The Company's offices are currently located in Irvine, California. Most of the Company's offices are leased, with the exception of a branch office in Phoenix, Arizona, which the Company owns, and an executive office building purchased in April, 1999.
The future executive office building located at 1111 E. Katella Avenue, Orange, CA was acquired with the proceeds of a $2,080,000 note that bears interest at the lending institutions prime rate and monthly principal payments of $4,442 per month. The note is collateralized by a deed of trust.
(1) Average fee per file information consists of gross title insurance premiums, escrow fees and other title-related fees divided by the number of closed files (not including revenue generated by, or closed files relating to, the Company's STAR Product, which are excluded due to the abbreviated characteristics of the policy). In addition, non title-related revenues and investment income are excluded as there are no associated closed files. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Company's revenue is closely related to the level of real estate activity and the average price of real estate sales. Real estate sales are directly affected by the availability of funds to finance purchases. Other factors affecting real estate activity include demand, mortgage interest rates, family income levels and general economic conditions. While the level of sales activity was relatively depressed in certain geographical areas during the period 1991 through mid-1993, reductions in mortgage interest rates beginning in the latter part of 1991 triggered an increase in refinancing activity, which continued at then record levels through 1993 and into the first quarter of 1994. During 1994 and early 1995, steady interest rate increases caused by actions taken by the Federal Reserve Board resulted in a significant decline in refinancing transactions and a stagnation in residential resales and new home sales. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a favorable effect on the level of real estate activity, including refinancing transactions, new home sales and resales. The overall economic environment, stable mortgage interest rates and strength in the California and West Coast real estate market contributed to very positive conditions for the industry throughout all of 1996, 1997 and 1998 and the first six months of 1999. However, mortgage rates began to climb during the last half of 1999, virtually eliminating the volume of refinance activity experienced in the prior year and early 1999. It is impossible to predict the direction interest rates and the real estate market may move in the future.
The Company was incorporated in November 1996, but had no operations until it acquired 60% of the outstanding stock of ATC in July 1997. For the year 1997, the Company's revenue and expenses included only six months of ATC's operations compared to a full year of ATC-related operations included in the year ended December 31, 1999 and 1998. Therefore, revenue and expenses related to the historical operations of the Company since its inception are not comparable from year to year.
The following discussion presents a comparison of (1) the Company for 1999, 1998 and the six month ended December 31, 1997, (2) the Company and Predecessor combined for 1997. Information provided for the six months ended June 30, 1997 is that of the Company's Predecessor, and should not be considered an indicative measure or comparison of the Company's current financial position or results of operations.
Favorable interest rates in 1997, 1998 and through early 1999 triggered refinancing activity at then record levels. The overall economic environment, stable mortgage interest rates and strength in real estate market, especially California, the Company's primary market, were positive factors for the industry. However, interest rates began to climb during the last six months of 1999, eliminating the volume of refinance activity experienced in the prior year.
Escrow Fees. Revenues from escrow fees increased by $923,000 or 3.8% to $25.2 million in 1999 from $24.3 million in 1998. In 1998, escrow fees increased $11.3 million or 87.6% to $24.3 million compared to $12.9 million in 1997. Escrow fees trend primarily with title insurance activity generated by the Company's direct operations. The increase is primarily the result of the first half of 1999 market conditions and the Company's focused efforts to expand its escrow market presence in certain areas, such as southern California.
Other operating expenses consist of facilities expenses, postage and courier services, computer services, professional services, advertising expense, general insurance, trade and note receivable allowances, depreciation and amortization expense and interest expense.
Personnel Costs. Personnel costs totaled $54.3 million, $49.4 million and $30.6 million for the years ended December 31, 1999,1998 and 1997. As a percentage of total revenue, personnel costs increased to 60.8% in 1999 from 54.1% in 1998, which had previously decreased from 56.1% in 1997. Personnel costs include base salaries, commissions and bonuses paid to employees and are the most significant operating expense incurred by the Company. These costs fluctuate with the level of orders opened and closed and the mix of revenue. The fluctuation in the Company's personnel expenses is due to the expansion of its direct operation business, in addition to acquiring other operations and hiring additional personnel to expand its national market. The Company has taken significant measures to maintain appropriate personnel levels and costs relative to the volume and mix of business and revenues. The Company continues to monitor the prevailing market conditions and attempts to respond as necessary.
Income Tax Expense. Income tax expense for 1999, 1998 and 1997 as a percentage of earnings before income taxes was 41.0%, 41.8% and 49.8%, respectively. The fluctuations in income tax expense as a percentage of earnings before income taxes are attributable to the effect of state income taxes on the Company's wholly-owned underwritten title company and the ancillary service companies; a change in the amount and the characteristics of net income, operating income versus investment income; and the tax treatment of certain items.
The Company's current cash requirements include debt service, debt relating to capital leases, personnel and other operating expenses, taxes and dividends on its common stock. The Company believes that all anticipated cash requirements for current operations will be met from internally generated funds. In the future, the Company's cash requirements will include those relating to the development of National's business. While the Company presently has in place much of the infrastructure (principally consisting of personnel) that will be used for this development, management believes that additional cash resources will be required. The development of direct sales operations for the expansion of National would require more cash resources than developing these operations using agency relationships. Cash requirements for the development of National are expected to be met from current cash balances and internally generated funds.
The Company's other subsidiary operations collect revenue and pay operating expenses; however, they are not regulated by insurance regulatory or banking authorities. Positive cash flow from the underwritten title companies and other subsidiary operations is invested primarily in cash and cash equivalents.
In May 1999, the Department of Insurance, State of New York approved the acquisition of National Title Insurance Company of New York, Inc. by ATC. The transaction was completed in June 1999, the purchase price of $3.25 million, was paid in cash.
The State Banking Department, State of Arizona ("State Banking Department") delivered their Report of Examination of American Title Insurance of Arizona, Inc. (formerly known as Nations Title Insurance of Arizona, Inc.) as of and for the three-year period ending October 31, 1998 on March 4, 1999. The report as forwarded to the Company by State Banking Department indicates that the Company may not be in compliance with certain State Banking Department regulations. The State Banking Department is providing the Company with an opportunity to present additional information prior to making their final determination as to compliance. The Company does not believe that resolution of this matter will have a material impact upon the financial statements of the Company. The Company provided additional information to the State Banking Department for review. As of March 2000, the Company has not received any further correspondence from the State Banking Department.
The American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"), in March 1998. SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use. SOP 98-1 requires that certain costs related to the development or purchase of internal use computer software be capitalized and amortized over the estimated useful life of the software. Costs related to the preliminary project stage and the post-implementation/operations stage, as defined, in an internal use computer software development project are to be expensed as incurred. Costs incurred prior to initial application of SOP 98-1, whether capitalized or not, are not adjusted to the amounts that would have been capitalized had SOP 98-1 been in effect when those costs were incurred. SOP 98-1 is applicable to all non-governmental entities and effective for fiscal years beginning after December 15, 1998. The adoption of SOP 98-1 has not had a material impact on the Company's financial position, results of operations or financial reporting
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The adoption of SFAS 133 is not expected to have a material impact on the Company's financial position, results of operations or financial reporting.
We have audited the accompanying consolidated balance sheets of American National Financial, Inc. and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of earnings, comprehensive earnings, shareholders' equity and cash flows for each of the years in the three year period ended December 31, 1999. 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 American National Financial, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for the years ended December 31, 1999, 1998 and 1997, in conformity with generally accepted accounting principles.
AMERICAN NATIONAL FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE DATA)
In May 1999, the Department of Insurance, State of New York, approved the acquisition of National Title Insurance of New York, Inc. ("National"), a New York domiciled underwriter, by American Title Company, a subsidiary of American National Financial Inc. from Fidelity National Financial, Inc. National is licensed to issue title insurance policies in 34 states, the District of Columbia and the U.S. Virgin Islands. The $3.25 million dollar purchase price was paid in cash and the transaction was completed in June 1999.
National did not underwrite any significant title insurance policies through direct operations or agency relationships during 1999. The primary purpose of the acquisition is to acquire an underwriter, which will enable the Company to generate underwriting fees and permit the Company to expand geographically into counties and states in which the Company is not presently licensed. The Company believes this expansion can be accomplished more quickly and cost-effectively through this acquisition than through other means. The Company also believes that the acquisition will expand the business opportunities for its current and potential employees and affiliates, which will aid in the Company's recruitment efforts, and will permit the Company to generate additional revenue by writing title insurance policies in those geographic areas which are not covered by ATC's exclusive agency arrangements with FNTIC. See Note 12.
Property and equipment are recorded at cost, less depreciation and amortization. Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets which range from three to 30 years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the applicable lease or the estimated useful lives of such assets.
Fixed maturity securities are purchased to support the investment strategies of the Company, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations and regulatory requirements. Fixed maturity securities which may be sold prior to maturity to support the Company's investment strategies are carried at fair value and are classified as available for sale. Fair values for fixed maturity securities are principally a function of current interest rates and are based on quoted market prices.
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income on a trade date basis. Unrealized gains or losses on fixed maturity and equity securities which are classified as available for sale, net of applicable deferred income taxes (benefits), are excluded from income and credited or charged directly to a separate component of stockholders' equity. If any unrealized losses on fixed maturity or equity securities are deemed other than temporary, such unrealized losses are recognized as realized losses.
Certain reclassifications have been made in 1999 and 1998 Consolidated Financial Statements to conform to the classifications used in 1999.
As a result of the July 1997 transaction with the Company, FNFI agreed to make no claim on ATC for claims arising from policies written prior to January 1, 1997. Such indemnification is not expected to have a material effect on the financial results of the Company.
On August 9, 1997, ATC signed a stock purchase agreement with Pacific Coast Title of Santa Barbara County for the purchase of 100% of the issued and outstanding stock of Santa Barbara Title Company. On January 9, 1998, the Insurance Commissioner of the State of California approved the transaction and the sale was consummated. The purchase price of $160,000 was paid in cash. The impact of the Santa Barbara Title
In May 1999, the Department of Insurance, State of New York, approved the acquisition of National, a New York domiciled underwriter by ATC a subsidiary of American National Financial Inc., from Fidelity National Financial, Inc. National is licensed to issue title insurance policies in 34 states, the District of Columbia and the U.S. Virgin Islands. The $3.25 million dollar purchase price was paid in cash and the transaction was completed in June 1999.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the National acquisition were as follows (dollars in thousands):
The following table sets forth certain information regarding the Company's investment securities at December 31, 1999. Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Investment securities with an amortized cost of $2,902,000 and a fair value of $2,848,000 were callable at December 31, 1999:
Based upon the Company's current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the benefit of its existing net deferred tax assets. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. However, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years. Certain tax planning or other strategies could be implemented, if necessary, to supplement income from operations to fully realize recorded tax benefits. The valuation allowance of $845,000 relates to National whose net operating losses are restricted as to their availability.
The Company had a $473,000 note payable bearing interest at prime due in full in December 1999 with interest payable monthly. The note was collateralized by a deed of trust on the office building. At December 31, 1998, the principal balance was $443,000. In March 1999, the Company paid the remaining principal balance of this note in full.
National is subject to regulations that restrict its ability to pay dividends or make other distributions of cash or property to its parent company without prior approval from the Department of Insurance of the State of New York. The maximum amount of dividends which can be paid by National to shareholders without prior approval of the Insurance Commissioner is subject to restrictions. No dividends, including all dividends paid in the preceding twelve months, which exceed 10% of the outstanding capital shares can be paid without prior approval unless after deducting dividends the Company has surplus to policyholders at least equal to the greater of 50% of its reinsurance reserves or 50% of the minimum capital required. Additionally, dividends are further limited to the Company's earned surplus. Based on this formula, National could not pay dividends or make distributions as of January 1, 2000.
The Company offers the American National Financial, Inc. 401(k) Profit Sharing Plan, a qualified voluntary contributory savings plan, available to substantially all employees. Eligible employees may contribute up to 15% of their pretax annual compensation, up to the amount allowed pursuant to the Internal Revenue Code. The Company may elect to make matching contributions. The Company has historically not made matching contributions.
In September 1999, the Company's Board of Directors approved the adoption of the American National Financial, Inc. Employee Stock Purchase Loan Plan ("Employee Plan") and the Non-Employee Director Stock Purchase Loan Program ("Director Program"). The purpose of the Loan Plan and Loan Program is to provide key employees and directors with further incentive to maximize shareholder value. The Company authorized an aggregate of $2.0 million in loans. Loan Plan and Loan Program funds must be used to make private or open market purchases of Company common stock through a broker-dealer designated by the Company. All loans are full recourse and unsecured, and will have a five-year term. Interest will accrue on the loans at a rate of six and one quarter percent (6 1/4%) per annum due at maturity. Loans may be prepaid any time without penalty. Through December 31, 1999, loans were made in the amount of $1,253,000 to purchase 316,767 shares of the Company's common stock at an average purchase price of $3.95 per share. The fair values of notes receivable are established using current market rates. The fair value calculated at December 31, 1999 is $1,134,000.
In August 1998, the shareholders approved the adoption of the 1998 Incentive Stock Plan (1998 Incentive Plan). Under the terms of the 1998 Incentive Plan, the Company may grant incentive or nonqualified stock options to certain key employees and non-employee directors or officers. The number of shares issuable under the 1998 Incentive Plan is 650,000 shares at not less than 100% and 85% of fair market value on the date of the grant for incentive options and nonqualified options, respectively. An additional 200,000 shares of common stock may be authorized on the date of each annual meeting of shareholders. Officers and other key employees of the Company or of an affiliated company are eligible to receive incentive stock options. Officers and other key employees of the Company or of an affiliated company, members of the Board and other service providers are eligible to receive nonqualified stock options. The term and provision for the termination of each option shall be fixed by the Board of Directors, but no option may be exercisable more than 10 years after the date it is granted. An incentive option granted to a person who is a 10% shareholder on the date of the grant shall not be exercisable more than 5 years after the date it is granted. Each option shall vest and become exercisable in one or more installments at such time or times and subject to such conditions, including within limitation the achievement of specified performance goals or objectives, as shall be determined by the Board of Directors. As of December 31, 1998, no options had been granted under the 1998 Incentive Plan. In connection with the February 1999 Initial Public Offering, 340,040 options were granted under the 1998 Incentive Plan at an exercise price of $6 per share.
Pro forma information regarding net earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the minimum fair value method of that Statement. The minimum fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions. The risk free interest rate used for options granted during 1997 was 6.45%. The expected dividend yield used for 1997 was 0%. A weighted average expected life of 10 years was used. There were no options granted in 1998. The risk free interest rate used for options granted during 1999 was 5.19%. The expected dividend yield used for 1999 was 10%. The weighted average expected life of 7 years was used for 1999. The volatility factor for 1999 was 50%.
In conducting its operations, ATC routinely holds customers' assets in trust, pending completion of real estate transactions. Such amounts are maintained in segregated bank accounts and have not been included in the accompanying consolidated balance sheets. ATC has a contingent liability relating to proper disposition of these balances for its customers, which amounted to $67,513,000 and $104,688,000 at December 31, 1999 and 1998, respectively.
In 1997, ATC entered into a capital lease arrangement with a subsidiary of FNFI, which terminated in December 1999, for certain equipment. The capital lease pertaining to certain equipment was paid in full in March 1999. Accumulated depreciation related to this equipment was $623,000, $935,000 and $312,000 at December 31, 1999, 1998 and 1997, respectively. Also in 1997, ATC entered into a capital lease agreement with FNTIC, which expires in June 2007, for three title plants. The gross amount of the title plant recorded under affiliated capital lease is $815,000 at December 31, 1999, 1998 and 1997, respectively.
Depreciation of the equipment held under capital leases is included in other operating expenses for the years ended December 31, 1999, 1998 and 1997.
On February 29, 2000, the Company purchased 100% of the stock of Pioneer Land Title Corporation ("Pioneer"), a New York corporation. Pioneer provides title and escrow services in the state of New York. The purchase price is $1.8 million, payable $360,000 in cash and a $1.4 million promissory note that bears interest at 6.56% per annum from the purchase date through the fourth anniversary date.
On February 29, 2000, the Company purchased 100% of the membership interests of Emerald Mortgagee Assistance Company, L.L.C., ("EMAC"), a full service provider of release and assignment document preparation, document retrieval and special title assistance headquartered in Colorado with operations nationwide. The purchase price of $1.9 million was paid in cash of $1.7 million, subject to certain purchase price adjustments based on the combined equity of EMAC and American Research Services, its affiliate, and 58,495 shares of the common stock of the Company.
The accompanying financial statements include the divisions and/or subsidiaries of Fidelity National Financial, Inc. ("FNFI") which were subsequently merged into or acquired by American Title Company ("ATC" or "the Company"). ATC was acquired by FNFI in January 1996 for $772,000 from an unaffiliated party. The purchase price primarily represented the value of licenses to operate as an underwritten title company in various counties in California. At the time of acquisition, the operations of the acquired company were not significant. In July 1997, 60% of ATC was sold to American National Financial, Inc. ("ANFI") for $6,000,000. ANFI is owned by certain members of management of ATC. Reference to "ANFI Predecessor" in these financial statements refers to operations of these entities.
Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets, which range from three to five years. Leasehold improvements are amortized on a straight- line basis over the lesser of the term of the applicable lease or the estimated useful lives of such assets.
Provision (benefit) for income taxes for the six months ended June 30, 1997 and for the year ended December 31, 1996 consists of the following:
On July 1, 1997, the Company signed an exclusive underwriting agreement with FNTIC which is effective for five years. Under the agreement, the Company is generally limited to write policies only for FNTIC within certain geographic territories. Underwriting fees are based on a percentage of the gross title insurance premiums written and approximate 12%. The 12% underwriting fee includes a one percent fee paid to a FNFI affiliate for management services provided by these affiliates for ATC.