The selected consolidated financial data for the Company for the five-year period ended December 31, 2001, has been derived from the audited Consolidated Financial Statements. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, “Item 1 - Business-Acquisitions,” and “
Interest rate declines, which started in the fourth quarter of 1997, continued throughout 1998 and into 1999. This, coupled with relatively high consumer confidence, and a particularly strong California real estate market, resulted in record-setting revenues for the first half of 1999. However, commencing in the second quarter of 1999, new orders began to soften as rising interest rates led to a significant decline in refinance transactions, although residential resale and commercial activity remained relatively strong. During the second half of 1999, the trend of higher interest rates continued. Refinance activity, as well as residential resale orders, continued to decline. This, coupled with fourth quarter seasonal factors, led to a decrease in operating revenues for the fourth quarter of 1999 and resulted in a low inventory of open orders going into the first quarter of 2000. The Company instituted personnel reductions and other cost-containment programs during the latter part of 1999; however, because of separation costs, the benefits of these programs were not fully realized in 1999.
As a result of the low inventory of open orders going into the first quarter of 2000, and the relatively weak real estate economy present during the first half of 2000, revenues and profits during this period decreased significantly when compared with the same period of 1999. During the second half of 2000, real estate activity began to increase as a result of declining mortgage interest rates. New order counts in the latter part of the third quarter began to show favorable comparisons with the same period of 1999. This trend continued into the fourth quarter of 2000 and resulted in a significant increase in revenues and profits in the second half of 2000 when compared with the same period of 1999.
Operating revenues from direct title operations increased 35.1% in 2001 over 2000 and 1.5% in 2000 over 1999. The increase in 2001 over 2000 was attributable to a 44.1% increase in the number of title orders closed by the Company’s direct operations, offset in part by a decrease in the average revenues per order closed. The increase in 2000 over 1999 was attributable to an increase in the average revenues per order closed, offset in part by a 12.9% decrease in the number of title orders closed. The Company’s direct title operations closed 1,404,600, 975,000 and 1,119,900 title orders during 2001, 2000 and 1999, respectively. The average revenues per order closed were $1,042, $1,111 and $953 for 2001, 2000 and 1999, respectively, representing a decrease of 6.2% in 2001 from 2000 and an increase of 16.6% in 2000 over 1999. The fluctuations noted in closed orders and average revenues per order closed were primarily attributable to the relative changes in the volume of refinance transactions year-over-year, as mentioned above. Operating revenues from agency title operations increased 20.5% in 2001 over 2000 and decreased 9.5% in 2000 from 1999. These fluctuations were primarily attributable to the same factors affecting direct title operations compounded by the inherent delay in the reporting of transactions by agents.
Consumer information operating revenues increased 15.0% in 2001 over 2000 and 22.1% in 2000 over 1999. These increases were primarily attributable to an increased awareness and acceptance of this business segment’s products, increased market share and acquisition activity. The increase in 2001 over 2000 was offset in part by a $13.4 million decrease in revenues at the Company’s property and casualty insurance division, as a result of the previously announced exit of the lender-placed homeowner’s insurance business. Excluding this item, operating revenues increased 20.3% in 2001 over 2000. Operating revenues of $22.1 million and $15.0 million were contributed by new acquisitions in 2001 and 2000, respectively.
Consumer information personnel expenses increased 24.7% in 2001 over 2000 and 14.9% in 2000 over 1999. These increases were primarily attributable to additional personnel required to service the increased business volume and acquisition activity. The increase for 2000 was offset in part by a $0.8 million reduction in personnel expenses related to the restructuring of the Company’s pension plan. Personnel expenses associated with new acquisitions were $10.1 million for 2001 and $4.8 million for 2000, respectively.
Corporate personnel expenses increased $30.4 million in 2001 over 2000 and decreased $20.6 million in 2000 from 1999. These fluctuations were primarily attributable to a reduction of $23.7 million in 2000 resulting from the restructuring of the Company’s pension plan.
Title insurance other operating expenses (principally direct operations) increased 30.3% in 2001 over 2000 and 11.2% in 2000 over 1999. The increase in 2001 over 2000 was primarily due to $8.8 million of costs associated with new acquisitions, as well as incremental costs (i.e., messenger costs, reproduction costs, title plant maintenance costs, etc.) associated with servicing the 50.5% increase in total order volume. The increase in 2000 over 1999 was primarily due to $19.7 million of costs associated with new acquisitions and $15.2 million of lease expense related to a sale-leaseback agreement entered into in December 1999.
Real estate information other operating expenses increased 13.0% in 2001 over 2000 and decreased 3.5% in 2000 from 1999. The increase in 2001 over 2000 was primarily due to costs incurred to service the increase in business volume, charges of $1.8 million relating to the restructuring of the Company’s field service division, impaired asset write-offs totaling $2.6 million at the appraisal division and $19.5 million in costs associated with new acquisitions. The decrease in 2000 from 1999 was primarily due to a reduction in costs resulting from the Company’s cost-containment programs, offset in part by $15.5 million of costs associated with new acquisitions.
The Company provides for title insurance losses by a charge to expense when the related premium revenue is recognized. The amount charged to expense (the loss rate) is calculated by the Company based on historical experience and other factors, including changes and trends in the type of title insurance policies issued, the real estate market and the interest rate environment. Management monitors the adequacy of the estimated loss reserves on a quarterly basis using a variety of techniques, including actuarial models, and adjusts the loss rate as necessary.
The provision for title insurance losses, expressed as a percentage of title insurance operating revenues (excluding the one-time 2001 adjustment mentioned below), was 4.0% in 2001, 3.7% in 2000 and 3.1% in 1999. The increase in 2001 over 2000 reflected adverse claims development, offset in part by the shift in current year revenue mix from resale to refinance, which is generally less claims intensive. The increase in 2000 over 1999 reflected the shift in revenue mix from refinance to resale, which is generally more claims intensive. During the third quarter of 2001, the Company recorded a $7.9 million adjustment to a purchase accounting estimate for loss reserves at one of its title insurance subsidiaries, which was purchased in 1998. This adjustment strengthened loss reserves to reflect subsequent adverse developement.
The provision for consumer information losses principally reflects home warranty claims. The provision for home warranty claims, expressed as a percentage of home warranty operating revenues, was 53.1% in 2001, 52.8% in 2000 and 49.8% in 1999. These increases were primarily due to increases in the average number of claims per contract, which was primarily attributable to the expansion of this business into new geographical markets. The Company’s management has been eliminating high-cost contractors that are servicing claims in new geographic areas and achieving positive results. The provision for home warranty claims, expressed as a percentage of home warranty operating revenues, has steadily declined throughout the current year, from a high of 56.2% in the first quarter of 2001, to 48.3% in the fourth quarter of 2001.
The Company’s title insurance profit margins vary according to a number of factors, including the volume, composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. For example, commercial transactions tend to generate higher revenues and greater profit margins than residential transactions. Further, profit margins from refinancing activities are lower than those from resale activities because in many states there are premium discounts on, and cancellation rates are higher for, refinancing transactions. Cancellations of title orders adversely affect profits because costs are incurred in opening and processing such orders but revenues are not generated. Also, the Company’s direct title insurance business has significant fixed costs in addition to its variable costs. Accordingly, profit margins from the Company’s direct title insurance business improve as the volume of title orders closed increases. Title insurance profit margins are also affected by the percentage of operating revenues generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Real estate information profits are generally unaffected by the type of real estate activity but increase as the volume of residential real estate loan transactions increases. Consumer information profits increase as the volume of transactions increases and are not affected by the volatility of real estate transactions. In general, the title insurance business is a lower-margin business when compared with the Company’s other segments. The lower margins reflect the high fixed cost of producing title evidence, whereas the corresponding revenues are subject to regulatory and competitive pricing constraints. Corporate expenses increased $25.6 million in 2001 over 2000 and decreased $19.1 million in 2000 from 1999. The increase in 2001 over 2000 was primarily due the previously disclosed $23.7 million reduction in expenses in 2000 resulting from the restructuring of the Company’s pension plan, as well as increased interest expense in 2001 due primarily to the issuance of the Company’s $210.0 million senior convertible debentures in April of 2001, offset in part by an increase in equity in earnings of unconsolidated affiliates. The decrease in 2000 from 1999 was primarily attributable to the restructuring of the Company’s pension plan and a decrease in equity in earnings of unconsolidated affiliates.
Income taxes-The Company’s effective income tax rate, which includes a provision for state income and franchise taxes for noninsurance subsidiaries, was 35.7%, 35.5% and 36.7% for 2001, 2000 and 1999, respectively. The differences in the effective tax rate were primarily due to changes in the ratio of permanent differences to income before income taxes and minority interests and changes in state income and franchise taxes resulting from fluctuations in the Company’s noninsurance subsidiaries’ contribution to pretax profits. Information regarding items included in the reconciliation of the effective rate with the federal statutory rate is contained in Note 9 to the consolidated financial statements.
On October 12, 2001, the Company entered into a credit agreement that provided for a $200.0 million line of credit. This agreement supercedes the Company’s prior credit agreements that were to expire in July 2002. Under the terms of the new credit agreement, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt-to-capitalization ratios. The Company’s line of credit was unused at December 31, 2001.
Notes and contracts payable, as a percentage of total capitalization, was 23.7% as of December 31, 2001, as compared with 16.9% as of the prior year end. This increase was primarily attributable to the issuance of the $210.0 million senior convertible debentures, offset in part by an increase in the capital base primarily due to net income for the year. Notes and contracts payable are more fully described in Note 7 to the consolidated financial statements.
A summary, by due date, of the Company’s total contractual obligations at December 31, 2001, is as follows:
Separate financial statements for subsidiaries not consolidated and 50% or less owned persons accounted for by the equity method have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of The First American Corporation and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Furniture and equipment includes computer software acquired and developed for internal use and for use with the Company’s products. Software development costs are capitalized from the time technological feasibility is established until the software is ready for use.
On July 20, 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). This statement addresses financial
To the extent that the undiscounted cash flows related to the businesses underlying the goodwill are less than the carrying value of the related goodwill, such goodwill will be reduced to fair value.
The Company provides for title insurance losses based upon its historical experience by a charge to expense when the related premium revenue is recognized. Title insurance losses and other claims associated with ceded reinsurance are provided for as the Company remains contingently liable in the event that the reinsurer does not satisfy its obligations. The reserve for known and incurred but not reported claims reflects management’s best estimate of the total costs required to settle all claims reported to the Company and claims incurred but not reported. The process applied to estimated claim costs is subject to many variables, including changes and trends in the type of title insurance policies issued, the real estate market and the interest rate environment. It is reasonably possible that a change in the estimate will occur in the future.
The Company provides for claims losses relating to its home warranty and property and casualty insurance businesses based on the average cost per claim as applied to the total of new claims incurred. The average cost per home warranty claim is calculated using the average of the most recent 12 months of claims experience. The average cost per property and casualty insurance claim is calculated using historical claims experience.
Real Estate Information - In December 1999, the Company adopted Staff Accounting Bulletin No. 101 (SAB), “Revenue Recognition in Financial Statements.” The SAB, which became effective January 1, 1999, applies to the Company’s tax service operations and requires the deferral of the tax service fee and the recognition of that fee as revenue ratably over the expected service period. The amortization rates applied to recognize the revenues assume a 10-year contract life and are adjusted to reflect prepayments. The Company reviews its tax service contract portfolio quarterly to determine if there have been changes in contract lives and/or changes in the number and/or timing of prepayments. Accordingly, the Company may adjust the rates to reflect current trends. The SAB finalized a series of changes instituted by the Securities and Exchange Commission concerning revenue recognition policies. As a result of adopting the SAB, in 1999, the Company reported a charge of $55.6 million, net of income taxes and minority interests, as a cumulative change in accounting principle and reduced net income by $10.9 million, or $0.16 per diluted share. During the year ended December 31, 2001, the Company recognized $18.2 million in revenues that were included in the cumulative effect adjustment. Revenues earned by the other products in the real estate information segment are recognized at the time of delivery, as the Company has no significant ongoing obligation after delivery.
Consumer Information - Revenues from home warranty contracts are recognized ratably over the 12-month duration of the contracts. Revenues from property and casualty insurance policies are recognized ratably over the 12-month duration of the policies. Interest on loans with the Company’s thrift subsidiary is recognized on the outstanding principal balance on the accrual basis. Loan origination fees and related direct loan origination costs are deferred and recognized over the life of the loan. Revenues earned by the other products in the consumer information segment are recognized at the time of delivery, as the Company has no significant ongoing obligation after delivery.
Pursuant to insurance and other regulations of the various states in which the Company’s insurance subsidiaries operate, the amount of dividends, loans and advances available to the Company is limited, principally for the protection of policyholders. Under such statutory regulations, the maximum amount of dividends, loans and advances available to the Company from its insurance subsidiaries in 2002 is $197.7 million.
The Company’s title insurance subsidiary, First American Title Insurance Company, maintained statutory capital and surplus of $534.2 million and $406.8 million at December 31, 2001 and 2000, respectively. Statutory net income for the years ended December 31, 2001, 2000 and 1999 was $118.7 million, $54.8 million and $71.2 million, respectively.
The amortized cost and estimated fair value of debt securities at December 31, 2001, by contractual maturities, are as follows:
The fair value of debt and equity securities was estimated using quoted market prices. Sales of debt and equity securities resulted in realized gains of $0.6 million, $2.2 million and $3.5 million; and realized losses of $0.6 million, $4.8 million and $1.6 million for the years ended December 31, 2001, 2000 and 1999, respectively.
In April, 2001, the Company sold $210.0 million of 4.5% senior convertible debentures due 2008. The debentures are convertible into common shares of the Company at $28 per share. The Company may redeem some or all of the senior convertible debentures at any time on or after April 15, 2004. The Company has also issued debt that is convertible into shares of its common stock to finance certain acquisitions. This debt, which is included in “Other notes and contracts payable,” is convertible at the option of each note holder at a conversion price of $30 per share. The balance of this convertible debt was $33.4 million and $29.8 million at December 31, 2001 and 2000, respectively.
The fair value of notes and contracts payable was $426.6 million and $223.8 million at December 31, 2001 and 2000, respectively, and was estimated based on the current rates offered to the Company for debt of the same remaining maturities. The weighted-average interest rate for the Company’s notes and contracts payable was 6.0% and 8.0% at December 31, 2001 and 2000, respectively.
At December 31, 2001, the Company had various foreign net operating loss carry forwards totaling approximately $4.0 million, which carry forward indefinitely.
For the three years ended December 31, 2001, 2.8 million, 4.5 million and 3.7 million options, respectively, were excluded from the weighted-average diluted common shares outstanding due to their antidilutive effect.
Net periodic pension cost for the Company’s pension and other retirement benefit plans includes the following components:
The Company also has a Stock Bonus Plan (the “Plan”) for key employees pursuant to which 9,000, 21,000 and 154,000 common shares were issued in 2001, 2000 and 1999, respectively, resulting in a charge to operations of $0.3 million, $0.2 million and $3.4 million, respectively. The Plan, as amended December 9, 1992, provides that a total of up to 1,350,000 common shares may be awarded in any one year.
In May 2001, in connection with the purchase of Credit Management Solutions, Inc. (CMSI), the Company adjusted the outstanding CMSI stock options to substitute Common shares of the Company for the shares of CMSI that were issuable upon exercise of those options. The shares and exercise price for the CMSI options were adjusted by an exchange factor, with the result being that the CMSI options became exercisable with respect to 900,000 Common shares of the Company at exercise prices ranging from $3.96 to $43.58.
Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). In accounting for its plan, the Company, as allowable under the provisions of SFAS No. 123, applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” As a result of this election, the Company does not recognize compensation expense for its stock option plans. Had the Company determined compensation cost based on the fair value for its stock options at grant date, as set forth under SFAS No. 123, the Company’s net income and earnings per share would have been reduced to the pro forma amounts as follows:
The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2001, 2000 and 1999, respectively; dividend yield of 1.4%, 2.1% and 1.5%; expected volatility of 53.6%, 51.4% and 39.6%; risk-free interest rate of 5.4%, 5.2% and 5.8%; and expected life of eight years, nine years and seven years.
The Company leases certain office facilities, automobiles and equipment under operating leases, which, for the most part, are renewable. The majority of these leases also provide that the Company will pay insurance and taxes. In December 2000, the Company’s subsidiary, First American Real Estate Information Services, Inc. and, in 1999, the Company entered into sale-leaseback agreements with regard to certain furniture and equipment with a net book value of $30.7 million and $65.7 million, respectively. Proceeds from the sales, which amounted to $33.8 million and $80.1 million and gains of $3.1 million and $14.4 million for the years ended December 31, 2000 and 1999, respectively, have been included in “Deferred revenue” and will be amortized over the life of the lease. Under the agreements, the Company’s subsidiary and the Company agreed to lease the equipment for three to five years with minimum annual lease payments of $5.0 million and $15.2 million, respectively. At the end of the term of the lease, the Company has the option to acquire the equipment or return it to the lessor.
issuance of the preferred securities, the Company issued to the subsidiary trust 8.5% subordinated interest notes, due in 2012. The sole assets of the subsidiary are, and will be, the subordinated interest notes. The Company’s obligations under the subordinated interest notes and related agreements, taken together, constitute a full and unconditional guarantee by the Company of the subsidiary’s obligations under the preferred securities. Distributions payable on the securities are included as interest expense in the Company’s consolidated income statements.
In December 1999, the Company announced plans to repurchase up to 5.0% of its then issued and outstanding shares. This plan was subsequently terminated in December 2000, at which time the Company had repurchased and retired 1,754,000 of its issued and outstanding shares.
On October 23, 1997, the Company adopted a Shareholder Rights Plan (the “Rights Plan”). Under the Rights Plan, after the close of business on November 15, 1997, each holder of the Company’s common shares received a dividend distribution of one Right for each common share held. Each Right entitles the holder thereof to buy a preferred share fraction equal to 1/100,000 of a share of Series A Junior Participating Preferred Shares of the Company at an exercise price of $265 per preferred share fraction. Each fraction is designed to be equivalent in voting and dividend rights to one common share.
Since the initial filing of the suit, the California attorney general’s office, on behalf of the state, the controller and the insurance commissioner, indicated that it would not seek to certify a class of defendents, but would instead amend its suit to name an unspecified number of title underwriters and underwritten title companies. To date, the attorney general has neither amended the suit nor, to the Company’s knowledge, taken steps to progress with it, including the service of process on any party. The attorney general, however, has entered into settlement discussions with various title insurance underwriters, including certain of the Company’s subsidiaries. No settlement agreements have been signed and certain material terms remain under discussion. Additionally, the attorney general has decided that all issues pertaining to escheat obligations will be dealt with through routine audits conducted by the controller’s office, rather than through the litigation filed by the attorney general.
The Company does not believe that the ultimate resolution of these actions will have a material adverse effect on its financial condition or results of operations.
During the year ended December 31, 2001, the Company completed 16 acquisitions, all accounted for using the purchase method of accounting. In applying the purchase method of accounting, the Company undertakes a comprehensive review of the acquired entity to ensure that all identifiable assets and liabilities are properly recorded at their fair value. In determining fair value, the Company utilizes a variety of valuation techniques, including discounted cash flow analysis and outside appraisals, to the extent necessary, given materiality and complexity. All excess purchase price is appropriately recorded as goodwill. The useful lives for all assets recorded in purchase accounting are based on market conditions, contractual terms and other appropriate factors.
Assuming all of the current year acquisitions had occurred January 1, 2000, pro forma revenues, net income and net income per diluted share would have been $3.79 billion, $164.9 million and $2.13, respectively, for the year ended December 31, 2001; and $3.07 billion, $80.7 million and $1.16, respectively, for the year ended December 31, 2000. All pro forma results include amortization of goodwill and interest expense on acquisition debt. The pro forma results are not necessarily indicative of the operating results that would have been obtained had the acquisitions occurred at the beginning of the periods presented, nor are they necessarily indicative of future operating results.
On July 31, 2000, the Company combined its Smart Title Solutions™ division, which it acquired in the 1998 business combination transaction with Experian, with the Datatrace division of LandAmerica Financial Group, Inc. The combined entity, Data Trace Information Services, is a provider of advanced title information delivery systems. The Company treated this transaction as an acquisition of the assets and liabilities of the Datatrace division in consideration for a 20% interest in its Smart Title Solutions division. The operating results of the combined entities are included in the Company’s consolidated financial statements commencing July 31, 2000.
On August 2, 2000, the Company combined its First American Real Estate Solutions (RES) division, which it acquired in the 1998 business combination transaction with Experian, with the Intellitech real estate information business of Transamerica Corporation, to form a new entity, First American Real Estate Solutions, L.P. This joint venture, is a provider of property characteristic information, supplying data and decision-support products to the real estate and mortgage finance industries. The Company treated this transaction as an acquisition of the assets and liabilities of the Intellitech division in consideration for a 20% interest in its RES division and $22.5 million in cash. The operating results of the joint venture are included in the Company’s consolidated financial statement commencing August 2, 2000.
and thrift services are provided in Southern California. Investment advisory, automotive insurance tracking and other services, resident screening, pre-employment screening, and property and casualty insurance are offered nationwide.
Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset.
Amount represents net $7,955,000 in purchase accounting adjustments, $11,251,000 related to the disposition of a subsidiary and $6,093,000 from the reserve for assets acquired in connection with claim settlements.