As of December 31, 2004, we leased office and storage space as follows:
The information set forth below should be read in conjunction with the consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K. Share and per share data has been retroactively adjusted for stock dividends and splits since our inception. Certain reclassifications have been made to the prior year amounts to conform with the 2004 presentation.
Our financial results for the year ended December 31, 2003 include the results of FI for the period from April 1, 2003, the acquisition date, through December 31, 2003, and include the results of operations of various other entities acquired on various dates during 2003, as discussed in “Business - Recent Developments” and Note B of Notes to Consolidated Financial Statements.
Investments as of December 31, 2004, 2003, 2002, 2001 and 2000 include securities pledged to secure trust deposits of $546.0 million, $448.1 million, $474.9 million, $319.1 million and $459.4 million, respectively.
During the third quarter of 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003, as discussed in Note M of Notes to Consolidated Financial Statements. Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. Net income, as a result of the adoption of SFAS No. 123, for the year ended December 31, 2003 reflects an expense of $3.9 million, which is included in the reported financial results. The adoption of SFAS 123 increased compensation cost by $5.8 million for the three months ended March 31, 2003, which resulted in a reduction of the reported net earnings of $3.6 million,
We are the largest title insurance company in the United States. Our title insurance underwriters - Fidelity National Title, Chicago Title, Ticor Title, Security Union Title and Alamo Title - together issued approximately 31.4% of all title insurance policy premiums issued nationally during 2003, including the 2003 results of American Pioneer Title Insurance Company, which we acquired in March 2004. We are also a leading provider of technology solutions, processing services, and information services to the financial services and real estate industries. Over 2,400 financial institutions use our services, including 45 of the 50 largest banks in the U.S. Our applications process nearly 50% of all U.S. residential mortgage loans by dollar volume with balances exceeding $3.6 trillion, and over 235 million deposit accounts and non-mortgage consumer loans and leases are processed on our core bank processing platform. We also provide customized business process outsourcing related to aspects of the origination and management of mortgage loans to national lenders and loan servicers. Our information services, including our property data and real estate-related services, are used by mortgage lenders, mortgage investors and real estate professionals to complete residential real estate transactions throughout the U.S. We provide information services that span the entire home purchase and ownership life cycle, from contact through closing, refinancing and resale.
Lender Outsourcing Solutions. The lender outsourcing solutions segment includes our loan facilitation services, which consist of centralized, customized title agency and closing services, which we offer to first mortgage, refinance, home equity and sub-prime lenders, and our default management services, which include foreclosure posting and publishing services, loan portfolio services, field services and property management. These services allow our customers to outsource the business processes necessary to take a loan and the underlying real estate securing the loan though the default and foreclosure process.
Information Services. The information services segment offers real estate related information services. Included in the information services we provide are property appraisal and valuation services, property records information, real estate tax services, borrower credit and flood zone information and certification and multiple listing software and services.
Corporate and Other. The corporate and other segment consists of the operations of the parent holding company, certain other unallocated corporate overhead expenses, the operations of our wholly-owned equipment-leasing subsidiary and other small operations.
Our title insurance and specialty insurance segments make up our insurance underwriting businesses, while our financial institution software and services, lender outsourcing solutions and information services segments make up the technology solutions, processing and information-based services businesses of our subsidiary Fidelity National Information Services, Inc. (“FIS”).
Historically, real estate transactions have produced seasonal revenue levels for title insurers. The first calendar quarter is typically the weakest quarter in terms of revenue due to the generally low volume of home sales during January and February. The fourth calendar quarter is typically the strongest in terms of revenue due to commercial customers desiring to complete transactions by year-end. Significant changes in interest rates may alter these traditional seasonal patterns due to the effect the cost of financing has on the volume of real estate transactions.
instead of simply licensing our applications. As a provider of outsourcing solutions, we benefit from the greater revenues that result from a financial institution’s decision to outsource its processing to us. Generally, financial institutions of all sizes will consider outsourcing information technology and business process services to varying degrees, although smaller financial institutions are more likely to outsource all information technology functions to companies such as ours since they generally do not have the staff, budget or competencies to implement and operate highly complex technical environments. Larger financial institutions have historically chosen to limit outsourcing to specific application functions or services in connection with a particular product or operation such as mortgage processing. Generally, demand for outsourcing solutions has increased over time as providers such as ourselves realize economies of scale and improve our ability to provide services that improve customer efficiencies and reduce costs.
Lender Outsourcing Solutions Segment. The level of residential real estate activity, which depends in part on the level of interest rates, affects the level of revenues from our lender outsourcing solutions segment. Revenues from loan facilitation services increase as the amount of mortgage originations, from both home purchases and mortgage refinancings, increases. During the second half of 2000, mortgage interest rates began to decline, causing an increase in refinance activity. This trend continued through the first six months of 2003. The increasing refinance activity, coupled with record levels of residential resale and new home sales, resulted in an exceptionally strong business climate for our loan facilitation services in 2003. According to the Mortgage Bankers Association, U.S. mortgage originations (including refinancings) were approximately $3.8 trillion, $2.9 trillion and $2.2 trillion in 2003, 2002 and 2001, respectively.
While prevailing mortgage interest rates have declined to record lows in recent years and the volume of real estate transactions has experienced record highs, we do not expect these trends to continue. Although originations in 2003 surpassed the record levels set in 2002, interest rates began to rise during the fourth quarter of 2003. Mortgage originations declined in 2004 to an estimated $2.8 trillion as the interest rate environment slowed the pace of refinancings. Most economists expect a relatively stable to marginally increasing mortgage interest rate environment in 2005 and the current Mortgage Bankers Association forecast is for $2.5 trillion of mortgage originations in 2005. Relatively higher interest rates are also likely to result in seasonal effects having more influence on real estate activity. Traditionally, the greatest volume of real estate activity, particularly residential resale transactions, has occurred in the spring and summer months.
The accounting policies described below are those we consider critical in preparing our Consolidated Financial Statements. Certain of these policies require management to make estimates and assumptions that
Goodwill and Other Intangible Assets. We have significant intangible assets that were acquired through business acquisitions. These assets consist of purchased customer relationships, contracts, and the excess of purchase price over the fair value of identifiable net assets acquired (goodwill). The determination of estimated useful lives and the allocation of the purchase price to the fair values of the intangible assets requires significant judgment and may affect the amount of future amortization on intangible assets other than goodwill.
Long-Lived Assets. We review long-lived assets, primarily computer software, property and equipment and other intangibles, such as customer relationships and contracts, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If indicators of impairment are present, we estimate the future net cash flows expected to be generated from the use of those assets and their eventual disposal. We would recognize an impairment loss if the aggregate future net cash flows were less than the carrying amount. As a result, the carrying values of these assets could be significantly affected by the accuracy of our estimates of future net cash flows, which cannot be selected with certainty. In 2004 and 2003, we determined that the carrying value of certain of our intangible assets may not be recoverable and recorded impairment charges of $6.3 million and $7.9 million, respectively relating to the
write-off of these assets, respectively. These impairments were recorded as other operating expenses in our 2004 and 2003 Consolidated Statements of Earnings.
Our claim loss provision for our title insurance segment as a percentage of total title premiums was 5.5% in 2004, 5.4% in 2003 and 5.0% in 2002. The title loss provision in our 2004 financial statements reflects a higher estimated loss for the 2004 policy year offset in part by a favorable adjustment in reserves for business in previous policy years. Consistent with 2002, the favorable adjustment was attributable to lower than expected payment levels on previous issue years that included periods of increased resale activity as well as a high proportion of refinance business. As a result, title policies issued in previous years have been replaced by the more recently issued policies, therefore generally terminating much of the loss exposure on the previously issued policies. The unfavorable development during 2003 reflects the higher than expected payment levels on previously issued policies. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations” and Note J of Notes to Consolidated Financial Statements for a summary of our reserves for claim losses at December 31, 2004, 2003 and 2002. Our independent actuaries perform projections of required reserves periodically during the year and at year-end. We compare these projections to the recorded reserves to evaluate their adequacy. Our reserves for claim losses are within the range projected by our independent actuaries. Our loss reserves for our specialty insurance business also require significant estimates.
Financial Institution Software and Services. In this segment, we recognize revenues relating to bank processing services and mortgage processing services along with software licensing and software related services. Several of our contracts include a software license and one or more of the following services: data processing, development, implementation, conversion, training, programming, maintenance and application management. In some cases, these services are offered in combination with one another and in other cases we offer them individually. Revenues from bank and mortgage processing services are typically volume-based depending on factors such as the estimated number of accounts, transactions processed and computer resources utilized.
We recognize software license and maintenance fees as well as associated development, implementation, training, conversion and programming fees in accordance with SOP NO. 97-2 and SOP NO. 98-9. Initial license fees are recognized when a contract exists, the fee is fixed or determinable, software delivery has occurred and collection of the receivable is deemed probable, provided that vendor-specific objective evidence, or VSOE, has been established for each element or for the undelivered elements. We determine the fair value of each element or the undelivered elements in multi-element software arrangements based on VSOE. If the arrangement is subject to accounting under SOP NO. 97-2, VSOE for each element is based on the price charged when the same element is sold separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of fair value does not exist for one or more undelivered elements of a contract, then all revenue is deferred until all elements are delivered or fair value is determined for all remaining undelivered elements. Revenue from maintenance and support is recognized ratably over the term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to revenue recognition.
With respect to a small percentage of revenues, we use contract accounting, as required by SOP NO. 97-2, when the arrangement with the customer includes significant customization, modification, or production of software. For elements accounted for under contract accounting, revenue is recognized in accordance with SOP 81-1, Accounting for Performance of Construction Type and Certain Production-Type Contracts, using the percentage-of-completion method since reasonably dependable estimates of revenues and contract hours applicable to various elements of a contract can be made. Revenues in excess of billings on these agreements are recorded as unbilled receivables and is included in accounts receivable. Billings in excess of revenue recognized on these agreements are recorded as deferred revenue until revenue recognition criteria are met. Changes in estimates for revenues, costs and profits are recognized in the period in which they are determinable. When our estimate indicates that the entire contract will be performed at a loss, a provision for the entire loss is recorded in that accounting period.
Lender Outsourcing Solutions. In this segment, we recognize revenues from loan facilitation services and default management services. Loan facilitation services primarily consist of centralized title agency and closing services for various types of lenders. Revenues relating to centralized title agency and closing services are recognized at the time of closing of the related real estate transaction. Ancillary service fees are recognized when the service is provided. Default management services consist of services provided to assist customers through the default and foreclosure process, including property preservation and maintenance services (such as lock changes, window replacement, debris removal and lawn service), posting and publication of foreclosure and auction notices, title searches, document preparation and recording services, and referrals for legal and
Year ended December 31, 2004. Our Consolidated Statements of Earnings for 2004 include the full year results of operations of FI, which we acquired on April 1, 2003, and various other entities acquired on various dates during 2004 and in 2003, as discussed in Note B of Notes to Consolidated Financial Statements. Our weighted average shares outstanding have increased in 2004 as compared with 2003 primarily as a result of issuing shares of our common stock to finance the acquisitions of ANFI, FI, FNIS, Hansen, Aurum and Sanchez. As such, basic and diluted net earnings per share have decreased in 2004 as compared with 2003, at a greater rate than our decrease in net earnings. In 2003, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003, as discussed in Note M of Notes to Consolidated Financial Statements. Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. Net income, as a result of the adoption of SFAS No. 123, for the year ended December 31, 2004 and 2003 reflect an expense of $21.8 million and $9.5 million, respectively, which is included in the reported financial results as other operating expense.
Total revenue in 2004 increased $580.8 million to $8,296.0 million, an increase of 7.5% over 2003. Total revenue in 2003 increased $2,632.6 million, or 51.8% to $7,715.2 million from $5,082.6 million in 2002. The increase in revenue in 2004 is primarily attributable to a full year of results from the 2003 acquisitions of FI and Webtone, along with the 2004 acquisitions of Aurum, Sanchez, Kordoba and InterCept in the financial institution software and services segment, and an increase in the specialty insurance segment relating to significant organic growth, offset in part by a reduction in realized gains and losses. Although the mix of direct and agency title premiums changed from 2003 to 2004, total title premiums and escrow and other title related fees remained fairly consistent in 2004 as compared with 2003. The increase in total revenue in 2003 is due in part to increases in real estate and refinance activity as a result of decreasing interest rates. Further, the acquisitions of financial institution software and services companies, real estate-related information service companies and specialty insurance companies and the integration of these operations into our core businesses in 2003, as well as increased realized gains on investments, also contributed to increased revenue in 2003 compared to 2002.
Title insurance premiums, including those that are part of the lender outsourcing solutions segment, were $4,739.3 million in 2004, $4,738.3 million in 2003 and $3,547.7 million in 2002. Direct title premiums decreased from 2003 to 2004 while agency title premiums increased during the same period. The decrease in direct title premiums is primarily due to a reduction in refinancing activity experienced in 2004 as compared with 2003 and was partially offset by an increase in the average fee per file. The increase in direct title premiums in 2003 was due primarily to increases in resale and refinance activity as a result of the decline in interest rates through mid-year 2003. The increase in resale and refinance activity in 2003 was partially offset by a decrease in the average fee per file. The increase in the fee per file in 2004 and the decrease in fee per file in 2003 is consistent with the overall level of refinance activity experienced during 2004 and 2003. The fee per file tends to increase as mortgage interest rates rise, and the mix of business changes from a predominately refinance driven market to more of a resale driven market.
In 2004, our mix of direct and agency title premiums changed, with agency premiums making up 55.1% of total premiums compared with 49.3% in 2003. Agency premiums increased in 2004 by $273.0 million, of which $193.5 million was attributed to our acquisition of APTIC in March 2004. The remainder of the increase can be attributed to our agent’s mix of business being different from our direct operations and the agency business not fluctuating as much in relation to the refinancing environment. However, agency business in general is not as profitable as direct business. Our mix of direct and agency title insurance premiums changed in 2003 as compared with 2002, primarily as a result of our acquisition of ANFI in March 2003, and the inclusion of ANFI’s title insurance premiums as direct title insurance premiums in 2003 and the acquisitions of LSI and Key Title in 2003. In 2002, ANFI’s title insurance premiums were included in agency title insurance premiums.
Trends in escrow and other title related fees are primarily related to title insurance activity generated by our direct operations. Escrow and other title related fees during the three-year period ended December 31, 2004, fluctuated in a pattern generally consistent with the fluctuation in direct title insurance premiums and order counts. Escrow and other title related fees were $1,042.2 million, $1,056.4 million and $789.7 million, respectively, during 2004, 2003 and 2002.
Interest and investment income levels are primarily a function of securities markets, interest rates and the amount of cash available for investment. Interest and investment income in 2004 was $70.8 million compared with $60.3 million in 2003 and $74.6 million in 2002. Average invested assets increased 16.8% to $3,622.0 million, from $3,101.5 million in 2003. The tax equivalent yield in 2004, excluding realized gains and losses, was 2.6% as compared with 2.4% in 2003 and 3.4% in 2002. Interest and investment income decreased $14.3 million, or 19.1% in 2003 to $60.3 million from $74.6 million in 2002.
Net realized gains and losses for 2004, 2003 and 2002 were $37.0 million, $106.4 million and $15.5 million, respectively. Net realized gains in 2004 include $16.2 million relating to the investment in Covansys warrants at FIS. Net realized gains in 2003 includes a $51.7 million realized gain as a result of InterActive Corp’s acquisition of Lending Tree Inc. and the subsequent sale of our Interactive Corp. common stock and a realized gain of $25.0 million on the sale of New Century Financial Corporation common stock.
Other income represents revenue generated by other smaller businesses, including our leasing business that are not included in a specific business segment. Other income was $48.7 million in 2004, $56.8 million in 2003 and $59.7 million in 2002.
Other operating expenses consist primarily of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums in lieu of franchise and other state taxes), postage and courier services, computer services (including personnel costs associated with information technology support), professional services, advertising expenses, general insurance, depreciation, amortization of other intangibles and trade and notes receivable allowances. Other operating expenses increased as a
We assumed APTIC’s outstanding reserve for claim losses in connection with its acquisition in 2004. We assumed LSI’s and ANFI’s outstanding reserve for claim losses in connection with their acquisitions in 2003.
Interest expense for the years ended December 31, 2004, 2003 and 2002 was $47.2 million, $43.1 million and $34.1 million, respectively. The increase in interest expense in 2004 is attributable to the increase in outstanding balances relating to our credit facilities and a full year of interest relating to our $250.0 million aggregate principal amount of 5.25% notes. The increase in interest expense in 2003 is attributable to the increase in outstanding notes payable as a result of the issuance of $250.0 million aggregate principal amount of 5.25% notes in March 2003 (see Note H of Notes to Consolidated Financial Statements), which was partially offset by the decline in interest rates.
Income tax expense as a percentage of earnings before income taxes for 2004, 2003 and 2002 was 37.0%, 38.0%, and 36.0%, respectively. The fluctuation in income tax expense as a percentage of earnings before income taxes is attributable to our estimate of ultimate income tax liability, and changes in the characteristics of net earnings year to year, such as the acquisition of FI and operating income versus investment income. The decrease in 2004 is due to change in state income tax apportionment. The increase in 2003 as compared with 2002 is due to an increase in the state income tax rate and the effect of foreign taxes as a result of our various acquisitions in 2003.
Revenue for the title insurance segment includes direct and agency title premiums, including those earned from the lender outsourcing solutions segment, as well as escrow and other title related fees, interest and investment income and realized gains and losses. The primary reason for the $72.4 million decrease in total title segment revenue in 2004 as compared with 2003 is a $79.8 million decrease in realized gains and losses attributable to investments owned by our title companies. For a discussion of title segment premiums and escrow and other title related fees, see the Consolidated Results of Operations revenues discussion above.
Personnel costs were $1,656.8 million, $1,666.0 million and $1,242.5 million in 2004, 2003 and 2002, respectively. As a percentage of title insurance revenues, personnel costs were 28.4% in 2004 and 28.2% in 2003 and 2002. We have taken significant measures to maintain appropriate personnel levels and costs relative to the volume and mix of business while maintaining customer service standards and quality controls. As such, with the decline in open orders on refinance transactions resulting from the increase in mortgage interest rates during the second half of 2003, we began reducing personnel costs with the reduction of approximately 22% of the title and escrow workforce from July to December of 2003 and maintained personnel at appropriate levels during 2004. We will continue to monitor prevailing market conditions and will adjust personnel costs in accordance with activity.
Other operating expenses were $943.2 million, $884.0 million and $659.8 million in 2004, 2003 and 2002, respectively. As a percentage of title insurance revenues, other operating expenses were 16.1%, 14.9% and 15.0% in 2004, 2003 and 2002, respectively.
As noted in the consolidated results of operations, the provision for claim losses includes an estimate of anticipated title and title related claims. The estimate of anticipated title and title related claims is accrued as a percentage of title premium revenue based on our historical loss experience and other relevant factors. We monitor our claims loss experience on a continual basis and adjust the provision for claim losses accordingly.
Earnings before income taxes and minority interest for this segment decreased in 2004 as compared with 2003 due primarily to the fact that the revenue mix changed towards agency premiums as discussed above which have a much lower margin.
Revenues from specialty insurance were $242.8 million, $137.4 million and $47.6 million in 2004, 2003 and 2002, respectively, and include revenues from the issuance of flood, home warranty and personal lines insurance policies. The increase in revenues in 2004 as compared with 2003 was primarily the result of significant organic growth of these business lines in 2004. Specialty insurance revenue increased in 2003 as compared with 2002 as a result of our January 2003 acquisition of Bankers Insurance Group and First Community Insurance Company, which gave us the ability to issue new and renewal flood insurance policies.
Personnel costs were $28.8 million, $19.8 million and $12.8 million in 2004, 2003 and 2002, respectively. As a percentage of specialty insurance revenues, personnel costs were 11.9%, 14.4% and 26.9% in 2004, 2003
and 2002, respectively. The decrease as a percentage of revenues in 2004 and 2003 is primarily the result of organic growth of the business lines, which has not required a proportionate increase in personnel.
Revenues from our lender outsourcing solutions primarily relate to our loan facilitation services and revenues from our default management services. Including title premiums generated and reported by this segment and also reported in the title insurance segment (eliminated as intersegment revenue), revenues from lender outsourcing solutions were $451.1 million, $605.4 million and $214.7 million in 2004, 2003 and 2002, respectively. The decrease in revenue for 2004 was primarily due to a decrease in loan facilitation services which had revenues of $225.7 million in 2004 as compared with $433.6 million in 2003. In 2003, we began a program whereby we automated the process for performing title agency services in connection with loan refinancings for borrowers who meet specific criteria. Loan facilitation services revenue decreased from 2003 because of the reduction in refinancing activity in 2004, which resulted in revenues from this automated process of $57.6 million in 2004 as compared with $188.7 million in 2003. Default management revenues were $224.7 million, $170.8 million and $121.4 million in 2004, 2003 and 2002, respectively. The significant increases in 2004 and in 2003 were the result of organic growth in the majority of our default businesses.
Other operating expenses in the lender outsourcing solutions segment consist primarily of professional fees, data processing costs, depreciation and amortization costs, costs to purchase real estate data and other expenses. Other operating expenses were $202.9 million, $260.4 million and $90.9 million in 2004, 2003 and 2002, respectively. The decrease in other operating costs of $57.5 million or 22.1% in 2004 is consistent with the decrease in revenues as other operating expenses are more closely related to the volume of business in this segment than are personnel costs. As a percentage of revenues, other operating expenses were 45.0%, 43.0% and 42.3% for 2004, 2003 and 2002, respectively.
Our two significant sources of internally generated funds are dividends and distributions from our subsidiaries. As a holding company, we receive cash from our subsidiaries in the form of dividends and as reimbursement for operating and other administrative expenses we incur. The reimbursements are executed within the guidelines of management agreements among us and our subsidiaries. Our insurance subsidiaries are restricted by state regulation in their ability to pay dividends and make distributions. Each state of domicile regulates the extent to which our title underwriters can pay dividends or make other distributions to us. As of December 31, 2004, $1,731.3 million of our net assets were restricted from dividend payments without prior approval from the Departments of Insurance. During 2005, our first tier title subsidiaries can pay or make distributions to us of approximately $209.8 million without prior approval. Our underwritten title companies, financial institution software and services companies, lender outsourcing businesses and information services companies collect revenue and pay operating expenses. However, they are not regulated to the same extent as our insurance subsidiaries. Positive cash flow from these subsidiaries is invested primarily in cash and cash equivalents.
On November 8, 2004, we, through a subsidiary, entered into a new credit agreement providing for a $500.0 million, 5-year revolving credit facility due November 8, 2009. The facility provided an option to increase the size of the credit facility an additional $100.0 million. This credit agreement bore interest at a variable rate based on leverage and was unsecured. The interest rate under the new credit agreement during
the time it was outstanding was LIBOR plus 0.50%. In addition, we were required to pay a 0.15% commitment fee on the entire facility. On November 8, 2004 we drew down approximately $410 million to fund the acquisition of InterCept. On March 9, 2005, we repaid this facility with a portion of the net proceeds from our sale of a minority interest in FIS to a group of investors and terminated the agreement.
The table below shows the pro forma impact on our capitalization of the recapitalization, minority interest sale, related debt agreements and the $10 per share special dividend as if the events announced on March 9, 2005 had occurred on December 31, 2004 (see Note R):
A decrease in equity of $1,527.8 million relating to the payment of the $1,725.6 million dividend offset by a gain of $197.7 million on the sale of the 25% minority interest in FIS.
Following the recapitalization, FIS is highly leveraged. As of March 14, 2005, it is paying interest at a rate of one month LIBOR plus 1.75%, or 4.51%. At that rate, the annual interest on its $2,800.0 million of debt would be $127.3 million. A one percent increase in the LIBOR rate would increase its annual debt service on the Term Loan Facilities by $28 million. The credit rating assigned to the Term Loan Facilities and Revolver by Standard & Poor’s is currently BB. We believe that FIS and its subsidiaries will generate sufficient cash flow from operations to pay all interest due on the Term Loan Facilities over at least the next twelve months. Over the long term, FIS may have to seek other sources of funds to repay the principal balances of the Term Loan Facilities. Because the performance of FIS is subject to risks and uncertainties, including those described in “Business - Risk Factors,” there can be no assurance that sufficient funds will be available for such purposes when needed.
Contractual Obligations. Our financing obligations generally include our credit agreement and other debt facilities and operating lease payments on certain of our premises and equipment. As of December 31, 2004, our required annual payments relating to these contractual obligations are as follows:
As of December 31, 2004 we had title insurance reserves of $987.1 million. The amounts and timing of these obligations are estimated and are not set contractually. Nonetheless, based on historical title insurance claim experience, we anticipate the above payment patterns. While we believe that historical loss payments are a reasonable source for projecting future claim payments, there is significant inherent uncertainty in this payment pattern estimate because of the potential impact of changes in:
Future mortgage interest rates, which will affect the number of real estate and refinancing transactions and, therefore, the rate at which title insurance claims will emerge;
The legal environment whereby court decisions and reinterpretations of title insurance policy language to broaden coverage could increase total obligations and influence claim payout patterns;
Loss cost trends whereby increases/decreases in inflationary factors (including the value of real estate) will influence the ultimate amount of title insurance loss payments; and
We do not believe the lessor is a variable interest entity, as defined in FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46”). In addition, we have verified that even if the lessor was determined to be a variable interest entity, we would not have to consolidate the lessor nor the assets and liabilities associated with the assets leased to us. This is because the assets leased by us will not exceed 50% of the total fair value of the lessor’s assets excluding any assets that should be excluded from such calculation under FIN 46, nor did the lessor finance 95% or more of the leased balance with non-recourse debt, target equity or similar funding (see Note K).
In December 2004, the FASB issued FASB Statement No. 123R (“SFAS No. 123R”), “Share-Based Payment”, which requires that compensation cost relating to share-based payments be recognized in the Company’s financial statements. The Company is preparing to implement this standard effective July 1, 2005. During 2003, the Company adopted the fair value recognition provision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003. The Company had elected to use the prospective method of transition, as permitted by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”). Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. SFAS No. 123R does not allow for the prospective method, but requires the recording of expense relating to the vesting of all unvested options beginning in the third quarter of 2005. Since we adopted SFAS No. 123 in 2003, the impact of recording additional expense in 2005 under SFAS No. 123R relating to options granted prior to January 1, 2003 will not be significant.
We have audited the accompanying Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2004 and 2003 and the related Consolidated Statements of Earnings, Comprehensive Earnings, Stockholders’ Equity and Cash Flows for each of the years in the three-year period ended December 31, 2004. These Consolidated Financial Statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these Consolidated Financial Statements based on our audits.
In our opinion, the Consolidated Financial Statements referred to above present fairly, in all material respects, the consolidated financial position of Fidelity National Financial, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Net of income tax expense of $5.7 million, $37.2 million and $11.0 million for 2004, 2003 and 2002, respectively.
Net of income tax expense (benefit) of $(17.8) million, $(45.0) million and $3.5 million for 2004, 2003 and 2002, respectively.
Net of income tax benefit of $(6.9) million, $(6.4) million and $(10.2) million in 2004, 2003 and 2002, respectively.
The carrying values reported in the Consolidated Balance Sheets for trade and notes receivables approximate their fair value. Included in trade receivables at December 31, 2004 and 2003 are unbilled receivables totaling $77.4 million and $61.6 million, respectively. Notes receivable at December 31, 2004 and 2003 include $474 thousand and $911 thousand, respectively, of notes from related parties.
During 2004 and 2003, in accordance with SFAS No. 144, the Company determined that the carrying value of certain of its intangible assets, software and license fees may not be recoverable and recorded an expense of $6.3 million and $7.9 million, respectively, relating to the impairment of these assets. Such expenses are included in other operating expenses in the Consolidated Statements of Earnings for the years ended December 31, 2004 and 2003.
Capitalized software includes software acquired in business acquisitions, purchased software and internally developed capitalized software. Purchased software is recorded at cost and amortized using the straight-line method over a 3-year period and software acquired in a business acquisition is recorded at its fair value upon acquisition and amortized using straight-line and accelerated methods over its estimated useful life, generally 5 to 10 years. Capitalized computer software development costs are accounted for in accordance with either SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed (SFAS No. 86), or with SOP No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. After the technological feasibility of the software has been established (for SFAS No. 86 software), or at the beginning of application development (for SOP No. 98-1 software), software development costs, which include salaries and related payroll costs and costs of independent contractors incurred during development, are capitalized. Research and development costs incurred prior to the establishment of technological feasibility (for SFAS No. 86 software), or prior to application development (for SOP No. 98-1 software), of a product are expensed as incurred and are not significant. The cost of internally developed computer software is amortized on a product-by-product basis commencing on the date of general release of the products (for SFAS No. 86 software) for internally developed software and the date of purchase for purchased software (for SOP No. 98-1 software). The capitalized cost of internally developed capitalized software (for SOP No. 98-1 software) is amortized on a straight-line basis over its estimated useful life, generally ten years. Software development costs (for SFAS No. 86 software) are amortized using the greater of (1) the straight-line method over its estimated useful life, which ranges from three to seven years or (2) the ratio of current revenues to total anticipated revenue over its useful life.
At December 31, 2004 and December 31, 2003, capitalized software costs were $581.1 million, less accumulated amortization of $140.3 million and $344.0 million, less accumulated amortization of $53.9 million, respectively. The increase in capitalized software costs is due to the Company’s acquisitions in 2004 and 2003 (see Note B). Amortization expense relating to computer software was $85.9 million, $39.6 million and $13.7 million for the years ended 2004, 2003 and 2002, respectively.
The Company’s reserve for claim losses includes known claims for title and specialty insurance as well as losses the Company expects to incur, net of recoupments. Each known claim is reserved based on a review by the Company as to the estimated amount of the claim and the costs required to settle the claim. Reserves for claims which are incurred but not reported are established at the time premium revenue is recognized based
on historical loss experience and other factors, including industry trends, claim loss history, current legal environment, geographic considerations and type of policy written.
Title Insurance Segment. Direct title insurance premiums and escrow and other title related fees are recognized as revenue at the time of closing of the related transaction as the earnings process is considered complete. Agency title insurance premiums are recognized as revenue when policies are reported to the Company and are recorded as revenue on a gross basis (before the deduction of agent commissions). In addition, the Company accrues for unreported agency title insurance premiums based on historical reporting patterns of its agents and current trends.
Financial Institution Software and Services. In this segment, the Company recognizes revenues relating to bank processing services and mortgage processing services along with software licensing and software related services. Several of the Company’s contracts include a software license and one or more of the following services: data processing, development, implementation, conversion, training, programming, maintenance and application management. In some cases, these services are offered in combination with one another and in other cases the Company offers them individually. Revenues from bank and mortgage processing services are typically volume-based depending on factors such as the estimated number of accounts, transactions processed and computer resources utilized.
The Company recognizes software license and maintenance fees as well as associated development, implementation, training, conversion and programming fees in accordance with SOP NO. 97-2 and SOP NO. 98-9. Initial license fees are recognized when a contract exists, the fee is fixed or determinable, software delivery has occurred and collection of the receivable is deemed probable, provided that vendor-specific objective evidence, or VSOE, has been established for each element or for the undelivered elements. The Company determines the fair value of each element or the undelivered elements in multi-element software arrangements based on VSOE. If the arrangement is subject to accounting under SOP NO. 97-2, VSOE for each element is based on the price charged when the same element is sold separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of fair value does not exist for one or more undelivered elements of a contract, then all revenue is deferred until all elements are delivered or fair value is determined for all remaining undelivered elements. Revenue from maintenance and support is recognized ratably over the term of the agreement. The Company records deferred revenue for maintenance amounts invoiced prior to revenue recognition.
Information Services. In this segment, the Company records revenue from providing data or data-related services. These services principally include appraisal and valuation services, property records information, real estate tax services, borrower credit and flood zone information and multiple listing software and services. Revenue derived from these services is recognized as the services are performed in accordance with SAB No. 104 as described above.
The Company’s flood and tax units provide various services including life-of-loan monitoring services. Revenue for life-of-loan services is deferred and recognized ratably over the estimated average life of the loan service period, which is determined based on the Company’s historical experience. The Company evaluates its historical experience on a periodic basis, and adjusts the estimated life of the loan service period prospectively. Revenue derived from software and service arrangements is recognized in accordance with SOP No. 97-2. Revenues from other services in this segment are recognized as the services are performed in accordance with SAB No. 104 as described above.
Basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net earnings available to common stockholders plus the impact of assumed conversions of dilutive potential securities. The Company has granted certain options, warrants and restricted stock, which have been treated as common share equivalents for purposes of calculating diluted earnings per share.
Options to purchase 1,419,052 shares, 1,759,782 shares and 93,665 shares of the Company’s common stock for the years ended December 31, 2004, 2003 and 2002, respectively, were not included in the computation of diluted earnings per share because they were anti-dilutive.
During 2003, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003. Under the fair value method of accounting, compensation cost is measured based on the fair value of the award at the grant date and recognized over the service period. The Company has elected to use the prospective method of transition, as permitted by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”). Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. Prior year financial statements were not restated.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to all outstanding and unvested awards in each period (see Note M):
The functional currency for the foreign operations of the Company is either the U.S. Dollar or the local currency. For foreign operations where the local currency is the functional currency, the translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The unrealized gains and losses resulting from the translation are included in accumulated other comprehensive earnings in the Consolidated Statement of Stockholders’ Equity and are excluded from net earnings. Gains or losses resulting from foreign currency transactions are included in realized gains and losses and are insignificant in 2004, 2003 and 2002.
credited to additional paid-in capital and a like amount charged to retained earnings during 2004 and 2002. Fractional shares were paid in cash.
Certain reclassifications have been made in the 2003 and 2002 Consolidated Financial Statements to conform to the classifications used in 2004.
The results of operations and financial position of the entities acquired during any year are included in the Consolidated Financial Statements from and after the date of acquisition. The Company generally employs an outside third party valuation firm to value the identifiable intangible and tangible assets and liabilities of each of its acquisitions. Based on this valuation any differences between the fair value of the indentifiable assets and liabilities and the purchase price paid is recorded as goodwill.
On January 28, 2003, the Company entered into a stock purchase agreement with ALLTEL Corporation, Inc., a Delaware corporation (“ALLTEL”), to acquire from ALLTEL its financial services division, ALLTEL Information Services, Inc. (“AIS”). On April 1, 2003, the Company closed the acquisition and subsequently renamed the division Fidelity Information Services (“FI”). FI is one of the largest providers of information-based technology solutions and processing services to the mortgage and financial services industries.
The Company acquired FI for approximately $1,069.6 million (including the payment for certain working capital adjustments and estimated transaction costs), consisting of $794.6 million in cash and $275.0 million of the Company’s common stock. The Company funded the cash portion of the purchase price through the issuance of $250.0 million aggregate principal amount of 5.25% notes due March 15, 2013 (See Note H), and $544.6 million in available cash. The stock portion of the purchase price resulted in the issuance of 11,206,692 shares of the Company’s common stock to ALLTEL.
In connection with the closing of the acquisition, the Company entered into a stockholder’s agreement, a non-competition agreement and certain transition agreements with ALLTEL. The stockholder’s agreement: (1) restricted the sale by ALLTEL of the Company’s common stock received in the transaction for a period of one year unless the Company consented to such sale or transfer or certain events set forth in the stockholder’s agreement with ALLTEL and the Company occur prior to the expiration of the one-year lock-up, (2) grants ALLTEL the right to designate one nominee to the Company’s Board of Directors, so long as it continues to hold at least 50% of the shares of the Company’s common stock received in the transaction, and (3) grants ALLTEL certain registration rights with respect to the Company’s common stock it receives in the transaction. The non-competition agreement prohibits, with certain exceptions, ALLTEL and its affiliates
On March 11, 2004, FNF acquired Aurum Technology, Inc. (Aurum) for $306.4 million, comprised of $185.0 million in cash and the issuance of 3,144,390 shares of FNF’s common stock valued using closing prices two days before and after the valuation date, which was $121.4 million. Aurum is a provider of outsourced and in-house information technology solutions for the community bank and credit union markets.
On April 14, 2004, FNF acquired Sanchez Computer Associates, Inc. (Sanchez) for $183.7 million, comprised of $88.1 million in cash and the issuance of 2,267,290 shares of FNF’s common stock valued using closing prices two days before and after the valuation date, which was approximately $88.1 million with the remaining purchase price of $7.5 million relating to the issuance of the Company’s stock options for vested Sanchez stock options. Sanchez develops and markets scalable and integrated software and services that provide banking, customer integration, outsourcing and wealth management solutions to financial institutions in several countries. Sanchez’ primary application offering is Sanchez Profiletm, a real-time, multi- currency, strategic core banking deposit and loan processing system that can be utilized on both an outsourced and in-house basis.
The assets acquired and liabilities assumed in the APTIC acquisition were as follows (dollars in thousands):
On September 30, 2003, the Company acquired the outstanding minority interest of FNIS, its majority-owned real estate information services public subsidiary that provides property data and real-estate related services, whereby FNIS became a wholly-owned subsidiary of the Company. In the acquisition, each share of FNIS common stock (other than FNIS common stock the Company already owned) was exchanged for 0.83 shares of the Company’s common stock. The Company issued 14,292,858 shares of its common stock to FNIS stockholders in the acquisition. The Company has allocated $154.8 million of the purchase price to goodwill and $88.9 million of the purchase price to other intangible assets and capitalized software based on studies and valuations that are finalized.
Impact of full year 2004 for Kordoba is approximately $93.2 million and $15.5 million in total revenue and net earnings, respectively and comparable information is not available for 2003 that is in conformity with U.S. generally accepted accounting principles.
On December 13, 2004, the Company acquired ClearParSM, LLC (“ClearPar”), a provider of a web-based commercial loan settlement system servicing the primary syndication and secondary loan trading markets. The acquisition price was $24.5 million in cash.
On September 15, 2004, FNF acquired 11 million shares of common stock and warrants to purchase 4 million additional shares of Covansys Corporation (Covansys), a publicly traded U.S.-based provider of application management and offshore outsourcing services with India based operations for $121.0 million in cash. FNF subsequently contributed the common stock and warrants to the Company which resulted in the Company owning approximately 29% of the common stock of Covansys. The Company will account for the investment in common stock using the equity method of accounting and will account for the warrants under SFAS No. 133. Under SFAS No. 133, the investment in warrants are considered derivative instruments and have been recorded at a fair value of approximately $23.5 million on the date of acquisition. The Company has also recorded a gain of $16.2 million on the increase in fair value of the warrants through December 31, 2004 which is reflected in the Consolidated Statement of Earnings in realized gains and losses. The Company also entered into a master service provider agreement with Covansys which requires the Company to purchase a minimum of $150 million in services over a five year period expiring June 30, 2009 or be subject to certain penalties if certain spending thresholds are not met. The Company is subject to penalties aggregating $8.0 million in the event that certain annual thresholds are not met and a final penalty equal to 6.67% of the unmet commitment.
On April 7, 2004, the Company acquired Bankware, a provider of check imaging solutions for financial institutions for $47.7 million in cash.
On May 2, 2003, the Company acquired the flood insurance business of Mutual of Omaha’s subsidiary, Omaha Property and Casualty Insurance Company (“OPAC”), for $18.0 million in cash. This acquisition, along with the Bankers Insurance Group acquisition (described below) expands the Company’s presence in the flood insurance business.
On March 26, 2003, the Company merged with ANFI, Inc. (“ANFI”), which is predominately a California underwritten title company, and ANFI became a wholly-owned subsidiary of the Company. In the merger, each share of ANFI common stock (other than ANFI common stock the Company already owned) was exchanged for 0.454 shares of the Company’s common stock. The Company issued 5,183,103 shares of its common stock to the ANFI stockholders in the merger.
On February 10, 2003, the Company acquired Lenders Service, Inc., a Delaware corporation (“LSI”), for $77.3 million in cash. LSI is a provider of appraisal, title and closing services to residential mortgage originators.
The following table presents certain information regarding contractual maturities of the Company’s fixed maturity securities at December 31, 2004:
The carrying value of the Company’s investment in equity securities is fair value. As of December 31, 2004, gross unrealized gains and gross unrealized losses on equity securities were $10.2 million and $3.5 million, respectively. Gross unrealized gains and gross unrealized losses on equity securities were $13.0 million and $0.3 million, respectively, as of December 31, 2003.
During the years ended December 31, 2004, 2003 and 2002, gross realized gains on sales of fixed maturity securities considered available for sale were $8.9 million, $18.5 million and $26.1 million, respectively; and gross realized losses were $0.2 million, $2.2 million and $7.7 million, respectively. Gross proceeds from the sale of fixed maturity securities considered available for sale amounted to $2,305.8 million, $1,451.7 million and $776.9 million during the years ended December 31, 2004, 2003 and 2002, respectively.
During the years ended December 31, 2004, 2003 and 2002, gross realized gains on sales of equity securities considered available for sale were $65.8 million, $104.1 million and $26.6 million, respectively; and gross realized losses were $52.3 million, $8.1 million and $53.9 million, respectively. Gross proceeds from the sale of equity securities amounted to $723.9 million, $793.4 million and $351.4 million during the years ended December 31, 2004, 2003 and 2002, respectively.
Amortization expense for amortizing intangible assets was $124.1 million, $115.4 million and $6.1 million for the years ended December 31, 2004, 2003 and 2002, respectively, and is amortized over a period of 5 to 20 years. Estimated amortization expense for the next five years is $134.8 million in 2005, $118.5 million in 2006, $100.7 million in 2007, $83.7 million in 2008 and $61.4 million in 2009.
The carrying value of the Company’s notes payable, excluding lease-backed notes payable, was approximately $35.0 million lower than its estimated fair value at December 31, 2004. At December 31, 2003, the carrying value of the Company’s outstanding notes payable, excluding lease-backed notes, was approximately $31.4 million lower than its estimated fair value. The fair value of the Company’s unsecured notes payable is based on established market prices for the securities on December 31, 2004 and 2003. The fair value of the Company’s remaining fixed rate and variable rate notes payable is estimated using discounted cash flow analyses based on current market interest rates and comparison of interest rates being paid to the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
During 2003, the Company entered into a credit agreement providing for a $700.0 million, 5-year revolving credit facility due November 4, 2008. The credit agreement bears interest at a variable rate based on the debt ratings assigned to the Company by certain independent agencies, and is unsecured. The current interest rate under the new credit agreement is LIBOR plus 0.50%. In addition, the Company pays a 0.15% facility fee on the entire facility.
The significant components of deferred tax assets and liabilities at December 31, 2004 and 2003 consist of the following:
At December 31, 2004 and December 31, 2003, the Company has a net operating loss carryforward of $146.1 million and $45.2 million and a foreign tax credit carryforward of $2.1 million and $2.8 million, respectively. There is a full valuation against the foreign tax credit carryovers for each year. The net operating losses expire between 2019 and 2024 and the foreign tax credits expire between 2005 and 2008.
The Company’s title insurance underwriting subsidiaries are, in the ordinary course of business, subject to claims made under, and from time-to-time are named as defendants in legal proceedings relating to, policies of
The Company has entered into various employment agreements with officers of the Company. These agreements provide for a specified salary to be paid to the officers and include incentive compensation 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 which the Company accrued for if the Company believes the amount to be estimable and probable. The Company believes that no actions, other than those listed below, depart from customary litigation incidental to its business and that the resolution of all pending and threatened litigation will not have a material effect on its results of operations, financial position or liquidity.
Several class actions are pending alleging improper rates were charged for title insurance. Four class action cases were filed in New York and have been consolidated for further proceedings. The cases allege that the named defendant companies failed to provide notice of premium discounts to consumers refinancing their mortgages, and failed to give discounts in refinancing transactions in violation of the filed rates. The actions seek refunds of the premiums charged and punitive damages. These actions were settled in the fall of 2004, and the court has granted preliminary approval of the settlement. A similar suit in Minnesota was also settled. Similar allegations have been made in class actions filed in Ohio, Pennsylvania, and Florida. Recently, the court refused to certify a class in one of the Ohio actions. Two class actions, one in California and one in Michigan allege the company violated the Real Estate Settlement Procedures Act (“RESPA”) and state law by giving favorable discounts or rates to builders and developers. The actions seek refunds of the premiums charged and additional damages. The Company intends to vigorously defend these actions.
Several class actions are pending alleging that the Company imposed improper charges in closing real estate transactions. A class action pending in New Jersey alleges the company has charged twice for fees to record satisfactions of mortgages, and charged for satisfactions that were not recorded. This case has been settled and the court has granted tentative approval of the settlement. Class actions making similar allegations were recently filed in Tennessee, Arkansas and New York. Two other class actions pending in Indiana allege that the Company overcharged recording fees. The Company intends to vigorously defend the pending actions.
A class action in Arkansas alleges that the issuance of title commitments, policies and actions taken in aid of clearing title by title companies is the unauthorized practice of law. This case was dismissed by the trial court for lack of jurisdiction reasoning the dispute could only be brought before the Arkansas Committee on the Unauthorized Practice of Law. The Arkansas Supreme Court recently reversed the holding of the trial court asserting that the trial court had concurrent jurisdiction, and remanded the matter back to the trial court. The Company will continue to vigorously defend this action. Two class actions were recently filed in
A threatened regulatory enforcement action initiated by the Office of the Comptroller of Currency of the U.S. Treasury Department in conjunction with the Office of Thrift Supervision of the U.S. Treasury Department, the U.S. Department of Housing and Urban Development and the Texas Department of Insurance based on alleged violations of the Real Estate Settlement Procedures Act (“RESPA”) has been settled by payment of a civil fine and an agreement to change certain policies and procedures.
The California Department of Insurance also announced its intent to examine levels of pricing and competition in the title insurance industry in California. Other states could follow with similar inquiries. At this stage, we are unable to predict what the outcome will be of this or any similar review.
In conducting its operations, the Company routinely holds customers’ assets in escrow, pending completion of real estate transactions. Certain of these amounts are maintained in segregated bank accounts and have not been included in the accompanying Consolidated Balance Sheets. The Company has a contingent liability relating to proper disposition of these balances for our customers, which amounted to $8.8 billion at December 31, 2004. As a result of holding these customers’ assets in escrow, the Company has ongoing programs for realizing economic benefits during the year through favorable borrowing and vendor arrangements with various banks. There were no investments or loans outstanding as of December 31, 2004 and 2003 related to these arrangements.
In conducting its operations, the Company routinely holds customers’ assets in escrow, pending completion of real estate transactions. Certain of these amounts are maintained in segregated bank accounts and have not been included in the Consolidated Balance Sheets. As a result of holding these customers’ assets in escrow, we have ongoing programs for realizing economic benefits during the year through favorable borrowing and vendor arrangements with various banks. There were no investments or loans outstanding as of December 31, 2004 or December 31, 2003 related to these arrangements.
Our insurance subsidiaries, including underwriters, underwritten title companies and independent agents, are subject to extensive regulation under applicable state laws. Each of the insurance underwriters is subject to a holding company act in its state of domicile which regulates, among other matters, the ability to pay dividends and investment policies. The laws of most states in which the Company transacts business establish supervisory agencies with broad administrative powers relating to issuing and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, accounting principles, financial practices, establishing reserve and capital and surplus as regards policyholders (“capital and surplus”) requirements, defining suitable investments for reserves and capital and surplus and approving rate schedules.
Pursuant to statutory accounting requirements of the various states in which the Company’s title 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 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, 2004,
the combined statutory unearned premium reserve required and reported for the Company’s title insurance subsidiaries was $1,180.6 million.
The combined statutory capital and surplus of the Company’s title insurance subsidiaries was $892.6 million, $879.0 million and $612.6 million as of December 31, 2004, 2003 and 2002, respectively. The combined statutory earnings of the Company’s title insurance subsidiaries were $369.5 million, $480.0 million and $162.6 million for the years ended December 31, 2004, 2003 and 2002, respectively.
As a condition to continued authority to underwrite policies in the states in which the Company’s title insurance subsidiaries conduct their business, they are required to pay certain fees and file information regarding their officers, directors and financial condition. In addition, the Company’s escrow and trust business is subject to regulation by various state banking authorities.
Pursuant to statutory requirements of the various states in which the Company’s title insurance subsidiaries are domiciled, they must maintain certain levels of minimum capital and surplus. Each of the Company’s title underwriters has complied with the minimum statutory requirements as of December 31, 2004.
On April 24, 2002, the Company’s Board of Directors approved a three-year stock repurchase program. Purchases were made by the Company from time to time in the open market, in block purchases or in privately negotiated transactions. From May 15, 2002, through December 31, 2002, the Company repurchased a total of 2,798,358 shares of common stock for $61.2 million, or an average price of $21.87. The amount repurchased includes 604,546 shares of common stock purchased from certain of the Company’s officers and directors during the third quarter of 2002, of which 228,181 shares were accepted as full payment for certain notes receivable, including accrued interest. In December 2002, the Company retired 774,908 of these shares held as treasury stock, totaling $14.3 million. For the year ended December 31, 2003, the Company repurchased 1,775,400 shares of common stock for $45.4 million, or an average price of $25.60. In the fourth quarter of 2003, the Company retired 989,450 of these shares held as treasury stock, totaling $27.3 million. As
a result of the increased cash dividend per share, the Company decided to suspend this stock repurchase program effective July 23, 2003; however, effective December 18, 2003, the stock repurchase program was reinstated. From January 1, 2004 through December 31, 2004, the Company repurchased a total of 430,500 shares of common stock for $16.5 million, or an average price of $38.33. Additionally, on December 13, 2004, we entered into an agreement to repurchase 2,530,346 shares of Company common stock from Willis Stein & Partners (“Willis Stein”) and J.P. Morgan Chase, as escrow agent for the former stockholder of Aurum. We acquired Aurum in March 2004. The purchase price per share of $44.35 was a discount to the closing price of the Company’s common stock on December 13, 2004.
In 1987, stockholders approved the adoption of an Employee Stock Purchase Plan (“ESPP”). Under the terms of the ESPP and subsequent amendments, eligible employees may voluntarily purchase, at current market prices, shares of the Company’s common stock through payroll deductions. Pursuant to the ESPP, employees may contribute an amount between 3% 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, 2004, 2003 and 2002, 1,413,950, 1,315,065 and 980,837 shares, respectively, were purchased and allocated to employees, based upon their contributions, at an average price of $37.86, $27.46 and $20.57 per share, respectively. The Company contributed $16.5 million or the equivalent of 438,264 shares for the year ended December 31, 2004; $9.2 million or the equivalent of 336,234 shares for the year ended December 31, 2003 and $7.5 million or the equivalent of 366,765 shares for the year ended December 31, 2002 in accordance with the employer’s matching contribution.
The Company offers its employees the opportunity to participate in the Fidelity National Financial, Inc. 401(k) Profit Sharing Plan (“401(k) Plan”), a qualified voluntary contributory savings plan, which is available to substantially all Fidelity employees. Eligible employees may contribute up to 40% of their pretax annual compensation, up to the amount allowed pursuant to the Internal Revenue Code. The Company matches 50% of each dollar of employee contribution up to six percent of the employee’s total compensation. The Company’s cost for the 401(k) Plan for the years ended December 31, 2004, 2003 and 2002 was $23.9 million, $22.3 million and $17.5 million, respectively.
During 1998, stockholders approved the adoption of the 1998 Stock Incentive Plan (“1998 Plan”). The 1998 Plan authorizes up to 9,985,828 shares of common stock, plus an additional 366,025 shares of common stock on the date of each annual meeting of the stockholders of the Company, for issuance under the terms of the 1998 Plan. As of December 31, 2004, there were 6,309,405 options outstanding under this plan. The 1998 Plan provides for grants of “incentive stock options” as defined in Section 422 of the Internal Revenue Code of 1986, as amended, non-qualified stock options and rights to purchase shares of common stock (“Purchase Rights”). The term of options may not exceed 10 years from the date of grant (five years in the case of a person who owns or is deemed to own more than 10% of the total combined voting power of all classes of stock of the Company), and the right to exercise such options shall vest equally over three years. The option exercise price for each share granted pursuant to an incentive stock option may not be less than 100% of the fair market value of a share of common stock at the time such option is granted (110% of fair market value in the case of an incentive stock option granted to a person who owns more than 10% of the combined voting power of all classes of stock of the Company). There is no minimum purchase price for shares of common stock purchased pursuant to a Purchase Right, and any such purchase price shall be determined by the Board of Directors.
In connection with the merger of Chicago Title, the Company assumed the options outstanding under Chicago Title’s existing stock option plans: the 1998 Long-Term Incentive Plan and the Director’s Stock Option Plan. Pursuant to the terms of the merger, options under these plans, totaling 5,304,456, became fully vested on March 20, 2000. The options granted in accordance with these two plans generally have a term of five to 10 years. As of December 31, 2004, there were 400,638 options outstanding under these plans.
In 2001, stockholders approved the adoption of the 2001 Stock Incentive Plan (“2001 Plan”). The 2001 Plan authorized up to 4,026,275 shares of common stock, plus an additional 332,750 shares of common stock on the date of each annual meeting of stockholders of the Company, for issuance under the terms of the 2001 Plan. As of December 31, 2004, there were 1,117,757 options outstanding under this plan. The 2001 Plan provides for grants of “incentive stock options” as defined in Section 422 of the Internal Revenue Code of 1986, as amended, nonqualified stock options, rights to purchase shares of common stock and deferred shares.
In 2003, the Company issued to its non-employee Directors and to certain of its employees, rights to purchase 879,450 shares of restricted common stock (“Restricted Shares”) of the Company, pursuant to the 2001 Plan. A portion of the Restricted Shares vest over a five-year period and a portion of the Restricted Shares vest over a four-year period, of which one-fifth vested immediately on the date of grant. The Company recorded compensation expense of $3.3 million and unearned compensation expense of $23.0 million in connection with the issuance of Restricted Stock in 2003. The Company recorded compensation expense of $5.4 million in 2004 in connection with these shares. The Company used 769,450 shares of its common stock held as treasury shares and 110,000 newly issued common shares for the sale of Restricted Shares to its employees.
In connection with the acquisition of FNIS, the Company assumed 2,585,387 options outstanding under FNIS’ existing option plans: the Fidelity National Information Solutions 2001 Stock Incentive Plan, the Vista Information Solutions, Inc. 1999 Stock Option Plan, the Micro General Corporation 1999 Stock Incentive Plan and the Micro General Corporation 1998 Stock Incentive Plan. The options granted under these plans generally had a term of 10 years. As of December 31, 2004, there were 1,067,967 options outstanding under these plans.
In connection with the acquisition of Sanchez, the Company assumed 1,024,588 options outstanding under Sanchez’ 1995 Stock Incentive Plan. The option granted under this plan generally had a term of 8 years. As of December 31, 2004, there were 708,222 options outstanding under this plan.
In 2004, stockholders approved the Fidelity National Financial 2004 Omnibus Incentive Plan (the “2004 Plan”). The 2004 Plan authorized up to 12,500,000 shares, plus the number of shares subject to prior plan awards that are outstanding as of the effective date of the 2004 Plan and that are deemed not delivered under the prior plans because of certain conditions. As of December 31, 2004, there were 1,566,250 options outstanding under this plan. The options granted under this plan have a life of 8 years and vest over a three year period. The 2004 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and performance shares, performance units, other stock-based awards and dividend equivalents.
The following table summarizes information related to stock options outstanding and exercisable as of December 31, 2004:
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 all of 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 are the rate that corresponds to the weighted average expected life of an option. The risk free interest rate used for options granted during 2004, 2003 and 2002 was 3.2%, 2.0% and 2.0%, respectively. A volatility factor for the expected market price of the common stock of 34%, 43% and 44% were
used for options granted in 2004, 2003 and 2002, respectively. The expected dividend yield used for 2004, 2003 and 2002 was 2.5%, 1.4% and 1.3%, respectively. A weighted average expected life of 3.8 years, 3.5 years and 3.25 years was used for 2004, 2003 and 2002, respectively. The weighted average fair value of each option granted during 2004, 2003 and 2002 was $10.71, $10.57 and $6.39, respectively.
Under Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions,” (“SFAS No. 87”) the measurement date shall be as of the date of the financial statements, or if used consistently from year to year, as of a date not more than three months prior to that date. The Company’s measurement date is December 31.
The net pension liability included in accounts payable and accrued liabilities as of December 31, 2004 and 2003 is $81.0 million and $54.2 million, respectively. The net pension liability at December 31, 2004 and 2003 includes the additional minimum pension liability adjustment of $18.7 million and $16.4 million, respectively, which was recorded as a net of tax charge of $11.8 million and $10.0 million to accumulated other comprehensive earnings (loss) in 2004 and 2003 in accordance with SFAS No. 87.
The components of net periodic (income) expense included in the results of operations for 2004, 2003 and 2002 are as follows:
Relates to Kordoba pension plan activity from September 30, 2004 to December 31, 2004.
The Company’s pension plan asset allocation at December 31, 2004 and 2003 and target allocation for 2005 are as follows:
The Company’s funding policy is to contribute annually at least the minimum required contribution under the Employee Retirement Income Security Act (ERISA). Contributions are intended to provide not only for benefits accrued to date, but also for those expected to be earned in the future. In 2004 and 2003, the Company made contributions of $18.0 million and $12.2 million, respectively. Due to regulatory requirements, the Company is not required to make a contribution to the pension plan in 2005. The Company has not yet determined if a voluntary contribution to the plan will be made in 2005.
Under Statement of Financial Accounting Standards No. 106, “Accounting for Postretirement Benefits Other Than Pensions,” the measurement date shall be as of the date of the financial statements, or if used consistently from year to year, as of a date not more than three months prior to that date. The Company’s measurement date is December 31.
The Company’s postretirement health care and life insurance costs included in the results of operations for 2004, 2003 and 2002 are as follows:
The Company generates a significant amount of title insurance premiums in California and Texas. In 2004, 2003 and 2002, California and Texas accounted for 22.3% and 10.9%, 25.0% and 11.1% and 25.2% and 12.1% of total title premiums, respectively.
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.
During 2004, subsequent to year end, the Company restructured its business segments to more accurately reflect a change in the Company’s current operating structure. All previously reported segment information has been restated to be consistent with the current presentation.
This segment, consisting of title insurance underwriters and wholly-owned title insurance agencies, provides core title insurance and escrow services, including document preparation, collection and trust activities. Included in the title insurance segment for the year ended December 31, 2003 are $26.3 million in pre-tax expenses relating to the migration of data center operations from FNIS to FIS and $11.3 million related to the relocation of the Company’s corporate headquarters to Jacksonville, Florida pursuant to SFAS No. 146, and $2.0 million in asset impairment charges pursuant to SFAS No. 144. See Notes A and B. In addition, the title insurance segment for 2003 includes a realized gain of $51.7 million as a result of InterActive Corp’s acquisition of Lending Tree Inc. and the subsequent sale of the Company’s InterActive Corp common stock and a realized gain of $25.0 million on the sale of New Century Financial Corporation common stock.
The Lender Outsourcing Solutions segment offers customized outsourced business process and information solutions to national lenders and loan servicers. This business provides loan facilitation services, which allows customers to outsource their title and closing requirements in accordance with pre-selected criteria, regardless of the geographic location of the borrower or property. Depending on customer requirements, the Company performs these services both in the traditional manner involving many manual steps, and through more automated processes, which significantly reduce the time required to complete the task. The Company also provides default management services, which allow customers to outsource the business processes necessary to take a loan and the underlying real estate securing the loan through the default and foreclosure process. The Company utilizes its own resources and networks established with independent contractors to provide outsourcing solutions. Included in the lender outsourcing solutions segment for the year ended December 31, 2003 is $2.7 million of pre-tax expenses relating to asset impairment charges pursuant to SFAS No. 144. See Notes A.
In December 2004, the FASB issued FASB Statement No. 123R (“SFAS No. 123R”), “Share-Based Payment”, which requires that compensation cost relating to share-based payments be recognized in the Company’s financial statements. The Company is preparing to implement this standard effective July 1, 2005. During 2003, the Company adopted the fair value recognition provision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), for stock-based employee compensation, effective as of the beginning of 2003. The Company had elected to use the
prospective method of transition, as permitted by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS No. 148”). Under this method, stock-based employee compensation cost is recognized from the beginning of 2003 as if the fair value method of accounting had been used to account for all employee awards granted, modified, or settled in years beginning after December 31, 2002. SFAS No. 123R does not allow for the prospective method, but requires the recording of expense relating to the vesting of all unvested options beginning in the third quarter of 2005. Since the Company adopted SFAS No. 123 in 2003, the impact of recording additional expense in 2005 under SFAS No. 123R relating to options granted prior to January 1, 2003 will not be significant.
The following table shows the pro forma effects on the consolidated balance sheet as of December 31, 2004 of the recapitalization, minority interest sale, related debt repayments and special cash dividend (the “Transactions” as if they had occurred on that date.
An increase in notes payable of $1,990.0 million relating to the $2,800 million from the Term Loan Facilities less the repayment of $810.0 million in credit facilities that were outstanding as of December 31, 2004.
An increase in minority interest of $138.9 million relating to the sale of 25% of FIS.
The following table shows the pro forma effects on the Consolidated Statement of Earnings of the Transactions as if they had occurred on January 1, 2004.
An increase in interest expense of $91.1 million which includes $94.8 million in additional interest expense relating to the Term Loan Facilities offset by savings of $3.7 million assuming that the proceeds paid off the balances outstanding on the Company’s credit facilities as of January 1, 2004.
An increase in minority interest expense of $32.3 million relating to calculating a 25% minority interest expense on the results of FIS for 2004.