During 1997, the Company sold its corporate home office building in Irvine, California, which housed the Company's corporate departments and certain operating subsidiaries, recording a net realized gain of $4.3 million, prior to applicable income taxes. Also during 1997, a subsidiary of the Company completed the purchase of a building in Santa Barbara, California, which houses certain of the Company's corporate departments.
The historical operating results data, per share data and balance sheet data set forth below are derived from the historical financial statements of the Company, certain of which have been restated to reflect the Granite and Alamo mergers on the pooling-of-interests method of accounting. Per share data has been retroactively adjusted for stock dividends and splits since the Company's inception. Consolidated Balance Sheets at December 31, 1998 and 1997 and Consolidated Statements of Earnings, Comprehensive Earnings, Stockholders' Equity and Cash Flows for the years ended December 31, 1998, 1997 and 1996, and Notes thereto, audited by KPMG LLP, independent certified public accountants, are included elsewhere herein and
(2) During 1995, the Company recognized an $813,000 extraordinary loss, net of related income taxes of $437,000, related to the early retirement of its Senior Secured Notes.
The Company acquired Alamo Title Holding Company and subsidiaries ("Alamo") on August 20, 1998. This acquisition has been accounted for as a pooling-of-interests. The selected financial data above includes the balance sheet accounts of Alamo at December 31, 1998, 1997, 1996, 1995 and 1994 and the results of its operations for the years ended December 31, 1998, 1997, 1996, 1995 and 1994.
The Company acquired Lexington Capital Corporation ("Lexington") effective September 1, 1998. The selected financial data above includes the balance sheet accounts of Lexington as of December 31, 1998 and the results of its operations for the four-month period September 1, 1998 through December 31, 1998.
(7) During 1997, the Company recognized an extraordinary loss of $1.7 million, net of related income taxes of $1.1 million, related to the early retirement of $45 million maturity value of the Company's LYONs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations- Extraordinary Item and Recent Developments."
The following discussion is intended to provide information to facilitate the understanding and assessment of significant changes and trends related to the financial condition and results of operations of the Company. The discussion and analysis below includes the results of operations of Granite Financial, Inc. (acquired February 26, 1998) and Alamo Title Holding Company (acquired August 20, 1998) for each of the years ended December 31, 1998, 1997 and 1996, as the acquisitions of Granite and Alamo have been accounted for as poolings-of-interests. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing elsewhere herein.
During 1997 the Company sold a majority interest of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. ATC functions as an exclusive agent of the Company, and represents one of the Company's largest agents.
The acquisition of Alamo Title Holding Company and subsidiaries, which closed on August 20, 1998, provided additional balance between the Company's direct and agency operations with the strength of Alamo's direct and agency operations in the important Texas market. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. As a result of its acquisitions of Nations and Alamo, the Company has significantly expanded the national scope of its core title operations by expanding its direct operations in key markets and balancing the mix of its direct and agency operations.
The Company also earns income from its non-title related operations and from its investment portfolio.
- expand into the commercial title insurance market while maintaining its strong position in the residential and institutional lender markets;
- generate an increasing portion of its revenue from the sale of ancillary services;
- adhere to quality controls and strict monitoring of direct and agency operations to minimize title claims paid;
- maintain a balance between direct and agency distribution to enable it to compete profitably on a national basis;
Favorable mortgage interest rates in the latter part of 1991 through early 1994 triggered refinancing activity at then record levels. Beginning in early 1994 through mid-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. Title orders and requests for title-related services followed the market trend as expected. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a positive impact on the level of real estate activity, order counts and closed orders. The overall economic environment, stable mortgage interest rates in the seven percent range and strength in the real estate market, especially in California, the Company's strongest market, and on the West Coast, were positive factors through 1996, 1997 and 1998.
the Company's agency force to 2,000 at the end of 1996 from 1,100 at the end of 1995. The percentage of title insurance premiums generated by agency operations was 53.3%, 53.5% and 50.8% in 1998, 1997 and 1996, respectively.
The Company's direct operations generate escrow fees from holding funds and documents in connection with the closing of real estate transactions, as well as real estate information and technology service fees, trustee sale guarantee fees, credit reporting fees, attorney service fees, flood certification fees, tax monitoring fees, home warranty insurance premiums, reconveyance fees, recording fees, foreclosure publishing and posting service fees and exchange intermediary service fees in connection with real estate transactions.
The trends in escrow fees are primarily related to the title insurance activity generated by the Company's direct operations. Escrow fees have fluctuated during the 1998, 1997 and 1996 years in a pattern generally consistent with the fluctuation in title insurance premiums. Escrow fees increased $44.3 million to $130.3 million in 1998, a 51.5% increase from $86.0 million in 1997. This increase is consistent with the trend in title premiums, but is also due to the Company's focused efforts to expand its escrow market presence in certain areas, such as Southern California. Escrow fees increased $14.9 million to $86.0 million in 1997, a 21.0% increase from $71.1 million in 1996. See "Overview."
Personnel costs include base salaries, commissions and bonuses paid to employees and are the most significant operating expense incurred by the Company. These costs generally fluctuate with the level of orders opened and closed and with the mix of revenue. Personnel costs totalled $394.3 million, $273.2 million and $240.2 million for the years ended December 31, 1998, 1997 and 1996, respectively. See "Overview" and "Revenue." Personnel costs, as a percentage of total revenue, have decreased to 30.6% in 1998 from 31.7% in 1997, which had previously decreased from 32.7% in 1996. The Company has taken significant measures to maintain appropriate personnel levels and costs relative to the volume and mix of business and revenues. These fluctuations reflect a continuing emphasis on expense control and an increase in productivity resulting from the Company's automation and electronic commerce. The Company will not, however, compromise its customer service standards or quality controls in responding to market conditions. The Company continues to monitor the prevailing market conditions and will adjust personnel costs in accordance with activity.
Other operating expenses consist of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums and title-related revenue in lieu of franchise and other state taxes), escrow losses, postage and courier services, computer services, professional services, advertising expenses, general insurance, trade and notes receivable allowances and depreciation. In response to market conditions, the Company implemented aggressive cost control programs in order to maintain operating expenses at levels consistent with the levels of revenue; however, certain fixed costs are incurred regardless of revenue levels, resulting in year over year percentage fluctuations. Other operating expenses decreased as a percentage of total revenue to 20.0% in 1998 from 21.9% in 1997, which had previously decreased from 24.0% in 1996. The Company continues to be committed to cost control measures. The Company's cost control programs are designed to evaluate expenses, both current and budgeted, relative to existing and projected market conditions. Items considered include, but are not limited to, capital expenditures, service contracts, property requirements (e.g., renewal/termination of leases and relocation of offices), expected fluctuations in the number of personnel, the impact of technology and profitability. Additionally, the Company has centralized its purchasing function in order to obtain the most favorable prices/rates available for vendor provided services and products which also facilitates a highly structured requisition/approval process and cost analysis program. Total other operating expenses totalled $257.1 million, $189.2 million and $176.5 million in 1998, 1997 and 1996, respectively. See "Overview."
Agent commissions and the resulting percentage of agent premiums retained by the Company vary according to regional differences in real estate closing practices and state regulations. During 1997, the Company sold a majority interest in its underwritten title company subsidiary ATC, resulting in the transfer of premiums from direct operations to agency operations and increased commission expense in 1997 compared to 1996, as well as a decrease in premiums retained by the Company on a year over year basis. Commission rates paid to ATC are higher than average commission rates paid to the 1996 agent base. The combination of higher agency commission rates and the significant agency revenue generated since the sale of ATC and by the Nations Title Inc. acquisition has resulted in higher overall commissions.
EXTRAORDINARY ITEM. In an effort to reduce the leverage of the Company while taking advantage of the favorable environment relative to the Company's common stock, on October 17, 1997, the Company, in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs), which exceeded the accreted value recorded by the Company pursuant to the LYONs Indenture at that date. The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock and $790,000 in cash. The purchase of the LYONs increased stockholders' equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. An extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, related to this transaction has been recorded in the Consolidated Statement of Earnings for the year ended December 31, 1997. See "Recent Developments."
The Company's cash requirements include debt service, operating expenses, lease fundings, lease securitizations, 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, through cash received from subsidiaries, cash generated by investment securities and bank borrowings through existing credit facilities.
Two of the significant sources of the Company's funds are dividends and distributions from its subsidiaries. As a holding company, the Company receives cash from its subsidiaries in the form of dividends and as reimbursement for operating and other administrative expenses it incurs. The reimbursements are executed within the guidelines of various management agreements among the Company and its subsidiaries. Fluctuations in operating cash flows are primarily the result of increases or decreases in revenue. See "Overview." The Company's Insurance Subsidiaries and UTCs collect premiums and pay claims and operating expenses. The Insurance Subsidiaries also have cash flow sources derived from investment income, repayments of principal and proceeds from sales and maturities of investments and dividends from subsidiaries. Positive cash flow from the Insurance Subsidiaries is invested primarily in short-term investments and medium-term bonds. Short-term investments held by the Company's Insurance Subsidiaries provide liquidity for projected claims and operating expenses. The Insurance Subsidiaries are restricted by state regulations in their ability to pay dividends and make distributions. Each state of domicile regulates the extent to which the Company's title underwriters can pay dividends or make other distributions to the Company. The UTCs are also regulated by insurance regulatory or banking authorities. The Company's ancillary service and leasing subsidiaries collect revenue and pay operating expenses; however, they are not regulated by insurance regulatory or banking authorities. Positive cash flow from the UTCs and ancillary service subsidiaries is invested primarily in cash and cash equivalents.
The short- and long-term liquidity requirements of the Company, Insurance Subsidiaries, UTCs, ancillary service and leasing subsidiaries are monitored regularly to match cash inflows with cash requirements. The Company, Insurance Subsidiaries, UTCs and ancillary service subsidiaries forecast their daily cash needs and periodically review their short- and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying these projections.
For purposes of satisfying insurance regulatory requirements, the Company is required to maintain certain levels of readily marketable securities and other liquid assets. At December 31, 1998, the fair value of the Company's total investment securities was approximately $510.5 million, approximately $207.2 million of which have been designated to support statutory liabilities, primarily the combined unearned premium reserve. These investments consist of securities which the Company believes are readily marketable and could be liquidated if necessary. See "Business -- Investment Policies and Investment Portfolio."
Effective August 1, 1998, the Company closed a $100 million credit agreement. Certain of the proceeds were utilized to refinance previously existing credit facilities. Additional amounts available under the new credit agreement are available for general corporate purposes. The Company believes that the terms and conditions of the $100 million credit agreement are significantly more favorable than those that existed previously. See Note H of Notes to Consolidated Financial Statements.
The Company must comply with certain affirmative and negative covenants related to its bank revolving lines of credit and other debt facilities, which require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth, capitalization, investments, acquisitions, restricted payments and certain dividend restrictions. The Company is in compliance with all of its debt covenants at December 31, 1998.
due 2009 for $581.25 per $1,000 maturity value on February 15, 1999. Additionally, the LYONs holders had the right to convert the outstanding LYONs to 28.077 shares of Company common stock per $1,000 maturity value of LYONs at any time. As of February 15, 1999, $123,681,000 maturity value of LYONs had converted to 3,473,000 shares of common stock, adding approximately $70 million to equity while reducing outstanding notes payable by a like amount. The remaining $432,000 of maturity value was redeemed for cash of approximately $251,000. See Note H of Notes to Consolidated Financial Statements.
In the normal course of business certain of the Company's subsidiaries enter into off-balance sheet credit risk associated with certain aspects of its title insurance policies and Manchester's real estate activities. This credit risk is in the form of standby letters of credit and general partnership guarantees. The Company believes that this credit risk is adequately secured by either legal remedies associated with settlement procedures or the underlying real estate assets. See Note K of Notes to Consolidated Financial Statements.
RECENT DEVELOPMENTS. On April 4, 1996, the Company purchased 17% of the outstanding common stock of National Alliance Marketing Group, Inc. ("National Alliance"), a California corporation, for $566,667; together with a warrant to acquire an additional 14% of National Alliance common stock. In addition, the Company loaned $1,200,000 to National Alliance at closing at a rate of Prime plus one percent. Subsequently, the Company agreed to increase the credit facility from $1,200,000 to $1,700,000. In consideration for the increase in the credit facility National Alliance agreed to increase the warrant shares which the Company could purchase. If the entire $1,700,000 was borrowed the Company could purchase an additional 34% of the outstanding shares of National Alliance. After receiving approval of the transaction from the California Department of Insurance, the transaction closed on July 12, 1996. National Alliance is the parent company of Alliance Home Warranty Company ("Alliance"), a California insurance company. Alliance sells home warranty plans to buyers of resale homes, primarily in the Central and Southern California markets. A home warranty contract generally promises the repair or replacement of major operating systems and built-in appliances inside a home for a period of one year. On July 3, 1997, the Company converted the outstanding note balance in conjunction with the exercise of the warrants and then owned 51% of the outstanding common stock of National Alliance. The outstanding balance of the note receivable due from National Alliance at conversion was approximately $1.6 million. On August 14, 1998, the Company acquired the outstanding minority interest in National Alliance, 49%, for a purchase price of $3,320,000. The Company now owns 100% of National Alliance, which is now known as Fidelity National Home Warranty. The acquisition of National Alliance has been accounted for as a purchase. See Note B of Notes to Consolidated Financial Statements.
National was acquired in April 1996, as part of the Nations Title Inc. acquisition, and has not been actively underwriting policies since the transaction closed. This transaction has not yet received regulatory approval. See Notes C and L of Notes to Consolidated Financial Statements.
On January 13, 1999, the Company announced that it was going to redeem, pursuant to the terms of the indenture, its outstanding Liquid Yield Option Notes due 2009 for $581.25 per $1,000 maturity value on February 15, 1999. Additionally, the LYONs holders had the right to convert the outstanding LYONs to 28.077 shares of Company common stock per $1,000 maturity value of LYONs at any time. As of February 15, 1999, $123,681,000 maturity value of LYONs had converted to 3,473,000 shares of common stock, adding approximately $70 million to equity while reducing outstanding note payable by a like amount. The remaining $432,000 of maturity value was redeemed for cash of approximately $251,000.
On April 17, 1998, the Company announced it had acquired an approximate 19.9% interest in Cruttenden Roth, a privately held investment banking firm located in Newport Beach, California, for a purchase price of $5,800,000, payable $3,750,000 in Company common stock (117,857 shares) and $2,050,000 in cash. The Company also acquired an option to increase its ownership to 25.6%. In connection with the acquisition, the Company also provided Cruttenden Roth working capital in the amount of $3,500,000 in exchange for a note.
On June 3, 1998, the Company announced that as a result of the closing of the merger of Data Tree Corporation ("Data Tree") with Image Acquisition Corporation, a wholly-owned subsidiary of First American Financial Corporation (NYSE:FAF), the Company's 27.9% ownership position in Data Tree was converted into approximately 176,600 shares of First American Financial Corporation common stock, resulting in a gain of $9.7 million, before applicable income taxes. The Company's investment in Data Tree was approximately $3.0 million, including its percentage equity in Data Tree's earnings. The gain on conversion has been reflected in the Consolidated Statements of Earnings for the year ended December 31, 1998.
Effective September 1, 1998, the Company acquired 100% of Lexington Capital Corporation ("Lexington"), a financial services company specializing in financing national and regional franchisee accounts, headquartered in Deerfield, Illinois, for a purchase price of $3.5 million, payable in $3.0 million in cash and $500,000 in restricted common stock of the Company (15,129 shares). This transaction has been accounted for as a purchase. See Note B of Notes to Consolidated Financial Statements.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS 130 requires all items that are necessary to be recognized under accounting standards as components of comprehensive income to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 does not require a specific format for that financial
The Company's principal subsidiaries consist of Fidelity National Title Insurance Company ("Fidelity Title"), Fidelity National Title Insurance Company of New York ("Fidelity New York"), Alamo Title Insurance ("Alamo Title"); (collectively, the "Insurance Subsidiaries"); its wholly-owned underwritten title companies (collectively, the "UTCs"); and its network of wholly-owned title-related ancillary service companies known as Fidelity National Lender Express Network ("FLEXNet"). The Company also originates, funds, purchases, sells, securitizes and services equipment leases for a broad range of businesses through its wholly-owned subsidiary Granite Financial, Inc.
Nations Title Insurance Company, Nations Title Insurance of New York Inc. and National Title Insurance of New York Inc. were acquired, along with Nations Title Inc. ("NTI," collectively, "Nations Title Inc."), in a transaction which closed on April 1, 1996. Certain of the ancillary service companies were acquired in separate transactions during 1996 and 1997. Granite Financial, Inc. and subsidiaries ("Granite") was acquired in a transaction which closed on February 26, 1998. Alamo Title was acquired in connection with the Company's acquisition of Alamo Title Holding Company and subsidiaries ("Alamo") in a transaction which closed August 20, 1998.
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All material intercompany profits, transactions and balances
have been eliminated. The Company's investments in non-majority-owned partnerships and subsidiaries are accounted for on the equity method.
The Company acquired the common stock of Alamo Title Holding Company and subsidiaries on August 20, 1998, in exchange for approximately 2.2 million shares of Company common stock plus cash in lieu of fractional shares. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $33.13 on August 20, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Alamo.
The results of operations of Fidelity, Granite and Alamo separately and the combined amounts presented in the Consolidated Financial Statements for the two years prior to the consummation of the poolings-of-interests are summarized below:
Effective as of October 1, 1997, the Company acquired Bron Research, Inc. ("BRON"), a flood certification company headquartered in Austin, Texas. The purchase price paid by the Company for the acquisition was $9.85 million, paid in 575,599 shares of Company common stock. BRON now operates as Fidelity National Flood, Inc. This transaction has been accounted for as a pooling-of-interests. Prior to 1997, BRON's financial position and results of operations were insignificant, and as such, the 1996 Consolidated Statement of Earnings and Related Notes to Consolidated Financial Statements have not been restated to reflect the inclusion of BRON.
Other long-term investments, which consist of a limited partnership investment in an investment fund, as well as certain other debt instruments and equity investments, are carried at cost or on the equity method, as appropriate, which approximates fair value.
Granite has entered into various lease agreements which, in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 13, "Accounting for Leases," meet the criteria of capitalization and are accounted for as direct financing leases. Under this method, the amount by which gross lease rentals exceed the cost of the related assets, less the estimated recoverable residual value at the expiration of the lease, is recognized as income from direct financing leases over the life of the lease using the interest method. Any permanent reduction in the estimated residual equipment value of leased property is charged to operations in the period it occurs. See Note D.
At the closing of each securitization which is accounted for as a sale the Company removes from its balance sheet the lease receivables held for sale and adds to its balance sheet (i) the cash received and (ii) the allocated cost of the Residuals which consists of (a) cash collateral account and (b) net excess cash flows.
The Company may recognize unrealized gains or losses through stockholders' equity attributable to the change in the fair value of the Residuals, which are recorded at estimated fair value and accounted for as available for sale securities. The Company is not aware of an active market for the purchase or sale of Residuals at this time. Accordingly, the Company estimates the fair value of the Residuals by calculating the present value of the estimated expected future excess cash flows received by the Company after being released by the Trust (cash out method) using a discount rate of 12%, which management believes is commensurate with the risks involved.
The Company is entitled to the cash flows from the Residuals that represent collections on the lease receivables in excess of the amounts required to pay the Bonds and Certificate principal and interest, the base servicing fees and certain other fees such as trustee and custodial fees. At the end of each collection period, the aggregate cash collections from the lease receivables are allocated first to the servicing fees and certain other fees such as trustee and custodial fees for the period, then to the Bond and Certificate holders for interest at the pass-through rate on the Bonds and Certificates plus principal as defined in the Trust and Security Agreements. If the amount of cash required for the above allocations exceeds the amount collected during the collection period, the shortfall is drawn from the Cash Collateral Account. If the cash collected during the period exceeds the amount necessary for the above allocations, and there is no shortfall in the related Cash Collateral Account, the excess is released to the Company. If the Cash Collateral Account balance is not at the required credit enhancement level, the excess cash collected is used to build the cash collateral account until the credit enhancement level is achieved. The specified credit enhancement levels are defined in the applicable Trust and Security Agreement which are expressed generally as a percentage of either the original or current collateral principal balance.
In future periods, the Company may increase the estimated fair value of the Residuals if the actual performance of the lease receivables is higher than the original estimate. If the actual performance of the lease receivables is lower than the original estimate, then an adjustment to the carrying value of the Residuals may be required if the estimated fair value of the Residuals is less than its carrying value.
Impairment of intangible assets is monitored on a continual basis, and is assessed based on an analysis of the cash flows generated by the underlying assets. No impairment of intangible assets has been noted.
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and expected benefits of utilizing net operating loss and credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and reflected in the financial statements in the period enacted.
The Company also accrues reserves for losses arising from the escrow, closing and disbursement functions due to fraud or operational error based on historical experience.
In the ordinary course of business, the Company reinsures certain risks with other insurers for the purpose of limiting its maximum loss exposure and also assumes reinsurance for certain risks of other insurers for the purpose of earning additional revenue. The Company cedes or assumes a portion of certain policy 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. Reinsurance activity is not considered significant.
In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), effective for fiscal years ending after December 15, 1997. The Company retroactively adopted SFAS 128 in 1997.
The following table sets forth the calculation of basic and diluted earnings per share for each of the years in the three-year period ended December 31, 1998:
Certain reclassifications have been made in the 1997 and 1996 Consolidated Financial Statements to conform to the classifications used in 1998.
On April 4, 1996, the Company purchased 17% of the outstanding common stock of National Alliance Marketing Group, Inc. ("National Alliance"), a California corporation, for $567,000; together with a warrant to acquire an additional 14% of National Alliance common stock. In addition, the Company loaned $1,200,000 to National Alliance at closing at a rate of Prime plus one percent. Subsequently, the Company agreed to increase the credit facility from $1,200,000 to $1,700,000. In consideration for the increase in the credit facility National Alliance agreed to increase the warrant shares which the Company could purchase. If the entire $1,700,000 was borrowed the Company could purchase an additional 34% of the outstanding shares of National Alliance. After receiving approval of the transaction from the California Department of Insurance, the transaction closed on July 12, 1996. National Alliance is the parent company of Alliance Home Warranty Company ("Alliance"), a California insurance company. Alliance sells home warranty plans to buyers of resale homes, primarily in the Central and Southern California markets. A home warranty contract generally promises the repair or replacement of major operating systems and built-in appliances inside a home for a period of one year. On July 3, 1997, the Company converted the outstanding note balance in conjunction with the exercise of the warrants and then owned 51% of the outstanding common stock of National Alliance. The outstanding balance of the note receivable due from National Alliance at conversion was approximately $1.6 million. On August 14, 1998, the Company acquired the outstanding minority interest in National Alliance, 49%, for a purchase price of $3,320,000. The Company now owns 100% of National Alliance, which is now known as Fidelity National Home Warranty. Prior to the conversion of the convertible note in July 1997, the Company accounted for its investment in National Alliance on the equity method. Since that time the Company has accounted for National Alliance as a purchase and has consolidated its interest in National Alliance's financial position and results of operations with those of the Company.
Alamo acquired substantially all of the assets of Southwest Land Title Company of Angleton effective January 31, 1997 for $1.1 million cash, and created a new corporation, Alamo Title Company of Brazoria, Inc. ("Brazoria") into which the acquired assets were placed. This transaction has been accounted for as a purchase.
agreement provides for additional contingent consideration of $916,000 based on the collection of certain receivables. Granite believes the collection of these receivables is remote. Therefore, no liability has been recorded in the Company's Consolidated Financial Statements. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Global acquisition were as follows (dollars in thousands):
On June 20, 1997, Granite acquired certain assets and liabilities of SFR Funding, Inc. ("SFR"), a small ticket equipment leasing company, for cash of $300,000, a note payable of $250,000 and the assumption of certain liabilities. The SFR transaction resulted in cost in excess of net assets acquired of $681,000. Neither the financial position nor the results of operations of SFR have been significant to the Company or Granite since acquisition. This transaction has been accounted for as a purchase.
On September 18, 1997, the Company acquired the common stock of Ifland Credit Services ("ICS"), a credit reporting company headquartered in Lexington, Kentucky, for a purchase price of $3.75 million. ICS has been merged with Credit Reports, Inc. ("CRI") and Classified Credit Data, Inc. ("CCD") in order to form Fidelity National Credit Services. The purchase price was payable 80% in common stock of the Company (187,170 shares or $3.0 million) and 20% cash ($750,000). This transaction has been accounted for as a purchase.
On October 9, 1997, the Company acquired the common stock of Credit Reports, Inc., a credit reporting company headquartered in Scottsdale, Arizona, with operations in California, Colorado, Nevada and Oregon.
CRI has been merged with ICS and CCD in order to form Fidelity National Credit Services. The purchase price for CRI was $200,000, subject to certain purchase price adjustments based on the combined equity of CRI and Express Network, Inc., its affiliate, payable in 12,601 shares of Company common stock. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the LDX acquisition were as follows (dollars in thousands):
Effective September 1, 1998, the Company acquired 100% of Lexington Capital Corporation ("Lexington"), a financial services company specializing in financing national and regional franchisee accounts, for a purchase price of $3.5 million, payable in $3.0 million in cash and $500,000 in restricted common stock of the Company (15,129 shares). The acquisition of Lexington resulted in $3,500,000 of cost in excess of net assets acquired. Neither the financial position or the results of operations of Lexington have been material to the Company since acquisition. This transaction has been accounted for as a purchase.
The carrying amounts and fair values of the Company's fixed maturity securities at December 31, 1998 and 1997 are as follows:
The change in unrealized gains (losses) on fixed maturities for the years ended December 31, 1998, 1997, and 1996 was $3,170,000, $5,263,000 and ($3,482,000), respectively.
The amortized cost and estimated fair value of fixed maturity securities, which are classified as available for sale at December 31, 1998, by contractual maturity, are shown as follows. 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:
Equity securities at December 31, 1998 and 1997 consist of investments in various industry groups as follows:
The carrying value of the Company's investment in equity securities is fair value. As of December 31, 1998, gross unrealized gains and gross unrealized losses on equity securities were $22,464,000 and $10,025,000, respectively. Gross unrealized gains and gross unrealized losses on equity securities were $38,464,000 and $2,582,000, respectively, as of December 31, 1997.
Included in equity securities is an investment in a certain equity security, CKE Restaurants, Inc., with a cost basis of $2,341,000 and a fair value of $18,462,000 at December 31, 1998 and a cost basis of $3,366,000 and a fair value of $31,404,000 at December 31, 1997.
2,478,000 shares of SBRG. The Company now owns approximately 31.1% of SBRG. The Company's investment in SBRG is accounted for under the equity method.
Effective July 1, 1997, the Company sold a majority interest (60%) of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. ATC functions as an exclusive agent of the Company. The sale price of the 60% interest was $6.0 million resulting in a realized gain of approximately $1.3 million before applicable income taxes. As a result of a tax free reorganization of American National Financial, Inc. ("ANFI"), the parent company of ATC and its subsidiaries, in November 1998, the Company's interest in ATC was converted to an ownership interest of approximately 43% of ANFI. Subsequent to ANFI's initial public offering in February 1999, the Company's ownership interest in ANFI became approximately 31.5%. The Company's investment in ANFI is accounted for under the equity method.
During the years ended December 31, 1998, 1997 and 1996, gross realized gains on sales of equity securities considered available for sale were $32,603,000, $12,986,000 and $6,186,000, respectively; and gross realized losses were $10,999,000, $2,515,000 and $2,091,000, respectively. Gross proceeds from the sale of equity securities amounted to $108,554,000, $120,094,000 and $94,161,000 during the years ended December 31, 1998, 1997 and 1996, respectively.
In March 1997, GF Funding III was formed to establish the Company's third securitization facility. The facility provides for the issuance of up to $27,500,000 in the aggregate principal amount of 6.82% Class A Lease-Backed Certificates due December 20, 2002 (the "1997 Certificates") in a private placement. The 1997 Certificates represent an undivided interest in a trust estate created by GF Funding III comprised of (i) payments to be made under leases contributed to GF Funding III, (ii) all of GF Funding III's right and interest in the leased equipment, (iii) a cash collateral account, a capitalized interest account, a prefunding account and a collection account and (iv) a financial guaranty insurance policy. This securitization was fully
In December 1997, GF Funding IV was formed to establish the Company's fourth securitization facility. The facility provides for the issuance of up to $150 million in aggregate principal amount of Class A Lease-Backed Certificates due September 2004 (the "GFIV Certificates") in a private placement. For purposes of computing interest, the GFIV Certificates are issued in two tranches, consisting of the Floating Rate Tranche and the Fixed Rate Tranche. The principal amount of the Floating Rate Tranche will generally convert to the Fixed Rate Tranche on a quarterly basis. The Floating Rate Tranche bears interest at an annual rate equal to the LIBOR Rate, as adjusted from time to time, plus .50%. The Fixed Rate Tranche bears interest at an annual rate equal to the Treasury Rate, as adjusted from time to time, plus .35%. The GFIV Certificates represent an undivided interest in a trust estate created by GF Funding IV comprised of (i) payments to be made under leases contributed to GF Funding IV, (ii) all of GF Funding IV's rights and interests in the lease equipment and (iii) a financial guaranty insurance policy. The Company is required to sell a minimum of $10,000,000 in leases to the securitization facility per quarter. The Company has recorded gains from the sales of leases with respect to this securitization of $6,456,000 and $1,418,000 during the years ended December 31, 1998 and 1997, respectively.
In October 1998, GF Funding VI was formed to establish the Company's sixth securitization facility. The facility provides for the issuance of $30.3 million in Lease-Backed Certificates (the "GFVI Certificates"). The GFVI Certificates represent an undivided interest in a trust estate created by GFVI which is comprised of (i) all rights, title and interest in the subordinated interest in GF Funding I, GF Funding II, GF Funding III, GF Funding IV and GF Funding V, and the related purchase agreements, (ii) a cash collection account and (iii) a cash reserve account. The issuance of the GFVI Class A and Class B Certificates is accounted for as a collateralized borrowing. Accordingly, the subordinated interest, recorded as a residual interest in securitization, and the related Class A and B are reflected in the Company's Consolidated Balance Sheet. The outstanding Class A and B Certificates were $16,006,000 at December 31, 1998.
The amounts due related to the Lease-Backed Notes and Certificates approximate fair value at December 31, 1998 and 1997 due to the fact that the interest rate paid on the Lease-Backed Notes and Certificates approximates market rates.
The Company has not established any servicing asset or liability, although the Company retained the servicing rights on the leases securitized because management has determined that revenues from contractually specified servicing fees and ancillary services are just adequate to compensate the Company for its servicing responsibilities
The carrying value and estimated fair values of the Company's notes receivable were as follows at December 31, 1998 and 1997 (dollars in thousands):
Manchester is also presently a partner with Sussex Holdings, Ltd. (an affiliate of Folco) in Folco Mission Valley Partners Limited Partnership, a California limited partnership. Manchester owns a 22% limited partnership interest and Sussex Holdings, Ltd. owns a 78% general partnership interest. Fidelity Title is the sole tenant in the building and received an approximate 30% decrease in its annual rental rate based upon its lease with Folco Mission Valley. Manchester's carrying value of this partnership interest was $224,000 and $3,000 at December 31, 1998 and 1997, respectively.
During 1997 and 1996, the Company sold investments in real estate to third parties at an aggregate purchase price of $6.4 million and $917,000, respectively, which approximated the carrying value of the investments sold. There were no sales in 1998.
The carrying value and estimated fair values of the Company's notes payable were as follows at December 31, 1998 and 1997:
Short-term borrowings approximate their fair value. The fair value of the Company's 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. The LYON's fair value is calculated based on quoted market prices.
The Company's credit agreement, dated as of September 21, 1995, included a $22 million term loan and a $13 million revolving credit facility, was secured by the common stock of certain Insurance Subsidiaries. This credit facility was terminated and paid in 1998 with the proceeds from a new revolving credit facility secured by the common stock of certain Insurance Subsidiaries and a certain UTC. Additionally, the Company must comply with certain affirmative and negative covenants related to its bank revolving lines of credit and other debt facilities, which require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth, capitalization, investments, acquisitions, restricted payments and certain dividend restrictions.
In February 1994, the Company issued zero coupon, convertible subordinated Liquid Yield Options Notes due February 2009 ("LYONs") at an interest rate of 5.5% with a principal amount at maturity of $235,750,000. Net proceeds to the Company were approximately $101,000,000. The proceeds were used for investment and general corporate purposes, including the repurchase of treasury shares. The conversion rate of the LYONs is 28.077 shares of common stock per $1,000 maturity value of LYONs. Conversion is at the option of the holder, at any time on or prior to maturity. Each holder, at its option, may put the LYONs to the Company as of February 15, 1999 and February 15, 2004 for a purchase price per LYON of $581.25 and $762.40, respectively. The Company at its option, may elect to pay the put in cash or shares of its common stock. The LYONs are redeemable by the Company for cash on or after February 15, 1999 at a price equal to the issue price of $441.31 plus accrued original issue discount through the date of redemption. The maturity value of LYONs outstanding at December 31, 1998 was approximately $124,113,000.
On October 17, 1997, the Company in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs). The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock (the "Exchange Shares"). The Company also paid Merrill Lynch the excess of a base price of $19.53 per Exchange Share over the actual sales price (less $0.05 per share in commissions) realized by Merrill Lynch for sales of up to 607,881 Exchange Shares. The Company also paid Merrill Lynch, for each day, an amount in cash to be determined by multiplying the Net Carry Amount (number of Exchange Shares multiplied by $19.53) by the Applicable Rate (LIBOR plus 2.50%). The Company's payment obligations were subject to reduction for dividends on Exchange Shares received by Merrill Lynch during the period. The Company paid the foregoing amounts to Merrill Lynch in cash of approximately $790,000 on November 7, 1997. The purchase of the LYONs increased stockholders'
Total income tax expense (benefit) for the years ended December 31, 1998, 1997 and 1996 was allocated as follows:
The deferred tax assets and liabilities at December 31, 1997 consist of the following:
arrangements. The agreements contain non-compete provisions. The terms of the agreements range from three to five years and normally contain extension provisions.
In the ordinary course of business, the Company is involved in various pending and threatened litigation matters related to its operations, some of which include claims for punitive or exemplary damages. Management believes that no actions depart from customary litigation incidental to the business of the Company and that resolution of all such litigation will not have a material adverse effect on the Company.
Pursuant to statutory accounting requirements of the various states in which the Insurance Subsidiaries are licensed, they must defer a portion of premiums earned as an unearned premium reserve for the protection of policyholders and must maintain qualified assets in an amount equal to the statutory requirements. The level of unearned premium reserve required to be maintained at any time is determined on a quarterly basis by
statutory formula based upon either the age, number of policies and dollar amount of policy liabilities underwritten or the age and dollar amount of statutory premiums written. As of December 31, 1998, the combined statutory unearned premium reserve required and reported for the Insurance Subsidiaries was $207.2 million.
The Insurance Subsidiaries are regulated by the insurance commissioners of their respective states of domicile. Regulatory examinations usually occur at three year intervals. Examinations are currently in progress for Fidelity Title (1998, which was previously scheduled for 1997 but will now be as of 1998), Fidelity New York (1996), Nations New York (1996) and National (1996). The Company has not received preliminary reports of examination for Fidelity Title, Fidelity New York, Nations New York or National, as the examinations are currently ongoing. Additionally, the Auditor Division of the Controller of the State of California is currently conducting an audit of the funds due the State of California under various escheatment regulations for the years ended December 31, 1998 and prior. The Company does not believe that either the audits performed by the insurance regulators or the Controller of the State of California will have a material impact on its financial position, its results of operations or its combined statutory capital and surplus.
In 1987, stockholders approved the adoption of an Employee Stock Purchase Plan ("ESPP"). Under the terms of the ESPP and subsequent amendments, there are 8,785,000 shares of the Company's common stock available for purchase at current market prices by Company employees who meet certain vesting requirements. Pursuant to the ESPP, Company employees may contribute an amount between 5% and 15% of their base salary and certain commissions. The Company contributes varying amounts as specified in the ESPP. During the years ended December 31, 1998, 1997 and 1996, 282,216, 353,594 and 371,852 shares, respectively, were purchased and allocated to employees, based upon their contributions, at an average price of $29.42, $13.73 and $11.32 per share, respectively. The Company contributed $2.0 million or the equivalent of 67,407 shares for the year ended December 31, 1998, $1.7 million or the equivalent of 122,740 shares for the year ended December 31, 1997 and $1.2 million or the equivalent of 107,218 shares for the year ended December 31, 1996 in accordance with the employer's matching contribution. A total of 7,526,473 shares have been purchased by both the ESPP and employees since the adoption of the ESPP.
In 1987, stockholders also approved the adoption of a Stock Option Plan ("1987 Option Plan"). Under the terms of the 1987 Option Plan, the Company may grant stock options to certain key employees and non-employee directors or officers. The number of shares issuable under the 1987 Option Plan is 1,812,000 shares of common stock at not less than fair market value on the date of grant. Employees are eligible to receive incentive stock options or non-qualified stock options and non-employee directors are eligible to receive non-qualified stock options. Options available to directors or officers may not exceed one-half of the aggregate number of shares available for grant. All options granted become exercisable at the discretion of the Board of Directors and expire five to eleven years from the date of grant. Options that lapse or are cancelled prior to exercise are added to the shares authorized for future grants. The 1987 Option Plan expired December 31, 1997.
In 1996, Granite adopted a Stock Option Plan ("Granite Plan", now issuable in Company common stock) allowing for the issuance of qualified and non-qualified stock options to purchase an aggregate of 347,000 shares of common stock to directors, officers, employees, agents and consultants of Granite. The Granite Plan is administered by the Board of Directors. The Granite Plan provides that qualified stock options be granted at an exercise price equal to fair market value of the common shares of Granite on the date of the grant, and must be at least 110% of fair market value when granted to a 10% or more shareholder. The term of all qualified stock options granted under the Granite Plan may not exceed ten years, except the term of qualified stock options granted to a 10% or more shareholder, which may not exceed five years. The Granite Plan provides that non-qualified stock options be granted at an exercise price not less than 85% of the fair market value of the common shares of Granite on the date of grant. The term of all non-qualified stock options granted under the Granite Plan may not exceed ten years, except the term of non-qualified stock options granted to a 10% or more shareholder, which may not exceed five years. In April 1997, the Granite Plan was amended and restated in order to make certain technical modifications thereto and was further amended in June 1997 to increase the shares of common stock reserved for issuance to 695,000.
The following table sets forth options outstanding and exercisable by price range as of December 31, 1998:
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("Opinion 25") and related Interpretations in accounting for its employee stock options. As discussed below, in management's opinion, the alternative fair value accounting provided for under Statement of Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under Opinion 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.
Pro forma information regarding net earnings and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The 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 rates used in the calculation is the rate on the date the options were granted. The risk free interest rate used for options granted during 1998, 1997 and 1996 were 5.7%, 6.0% and 6.5%, respectively. A volatility factor for the expected market price of the common stock of 50% was used for options granted in 1998, 1997 and 1996. The expected dividend yield used for 1998, 1997 and 1996 was 1.0%, 1.0% and 2.0%, respectively. A weighted average expected life of seven years was used in all years as the Company has little history of options being exercised.
O. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF RISK
Granite's leases are originated through a network of approximately 73 independent lease originators located throughout the United States. No single lease originator accounted for more than 10% of the leases funded by the Company during the years ended December 31, 1998 and 1997. Transactions generated by the Company's ten largest independent lease originators accounted for approximately 26.0% and 53.9% of leases funded during the years ended December 31, 1998 and 1997.
Concentrations of credit risk with respect to trade receivables are limited because a large number of geographically diverse customers make up the Company's customer base, thus spreading the trade receivables credit risk. The Company controls credit risk through monitoring procedures.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS 130 requires all items that are necessary to be recognized under accounting standards as components of comprehensive earnings to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 does not require a specific format for that financial statement, but requires that an enterprise display an amount representing total comprehensive earnings for the period covered by that financial statement. SFAS 130 requires an enterprise to (a) classify items of other comprehensive earnings by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS 130 became effective for fiscal years beginning after December 15, 1997. The adoption of SFAS 130 has not had a material impact on the Company's financial reporting.
Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for public business enterprises to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends FASB Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. SFAS 131 requires, among other items, that a public business enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the revenues derived from the enterprise's products or services and major customers. SFAS 131 also requires that the enterprise report descriptive information about the way that the operating segments were determined and the products and services provided by the operating segments. SFAS 131 became effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. SFAS 131 need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Also on March 17, 1999, the Company's Board of Directors approved the adoption of the Fidelity National Financial, Inc. Employee Stock Purchase Loan Plan ("Loan Plan"). The purpose of the Loan Plan is to provide key employees with further incentive to maximize shareholder value. The Company intends to offer an aggregate of $7,750,000 in loans. Loan Plan 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 will be full recourse and unsecured, and will have a five year term. Interest will accrue on the loans at a rate of 5% per annum due at maturity. Loans may be prepaid at any time without penalty. Through March 25, 1999, loans have been made in the amount of $5,700,000 to purchase 382,650 shares of Company common stock at an average purchase price of $14.90 per share.