The Company owns an office building and adjacent real estate in Richmond, Virginia that it uses for its corporate headquarters. This property consists of approximately 128,000 square feet of office space and parking facilities. The Company's title insurance subsidiaries conduct their business operations primarily in leased office space. As of December 31, 2001, the Company had numerous leases for its branch offices and subsidiaries throughout the states in which it operates. In addition, it owns several other properties that in aggregate are not material to its business taken as a whole.
The Company's title plants constitute a principal asset. Such plants comprise copies of public records, maps, documents, previous reports and policies indexed to specific properties in an area. The plants are generally located at the office which serves a particular locality or in "service centers" serving multiple localities in major metropolitan areas. They enable title
On February 23, 1998, the Company entered into an Agreement Containing Consent Order (the "Consent Order") with the Federal Trade Commission (the "FTC") in connection with the acquisition of Commonwealth and Transnation. The Consent Order required, and the Company completed, the divestiture of certain title plants in 12 localities named in the Consent Order. Seven of such localities were in Florida, three were in Michigan, and one each was in Washington, D.C. and St. Louis, Missouri. Pursuant to the terms of the Consent Order, the Company may not acquire, without prior notice to the FTC, any interest in a title plant in any of the named localities for a period of 10 years following the date of the Consent Order.
- ---------- (1) The net loss reported by the Company for the fiscal year ended December 31, 2000 resulted from a change in the Company's method for assessing the recoverability of goodwill (not associated with impaired assets) during the fourth quarter of 2000 which resulted in net of tax charges of $110,369. See Note 2 to the Consolidated Financial Statements.
. Deferred Tax Asset. The Company recorded net deferred tax assets at December 31, 2001 and 2000 related primarily to policy and contract claims, the write off of intangibles (See Note 2 to Consolidated Financial Statements) and employee benefit plans. Based upon the Company's historical results of operations, the existing financial condition of the Company and management's assessment of all other available evidence, management believes that the benefit of these assets will more likely than not be realized. A valuation allowance is provided for deferred tax assets if it is more likely than not that some portion or all of these items will expire before the Company is able to realize their benefit.
. Goodwill. During the fourth quarter of 2000 the Company changed its method for assessing the recoverability of goodwill not associated with impaired assets from an undiscounted cash flow approach to a discounted cash flow approach and wrote off a portion of its recorded goodwill (See Note 2 to Consolidated Financial Statements). Prior to July 1, 2001, goodwill was subject to periodic amortization on a straight-line
basis over its estimated life. Subsequent to December 31, 2001, goodwill is no longer subject to amortization. For fiscal years beginning after December 15, 2001 the carrying amount of goodwill is subject to impairment tests prescribed by the Financial Accounting Standards Board ("FASB") Statements of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets.
During 2000, the Company decided to place increased emphasis on other products and services related to real estate transactions. As a result, in October 2000, the Company acquired Primis, Inc., a web-based provider of real estate services. In 2001, the acceptance of Primis' technology by the Company's customer base proved to be much slower than anticipated, necessitating a fourth quarter non cash write off of intangibles, including goodwill, acquired in the acquisition.
The Company's profit margins are affected by several factors, including the volume of real estate and mortgage refinance activity, policy amount and the nature of real estate transactions. Volume is an important determinant of profitability because the Company, like any other real estate services company, has a significant level of fixed costs arising from personnel, occupancy costs and maintenance of title plants. Because premiums are based on the face amount of the policy, larger policies generate higher premiums although expenses of issuance do not necessarily increase in proportion to policy size. Cancellations affect profitability because costs incurred both in opening and in processing orders typically are not offset by fees. Commercial transactions tend to be more profitable than residential transactions.
Generally, title insurance claim rates are lower than other types of insurance because title insurance policies insure against prior events affecting the quality of real estate titles, rather than against unforeseen, and therefore less predictable, future events. A provision is made for estimated future claim payments at the time revenue is recognized. Both the Company's experience and industry data indicate that claims activity occurs for more than 20 years after the policy is issued. Management considers historical claim payment patterns, current economic conditions and changes in the mix of business in setting its loss provision ratio. Independent actuaries review the adequacy of reserves on an interim basis and certify as to their adequacy on an annual basis. Management has continued to emphasize and strengthen claims prevention and product quality programs.
Operating revenues for 2001 were $2.1 billion compared to $1.8 billion in 2000 and $2.0 billion in 1999. The revenue increase in 2001 compared to 2000 was primarily the result of a drop in average annual mortgage interest rates from 8.1% to 7.0% which gave rise to a large volume of refinance transactions in 2001. Direct revenue increased 25.7% exclusive of the effect of the Primis acquisition while agency revenue increased 12.3% in 2001 compared to 2000. The smaller increase in agency revenue was the result of the industry's typical time lag in reporting business through independent agents. Orders opened in Company offices increased 57.0% from 680,000 in 2000 to 1,069,000 in 2001. Due to a higher interest rate environment during most of the year, the Company experienced lower revenue levels in 2000 than in 1999.
Operating Expenses. The Company's expense ratio was 90.5% in 2001 compared to 94.3% in 2000 and 92.2% in 1999. The expense ratio improved in 2001 compared to 2000 due to the fact that the Company was able to more efficiently utilize the level of fixed costs while closely controlling variable costs. This improvement was partially offset by weaker than expected results attributable to the Primis acquisition. The increase in the expense ratio in 2000 compared to 1999 was due to a significant decrease in revenue levels measured against costs that do not vary in direct proportion to revenue changes.
In the fourth quarter of 2000, the Company elected to change its accounting policy for assessing the recoverability of goodwill from one based on undiscounted cash flows to one based on discounted cash flows. The Company believes that using the discounted cash flow approach to assess recoverability is a preferable policy as it is consistent with the methodology used by the Company to evaluate investment and acquisition decisions (See Note 2 to Consolidated Financial Statements). In connection with this change, the Company incurred a non-cash pre-tax charge of $172.5 million.
related expenses were 30.2%, 29.4% and 28.1% in 2001, 2000 and 1999, respectively. These percentages, exclusive of the Primis acquisition, were 28.5% and 29.2% in 2001 and 2000, respectively. Staffing levels, excluding these attributable to the Primis acquisition, were 7,755, 8,905 and 8,500 at December 31, 2001, 2000 and 1999, respectively.
Provision for Policy and Contract Claims. The Company's claims experience has shown improvement in recent years. The loss ratio (the provision for policy and contract claims as a percentage of operating revenues) was 4.0%, 4.4% and 4.9% in 2001, 2000 and 1999, respectively. Claims paid as a percentage of operating revenues were 3.7%, 4.3% and 3.2% in 2001, 2000 and 1999, respectively.
The Company did not record a valuation allowance at December 31, 2001. At December 31, 2000 and 1999, the Company recorded a valuation allowance of $1.7 million and $11.5 million, respectively, related to deferred tax assets created by the unrealized losses associated with the Company's investment portfolio. A valuation allowance associated with unrealized losses is necessary because there is no assurance that the capital losses will be offset by capital gains during the statutory carryback and carryforward periods, and, therefore, would expire.
The Company will apply the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement is expected to result in an increase in net income of $6.0 million ($0.32 per diluted share) per year.
In December 2001, the Board of Directors approved a program allocating $25.0 million to repurchase up to 1.25 million shares or 7% of the Company's outstanding stock over the following twelve months. The Company implemented this program in December 2001. Through February 2002, the Company had repurchased 52,400 shares.
During the first six months of 2001, 2.2 million shares of the Company's preferred stock were converted to 4.8 million shares of common stock. This conversion decreased the amount of preferred dividends paid by $7.7 million on an annual basis. The new common shares will require dividends of the same rate paid on all other outstanding common shares.
On August 31, 2001, the Company issued $150.0 million of senior notes through a private placement. The notes were divided into three series with $50.0 million due 2006 bearing interest at 7.16%, $50 million due 2008 bearing interest at 7.45% and $50 million due 2011 bearing interest at 7.88%. The proceeds of this private placement were used to repay outstanding debt under the Company's revolving credit facility.
In view of the historical ability of the Company to generate strong, positive cash flows, and the strong cash position and relatively conservative capitalization structure of the Company, management believes that the Company will have sufficient liquidity and adequate capital resources to meet both its short- and long-term capital needs. In addition, the Company has $94.5 million available under a credit facility which was unused at December 31, 2001.
In connection with the title insurance industry in general, factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include
the following: (i) the costs of producing title evidence are relatively high, whereas premium revenues are subject to regulatory and competitive restraints; (ii) real estate activity levels have historically been cyclical and are influenced by such factors as interest rates and the condition of the overall economy; (iii) the value of the Company's investment portfolio is subject to fluctuation based on similar factors; (iv) the title insurance industry may be exposed to substantial claims by large classes of claimants and (v) the industry is regulated by state laws that require the maintenance of minimum levels of capital and surplus and that restrict the amount of dividends that may be paid by the Company's insurance subsidiaries without prior regulatory approval.