced rates and maximum rate caps set by the California Regulations will significantly reduce the title and escrow rates that are charged in California, while precluding title insurers from seeking relief from those reduced or maximum rates. In addition, the proposed California regulations contemplate the creation of a detailed statistical plan, requiring data to be collected by each title insurer, underwritten title company, and controlled escrow company at the individual transaction level beginning on January 1, 2008. The statistical plan would also require that all expenses be allocated among 18 “activities,” such as title search/examination, preliminary report issuance, general management, customer support, sales, recording of documents, and escrow document production. The data collected under the statistical plan would be submitted annually to the CDI beginning on April 30, 2009. Compliance with the data collection and reporting requirements of the California Regulations, if adopted, would necessitate a significant revision and augmentation of the Company’s existing data collection and accounting systems before January 1, 2008, and would require a significant expenditure to comply with the April 30, 2009 deadline. The proposed required rate reductions and maximum rates would significantly reduce the title insurance rates that the Company’s subsidiaries can charge, and would likely have a significant negative impact on the Company’s California revenues. In addition, the increased cost of compliance with the statistical data collection and reporting requirements would negatively impact the Company’s cost of doing business in California. California is the largest source of revenue for the title insurance industry, including for the Company. On February 21, 2007, the OAL disapproved the proposed California Regulations and requested certain clarifications from the CDI. On February 22, 2007, the CDI announced its intention to move forward expeditiously to satisfy the OAL’s request in consultation with consumer groups and the title industry and resubmit the regulations for approval.
The Washington Insurance Commissioner has issued a report concluding that the title insurance industry has engaged in illegal referral fees. The Commissioner has appointed a panel to recommend title industry reforms.
The 2006 Distribution would become taxable to Old FNF (and to its successor after the merger, FIS) pursuant to Section 355(e) of the Internal Revenue Code if 50% or more of the shares of either Old FNF common stock (taking into account FIS common stock, as successor to FNF after the merger) or 50% or more of the FNT common stock were acquired, directly or indirectly, as part of a plan or series of related transactions that included the 2006 Distribution. Because the Old FNF stockholders owned more than 50% of the FIS common stock following the merger, the merger, standing alone, would not cause the distribution to be taxable to Old FNF under Section 355(e).
However, if the Internal Revenue Service successfully asserted that acquisitions of Old FNF common stock or FIS common stock, either before or after the distribution, were part of a plan or series of related transactions that included the 2006 Distribution, such determination likely would result in the recognition of gain by Old FNF under Section 355(e) taking into account that the merger resulted in an acquisition of approximately 49% of the stock of FIS pursuant to a plan that includes the 2006 Distribution. In any such case, the gain recognized by Old FNF would equal the fair market value of all of the stock in FNT that Old FNF owned (including the FNT common stock Old FNF received for the Asset Contribution to FNT) immediately prior to the 2006 Distribution minus Old FNF’s basis in the stock of FNT. Old FNF estimated the resulting tax on such gain to be in the range of $150 million and possibly greater depending on, among other things, the value of the FNT stock at the time of the distribution. Under the agreements executed by the parties, FNT would generally be required to indemnify FIS (as successor to Old FNF after the merger) against tax-related losses to FIS that arise if the distribution were to become taxable under Section 355(e). However, FIS would be required to indemnify FNT if FIS had taken certain actions within its control that caused the 2006 Distribution to be taxable. If Section 355(e) were to cause the 2006 Distribution to be taxable to Old FNF and indemnifiable by FNT or FIS, the 2006 Distribution would remain tax free to Old FNF’s stockholders, assuming the other requirements of Section 355 were otherwise satisfied.
Pursuant to statutory requirements of the various states in which the Company’s insurers are domiciled, such insurers must maintain certain levels of minimum capital and surplus. Each of the Company’s underwriters has complied with the minimum statutory requirements as of December 31, 2006.
On October 25, 2006, the Company’s Board of Directors approved a three-year stock repurchase program under which the Company can repurchase up to 25 million shares of its common stock. The Company may make purchases from time to time in the open market, in block purchases or in privately negotiated transactions, depending on market conditions and other factors. There were no repurchases of the Company’s common stock under this plan in 2006.
During the three-year period ended December 31, 2006, eligible employees of the Company and its subsidiaries could voluntarily participate in employee stock purchase plans (“ESPPs”) sponsored by the Company and its subsidiaries. Pursuant to the ESPPs, employees may contribute an amount between 3% and 15% of their base salary and certain commissions. The Company and its subsidiaries contribute varying amounts as specified in the ESPPs. The Company and its subsidiaries contributed $24.5 million $21.9 million, and $16.5 million to the ESPPs in the years ended December 31, 2006, 2005, and 2004, respectively, in accordance with the employer’s matching contribution.
During the three-year period ended December 31, 2006, the Company and its subsidiaries have offered their employees the opportunity to participate in 401(k) profit sharing plans (the “401(k) Plans”), qualified voluntary contributory savings plans which are 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 and its subsidiaries match 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) Plans for the years ended December 31, 2006, 2005 and 2004 was $39.5 million, $40.0 million and $33.5 million, respectively.
Following the closing of the SEDA transaction on October 24, former Old FNF options and restricted stock held by employees of the Company were converted in an intrinsic value swap to options and restricted stock of the Company as noted above. Options and restricted stock held by FIS employees were converted into FIS options and restricted stock.
Stock option transactions under the Current Omnibus Plan for 2005 and 2006 were as follows:
The following table summarizes information related to stock options outstanding and exercisable as of December 31, 2006:
The risk free interest rates used in the calculation are the rate that corresponds to the weighted average expected life of an option. The risk free interest rate used for options granted during 2006, 2005 and 2004 was 4.9%, 4.1%, and 3.2%, respectively. A volatility factor for the expected market price of the common stock of 28%, 27%, and 34% were used for options granted in 2006, 2005 and 2004, respectively. The expected dividend yield used for 2006, 2005 and 2004 was 2.6%, 2.4%, and 2.5%, respectively. A weighted average expected life of 4.1 years, 4.0 years, and 3.8 years was used for 2006, 2005 and 2004, respectively. The weighted average fair value of each option granted during 2006, 2005 and 2004 was $9.25 , $8.56, and $10.71 ( $4.66, $4.32, and $5.40 as adjusted for the SEDA intrinsic value conversion) respectively.
The risk free interest rates used in the calculation are the rates that correspond to the weighted average expected life of an option. The risk free interest rate used for options granted during 2006 and 2005 was 4.6% and 4.3%, respectively. A volatility factor for the expected market price of the common stock of 29% and 28% were used for options granted in 2006 and 2005, respectively. The expected dividend yield used for 2006 and 2005 was 5.1%, 4.6%, respectively. A weighted average expected life of 4.4 years and 4.0 years was used for 2006 and 2005, respectively. The weighted average fair value of each option granted during 2006 and 2005 was $4.23 and $3.98, respectively.
The following table sets forth the funded status of the Pension Plan and amounts reflected in the Company’s Consolidated Balance Sheets as of December 31, 2006, 2005 and 2004:
The net pension liability included in accounts payable and accrued liabilities as of December 31, 2006 and 2005 is $31.3 million and $50.2 million, respectively. Pursuant to the required implementation of FASB SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Post Retirement Plans” (“SFAS 158”), for this fiscal year end, accumulated other comprehensive expense amounts associated with the additional minimum pension liability are eliminated. Adoption of SFAS 158 resulted in a $36.4 million decrease in prepaid expenses and other assets and an equivalent decrease in accounts payable and accrued liabilities.
The Company’s pension plan asset allocation at December 31, 2006 and 2005 and target allocation for 2007 are as follows:
Under SFAS No. 106, “Accounting for Postretirement Benefits Other Than Pensions,” the measurement date shall be as of the date of the financial statements, or if used consistently from year to year, as of a date not more than three months prior to that date. The Company’s measurement date is December 31. Under SFAS 158, companies must now use the date of the financial statements.
As of and for the year ended December 31, 2005 (dollars in thousands):
The corporate and other segment consists of the operations of the FNF parent holding company, certain other unallocated corporate overhead expenses, and the Company’s share in the operations of certain equity investments, including Sedgwick and Fidelity National Real Estate Solutions.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 requires an evaluation to determine the likelihood that an uncertain tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. If it is determined that it is more likely than not that an uncertain tax position will be sustained upon examination, the next step is to determine the amount to be recognized. FIN 48 prescribes recognition of the largest amount of tax benefit that is greater than 50 percent likely of being recognized upon ultimate settlement of an uncertain tax position. Such amounts are to be recognized as of the first financial reporting period during which the more-likely-than-not recognition threshold is met. Similarly, an amount that has previously been recognized will be derecognized as of the first financial reporting period during which the more-likely-than-not recognition threshold is not met. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the impact on the Company’s statements of financial position and operations.