In September 1999, the Company moved its executive offices to one of three constructed office buildings at MacArthur Place in Santa Ana, California. Later that same year, the Orange County branch and certain other operations of the Company’s title insurance segment moved into the two other buildings constructed on the site. The three buildings totaled approximately 210,000 square feet and were situated in a campus environment comprising approximately 32 acres. In the first quarter of 2004, the Company began the expansion of its office campus. This expansion was completed in the fourth quarter of 2005 with the addition of two 4-story office buildings totaling approximately 226,000 square feet, a two-story, free standing, 52,000 square foot technology center and a two-story parking structure, bringing the total square footage of the Company’s campus at MacArthur Place to approximately 490,000 square feet. The two new office buildings are occupied primarily by the Company’s property information segment and trust company. The original three office buildings, including the underlying land and the fixtures thereto, are subject to a deed of trust and security agreement securing payment of a promissory note evidencing a loan made in October 2003, to the Company’s subsidiary, First
In 1999, the Company completed the construction of two office buildings in Poway, California. These two buildings, which are owned by the Company’s title insurance subsidiary and are leased to First Advantage for use by its lender services segment and certain businesses in its Dealer Services segment, total approximately 153,000 square feet and are located on a 17 acre parcel of land.
The second step of the process is to use a third party actuary. Generally, twice a year, the actuary identifies a range of reserve estimates for IBNR, a single point estimate for IBNR, as well as loss rates that reflect the total projected ultimate loss by policy year as a percentage of that year’s title insurance operating revenues. The actuarial report is primarily based on the company’s historical claim payment and incurred loss patterns. It does not fully reflect current trends (such those described above) that may impact future claims development.
Title insurance policies are long-duration contracts with the majority of the claims reported to the Company within the first few years following the issuance of the policy. Generally, 70 to 75 percent of claims become known in the five first years of the policy life. Therefore, the majority of IBNR reserves relate to the five most recent policy years. A material change in expected ultimate losses and corresponding loss rates for policy years older than five years is not considered reasonably likely by the Company. However, changes in expected ultimate
Purchase accounting and impairment testing for goodwill and other intangible assets. Pursuant to Statement of Financial Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS 142), the Company is required to perform an annual impairment test for goodwill and other indefinite-lived intangible assets by reporting unit. This annual test, which the Company has elected to perform every September 30, utilizes a variety of valuation techniques, all of which require management to make estimates and judgments, and includes discounted cash flow analysis, market approach valuations and the use of third-party valuation advisors. Certain of these valuation techniques are also utilized by the Company in accounting for business combinations, primarily in the determination of the fair value of acquired assets and liabilities. The Company’s reporting units, for purposes of applying the provisions of SFAS 142, are title insurance, home warranty, property and casualty insurance, trust and other services, mortgage origination products and services, mortgage servicing products and
services, property information services, lender services, data services, dealer services, employer services, multifamily services and investigative and litigation services. In accordance with the provisions of SFAS 142, the Company completed the required annual impairment testing for goodwill and other intangible assets for the years ended December 31, 2006 and 2005, and determined that there was no impairment of value.
Depreciation and amortization lives for assets. Management is required to estimate the useful lives of several asset classes, including capitalized data, internally developed software and other intangible assets. The estimation of useful lives requires a significant amount of judgment related to matters such as future changes in technology, legal issues related to allowable uses of data and other matters.
Stock-based compensation. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS 123R). This standard is a revision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. Effective January 1, 2006, the Company adopted SFAS 123R, which establishes standards for share-based awards for employee services. SFAS 123R has two transition method applications to choose from and the Company selected the modified-prospective method, under which prior periods are not revised for comparative purposes. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. In accordance with the modified prospective method, the Company will continue to use the Black-Scholes option-pricing model for all unvested options as of December 31, 2005. The Company has selected the binomial lattice option-pricing model to estimate the fair value for any options granted after December 31, 2005. In conjunction with the adoption of SFAS 123R, the Company changed the method of attributing the value of stock-based compensation expense from the accelerated multiple-option method to the straight-line single option method. Compensation expense for all stock-based awards granted prior to January 1, 2006 will continue to be recognized using the accelerated multiple-option approach, while compensation expense for all stock-based awards granted subsequent to January 1, 2006, will be recognized using the straight-line single option method. As stock-based compensation expense recognized in the results is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to 2006, forfeitures were recognized as they occurred. Share-based compensation expense included in salaries and other personnel costs recognized during the twelve months ended December 31, 2006, was $25.7 million, $13.1 million after tax and minority interest expense, or $0.13 per diluted share. This amount includes expense for all share-based payments granted prior to, but not yet vested as of December 31, 2005 as well as share-based awards granted during the twelve months ended December 31, 2006. In addition to stock options, the Company has an employee stock purchase plan that allows eligible employees to purchase common stock of the Company at 85% of the closing price on the last day of each month. Under the provisions of SFAS 123R, commencing the first quarter of 2006, the Company began recognizing an expense in the amount equal to the discount. For the twelve months ended December 31, 2006, the amount of the discount was $1.0 million. This amount is included in the share-based compensation amount mentioned above.
Overview-A substantial portion of the revenues for the Company’s title insurance and services and mortgage information segments result from resales and refinancings of residential real estate and, to a lesser extent, from commercial transactions and the construction and sale of new housing. Over one-half of the revenues in the Company’s property information segment and in excess of 20.0% of the revenues from the Company’s First Advantage segment also depend on real estate activity. The remaining portion of the property information and First Advantage segments’ revenues, as well as the revenues of the Company’s specialty insurance segment, are isolated from the volatility of real estate transactions. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, changes in interest rates, as well as other economic factors, can cause fluctuations in the traditional pattern of real estate activity.
Total operating revenues for the Company increased in 2006 compared with 2005, despite a decline in mortgage originations, primarily as a result of acquisition activity and organic growth at the Company’s specialty insurance, property information and First Advantage segments. Operating revenues in 2005 also increased when compared with 2004 primarily as a result of a relatively strong resale and commercial real estate market, an increase in the average revenues per order closed in the Company’s title business as well as acquisition activity. Operating revenues in 2004 increased from 2003 primarily due to new acquisitions, declining mortgage interest rates in the second half of the year and an increase in the average revenues per title order closed.
Operating revenues-A summary by segment of the Company’s operating revenues is as follows:
Financial Services. Operating revenues from direct title operations increased 1.6% in 2006 over 2005 and 18.8% in 2005 over 2004. The increase in 2006 over 2005 was primarily due to an increase in the average revenues per order closed, offset in part by a decrease in the number of orders closed. The increase in 2005 over 2004 was primarily due to an increase in the average revenues per order closed, and to a lesser extent, an increase in the number of orders closed. The average revenues per order closed were $1,643, $1,496 and $1,331 for 2006, 2005 and 2004, respectively. These increases in average revenues per order closed were primarily due to a decrease in the mix of lower-premium refinance transactions and an increase in higher-premium resale and commercial transactions. The Company’s direct title operations closed 1,865,700, 2,017,200 and 1,908,600 title orders during 2006, 2005 and 2004, respectively, a decrease of 7.5% in 2006 from 2005 and an increase of 5.7% in 2005 from 2004. The fluctuations in closings primarily reflected decreasing mortgage origination activity, balanced against market share gains that resulted from organic growth and acquisition activity. Operating revenues from agency title operations increased 4.8% in 2006 over 2005 and 27.2% in 2005 over 2004. These increases were primarily attributable to the same factors affecting direct title operations compounded by the inherent delay in the reporting of transactions by agents.
Total operating revenues for the title insurance segment (direct and agency operations) contributed by new acquisitions were $230.3 million, $376.4 million and $252.8 million for 2006, 2005 and 2004, respectively.
Specialty insurance operating revenues increased 12.4% in 2006 over 2005 and 24.9% in 2005 over 2004. These increases reflected continued geographic expansion at the Company’s home warranty division as well as market share gains and premium increases at the Company’s property and casualty insurance division.
Information Technology. Mortgage information operating revenues decreased 10.1% in 2006 over 2005 and 10.6% in 2005 over 2004. These decreases were primarily attributable to the declining mortgage origination volume in 2006 and 2005, as well as increases in the estimated servicing life of the tax service loan portfolio due to a slowdown in prepayment speeds, which resulted in the deferral of a larger portion of the tax service fee.
Total operating revenues for the mortgage information segment contributed by new acquisitions were $3.9 million, $23.3 million and $166.4 million for 2006, 2005 and 2004, respectively.
acquisitions for the respective periods and the continued growth in this segment’s less cyclical, subscription-based information businesses, offset in part by the reduction in mortgage originations.
First Advantage operating revenues increased 27.8% in 2006 over 2005 and 25.2% in 2005 over 2004. These increases were primarily attributable to $137.1 million and $87.4 million of operating revenues contributed by new acquisitions for the respective periods as well as organic growth.
Investment and other income-Investment and other income totaled $239.4 million, $210.3 million and $141.8 million in 2006, 2005 and 2004, respectively, an increase of $29.1 million, or 13.8% in 2006 from 2005, and an increase of $68.5 million, or 48.3% in 2005 from 2004. These increases were primarily due to the growth in interest income resulting from increases in the average investment portfolio balance and higher yields. Offsetting in part the growth in interest income for 2006 was a 33.3% decrease in equity in earnings of unconsolidated affiliates, which are accounted for under the equity method of accounting. Equity in earnings of unconsolidated affiliates increased 16.3% in 2005 over 2004.
Gain on issuance of subsidiary stock-Gain on issuance of subsidiary stock totaled $9.3 million in 2006, $25.7 million in 2005 and $8.5 million in 2004. These amounts represent realized gains relating to the issuance of shares by the Company’s publicly-traded subsidiary, First Advantage Corporation.
Net realized investment gains/losses-Net realized investment gains totaled $6.1 million in 2006, $9.7 million in 2005 and $1.3 million in 2004. The 2006 total included a realized gain of $7.0 million recognized by the Company’s First Advantage segment relating to a follow on stock offering by DealerTrack Holdings, Inc., an entity partially owned by First Advantage, as well as a $3.0 million realized loss recognized at the Company’s title insurance segment resulting from an asset write-down. The 2005 total included a realized gain of $9.5 million recognized by the First Advantage segment, relating to the completion of an initial public offering by DealerTrack Holdings, Inc.
Financial Services. The Company’s title insurance segment comprises over 96% of total salaries and other personnel costs for the Financial Services group. The title insurance segment (primarily direct operations) is labor intensive; accordingly, a major variable expense component is salaries and other personnel costs. This expense component is affected by two competing factors: the need to monitor personnel changes to match the level of corresponding or anticipated new orders, and the need to provide quality service. In addition, this segment’s growth in operations that specialize in commercial, builder and lender title business has created ongoing fixed costs required to service accounts.
Information Technology. Personnel expenses in total for the Information Technology group increased 12.0% in 2006 over 2005 and 10.0% in 2005 over 2004. These increases were primarily due to $46.2 million and $65.5 million of personnel costs associated with new acquisitions for the respective periods, increased expenses incurred at the property information and First Advantage segments to service the increase in business volume, offset in part by a decline in expenses at the mortgage information segment related to the decrease in revenues.
The premium split between underwriter and agents is in accordance with their respective agency contracts and can vary from region to region due to divergencies in real estate closing practices, as well as rating structures. As a result, the percentage of title premiums retained by agents varies due to the geographical mix of revenues from agency operations.
Corporate. Corporate other operating expenses increased $36.5 million in 2006 over 2005 and $6.2 million in 2005 over 2004. These increases reflected higher general costs, primarily consulting and professional fees, associated with the support effort needed to service the Company’s national and international operations. The increase in 2006 over 2005 was also due to increased technology costs as well as expenses incurred in connection with the Company’s review of its historical stock option granting practices.
The provision for title insurance losses, expressed as a percentage of title insurance operating revenues, was 8.0% in 2006, 4.9% in 2005 and 4.1% in 2004. The increase in rate for 2006 was primarily due to a $155.0 million reserve strengthening adjustment recorded in the second quarter of 2006. This adjustment reflects a change in estimate for ultimate losses expected primarily from policy years 2002 through 2005. The change in estimate resulted primarily from higher than expected claims frequency experienced for those policy years during the first half of 2006, and included in the mid-year actuarial analysis performed by the Company’s independent actuaries. In addition, given the increase in short and long term interest rates during the first half of 2006, as well as the resulting increase in fixed and adjustable mortgage rates, the Company’s management believes that claims development patterns for policy years 2003 through 2005 may extend. Given the increase in claims frequency that became apparent during the period and the potential extension of claims development patterns, management has placed greater weight on the historical claim payment patterns (which do not fully reflect the potential impact of refinance activity) in determining the appropriate IBNR reserve. Management continues to believe that some adjustment to historical claim development patterns is appropriate to make to policy years 2002 through 2005, however, management has lowered the degree of the adjustment during the period given the factors described above. The increased rate for 2005 primarily reflected the claims intensity of policy years 2005 and 2004. The Company started 2005 with a rate of 4.1% that was applied to title insurance operating revenues for the first and second quarters of 2005. Effective July 1, 2005, the Company increased the loss provision rate to 5.0% to reflect an increase in claims intensity. During the fourth quarter 2005, the Company increased the rate to 6.2% as a result of a further increase in claims intensity, ending the year with an average annual rate of 5.0%.
Depreciation and amortization-Depreciation and amortization increased 31.4% in 2006 over 2005 and 22.1% in 2005 over 2004. These increases were primarily due to an increase in the amortization of intangibles as a result of acquisition activity and an increase in the amortization of capitalized data and software as a result of new capital expenditures. Depreciation and amortization, as well as capital expenditures for each of the Company’s segments, are summarized in Note 22 to the consolidated financial statements.
amount equal to 1.0% of their respective net operating revenues; therefore, no additional allocation was made to them. All periods presented above consistently reflect the new allocation policy.
Income taxes-The Company’s effective income tax rate (income tax expense as a percentage of pretax income after minority interest expense), was 43.3% for 2006, 40.2% for 2005 and 41.2% for 2004. The effective income tax rate includes a provision for state income and franchise taxes for noninsurance subsidiaries. The difference in the effective tax rate was primarily due to the $155 million reserve adjustment recorded in the second quarter of 2006, for which a corresponding tax benefit was recognized at 36%, as well as changes in the ratio of permanent differences to income before income taxes and minority interests and changes in state income and franchise taxes resulting from fluctuations in the Company’s noninsurance subsidiaries’ contribution to pretax profits. Information regarding items included in the reconciliation of the effective rate with the federal statutory rate is contained in Note 13 to the consolidated financial statements.
Minority interests-Minority interests in net income of consolidated subsidiaries decreased $4.7 million in 2006 from 2005 and increased $8.9 million in 2005 over 2004. These changes were primarily due to the fluctuations in the operating results of FARES, which includes certain companies in the Company’s mortgage information, property information and First Advantage segments.
On February 2, 2007, the Company’s joint venture with Experian, FARES, entered into a Credit Agreement with Wells Fargo Bank, whereby FARES borrowed $100 million for the purpose of consummating a business merger. The Company guaranteed repayment of the loan pursuant to a Continuing Guaranty, dated as of February 2, 2007, between the Company and Wells Fargo Bank, NA. The business merger involved the Company’s First American Real Estate Solutions (RES) division, a part of its FARES subsidiary, and Sacramento, Calif.-based CoreLogic Systems, Inc., a leading provider of mortgage risk assessment and fraud prevention solutions. The merger resulted in a new, combined company, majority owned by FARES. FARES owns approximately 82 percent of the economic interests of the combined company through the ownership of high vote Class B shares. CoreLogic’s stockholders own approximately 18 percent of the economic interests of the combined company through the ownership of Class A shares. In addition to the Class A shares, CoreLogic’s stockholders received cash consideration of $100 million. To finance the cash consideration, FARES has made a loan of $100 million to the combined company.
On December 31, 2004, the Company entered into a sale-leaseback transaction for certain equipment and software. The transaction totaled $122.0 million and was accounted for as a capital lease in the accompanying consolidated financial statements.
Off-balance sheet arrangements and contractual obligations. The Company administers escrow and trust deposits as a service to its customers. Escrow deposits totaled $8.7 billion and $6.2 billion at December 31, 2006 and 2005, respectively, of which $755.4 million and $639.9 million were held at the Company’s trust company and thrift company. The escrow deposits held at the Company’s trust company and thrift company are included in the accompanying consolidated balance sheets. The remaining escrow deposits were held at third-party financial institutions. Trust deposits totaled $3.3 billion and $3.0 billion at December 31, 2006 and 2005, respectively, and were held at the Company’s trust company. Escrow deposits held at third-party financial
A summary, by due date, of the Company’s total contractual obligations at December 31, 2006, is as follows:
Pursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to the Company in 2007 from its insurance subsidiaries is $285.7 million. Such restrictions have not had, nor are they expected to have, an impact on the Company’s ability to meet its cash obligations. See Note 2 to the consolidated financial statements.
Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or in the notes thereto.
We have completed integrated audits of The First American Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Also, in our opinion, management’s assessment, included in “Management’s Annual Report on Internal Control Over Financial Reporting” appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting,
The following tables set forth the effects of the restatement on certain line items within the Company’s consolidated statements of income and comprehensive income for the twelve months ended December 31, 2005, and December 31, 2004:
The following tables set forth the effects of the restatement on certain line items within the Company’s consolidated balance sheet as of December 31, 2005, December 31, 2004 and December 31, 2003:
Certain 2004 and 2005 amounts have been reclassified to conform to the 2006 presentation.
Title plants and other indexes include the Company’s title plants, flood zone databases and capitalized real estate data. Title plants and flood zone databases are carried at original cost, with the costs of daily maintenance (updating) charged to expense as incurred. Because properly maintained title plants and flood zone databases have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation or amortization. Capitalized real estate data, which is primarily used by the Company’s property information segment, is amortized using the straight-line method over estimated useful lives of 5 to 15 years. Amortization expense for the capitalized real estate data was $11.8 million, $10.2 million and $8.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company continually analyzes its title plant and other indexes for impairment. This analysis includes, but is not limited to, the effects of obsolescence, duplication, demand and other economic factors.
In connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property or judgment liens. These assets, sometimes referred to as “salvage assets,” are carried at the lower of cost or fair value less costs to sell and are included in “Other assets” in the Company’s consolidated balance sheets. The balance for these assets was $40.4 million and $49.0 million at December 31, 2006 and 2005, respectively.
Goodwill is not amortized but is tested at least annually for impairment. The Company has selected September 30 as the annual valuation date to test goodwill for impairment. As of December 31, 2006 and 2005 no indications of impairment were identified.
The Company’s intangible assets consist of covenants not to compete, customer lists, trademarks and licenses. Each of these intangible assets, excluding licenses, are being amortized on a straight-line basis over their useful lives ranging from 2 to 20 years and are subject to impairment tests on a periodic basis. Licenses are an intangible asset with an indefinite life and are therefore not amortized but rather tested annually for impairment by comparing the fair value of the license with its carrying value. The carrying value for licenses as of December 31, 2006 and 2005 is $17.7 million.
Loans receivable are impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans receivable are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral-dependent. No indications of impairment of loans receivable were identified during the three-year period ended December 31, 2006.
The Company provides for estimated title insurance losses by a charge to expense when the related premium revenue is recognized. The amount charged to expense is generally determined by applying a rate (the loss provision rate) to total title insurance operating revenues. The Company’s management estimates the loss provision rate at the beginning of each year and reassesses the rate quarterly to ensure that the resulting incurred but not reported (IBNR) loss reserve included in the Company’s consolidated balance sheets reflects management’s best estimate of the total costs required to settle all IBNR claims.
Financial Services Group-Title premiums on policies issued directly by the Company are recognized on the effective date of the title policy and escrow fees are recorded upon close of the escrow. Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent, which is generally when cash payment is received by the Company.
Information Technology Group-The Company’s tax service division defers the tax service fee and recognizes that fee as revenue ratably over the expected service period. The amortization rates applied to recognize the revenues assume a 10-year contract life and are adjusted to reflect prepayments. The Company reviews its tax service contract portfolio quarterly to determine if there have been changes in contract lives and/or changes in the number and/or timing of prepayments. Accordingly, the Company may adjust the rates to reflect current trends. Revenues earned by most other products in the Information Technology group are recognized at the time of delivery, as the Company has no significant ongoing obligation after delivery.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS 123R). This standard is a revision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. The company had previously applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Effective January 1, 2006, the Company adopted SFAS 123R, which establishes standards for share-based awards for employee services. SFAS 123R has two transition method applications to choose from and the Company selected the modified-prospective method, under which prior periods are not revised for comparative purposes. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). The cost will be recognized over the period during which an employee is required to provide services in exchange for the award. In accordance with the modified-prospective method, the Company will continue to use the same valuation method (Black-Scholes option-pricing model) currently used for its pro forma disclosures for all unvested options as of December 31, 2005. The Company has selected the binomial lattice option-pricing model to estimate the fair value for any options granted after December 31, 2005. In conjunction with the adoption of SFAS 123R, the Company changed the method of attributing the value of stock-based compensation expense from the accelerated multiple-option method to the straight-line single option method. Compensation expense for all stock-based awards granted prior to January 1, 2006, will continue to be recognized using the accelerated
Real estate activity is cyclical in nature and is affected greatly by the cost and availability of long-term mortgage funds. Real estate activity and, in turn, the majority of the Company’s revenues can be adversely affected during periods of high interest rates and/or limited money supply.
The Company administers escrow and trust deposits as a service to its customers. Escrow deposits totaled $8.7 billion and $6.2 billion at December 31, 2006 and 2005, respectively, of which $755.4 million and $639.9 million were held at the Company’s Trust Company and the Thrift. The escrow deposits held at the Company’s Trust Company and Thrift are included in the accompanying consolidated balance sheets, with $143.5 million and $75.6 million included in cash and cash equivalents and $611.9 million and $564.3 million included in debt securities at December 31, 2006 and 2005, respectively. The remaining escrow deposits were held at third party financial institutions. Trust deposits totaled $3.3 billion and $3.0 billion at December 31, 2006 and 2005, respectively, and were held at the Company’s Trust Company. Escrow deposits held at third-party financial institutions and trust deposits are not considered assets of the Company and, therefore, are not included in the accompanying consolidated balance sheets. However, the Company remains contingently liable for the disposition of these assets.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value within generally accepted accounting principles (GAAP), and expands disclosure requirements regarding fair value measurements. Although SFAS 157 does not require any new fair value measurements, its application may, in certain instances, change current practice. Where applicable, SFAS 157 simplifies and codifies fair value related guidance previously issued within GAAP. The provisions for SFAS 157 are effective for fiscal years ending after November 15, 2007, and interim periods within those fiscal years. The Company is currently assessing the impact of adopting SFAS 157 on its consolidated financial statements.
(a component of shareholders’ equity). The funded status is measured as the difference between the fair value of plan assets and benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for the other post-retirement plans). Actuarial gains and losses and prior service costs and credits that have not been recognized as a component of net periodic benefit cost as of the statement adoption date are recorded as a component of accumulated other comprehensive income. This standard also requires plan assets and obligations to be measured as of the employer’s balance sheet date. The measurement provision of this standard will be effective for years beginning after December 15, 2008, with early application encouraged. The Company is already in compliance with the measurement provisions of the standard.
Prior to the adoption of the recognition provisions of SFAS 158, the Company accounted for its defined benefit pension plans under SFAS 87. SFAS 87 required that a liability (minimum pension liability) be recorded as a non-cash charge to accumulated other comprehensive income in stockholder’s equity. Under SFAS 87, changes in the funded status were not immediately recognized; rather they were deferred and recognized ratably over future periods. Upon adoption of the recognition provisions of SFAS 158, the Company recognized the amounts of prior charges in the funded status of its post-retirement benefit plans through accumulated other comprehensive income. As a result, the Company recognized the following adjustments in individual line items of its Consolidated Balance Sheet as of December 31, 2006:
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This statement permits companies to choose to measure many financial assets and liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS 159 on its consolidated financial statements.
Investments carried at $56.3 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 2006.
The amortized cost and estimated fair value of debt securities at December 31, 2006, by contractual maturities, are as follows:
The Company had gross unrealized losses as of December 31, 2006 and December 31, 2005:
The fair value of loans receivable was $98.8 million and $94.8 million at December 31, 2006 and 2005, respectively, and was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality.
In December 2004, the Company entered into a sale-leaseback transaction for certain equipment and capitalized software. This transaction, which totaled $122.0 million, was accounted for as a capital lease. As of December 31, 2006, equipment and capitalized software with a net book value of $27.4 million and $17.3 million, respectively, including accumulated depreciation of $21.5 million and $8.0 million, respectively, were leased under a capital lease. The assets and related obligation have been included in the accompanying consolidated financial statements.
A reconciliation of the changes in the carrying amount of net goodwill, by operating segment, as of December 31, 2006, is as follows:
Estimated amortization expense for other finite-lived intangible assets anticipated for the next five years is as follows:
The fair value of notes and contracts payable was $855.3 million and $862.2 million at December 31, 2006 and 2005, respectively, and was estimated based on the current rates offered to the Company for debt of the same remaining maturities. The weighted-average interest rate for the Company’s notes and contracts payable was 6.2% and 6.1% at December 31, 2006 and 2005, respectively.
the applicable taxing jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings. The increase in the valuation allowance primarily results from current year losses from foreign subsidiaries.
As of December 31, 2006, United States taxes were not provided for the earnings of our foreign subsidiaries, as the Company has invested or expects to invest the undistributed earnings indefinitely. If in the future these earnings are repatriated to the United States, or if the Company determines that the earnings will be remitted in the forseeable future, additional tax provisions may be required.
The Savings Plan allows for employee-elective contributions up to the maximum deductible amount as determined by the Internal Revenue Code. The Company makes discretionary contributions to the Savings Plan based on profitability, as well as contributions of the participants. The Company’s expense related to the Savings Plan amounted to $35.9 million, $66.3 million and $58.3 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Savings Plan allows the participants to purchase the Company’s stock as one of the investment options. The Savings Plan held 10,441,000 and 11,611,000 shares of the Company’s common stock, representing 10.8% and 12.1% of the total shares outstanding at December 31, 2006 and 2005, respectively.
(1) Disclosures not applicable as of December 31, 2006 due to the adoption of SFAS 158.
The Company expects to make cash contributions to its pension plans of approximately $34.0 million during 2007.
The following table summarizes stock option activity related to the Company’s plans:
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS 123R), which establishes standards for share-based awards for employee services and requires companies to expense the grant-date fair value of these awards (with limited exceptions) over the requisite employee service period. SFAS 123R has two transition method applications to choose from and the Company selected the modified-prospective method, under which prior periods are not revised for comparative purposes. Share-based compensation expense included in salaries and other personnel costs recognized during the twelve months ended December 31, 2006, was $25.7 million, $13.1 million after tax and minority interest or $0.13 per diluted share. This amount includes expense for all share-based payments granted prior to, but not yet vested as of December 31, 2005, as well as share-based awards granted during the twelve months ended December 31, 2006.
Total intrinsic value of options exercised for the twelve months ended December 31, 2006, 2005 and 2004 was $7.6 million, $53.8 million and $23.0 million, respectively. This intrinsic value represents the difference between the fair market value of the Company’s common stock on the date of exercise and the exercise price of each option.
As of December 31, 2006, there was $1.4 million of total unrecognized compensation cost related to nonvested restricted stock units that is expected to be recognized over a weighted-average period of 4.3 years. Restricted stock units and activity for the twelve months ended December 31, 2006, is as follows:
The Company has an employee stock purchase plan that allows eligible employees to purchase common stock of the Company at 85.0% of the closing price on the last day of each month. Under the provisions of SFAS 123R, the Company recognized an expense of $1.0 million for the twelve months ended December 31, 2006.
Future minimum rental payments under operating and capital leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2006 are as follows:
Total rental expense for all operating leases and month-to-month rentals was $313.2 million, $280.4 million and $259.0 million for the years ended December 31, 2006, 2005 and 2004, respectively.
On May 18, 2004, the Company announced that its Board of Directors adopted a plan authorizing the repurchase of $100 million of its common shares. On May 19, 2005, the Company announced an amendment to this plan increasing the amount of shares that the Company may repurchase to $200 million. On June 26, 2006, the Company announced a further amendment to this plan, increasing the amount of shares that may be
repurchased to $500 million. Between inception of the plan and December 31, 2006, the Company had repurchased and retired 3.9 million of its common shares for a total purchase price of $133.7 million.
The Company and its subsidiaries have been named in various class action lawsuits related to their title insurance operations, including a number of cases alleging that the Company failed to charge the correct rate for title insurance policies issued in refinance transactions. In cases where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure for each case based on facts known to the Company. As of December 31, 2006, the Company’s estimate of its range of exposure with respect to these lawsuits was $2.5 million to $8.7 million in the aggregate. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies” (FAS 5), the Company maintained reserves for these lawsuits totaling $8.6 million and $9.6 million at December 31, 2006 and 2005, respectively. Expense recognized relating to these matters totaled $9.4 million, $6.6 million and $3.0 million in 2006, 2005 and 2004, respectively. Actual losses may materially differ from the amounts recorded. The Company does not believe that the ultimate resolution of these cases, either individually or in the aggregate, will have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
On January 25, 2005, a jury in the case of Chicago Title Insurance Corporation v. James A. Magnuson, et al. awarded damages in the amount of $43.2 million against a subsidiary of the Company. This matter involved
The Company’s title insurance, property and casualty insurance, home warranty, thrift, trust and investment businesses are regulated by various federal, state and local governmental agencies. Many of the Company’s other businesses operate within statutory guidelines. Consequently, the Company may from time to time be subject to audit or investigation by such governmental agencies. Currently, governmental agencies are auditing or investigating certain of the Company’s operations. These audits or investigations include inquiries into, among other matters, pricing and rate setting practices in the title insurance industry, competition in the title insurance industry and title insurance customer acquisition and retention practices. With respect to matters where the Company has determined that a loss is both probable and reasonably estimable, the Company has recorded a liability representing its best estimate of the financial exposure for each matter based on facts known to the Company. As of December 31, 2006, the Company’s estimate of its range of exposure with respect to these matters was $15.5 to $30.5 million in the aggregate. In accordance with FAS 5, the Company maintained reserves for these matters totaling $18.5 million and $0 at December 31, 2006 and 2005, respectively. Expense recognized relating to these matters totaled $18.5 million, $5.0 million, and $0 in 2006, 2005 and 2004, respectively. While the ultimate disposition of each such audit or investigation is not yet determinable, the Company does not believe that individually or in the aggregate, they will have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These audits or investigations could result in changes to the Company’s business practices which could ultimately have a material adverse impact on the Company’s financial condition, results of operations or cash flows.
On September 14, 2005, the Company contributed its Credit Information Group to First Advantage in exchange for approximately 29.1 million shares of First Advantage Class B common stock. All of the parties
Commencing in the second quarter of 2006, the Company began allocating certain expenses which had previously been reported as corporate expenses to the title insurance, specialty insurance, mortgage information and property information segments. These expenses include costs associated primarily with a supplemental employee retirement plan, stock option expense and certain general expenses. The expenses associated with the supplemental retirement plan and the stock option plan were allocated to each segment based on actual costs. The
The Company merged its First American Real Estate Solutions (RES) division, a part of its FARES subsidiary, with Sacramento, Calif.-based CoreLogic Systems, Inc., a leading provider of mortgage risk assessment and fraud prevention solutions. The new, combined company is majority owned by the Company through its FARES joint venture with Experian. FARES owns approximately 82% of the economic interests of the combined company through the ownership of high vote Class B shares. CoreLogic’s stockholders own approximately 18% of the economic interests of the combined company through the ownership of Class A shares. In addition to the Class A shares, CoreLogic’s stockholders received cash consideration of $100 million. To finance the cash consideration, FARES has made a loan of $100 million to the combined company. FARES secured bank financing for the $100 million loan to the combined company.
As discussed in Note 1 to the consolidated financial statements included in this Form 10-K, the Company has restated certain prior year financial statements to correct for errors in the accounting for stock options. The Company's quarterly financial statements for the periods ended June 30 and September 30, 2005, were previously restated in the Company's quarterly reports on Form 10-Q for the respective periods in 2006. The restatement also impacts the quarters ended March 31, 2006 and 2005 and the quarter ended December 31, 2005, each of which are restated herein and will be reflected as such in future filings. In addition, each of the four quarters in the year ended December 31, 2004, are restated herein. Management believes that the impact of the restatement on each of the aforementioned quarterly periods is not material.