ITEM 1. BUSINESS
Fidelity National Financial, Inc., through its principal subsidiaries (collectively, the "Company"), is one of the largest national underwriters engaged in the business of issuing title insurance policies and performing other real estate related services such as escrow, collection and trust activities, real estate information and technology services, trustee sale guarantees, credit reporting, attorney services, flood certification, tax monitoring, home warranty insurance, reconveyances, recordings, foreclosure publishing and posting services and exchange intermediary services in connection with real estate transactions. Title insurance services are provided through the Company's direct operations and otherwise through independent title insurance agents who issue title policies on behalf of the underwriting subsidiaries. Title insurance is generally accepted as the most efficient means of determining title to, and the priority of interests in, real estate in nearly all parts of the United States. Today, virtually all real property mortgage lenders require their borrowers to obtain a title insurance policy at the time a mortgage loan is made or to allow the sale of loans in the secondary market.
The Company's principal subsidiaries consist of Fidelity National Title Insurance Company ("Fidelity Title"), Fidelity National Title Insurance Company of New York ("Fidelity New York"), Alamo Title Insurance ("Alamo Title"); (collectively, the "Insurance Subsidiaries"); its wholly-owned underwritten title companies (collectively, the "UTCs"); and its network of wholly-owned title-related ancillary service companies known as Fidelity National Lender Express Network ("FLEXNet"). The Company also originates, funds, purchases, sells, securitizes and services equipment leases for a broad range of businesses through its wholly-owned subsidiary Granite Financial, Inc.
Fidelity Title was the parent company of Fidelity National Title Insurance Company of Tennessee ("Fidelity Tennessee"), Fidelity National Title Insurance Company of California ("Fidelity California") and Nations Title Insurance Company ("Nations Title"). Fidelity Tennessee, Fidelity California and Nations Title were merged into Fidelity Title on December 31, 1998, August 7, 1997 and December 29, 1997, respectively. Fidelity New York is the parent company of Nations Title Insurance of New York Inc. ("Nations New York") and National Title Insurance of New York Inc. ("National"). Fidelity National Title Insurance Company of Pennsylvania ("Fidelity Pennsylvania") was merged into Fidelity New York as of April 11, 1997, which in turn, was the parent company of American Title Insurance Company ("ATIC"), which was merged into Fidelity Pennsylvania as of November 21, 1996.
Nations Title Insurance Company, Nations Title Insurance of New York Inc. and National Title Insurance of New York Inc. were acquired, along with Nations Title Inc. ("NTI," collectively, "Nations Title Inc."), in a transaction which closed on April 1, 1996. Certain of the ancillary service companies were acquired in separate transactions during 1996 and 1997. Granite Financial, Inc. and subsidiaries ("Granite") was acquired in a transaction which closed on February 26, 1998. Alamo Title was acquired in connection with the Company's acquisition of Alamo Title Holding Company and subsidiaries ("Alamo") in a transaction which closed August 20, 1998.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments" and Note B of Notes to Consolidated Financial Statements.
INDUSTRY OVERVIEW
TITLE POLICIES. Title insurance policies state the terms and conditions upon which a title underwriter will insure title to real estate. The beneficiaries of title insurance policies are generally buyers of real property or mortgage lenders. Most mortgage lenders require title insurance as a condition to making loans secured by real estate.
Title insurance is different from other types of insurance because it relates to past events which affect title to property at the time of closing and not unforeseen future events. Prior to issuing policies, underwriters can reduce or eliminate future losses by accurately performing searches and examinations. Title insurance policies are issued on the basis of a preliminary title report or commitment. These reports are prepared after a search
of public records, maps and other relevant documents to ascertain title ownership and the existence of easements, restrictions, rights of way, conditions, encumbrances or other matters affecting the title to, or use of, real property. A visual inspection or survey of the property may also be made prior to the issuance of certain title insurance policies. To facilitate the preparation of preliminary reports without the necessity of manually searching public records, copies of public records, maps and other relevant historical documents are compiled and indexed in a "title plant." Each title plant relates to a particular county and is kept current on a daily or other periodic basis by the continual addition of copies of recorded documents which affect real property in the particular county. Title companies often subscribe to independent title information services to assist in the updating of their title plants and the maintenance of title records.
The premium for title insurance is due in full at the closing of the real estate transaction and is based upon the purchase price of the property insured or the amount of the mortgage loan. The major expense of a title company is the search and examination function in preparing preliminary title reports, commitments and title policies, and not from claim losses associated with the issuance of said policies. Claim losses generally result from errors or mistakes made in the title search and examination process, hidden defects such as fraud, forgery, incapacity, missing heirs or errors made in the escrow process. Coverage under the policy generally terminates upon resale or refinance of the property. The terms of coverage have become relatively standardized in accordance with forms approved by state or national trade associations.
DIRECT AND AGENCY OPERATIONS. The Company's title reports and commitments are issued either directly, by the Insurance Subsidiaries or UTCs, or by independent agents working on behalf of the Insurance Subsidiaries. The terms and conditions upon which the real property will be insured are determined in accordance with the underwriting standards, policies and procedures of the title underwriter. In direct operations, the title underwriter issues the title insurance policy and retains the entire premium paid in connection with the transaction. In agency operations, the search and examination function is performed by an independent agent. The majority of the title premium collected is retained by the agent with the balance remitted to the title underwriter for bearing the risk of loss in the event that a claim is made under the title insurance policy. Independent agents may select among several title underwriters based upon the amount of the premium "split" offered by the underwriter, the overall terms and conditions of the agency agreement and the scope of services offered to the agent. Premium splits vary be geographic region.
THE TITLE POLICY PROCESS. A brief description of the process of issuing a title insurance policy, which usually occurs over a thirty to ninety day period, is as follows:
(i) The customer, typically a real estate salesperson or broker, escrow agent or lender, places an order for a title policy.
(ii) The specifics of the order are noted and a request is placed with the title department for a preliminary report.
(iii) After the relevant historical data on the property is compiled, the title officer prepares a preliminary title report which documents (a) the current status of title and conditions affecting the property, (b) any exclusions, exceptions and/or limitations which the title underwriter might include in the policy and (c) specific issues which need to be addressed and resolved by the parties to the transaction before the title policy will be issued. The preliminary report is circulated to all the parties for satisfaction of any specific issues.
(iv) After the specific issues identified in the preliminary report are satisfied, an escrow agent closes the transaction in accordance with the instructions of the parties and the title underwriter's conditions.
(v) Once the transaction is closed and all monies have been released, the title underwriter issues the policies (a) to the owner and the lender on a new home sale or resale transaction or (b) to the lender only, on a refinance transaction.
LOSSES AND RESERVES. The maximum amount of liability under a title insurance policy is usually the face amount of the policy plus the cost of defending the insured's title against an adverse claim. The reserve for claim losses is based upon known claims, as well as losses the insurer expects to incur based on historical
experience and other factors, including industry averages, claim loss history, legal environment, geographic considerations, expected recoupments and the types of policies written. The title underwriter establishes a reserve for each known claim based on a review and evaluation of potential liability.
ECONOMIC FACTORS AFFECTING INDUSTRY. Title insurance revenue is closely related to the level of real estate activity and the average price of real estate sales. Real estate sales are directly affected by the availability of funds to finance purchases, i.e., mortgage interest rates. Other factors affecting real estate activity include demand, family income levels and general economic conditions. While the level of sales activity was relatively depressed in certain geographical areas during the period 1991 through mid-1993, lower mortgage interest rates beginning in the latter part of 1991 triggered an increase in refinancing activity which continued at then record levels through 1993 and into the first quarter of 1994. During 1994 and early 1995, steady interest rate increases caused by actions taken by the Federal Reserve Board, resulted in a significant decline in refinancing transactions and a stagnation in residential resales and new home sales. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a favorable effect on the level of real estate activity, including refinancing transactions, new home sales and resales. The overall economic environment, stable mortgage interest rates and strength in the real estate market, especially in California and on the West Coast, contributed to very positive conditions for the industry throughout 1996, 1997 and 1998. It is impossible to predict in what future direction interest rates and the real estate market may move or fluctuate.
TITLE INSURANCE OPERATIONS
The Insurance Subsidiaries are currently licensed to issue title insurance policies through direct operations and independent agents in all states (with the exception of Iowa, where title insurance is not legally permitted) the District of Columbia, the Virgin Islands and Puerto Rico.
The Company maintains direct operations in Alabama, Arizona, California, Florida, Georgia, Hawaii, Nevada, New Jersey, New Mexico, New York, North Carolina, Oregon, Pennsylvania, South Carolina, Tennessee, Texas and Washington. Direct operations are divided into approximately 90 branches consisting of more than 410 offices. Each branch processes title insurance transactions within its geographical area, which is usually a county boundary. Each branch is operated as a separate profit center.
The Company also transacts title insurance business through a network of approximately 2,900 agents, primarily in those areas in which agents are the more accepted title insurance provider.
The following table sets forth for the years 1998, 1997 and 1996, respectively, the approximate dollars and percentages of title insurance premium revenue by state according to records maintained by the Company:
For the entire title insurance industry, 12 states accounted for 72.4% of title premiums written in the United States in 1997. California represented the single largest state with 18.2%. The Company is licensed and has operations in all 12 of these states.
MARKETING. The Company markets and distributes its products and services to customers in the residential, institutional lender and commercial market sectors of the real estate industry. The Company attempts to increase the volume of its title insurance business primarily through customer solicitation by sales personnel. The Company actively encourages its personnel to develop new business relationships with persons in the real estate community, such as real estate sales agents and brokers, financial institutions, independent escrow companies and title agents, real estate developers, mortgage brokers and attorneys. The Company's marketing efforts are also assisted by general advertising. The Company believes customer service is the most important factor in attracting and retaining customers and measures customer service in terms of quality and timeliness in the delivery of services.
DIRECT AND AGENCY OPERATIONS. Preliminary title reports and commitments to issue policies are prepared by title underwriters or wholly-owned underwritten title companies (direct operations) or by independent agents on behalf of the underwriters (agency operations). The terms and conditions upon which the real property will be insured are determined in accordance with the underwriting standards, policies and procedures of the title underwriter. In direct operations, the title underwriter issues the title insurance policy and retains the entire premium paid in connection with the transaction. In agency operations, the search and examination function is performed by an independent agent. The majority of the title premium collected is retained by the agent with the balance remitted to the title underwriter. Independent agents may select among several title underwriters based upon the amount of the premium "split" offered by the underwriter, the overall terms and conditions of the agency agreement and the scope of services offered to the agent. Premium splits vary by geographic region. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview, Revenue, Expenses and Recent Developments."
Prior to the acquisition of the Nations Title Inc. group of companies, which was completed on April 1, 1996, the Company generated the majority of its revenue from its network of direct operations as opposed to agency relationships, the latter being more common in the title industry. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview and Recent Developments." The Company's direct operations generate higher margins than agency operations because the Company retains the entire premium from each transaction instead of paying commissions to agents and claim losses are less than in agency based operations because the Company controls the issuance of the title policy. Direct operations also provide additional sources of income, such as escrow fees, collection and trust fees, real estate information and technology service fees, trustee sale guarantee fees, credit reporting fees, attorney service fees, flood certification fees, tax monitoring fees, home warranty insurance premiums, reconveyance fees, recording fees, foreclosure publishing and posting service fees and exchange intermediary service fees in connection with real estate transactions.
Effective July 1, 1997, the Company sold a majority interest (60%) of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. ATC functions as an exclusive agent of the Company. As a result of a tax free reorganization of American National Financial, Inc. ("ANFI"), the parent company of ATC and its subsidiaries, in November 1998, the Company's interest in ATC was converted to an ownership interest of approximately 43% of ANFI. Subsequent to ANFI's initial public offering in February 1999, the Company's ownership interest in ANFI became approximately 31.5%. Additionally, on March 18, 1998, the Company announced that it had entered into an agreement to sell National Title Insurance of New York Inc. to ATC for $3.25 million, subject to regulatory approval and certain other conditions. National was acquired in April 1996, as part of the Nations Title Inc. acquisition, and has not been actively underwriting policies since the transaction closed. This transaction has not yet received regulatory approval. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments" and Notes C and L of Notes to Consolidated Financial Statements.
The relationship between the Company and each agent is governed by an agency agreement which states the conditions under which the agent is authorized to issue a title insurance policy on behalf of the Company. The agency agreement also prescribes the circumstances under which the agent may be liable to the Company if a policy loss is attributable to errors made by the agent. The agency agreement typically is terminable upon 30 days' notice or immediately for cause. In determining whether to engage or retain an independent agent the
Company considers the agent's experience, financial condition and loss history. Loss history is an important consideration in the Company's decision to initiate or continue agency relationships. The Company maintains financial and loss experience records for each agent and conducts periodic audits of its agents.
On April 1, 1996, the Company completed its acquisition of one hundred percent of Nations Title Inc. and its wholly-owned subsidiaries. The acquisition positioned the Company as the nation's fourth largest title insurance underwriter. The combination of the Company's direct operations and Nations Title Inc.'s strong agency network provides a balance to the Company's title premium revenue between direct and agency, as well as a hedge against future market downturns. The acquisition of Nations Title Inc. has also increased the Company's revenue and positively impacted its balance sheet and margins due to the operating economies of the combined companies. The acquisition has also increased market share in areas where the Company has had a limited presence, particularly in those areas where business is primarily agent driven, as well as in states where the Company has a strong market position.
The acquisition of Alamo Title Holding Company and subsidiaries, which closed on August 20, 1998, provided additional balance between the Company's direct and agency operations with the strength of Alamo's direct and agency operations in the important Texas market. As a result of its acquisitions of Nations Title Inc. and Alamo, the Company has significantly expanded the national scope of its core title operations by expanding its direct operations in key markets and balancing the mix of its direct and agency operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview, Revenue and Recent Developments."
ESCROW, TRUST AND OTHER TITLE-RELATED SERVICES. The Company holds funds and documents in real estate transactions for delivery upon closing pursuant to the instructions of the respective parties to an escrow. The Company derives revenue from other ancillary services generated from direct operations, such as collection and trust fees, real estate information and technology service fees, trustee sale guarantee fees, credit reporting fees, attorney service fees, flood certification fees, tax monitoring fees, home warranty insurance premiums, reconveyance fees, recording fees, foreclosure publishing and posting service fees and exchange intermediary service fees in connection with real estate transactions.
In a few cases, the Company leases its title plants to independent agents for their examination of title records for a rental or usage fee.
UNDERWRITING, LOSSES AND RESERVES. The Company believes that the level of risk undertaken pursuant to its underwriting standards is consistent with that of the industry. The maximum amount of liability under a title insurance policy is usually the face amount of the policy plus the cost of defending the insured's title against an adverse claim. The Company's reserve for claim losses includes known claims as well as losses the Company expects to incur, net of recoupments. Each known claim is reserved for on the basis of 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 provided for at the time premium revenue is recognized based on historical loss experience and other factors, including industry averages, claim loss history, legal environment, geographic considerations and types of policies written. The occurrence of a significant major claim (those greater than $500,000) in any given period could have a material adverse effect on the Company's financial condition and results of operations for such period. See "Reinsurance."
If a loss is related to a policy issued by an independent agent, the Company may proceed against the independent agent pursuant to the terms of the agency agreement. In any event, the Company may proceed against third parties who are responsible for any loss sustained under the title insurance policy under rights of subrogation.
The Company believes that its quality controls and underwriting standards have helped minimize its net title claims paid. The Company further reduces its losses by following aggressive recoupment procedures under rights of subrogation or warranties and by carefully reviewing all claims. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Expenses." There can be no assurance that the Company's current paid loss experience will continue at these levels.
Courts and juries sometimes award damages against insurance companies, including title insurance companies, in excess of policy limits. Such awards are typically based on allegations of fraud, misrepresentation, deceptive trade practices or other wrongful acts commonly referred to as "bad faith." Although the Company has not experienced damage awards materially in excess of policy limits, the possibility of such bad faith damage awards may cause the Company to experience increased costs and difficulty in settling title claims.
The Company generally pays losses in cash. In some instances claims are settled by purchasing the interest of the insured in the real property or the interest of the adverse claimant. Such interests are generally recorded as an asset on the Company's books at the lower of cost or fair value less selling costs and any related indebtedness is carried as a liability. At December 31, 1998, the amount of these interests was $8.8 million.
The Company also accrues reserves for losses arising from the escrow, closing and disbursement functions due to fraud or operational error based on historical experience.
REINSURANCE. In the ordinary course of business, the Company reinsures certain risks with other title insurers for the purpose of limiting its maximum loss exposure and also assumes reinsurance for certain risks of other title insurers for the purpose of earning additional income. The Company cedes or assumes a portion of certain policy liabilities under agent fidelity, excess of loss and case-by-case reinsurance agreements. Reinsurance agreements provide that the reinsurer is liable for loss and loss adjustment expense payments exceeding the amount retained by the ceding company. However, the ceding company remains primarily liable in the event the reinsurer does not meet its contractual obligations. See Note A of Notes to Consolidated Financial Statements.
COMPETITION. The title insurance industry is highly competitive. The number and size of competing companies varies in the different geographic areas in which the Company conducts its business. In the Company's principal markets, competitors include other major title underwriters such as Chicago Title Corporation, First American Financial Corporation, LandAmerica Financial Group, Inc., Old Republic International Corporation and Stewart Information Services Corporation, as well as numerous independent agency operations at the regional and local level. These smaller companies may expand into other markets in which the Company competes. Also, the removal of regulatory barriers in the future might result in new competitors entering the title insurance business that have greater financial resources and other competitive advantages. Competition among the major title insurance companies, expansion by smaller regional companies and any new entrants could affect the Company's business operations and financial condition.
Competition is based primarily on the quality and timeliness of service, since the parties to a real estate transaction are usually concerned with time schedules and costs associated with delays in closing the transaction. In those states where prices are not established by regulatory authorities the price of the title insurance policy is also a competitive factor. The Company believes that its competitive position is enhanced by its quality customer service and pricing.
REGULATION. Title insurance companies, including underwriters, underwritten title companies and independent agents, are subject to extensive regulation under applicable state laws. Each insurance underwriter is usually 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 requirements, defining suitable investments for reserves, capital and surplus and approving rate schedules. In 1998, the National Association of Insurance Commissioners approved codified accounting practices that changed the definition of what constitutes prescribed statutory accounting practices and will result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements commencing in 2001. The Company is currently evaluating the impact of the rules.
Pursuant to statutory accounting requirements of the various states in which the Insurance Subsidiaries are licensed, they must defer a portion of premiums earned as an unearned premium reserve for the protection
of policyholders and must maintain qualified assets in an amount equal to the statutory requirements. The level of unearned premium reserve required to be maintained at any time is determined on a quarterly basis by statutory formula based upon either the age, number of policies and dollar amount of policy liabilities underwritten or the age and dollar amount of statutory premiums written. As of December 31, 1998, the combined statutory unearned premium reserve required and reported for the Insurance Subsidiaries was $207.2 million.
The Insurance Subsidiaries are regulated by the insurance commissioners of their respective states of domicile. Regulatory examinations usually occur at three year intervals. Examinations are currently in progress for Fidelity Title (1998, which was previously scheduled for 1997 but will now be as of 1998), Fidelity New York (1996), Nations New York (1996) and National (1996). The Company has not received preliminary reports of examination for Fidelity Title, Fidelity New York, Nations New York or National, as the examinations are currently ongoing. Additionally, the Auditor Division of the Controller of the State of California is currently conducting an audit of the funds due the State of California under various escheatment regulations for the years ended December 31, 1998 and prior. The Company has not yet received a preliminary report as the audit is ongoing. The Company does not believe that either the audits performed by the insurance regulators or the Controller of the State of California will have a material impact on its financial position, its results of operations or its combined statutory capital and surplus.
Statutorily calculated net worth determines the maximum insurable amount under any single title insurance policy. As of January 1, 1999, the Company's self-imposed single policy maximum insurable amounts, which comply with all statutory limitations, for Fidelity Title, Fidelity New York and Alamo Title were $60.0 million, $90.0 million and $17.5 million, respectively. The self-imposed single policy maximum insurable amounts for Nations New York and National were $19.0 million and $5.0 million, respectively.
The Insurance Subsidiaries are subject to regulations that restrict their ability to pay dividends or make other distributions of cash or property to their immediate parent company without prior approval from the Department of Insurance of their respective states of domicile. In the case of Fidelity Title, the total amount of dividends made in any twelve-month period may not exceed the greater of 10% of the surplus as regards policyholders as of the last day of the preceding year or net earnings for the twelve-month period ending the last day of the preceding year. In the case of Fidelity New York, the total amount of dividends and distributions is limited to surplus as regards policyholders, excluding capital stock and surplus resulting from unrealized gains on investments, less fifty percent of statutory premium reserve as of the last day of the preceding year and capital contributions received in the latest five-year period. In the case of Alamo Title, the total amount of dividends made in any twelve-month period may not exceed the greater of 20% of the surplus as regards policyholders as of the last day of the preceding year or net earnings for the twelve-month period ending the last day of the preceding year. As of January 1, 1999, Fidelity Title could pay dividends or make other distributions to the Company of $10,588,000, Fidelity New York could pay dividends or make other distributions to the Company of $13,325,000 and Alamo Title could pay dividends or make other distributions to the Company of $9,064,000.
The combined statutory capital and surplus of the Insurance Subsidiaries was $164,953,000, $122,107,000 and $97,845,000 as of December 31, 1998, 1997 and 1996, respectively. The combined statutory earnings of the Insurance Subsidiaries were $37,771,000, $26,701,000 and $12,243,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
As a condition to continued authority to underwrite policies in the states in which the Insurance Subsidiaries conduct their business, the Insurance Subsidiaries 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 Insurance Subsidiaries are domiciled, they must maintain certain levels of minimum capital and surplus. Each of the Company's title underwriters have complied with the minimum statutory requirements as of December 31, 1998. See Note L of Notes to Consolidated Financial Statements.
The UTCs are also subject to certain regulation by insurance regulatory or banking authorities, primarily relating to minimum net worth. Minimum net worth of $7.5 million and $2.5 million is required for Fidelity National Title Company ("FNTC") and Fidelity National Title Company of California ("FNCAL"), respectively. FNTC and FNCAL are in compliance with their respective minimum net worth requirements at December 31, 1998.
RATINGS
The Insurance Subsidiaries are regularly assigned ratings by independent agencies designed to indicate their financial condition and/or claims paying ability. Financial data and other information are supplied to the rating agencies and subjected to quantitative and qualitative analyses from which the ratings are derived. Ratings of the Company's principal Insurance Subsidiaries, as assigned during 1998 and 1999, are listed below:
INVESTMENT POLICIES AND INVESTMENT PORTFOLIO
The Company's investment policy is designed to maintain a high quality portfolio, maximize income, minimize interest rate risk and match the duration of the portfolio to the Company's liabilities. The Company also makes investments in certain equity securities in order to take advantage of perceived value and for strategic purposes. Most of the Company's investment assets qualify as "admitted assets" and for purposes of capital and surplus and unearned premium reserves as prescribed by various state insurance regulations. These investments are restricted by the state insurance regulations of their domiciliary states and are limited primarily to cash and cash equivalents, federal and municipal governmental securities, mortgage loans, certain investment grade debt securities, equity securities and real estate. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
As of December 31, 1998 and 1997, the carrying amount, which approximates the fair value, of total investments was $510.5 million and $358.4 million, respectively.
It is the practice of the Company to purchase investment grade fixed maturity securities, selected non-investment grade fixed maturity securities and equity securities. The securities in the Company's portfolio are subject to economic conditions and normal market risks and uncertainties.
The following table sets forth certain information regarding the investment ratings of the Company's fixed maturity portfolio at December 31, 1998 and 1997:
- --------------- (1) Ratings as assigned by Standard & Poor's Corporation
The following table sets forth certain information regarding the Company's fixed maturity securities at December 31, 1998. Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Fixed maturity securities with an amortized cost of $47,491,000 and a fair value of $48,600,000 were callable at December 31, 1998:
Equity securities at December 31, 1998 and 1997 consist of investments in various industry groups as follows:
The Company's investment results for the years ended December 31, 1998, 1997 and 1996 were as follows:
- --------------- (1) Excludes investments in real estate. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Revenue."
(2) Net investment income as reported in the Consolidated Statements of Earnings has been adjusted in the presentation above to provide the tax equivalent yield on tax exempt investments and to exclude net realized capital gains on the sale of investments and other assets. Net realized capital gains totalled $17,190,000, $16,839,000 and $2,476,000 in 1998, 1997 and 1996, respectively.
REAL ESTATE AND PROPERTY MANAGEMENT OPERATIONS
The Company, principally through Manchester Development Corporation ("Manchester", currently doing business as Orion Realty Group), a wholly-owned subsidiary of the Company, previously invested in various real estate projects directly and through partnerships. Some of these partnerships involve related parties. See Notes F and G of Notes to Consolidated Financial Statements. Manchester currently assists in the identification and leasing of space for operating purposes and manages property owned by the Company. The Company's investments in real estate and partnerships represented approximately 0.5% of the Company's assets at December 31, 1998.
EMPLOYEES
As of December 31, 1998, the Company had approximately 7,400 full-time equivalent employees. The Company believes that its relations with employees are generally good.
YEAR 2000 ISSUES
Information technology is an integral part of the Company's business. The Company also recognizes the critical nature of and the technological challenges associated with the Year 2000 issue. The Year 2000 issue ("Y2K") results from computer programs and computer hardware that utilize only two digits to identify a year in the date field, rather than four digits. If such programs or hardware are not modified or upgraded information systems could fail, lock up, or in general fail to perform according to normal expectations. The Company has implemented a program and committed both personnel and other resources to determine the extent of potential Y2K issues. Included within the scope of this program are systems used in title plants, title policy processing, escrow production, claims processing, real estate related services, financial management, human resources, payroll and infrastructure. In addition to a review of internal systems, the Company has initiated formal communications with third parties with which it does business in order to determine whether or not they are Y2K compliant and the extent to which the Company may be vulnerable to third parties' failure to become Y2K compliant. The Company is in the process of identifying Y2K compliant issues in its systems, equipment and processes. The Company is making changes to such systems, updating or replacing such equipment, and modifying such processes to make them Y2K compliant.
The Company has developed a four phase program to become Y2K compliant. Phase I is, "Plan Preparation and Identification of the Problem." This is an ongoing phase that will continue beyond the year 2000 itself. Phase II is, "Plan Execution and Remediation." Phase III is, "Testing." Phase IV is, "Maintaining Y2K Compliance." The Company anticipates that its systems processes will be substantially Y2K compliant by July 1999. The status of the Y2K compliance program is monitored by senior management of the Company and by the Audit Committee of the Company's Board of Directors. The costs of the Y2K related efforts incurred to date have not been material, and the estimate of remaining costs to be incurred is not considered to be material. Due to the complexities of estimating the cost of modifying applications to become Y2K compliant and the difficulties in assessing third parties', including various local governments upon which the Company relies upon to provide title-related data, ability to become Y2K compliant, estimates may be subject to change.
Management of the Company believes that its electronic data processing and information systems will be Y2K compliant; however, there can be no assurance that all of the Company's systems will be Y2K compliant, that the costs to be Y2K compliant will not exceed management's current expectations, or that the failure of such systems to be Y2K compliant will not have a material adverse effect on the Company's business. The Company believes that functions currently performed with the assistance of electronic data processing
equipment could be performed manually or outsourced if certain systems were determined not to be Y2K compliant on or after January 1, 2000.
The Company has not yet completed a contingency plan in the event that any systems are not Y2K compliant, but will do so once the Phase III process of its compliance program is begun. We expect this contingency plan to be complete by July 1999.
This entire section "Year 2000 Issues" is hereby designated a "Year 2000 Readiness Disclosure", as defined in the Year 2000 Information and Readiness Disclosure Act.
RISK FACTORS
The risk factors listed in this section and other factors noted below could cause the Company's actual results to differ materially from those contained in any forward-looking statements. Risk factors include, but are not limited to:
Real Estate Market and Interest Rate Sensitivity
The level of title insurance and real estate related services activity is dependent upon, among other things, the volume of real estate transactions. The volume of real estate transactions nationally and within particular geographic regions has historically been influenced by such factors as the overall interest rate environment (which impacts the availability of capital for investment in real estate, particularly in the commercial refinancings as well as the number of sales), the strength of the national and/or regional economy and family income levels. Recently, historically low interest rates have resulted in an increased number of real estate sales, resales and refinancings. However, when interest rates increase, real estate activity typically declines and the title insurance industry tends to experience lower revenues. Moreover, a favorable interest rate environment or trend may not necessarily result in increased levels or continued high levels of real estate transactions if other market factors (such as a recessionary economy or increased unemployment) combine to depress the volume of real estate transactions. Accordingly, no assurance can be given that historical levels of premiums and fees previously received by the Company will be available in the future.
Geographic Concentration
Part of the Company's strategy has been to expand its market share and increase its title insurance premiums and other real estate related revenue in the key real estate markets of California, Texas, Florida and New York. Approximately 67.4% of the Company's title insurance premium revenue was generated from real estate transactions in those states in 1998. This geographic concentration makes the Company susceptible to the risk that adverse economic conditions or other factors affecting the real estate markets in these areas, even with a strong national economy, could have a more pronounced adverse affect on its premium and fee revenues than if its revenue base were more broadly dispersed across the country.
Risks Associated With Acquisitions
Part of the Company's strategy is to pursue opportunities to diversify and expand its operations by acquiring or making investments in other companies. Acquisitions involve a number of risks that could adversely effect the Company's operations, including the diversion of management's attention and the integration of the operations and personnel of the acquired companies. If the Company acquires other business operations, the Company cannot be certain that such businesses will be successful, that they will enhance the Company's existing business or that the Company will not incur significant expenses, including goodwill, relating to such acquisitions. The Company may be required to sell additional securities or borrow additional funds to complete any significant acquisitions. The sale of additional equity or debt securities may dilute stockholder interests in or increase the leverage of the Company.
Risks Associated With New Business Lines
The Company has acquired, and may in the future acquire, businesses in industries with which management is less familiar than the title insurance industry. For example, in February 1998, the Company acquired Granite Financial, Inc., whose primary business is financing equipment leases. Also, in the last three years, the Company has expanded the range and amount of ancillary title and real estate related services it provides, began underwriting home warranty policies, invested in restaurant businesses, expanded its commercial title insurance business and considered acquiring underwriters of other lines of insurance products. These activities involve risks that could adversely affect the Company's operating results, such as diversion of management's attention, integration of the operations, systems and personnel of the new businesses and lack of substantial experience in operating such businesses.
Competition
The title insurance and real estate services industries are highly competitive. Competition is based primarily on the quality and timeliness of services. Where price is not regulated by governmental authorities, pricing can also be an important competitive factor. For larger commercial customers and mortgage originators the size and financial strength of the title insurer are important competitive factors. Our principal competitors include Chicago Title Corporation, First American Financial Corporation, LandAmerica Financial Group, Inc., Old Republic International Corporation and Stewart Information Services Corporation, each of whom has the size, capital base and distribution channels to compete effectively with the Company. The Company also competes with many smaller title insurance and real estate services companies that serve regional market areas. These smaller companies may expand into other markets in which the Company competes. Also, the removal of regulatory barriers in the future might result in new competitors entering the title insurance business that have greater financial resources and other competitive advantages. Competition among the major title insurance companies, expansion by smaller regional companies and any new entrants could adversely affect the Company's business operations and financial condition.
Government Regulation
Our title insurance business is subject to extensive regulation by state insurance authorities in each state in which the Company operates. These agencies have broad administrative and supervisory power relating to the following:
- licensing requirements;
- trade practices;
- accounting and financing practices;
- capital and surplus requirements;
- investment practices; and
- rate schedules.
Most states also regulate insurance holding companies, like Fidelity National Financial, Inc., in a variety of matters such as acquisitions, change of control and terms of affiliate transactions. These regulations may impede, or impose burdensome conditions on rate increases or other actions that the Company may want to take to enhance its operating results, and could affect its ability to pay dividends on its common stock. In addition, the Company may incur significant costs to comply with regulatory requirements. No assurance can be given that future legislative or regulatory changes will not adversely affect the Company's business operations.
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION
The Company wishes to caution readers that the forward-looking statements contained in this Form 10-K under "Item 1. Business," "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Form 10-K involve known and unknown risks and uncertainties which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by any forward-looking statements
made by or on behalf of the Company. In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company is filing the following cautionary statements identifying important factors that in some cases have affected, and in the future could cause the Company's actual results to differ materially from those expressed in any such forward-looking statements.
The factors that could cause the Company's results to differ materially include, but are not limited to, general economic and business conditions, including interest rate fluctuations; the impact of competitive products and pricing; success of operating initiatives; adverse publicity; changes in business strategy or development plans; quality of management; availability, terms, and deployment of capital; the results of financing efforts; the Year 2000 issue; business abilities and judgment of personnel; availability of qualified personnel; employee benefit costs and changes in, or the failure to comply with government regulations.
ITEM 2.
ITEM 2. PROPERTIES
During 1997, the Company sold its corporate home office building in Irvine, California, which housed the Company's corporate departments and certain operating subsidiaries, recording a net realized gain of $4.3 million, prior to applicable income taxes. Also during 1997, a subsidiary of the Company completed the purchase of a building in Santa Barbara, California, which houses certain of the Company's corporate departments.
The majority of the branch offices of the Company are leased from third parties. The remainder are owned by the Company or leased from partnerships in which the Company has an interest or leased from affiliates.
As of December 31, 1998, the Company leased office and storage spaces as follows:
See Note K of Notes to Consolidated Financial Statements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, the Company is involved in various pending and threatened litigation matters related to its operations, some of which include claims for punitive or exemplary damages. Management believes that no actions depart from customary litigation incidental to the business of the Company and that resolution of all such litigation will not have a material adverse effect on the Company.
See Note K of Notes to Consolidated Financial Statements.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders in the fourth quarter of 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The following table sets forth the range of high and low closing prices for the common stock on the New York Stock Exchange. The high and low closing prices and the amount of dividends declared for the periods indicated have been retroactively adjusted for stock dividends and splits declared since the Company's inception.
On March 25, 1999, the last reported sale price of the common stock on the New York Stock Exchange Composite Tape was $15.44 per share. As of March 25, 1999, the Company had approximately 925 stockholders of record.
DIVIDEND POLICY AND RESTRICTIONS ON DIVIDEND PAYMENTS. Since the last quarter of 1987, the Company has consistently paid cash dividends on a quarterly basis, which payments have been made at the discretion of the Company's Board of Directors. On March 17, 1999, the Company's Board of Directors declared a cash dividend of $.07 per share which will be payable on May 28, 1999 to stockholders of record on April 9, 1999. The continued payment of dividends will depend upon operating results, business requirements, contractual restrictions, regulatory considerations and other factors. The Company anticipates the continued payment of dividends. See "Business -- Regulation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources."
CONTRACTUAL RESTRICTIONS ON DIVIDEND PAYMENTS. The Company's ability to pay dividends on its common stock and make certain payments is restricted by provisions contained in the Company's various debt agreements. The Company believes that amounts to fund currently anticipated dividends and certain payments are available pursuant to the terms and conditions of its various debt agreements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note H of Notes to Consolidated Financial Statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The historical operating results data, per share data and balance sheet data set forth below are derived from the historical financial statements of the Company, certain of which have been restated to reflect the Granite and Alamo mergers on the pooling-of-interests method of accounting. Per share data has been retroactively adjusted for stock dividends and splits since the Company's inception. Consolidated Balance Sheets at December 31, 1998 and 1997 and Consolidated Statements of Earnings, Comprehensive Earnings, Stockholders' Equity and Cash Flows for the years ended December 31, 1998, 1997 and 1996, and Notes thereto, audited by KPMG LLP, independent certified public accountants, are included elsewhere herein and
should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein:
- --------------- (1) During 1994, the Company recognized a $2.4 million extraordinary gain, net of related income taxes of $1.3 million, related to the early retirement of $48 million maturity value of the Company's Liquid Yield Option Notes (the "LYONs").
(2) During 1995, the Company recognized an $813,000 extraordinary loss, net of related income taxes of $437,000, related to the early retirement of its Senior Secured Notes.
(3) The Company acquired Nations Title Inc. and its wholly-owned subsidiaries Nations Title, Nations New York and National on April 1, 1996. See Management's Discussion and Analysis of Financial Condition and Results of Operations. The selected financial data above includes the balance sheet accounts of Nations Title Inc. and subsidiaries at December 31, 1998, 1997 and 1996 and the results of its operations for the years ended December 31, 1998, 1997 and for the nine-month period ended December 31, 1996.
(4) The selected financial data above includes the balance sheet accounts and results of operations of ATC as a wholly-owned subsidiary as of December 31, 1996, 1995 and 1994 and for the six-month period ended June 30, 1997 and for the years ended December 31, 1996, 1995 and 1994, and ATC's activities as an agent for the six-month period ended December 31, 1997 and for the year ended December 31, 1998.
On July 3, 1997, the Company converted an outstanding note balance in conjunction with the exercise of warrants into a 51% ownership interest of National Alliance Marketing Group ("National Alliance"). The Company acquired the outstanding minority interest in National Alliance on August 14, 1998. The selected financial data above includes the Company's interest in the balance sheet accounts of National Alliance at December 31, 1998 and 1997 and the Company's interest in the results of operations for the year ended December 31, 1998 and for the period from July 3, 1997 through December 31, 1997.
(5) The Company acquired Granite Financial, Inc. and subsidiaries ("Granite") on February 26, 1998. This acquisition has been accounted for as a pooling-of-interests. The selected financial data above includes the balance sheet accounts of Granite at December 31, 1998, 1997 and 1996 and the results of its operations for the years ended December 31, 1998, 1997 and 1996. Granite's financial position and results of operations for the years ended December 31, 1995 and prior were insignificant, and as such, the selected financial data above has not been restated for prior years.
The Company acquired Alamo Title Holding Company and subsidiaries ("Alamo") on August 20, 1998. This acquisition has been accounted for as a pooling-of-interests. The selected financial data above includes the balance sheet accounts of Alamo at December 31, 1998, 1997, 1996, 1995 and 1994 and the results of its operations for the years ended December 31, 1998, 1997, 1996, 1995 and 1994.
(6) The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") on May 14, 1998. This transaction has been accounted for as a reverse merger of Micro General into the Company. The selected financial data above includes the balance sheet accounts of Micro General at December 31, 1998 and the results of its operations for the period from May 14, 1998 through December 31, 1998.
The Company acquired Lexington Capital Corporation ("Lexington") effective September 1, 1998. The selected financial data above includes the balance sheet accounts of Lexington as of December 31, 1998 and the results of its operations for the four-month period September 1, 1998 through December 31, 1998.
(7) During 1997, the Company recognized an extraordinary loss of $1.7 million, net of related income taxes of $1.1 million, related to the early retirement of $45 million maturity value of the Company's LYONs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations- Extraordinary Item and Recent Developments."
(8) Percentage return on average equity is net earnings for the period divided by the simple average of total stockholders' equity as of the beginning and end of each year presented.
N/A Meaningful information not available.
See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Recent Developments" and Note B of Notes to Consolidated Financial Statements.
QUARTERLY FINANCIAL DATA
Selected quarterly financial data is as follows:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is intended to provide information to facilitate the understanding and assessment of significant changes and trends related to the financial condition and results of operations of the Company. The discussion and analysis below includes the results of operations of Granite Financial, Inc. (acquired February 26, 1998) and Alamo Title Holding Company (acquired August 20, 1998) for each of the years ended December 31, 1998, 1997 and 1996, as the acquisitions of Granite and Alamo have been accounted for as poolings-of-interests. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing elsewhere herein.
OVERVIEW
The following table sets forth certain financial and other data for the years indicated:
- --------------- (1) Percentage return on average equity is net earnings for the period divided by the simple average of total stockholders' equity as of the beginning and end of each year presented.
Title insurance revenue is closely related to the level of real estate activity and the average price of real estate sales. Real estate sales are directly affected by the availability of funds to finance purchases, i.e., mortgage interest rates. Other factors affecting real estate activity include demand, family income levels and general economic conditions. While the level of sales activity was relatively depressed in certain geographical areas during the period 1991 through mid-1993, lower mortgage interest rates beginning in the latter part of 1991 triggered an increase in refinancing activity which continued at then record levels through 1993 and into the first quarter of 1994. During 1994 and early 1995, steady interest rate increases caused by actions taken by the Federal Reserve Board resulted in a significant decline in refinancing transactions and a stagnation in residential resales and new home sales. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a favorable effect on the level of real estate activity, including refinancing transactions, new home sales and resales. The overall economic environment, stable mortgage interest rates and strength in the real estate market, especially in California and on the West Coast, contributed to very positive conditions for the industry throughout 1996, 1997 and 1998. It is impossible to predict in what future direction interest rates and the real estate market may move or fluctuate.
During 1995 and prior, the majority of the Company's total title-related revenue was generated from direct operations. The Company traditionally focused on direct operations because it retains the entire premium from each transaction and is better able to generate additional revenues by promoting and cross- selling other title-related services. In 1996, the Company continued the implementation of its strategy to become a leading national title underwriter by expanding into other markets and diversifying its premium revenue base to a more balanced mix of direct and agency operations.
On April 1, 1996, the Company completed its acquisition of the Nations Title Inc. group of companies. The acquisition positioned Fidelity National Financial, Inc. as the nation's fourth largest title insurance underwriter. Nations Title Inc. and its three wholly-owned underwriting subsidiaries, Nations Title Insurance
Company (which was subsequently merged into Fidelity Title), Nations Title Insurance of New York Inc. and National Title Insurance of New York Inc., expanded the Company's national agency network and increased its market share in the more traditional agency driven states. The Nations Title Inc. acquisition resulted in additional agency business and a shift in the mix of business from direct to agency during 1996. The revenue and expense information presented in Management's Discussion and Analysis of Financial Condition and Results of Operations includes the Nations Title Inc. group's results of operations for the nine-month period ended December 31, 1996 and for the years ended December 31, 1997 and 1998. In 1996, the total title-related revenue (excluding interest and investment income and non-title-related other fees and revenue) generated by agency operations increased to 41.3% from 32.4% in 1995.
During 1997 the Company sold a majority interest of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. ATC functions as an exclusive agent of the Company, and represents one of the Company's largest agents.
Also, during 1996 and 1997, the Company acquired certain ancillary service companies in various separate transactions. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. The acquired ancillary service companies have been bundled with other existing lender services to form Fidelity National Lender Express Network ("FLEXNet"). FLEXNet provides a complete range of real estate transactional services, leading to a broader base of services provided and increased other fees and revenue.
The acquisition of Alamo Title Holding Company and subsidiaries, which closed on August 20, 1998, provided additional balance between the Company's direct and agency operations with the strength of Alamo's direct and agency operations in the important Texas market. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. As a result of its acquisitions of Nations and Alamo, the Company has significantly expanded the national scope of its core title operations by expanding its direct operations in key markets and balancing the mix of its direct and agency operations.
The Company also earns income from its non-title related operations and from its investment portfolio.
The following table sets forth information regarding title-related revenue derived from direct and agency operations:
The Company's strategies are to (i) maximize operating profits by increasing its share of the title insurance business in the markets it serves; (ii) effectively manage operating expenses through the real estate cycle; (iii) minimize net claim payments and (iv) continue to implement a value-added acquisition and diversification strategy. The Company intends to execute these strategies by continuing to implement the following elements:
- expand into the commercial title insurance market while maintaining its strong position in the residential and institutional lender markets;
- generate an increasing portion of its revenue from the sale of ancillary services;
- develop and integrate advanced proprietary technologies that respond to the needs of customers in each of its markets;
- adhere to quality controls and strict monitoring of direct and agency operations to minimize title claims paid;
- maintain a balance between direct and agency distribution to enable it to compete profitably on a national basis;
- explore opportunities that are less interest rate sensitive; and
- deliver quality customer service and provide its employees with extensive training and incentive and equity based compensation programs.
RESULTS OF OPERATIONS
REVENUE. The following table presents information regarding the components of the Company's revenue:
Favorable mortgage interest rates in the latter part of 1991 through early 1994 triggered refinancing activity at then record levels. Beginning in early 1994 through mid-1995, steady interest rate increases caused by actions taken by the Federal Reserve Board resulted in a significant decline in refinancing transactions and a stagnation in residential resales and new home sales. Title orders and requests for title-related services followed the market trend as expected. Since late 1995, decreases in mortgage interest rates and the resulting improvement in the real estate market have had a positive impact on the level of real estate activity, order counts and closed orders. The overall economic environment, stable mortgage interest rates in the seven percent range and strength in the real estate market, especially in California, the Company's strongest market, and on the West Coast, were positive factors through 1996, 1997 and 1998.
Total revenue in 1998 increased 49.3% to $1,288.5 million from $863.1 million in 1997. Revenue in 1997 of $863.1 million reflected a 17.5% increase from 1996 revenue of $734.8. The increases in total revenue are primarily the result of strength in the Company's core title and real estate related operations, which were positively impacted by favorable market conditions leading to an increase in real estate activity. The increased real estate activity, combined with acquisitions of ancillary service companies and the integration of those service operations into the Company's core businesses, also contributed to the increased revenues. Results of operations in 1997 also include a full year of operations of Nations, which was acquired in April 1996.
Title insurance premiums, increased by 47.8% to $910.3 million in 1998 from $616.1 million in 1997. In 1997, title premiums increased by 11.4% to $616.1 million from $552.8 million in 1996. The increases in title premiums reflect the favorable real estate market and a significant increase in title premiums from agency operations resulting primarily from the Nations Title Inc. acquisition in 1996. Prior to the acquisition of the Nations Title Inc. group of companies, which was completed on April 1, 1996, the Company generated the majority of its title premiums from its network of direct operations as opposed to agency relationships, the latter being more common in the title industry. The acquisition of the Nations group of companies increased
the Company's agency force to 2,000 at the end of 1996 from 1,100 at the end of 1995. The percentage of title insurance premiums generated by agency operations was 53.3%, 53.5% and 50.8% in 1998, 1997 and 1996, respectively.
The Company's direct operations generate escrow fees from holding funds and documents in connection with the closing of real estate transactions, as well as real estate information and technology service fees, trustee sale guarantee fees, credit reporting fees, attorney service fees, flood certification fees, tax monitoring fees, home warranty insurance premiums, reconveyance fees, recording fees, foreclosure publishing and posting service fees and exchange intermediary service fees in connection with real estate transactions.
The trends in escrow fees are primarily related to the title insurance activity generated by the Company's direct operations. Escrow fees have fluctuated during the 1998, 1997 and 1996 years in a pattern generally consistent with the fluctuation in title insurance premiums. Escrow fees increased $44.3 million to $130.3 million in 1998, a 51.5% increase from $86.0 million in 1997. This increase is consistent with the trend in title premiums, but is also due to the Company's focused efforts to expand its escrow market presence in certain areas, such as Southern California. Escrow fees increased $14.9 million to $86.0 million in 1997, a 21.0% increase from $71.1 million in 1996. See "Overview."
Other fees and revenue trend closely with the level and mix of business, as well as the performance of certain of the Company's title-related subsidiaries. During 1996 and 1997, the Company acquired certain ancillary service companies in various separate transactions. See "Recent Developments" and Note B of Notes to Consolidated Financial Statements. The Company's strategy in making the ancillary service company acquisitions was to acquire previously existing entities in businesses it believed to be complementary to its core title and escrow businesses. Further, the Company sought to acquire companies with strong management and efficient operations in order to provide for a seamless transition from their being stand-alone operations to being subsidiaries of the Company and to prevent any disruption of the acquired companies' businesses, while minimizing integration costs. The integration of the ancillary service companies continues as expected and integration related costs have been negligible. The acquired ancillary service companies have been bundled with other existing lender services to form Fidelity National Lender Express Network ("FLEXNet"). Utilizing its extensive network of direct operations as its primary distribution channel and FLEXNet as the platform to provide a comprehensive network of real estate related services, the Company has made a concerted effort to develop the ancillary service contribution to title and real estate related revenue. The Company has been able to leverage its core title and escrow businesses, national presence and proprietary technology in successfully expanding the market presence of its ancillary service businesses. FLEXNet provides a complete range of real estate transactional services, leading to increased other fees and revenues in 1998 as compared to 1997 and in 1997 compared to 1996. 1998 other fees and revenue were $208.3 million, an increase of $83.2 million, or 66.4%, over 1997 other fees and revenue of $125.1 million. In 1997, other fees and revenue increased $33.5 million, or 36.6%, to $125.1 million from $91.6 million in 1996. The year over year increases are primarily attributable to the growth of the ancillary service businesses.
Interest and investment income levels are primarily a function of securities markets, interest rates and the amount of cash available for investment. 1998 investment income increased $3.8 million, or 10.6%, to $39.6 million compared to $35.8 million in 1997. Average invested assets, excluding real estate, increased 28.6% to $482.5 million in 1998 from $375.1 million in 1997, while the tax equivalent yield remained at 5.5%. The increase in investment income in 1998 over 1997 is primarily the result of an increase in interest and dividend income generated by the increased invested asset base. Net realized gains from the sale of investment securities and other assets in 1998 were $17.2 million compared to $16.8 million in 1997. Included in 1998 net realized gains is a gain from the conversion of the Company's investment in Data Tree Corporation of approximately $9.7 million. The Company shifted the emphasis in its fixed income portfolio from taxable to non-taxable securities during 1997. During 1997, interest and investment income increased 86.2% to $35.8 million from $19.2 million in 1996. Average invested assets, excluding real estate, increased $71.2 million, or 23.4%, to $375.1 million in 1997 from $303.9 million in 1996. The difference in investment income is primarily attributable to increased capital gains in 1997 compared to 1996. During 1997, the Company recognized $16.8 million of capital gains compared to $2.5 million of capital gains recorded in 1996. The primary components of 1997 capital gains, prior to applicable income taxes, are the following: $10.4 million in
capital gains from the sale of investment securities and other assets, $4.3 million in capital gain from the sale of the Company's former home office building, $1.3 million from the sale of a majority interest in American Title Company and approximately $800,000 in capital gain from the sale of the Company's former small business investment company subsidiary, FNF Ventures, Inc. See "Recent Developments."
EXPENSES. The following table presents the components of the Company's expenses:
The Company's operating expenses primarily consist of personnel costs and other operating expenses which are incurred as orders are received and processed. Title insurance premiums, escrow fees and other fees and revenue are generally recognized as income at the time the underlying transaction closes. Certain other fees and revenue are recognized over the period the related services are provided. As a result, revenue lags approximately 60-90 days behind expenses and therefore gross margins may fluctuate.
Personnel costs include base salaries, commissions and bonuses paid to employees and are the most significant operating expense incurred by the Company. These costs generally fluctuate with the level of orders opened and closed and with the mix of revenue. Personnel costs totalled $394.3 million, $273.2 million and $240.2 million for the years ended December 31, 1998, 1997 and 1996, respectively. See "Overview" and "Revenue." Personnel costs, as a percentage of total revenue, have decreased to 30.6% in 1998 from 31.7% in 1997, which had previously decreased from 32.7% in 1996. The Company has taken significant measures to maintain appropriate personnel levels and costs relative to the volume and mix of business and revenues. These fluctuations reflect a continuing emphasis on expense control and an increase in productivity resulting from the Company's automation and electronic commerce. The Company will not, however, compromise its customer service standards or quality controls in responding to market conditions. The Company continues to monitor the prevailing market conditions and will adjust personnel costs in accordance with activity.
Other operating expenses consist of facilities expenses, title plant maintenance, premium taxes (which insurance underwriters are required to pay on title premiums and title-related revenue in lieu of franchise and other state taxes), escrow losses, postage and courier services, computer services, professional services, advertising expenses, general insurance, trade and notes receivable allowances and depreciation. In response to market conditions, the Company implemented aggressive cost control programs in order to maintain operating expenses at levels consistent with the levels of revenue; however, certain fixed costs are incurred regardless of revenue levels, resulting in year over year percentage fluctuations. Other operating expenses decreased as a percentage of total revenue to 20.0% in 1998 from 21.9% in 1997, which had previously decreased from 24.0% in 1996. The Company continues to be committed to cost control measures. The Company's cost control programs are designed to evaluate expenses, both current and budgeted, relative to existing and projected market conditions. Items considered include, but are not limited to, capital expenditures, service contracts, property requirements (e.g., renewal/termination of leases and relocation of offices), expected fluctuations in the number of personnel, the impact of technology and profitability. Additionally, the Company has centralized its purchasing function in order to obtain the most favorable prices/rates available for vendor provided services and products which also facilitates a highly structured requisition/approval process and cost analysis program. Total other operating expenses totalled $257.1 million, $189.2 million and $176.5 million in 1998, 1997 and 1996, respectively. See "Overview."
The 1996 addition of Nations Title Inc. title premiums, which are primarily agency-related, has provided a balance between direct operation and agency revenue. In previous periods the majority of title premiums and
total revenue were generated by direct operations, which resulted in higher personnel costs and other operating expenses.
Agent commissions represent the portion of premiums retained by agents pursuant to the terms of their respective agency contracts. The following table illustrates the relationship of agent premiums and agent commissions:
Agent commissions and the resulting percentage of agent premiums retained by the Company vary according to regional differences in real estate closing practices and state regulations. During 1997, the Company sold a majority interest in its underwritten title company subsidiary ATC, resulting in the transfer of premiums from direct operations to agency operations and increased commission expense in 1997 compared to 1996, as well as a decrease in premiums retained by the Company on a year over year basis. Commission rates paid to ATC are higher than average commission rates paid to the 1996 agent base. The combination of higher agency commission rates and the significant agency revenue generated since the sale of ATC and by the Nations Title Inc. acquisition has resulted in higher overall commissions.
The provision for claim losses includes an estimate of anticipated title claims and major claims. The estimate of anticipated title claims is accrued as a percentage of title premium revenue based on the Company's historical loss experience and other relevant factors. The Company monitors its claims experience on a continual basis and adjusts the provision for claim losses accordingly. Based on Company loss development studies, the Company believes that as a result of its underwriting and claims handling practices, as well as the refinancing business of prior years, the Company will maintain the trend of favorable claim loss experience. Based on this information, in 1998, 1997 and 1996, the Company recorded a provision for claim losses of 7.0% of title insurance premiums prior to major claim expense, net of recoupments and prior to the impact of premium rates and Company loss experience in the state of Texas. Premiums in Texas are all-inclusive and include a closing fee in addition to a risk-related premium, which differs from similar coverage in other states, while loss experience is comparable. As a result, the provision for claim losses in Texas is much lower than in states that do not have all-inclusive premiums. These factors resulted in a net provision for claim losses of 6.5%, 6.7% and 6.6% in 1998, 1997 and 1996, respectively.
A summary of the reserve for claim losses follows:
Interest expense is incurred by the Company in financing its capital asset purchases, lease originations, certain acquisitions and certain general corporate purposes. Interest expense consists of interest related to the Company's outstanding debt and the amortization of original issue discount and debt issuance costs related to the Liquid Yield Option Notes due 2009 ("LYONs") issued in February 1994. Interest expense on non-LYONs debt totalled $12.8 million, $7.0 million and $6.4 million for the years 1998, 1997 and 1996, respectively. The LYONs-related component of interest expense amounted to $4.2 million, $5.3 million and $5.2 million for 1998, 1997 and 1996, respectively. Included in 1998 interest expense is $4.7 million of interest relating to the settlement of an Internal Revenue Service examination for the tax years 1990 through 1994. Excluding the interest expense related to the tax examination, the fluctuation in interest expense can be attributed to an increase in non-LYONs debt outstanding offset by more favorable interest rates in 1998 than 1997, and improved rates in 1997 compared to 1996. See "Extraordinary Item" and "Recent Developments."
Income tax expense for 1998, 1997 and 1996, as a percentage of earnings before income taxes, including the extraordinary losses in 1997 was 39.7%, 42.8% and 39.4%, respectively. See "Extraordinary Item." The fluctuations in income tax expense as a percentage of earnings before income taxes, including the extraordinary item, are attributable to the effect of state income taxes on the Company's wholly-owned underwritten title companies and ancillary service companies; a change in the amount and characteristics of net income, operating income versus investment income; and the tax treatment of certain items. See Note I of Notes to Consolidated Financial Statements for additional information regarding income taxes.
EXTRAORDINARY ITEM. In an effort to reduce the leverage of the Company while taking advantage of the favorable environment relative to the Company's common stock, on October 17, 1997, the Company, in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs), which exceeded the accreted value recorded by the Company pursuant to the LYONs Indenture at that date. The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock and $790,000 in cash. The purchase of the LYONs increased stockholders' equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. An extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, related to this transaction has been recorded in the Consolidated Statement of Earnings for the year ended December 31, 1997. See "Recent Developments."
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements include debt service, operating expenses, lease fundings, lease securitizations, taxes and dividends on its common stock. The Company believes that all anticipated cash requirements for current operations will be met from internally generated funds, through cash received from subsidiaries, cash generated by investment securities and bank borrowings through existing credit facilities.
Two of the significant sources of the Company's funds are dividends and distributions from its subsidiaries. As a holding company, the Company receives cash from its subsidiaries in the form of dividends and as reimbursement for operating and other administrative expenses it incurs. The reimbursements are executed within the guidelines of various management agreements among the Company and its subsidiaries. Fluctuations in operating cash flows are primarily the result of increases or decreases in revenue. See "Overview." The Company's Insurance Subsidiaries and UTCs collect premiums and pay claims and operating expenses. The Insurance Subsidiaries also have cash flow sources derived from investment income, repayments of principal and proceeds from sales and maturities of investments and dividends from subsidiaries. Positive cash flow from the Insurance Subsidiaries is invested primarily in short-term investments and medium-term bonds. Short-term investments held by the Company's Insurance Subsidiaries provide liquidity for projected claims and operating expenses. The Insurance Subsidiaries are restricted by state regulations in their ability to pay dividends and make distributions. Each state of domicile regulates the extent to which the Company's title underwriters can pay dividends or make other distributions to the Company. The UTCs are also regulated by insurance regulatory or banking authorities. The Company's ancillary service and leasing subsidiaries collect revenue and pay operating expenses; however, they are not regulated by insurance regulatory or banking authorities. Positive cash flow from the UTCs and ancillary service subsidiaries is invested primarily in cash and cash equivalents.
The short- and long-term liquidity requirements of the Company, Insurance Subsidiaries, UTCs, ancillary service and leasing subsidiaries are monitored regularly to match cash inflows with cash requirements. The Company, Insurance Subsidiaries, UTCs and ancillary service subsidiaries forecast their daily cash needs and periodically review their short- and long-term projected sources and uses of funds, as well as the asset, liability, investment and cash flow assumptions underlying these projections.
For purposes of satisfying insurance regulatory requirements, the Company is required to maintain certain levels of readily marketable securities and other liquid assets. At December 31, 1998, the fair value of the Company's total investment securities was approximately $510.5 million, approximately $207.2 million of which have been designated to support statutory liabilities, primarily the combined unearned premium reserve. These investments consist of securities which the Company believes are readily marketable and could be liquidated if necessary. See "Business -- Investment Policies and Investment Portfolio."
Effective August 1, 1998, the Company closed a $100 million credit agreement. Certain of the proceeds were utilized to refinance previously existing credit facilities. Additional amounts available under the new credit agreement are available for general corporate purposes. The Company believes that the terms and conditions of the $100 million credit agreement are significantly more favorable than those that existed previously. See Note H of Notes to Consolidated Financial Statements.
The Company must comply with certain affirmative and negative covenants related to its bank revolving lines of credit and other debt facilities, which require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth, capitalization, investments, acquisitions, restricted payments and certain dividend restrictions. The Company is in compliance with all of its debt covenants at December 31, 1998.
In February 1994, the Company issued zero coupon, convertible subordinated Liquid Yield Option Notes due February 2009 at an interest rate of 5.5% with a principal amount at maturity of $235,750,000. Net proceeds to the Company were approximately $101,000,000. The proceeds were used for investment and general corporate purposes, including the repurchase of treasury shares. The amount of LYONs outstanding on December 31, 1998 was $124,113,000 of maturity value. On January 13, 1999, the Company announced that it was going to redeem, pursuant to the terms of the indenture, its outstanding Liquid Yield Option Notes
due 2009 for $581.25 per $1,000 maturity value on February 15, 1999. Additionally, the LYONs holders had the right to convert the outstanding LYONs to 28.077 shares of Company common stock per $1,000 maturity value of LYONs at any time. As of February 15, 1999, $123,681,000 maturity value of LYONs had converted to 3,473,000 shares of common stock, adding approximately $70 million to equity while reducing outstanding notes payable by a like amount. The remaining $432,000 of maturity value was redeemed for cash of approximately $251,000. See Note H of Notes to Consolidated Financial Statements.
In the normal course of business certain of the Company's subsidiaries enter into off-balance sheet credit risk associated with certain aspects of its title insurance policies and Manchester's real estate activities. This credit risk is in the form of standby letters of credit and general partnership guarantees. The Company believes that this credit risk is adequately secured by either legal remedies associated with settlement procedures or the underlying real estate assets. See Note K of Notes to Consolidated Financial Statements.
SEASONALITY. Historically, the greatest volume of residential resale activity has occurred in the spring and summer months. However, events during the past five years, including numerous actions taken by the Federal Reserve Board, have caused unusual fluctuations in real estate activity, particularly in the seasonal pattern of resale and refinance activity. The Company cannot predict whether the historical pattern of resale and refinance activity will continue to be affected by such outside factors.
INFLATION. To the extent real estate prices or mortgage interest rates increase due to inflationary factors, the Company's title insurance premium revenue generally increases because premiums are determined in part by the value of property or the amount of the mortgage loan. The Company's personnel costs and other operating expenses are also sensitive to inflation.
RECENT DEVELOPMENTS. On April 4, 1996, the Company purchased 17% of the outstanding common stock of National Alliance Marketing Group, Inc. ("National Alliance"), a California corporation, for $566,667; together with a warrant to acquire an additional 14% of National Alliance common stock. In addition, the Company loaned $1,200,000 to National Alliance at closing at a rate of Prime plus one percent. Subsequently, the Company agreed to increase the credit facility from $1,200,000 to $1,700,000. In consideration for the increase in the credit facility National Alliance agreed to increase the warrant shares which the Company could purchase. If the entire $1,700,000 was borrowed the Company could purchase an additional 34% of the outstanding shares of National Alliance. After receiving approval of the transaction from the California Department of Insurance, the transaction closed on July 12, 1996. National Alliance is the parent company of Alliance Home Warranty Company ("Alliance"), a California insurance company. Alliance sells home warranty plans to buyers of resale homes, primarily in the Central and Southern California markets. A home warranty contract generally promises the repair or replacement of major operating systems and built-in appliances inside a home for a period of one year. On July 3, 1997, the Company converted the outstanding note balance in conjunction with the exercise of the warrants and then owned 51% of the outstanding common stock of National Alliance. The outstanding balance of the note receivable due from National Alliance at conversion was approximately $1.6 million. On August 14, 1998, the Company acquired the outstanding minority interest in National Alliance, 49%, for a purchase price of $3,320,000. The Company now owns 100% of National Alliance, which is now known as Fidelity National Home Warranty. The acquisition of National Alliance has been accounted for as a purchase. See Note B of Notes to Consolidated Financial Statements.
Effective July 1, 1997, the Company sold a majority interest (60%) of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. ATC functions as an exclusive agent of the Company. The sale price of the 60% interest was $6.0 million resulting in a realized gain of approximately $1.3 million before applicable income taxes. As a result of a tax free reorganization of American National Financial, Inc. ("ANFI"), the parent company of ATC and its subsidiaries, in November 1998, the Company's interest in ATC was converted to an ownership interest of approximately 43% of ANFI. Subsequent to ANFI's initial public offering in February 1999, the Company's ownership interest in ANFI became approximately 31.5%. The Company's investment in ANFI is accounted for under the equity method. Additionally, on March 18, 1998, the Company announced that it had entered into an agreement to sell National Title Insurance of New York Inc. to ATC for $3.25 million, subject to regulatory approval and certain other conditions. The purchase price is structured at a premium to book value.
National was acquired in April 1996, as part of the Nations Title Inc. acquisition, and has not been actively underwriting policies since the transaction closed. This transaction has not yet received regulatory approval. See Notes C and L of Notes to Consolidated Financial Statements.
On July 22, 1997, the Company purchased 1,000,000 shares of common stock of GB Foods Corporation, now known as Santa Barbara Restaurant Group ("SBRG"), which represented approximately 15.5% of the outstanding common stock of SBRG for a purchase price of $5.0 million. Additionally, the Company purchased warrants to acquire an additional 3,500,000 shares of SBRG at various prices ranging from $5.00 - $7.50 for a purchase price of $800,000; 1,500,000 warrants exercisable at $5.00 per share, 1,000,000 warrants exercisable at $7.00 per share and 1,000,000 warrants exercisable at $7.50 per share. In conjunction with the common stock purchase, the Company gained control of three seats on the SBRG Board of Directors. During 1998, the Company exercised 1,000,000 of the $5.00 warrants in conjunction with an acquisition by SBRG in order to provide SBRG additional capital. In addition, on December 31, 1998, the Company exchanged certain investments in restaurant common stocks with a combined value of $9.45 million for an additional 2,478,000 shares of SBRG. The Company now owns approximately 31.1% of SBRG. The Company's investment in SBRG is accounted for under the equity method. See Note C of Notes to Consolidated Financial Statements.
On October 17, 1997, the Company in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs). The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock (the "Exchange Shares"). The Company also paid Merrill Lynch the excess of a base price of $19.53 per Exchange Share over the actual sales price (less $0.05 per share in commissions) realized by Merrill Lynch for sales of up to 607,881 Exchange Shares. The Company also paid Merrill Lynch, for each day, an amount in cash to be determined by multiplying the Net Carry Amount (number of Exchange Shares multiplied by $19.53) by the Applicable Rate (LIBOR plus 2.50%). The Company's payment obligations were subject to reduction for dividends on Exchange Shares received by Merrill Lynch during the period. The Company paid the foregoing amounts to Merrill Lynch in cash of approximately $790,000 on November 7, 1997. The purchase of the LYONs increased stockholders' equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. Additionally, an extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, was recorded in the fourth quarter of 1997. The maturity value of LYONs outstanding at December 31, 1998 was approximately $124,113,000.
On January 13, 1999, the Company announced that it was going to redeem, pursuant to the terms of the indenture, its outstanding Liquid Yield Option Notes due 2009 for $581.25 per $1,000 maturity value on February 15, 1999. Additionally, the LYONs holders had the right to convert the outstanding LYONs to 28.077 shares of Company common stock per $1,000 maturity value of LYONs at any time. As of February 15, 1999, $123,681,000 maturity value of LYONs had converted to 3,473,000 shares of common stock, adding approximately $70 million to equity while reducing outstanding note payable by a like amount. The remaining $432,000 of maturity value was redeemed for cash of approximately $251,000.
On April 17, 1998, the Company announced it had acquired an approximate 19.9% interest in Cruttenden Roth, a privately held investment banking firm located in Newport Beach, California, for a purchase price of $5,800,000, payable $3,750,000 in Company common stock (117,857 shares) and $2,050,000 in cash. The Company also acquired an option to increase its ownership to 25.6%. In connection with the acquisition, the Company also provided Cruttenden Roth working capital in the amount of $3,500,000 in exchange for a note.
Effective August 1, 1998, the Company closed a $100 million credit agreement. Certain of the proceeds were utilized to refinance previously existing credit facilities. Additional amounts available under the new credit agreement are available for general corporate purposes. The Company believes that the terms and conditions of the $100 million credit agreement are significantly more favorable than those that existed previously. See Note H of Notes to Consolidated Financial Statements.
The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") for 4.6 million shares of Micro General common stock, valued at $1,297,000, on May 14, 1998. ACS provides small to medium size businesses within the real estate industry with software, systems integration and communication services including telecommunications hardware, long distance reselling, computer hardware and system software reselling, consulting services, technical services, internet services, electronic commerce and title and escrow software applications. ACS will continue to provide the above listed services to the Company at preferred customer rates. This transaction has been accounted for as a reverse merger of Micro General into the Company. The Company currently owns 70.6% of Micro General Corporation. See Note B of Notes to Consolidated Financial Statements.
Additionally, on November 17, 1998, Micro General acquired LDExchange.com, Inc. ("LDX"), for a purchase price of $3.1 million, payable $1.1 million in cash and $2.0 million in Micro General common stock (1,000,000 shares). LDX is a facilities based, wholesale carrier providing international telecommunication services.
On June 3, 1998, the Company announced that as a result of the closing of the merger of Data Tree Corporation ("Data Tree") with Image Acquisition Corporation, a wholly-owned subsidiary of First American Financial Corporation (NYSE:FAF), the Company's 27.9% ownership position in Data Tree was converted into approximately 176,600 shares of First American Financial Corporation common stock, resulting in a gain of $9.7 million, before applicable income taxes. The Company's investment in Data Tree was approximately $3.0 million, including its percentage equity in Data Tree's earnings. The gain on conversion has been reflected in the Consolidated Statements of Earnings for the year ended December 31, 1998.
Effective September 1, 1998, the Company acquired 100% of Lexington Capital Corporation ("Lexington"), a financial services company specializing in financing national and regional franchisee accounts, headquartered in Deerfield, Illinois, for a purchase price of $3.5 million, payable in $3.0 million in cash and $500,000 in restricted common stock of the Company (15,129 shares). This transaction has been accounted for as a purchase. See Note B of Notes to Consolidated Financial Statements.
The Company's Board of Directors declared a cash dividend of $.07 per share on March 17, 1999, which will be payable on May 28, 1999 to stockholders of record on April 9, 1999.
On March 17, 1999, the Company's Board of Directors approved an increase to the number of shares of outstanding Company common stock authorized for purchase under the Company's previously announced purchase program. The new authorization will permit the Company to purchase up to 4.0 million shares. Through March 25, 1999, the Company has purchased 1,202,050 shares at an average purchase price of $16.61 per share totalling $19,960,000. Purchases may be made from time to time by the Company in the open market or in block purchases or in privately negotiated transactions depending on market conditions and other factors.
Also on March 17, 1999, the Company's Board of Directors approved the adoption of the Fidelity National Financial, Inc. Employee Stock Purchase Loan Plan ("Loan Plan"). The purpose of the Loan Plan is to provide key employees with further incentive to maximize shareholder value. The Company intends to offer an aggregate of $7,750,000 in loans. Loan Plan funds must be used to make private or open market purchases of Company common stock through a broker-dealer designated by the Company. All loans will be full recourse and unsecured, and will have a five year term. Interest will accrue on the loans at a rate of 5% per annum due at maturity. Loans may be prepaid at any time without penalty. Through March 25, 1999, loans have been made in the amount of $5,700,000 to purchase 382,650 shares of Company common stock at an average purchase price of $14.90 per share.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS 130 requires all items that are necessary to be recognized under accounting standards as components of comprehensive income to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 does not require a specific format for that financial
statement, but requires that an enterprise display an amount representing total comprehensive earnings for the period covered by that financial statement. SFAS 130 requires an enterprise to (a) classify items of other comprehensive earnings by their nature in a financial statement and (b) display the accumulated balance of other comprehensive earnings separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS 130 became effective for fiscal years beginning after December 15, 1997. The adoption of SFAS 130 has not had a material impact on the Company's financial reporting.
Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for public business enterprises to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends FASB Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. SFAS 131 requires, among other items, that a public business enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the revenues derived from the enterprise's products or services and major customers. SFAS 131 also requires that the enterprise report descriptive information about the way that the operating segments were determined and the products and services provided by the operating segments. SFAS 131 became effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. SFAS 131 need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial statements for interim periods in the second year of application. The adoption of SFAS 131 has not had a material impact on the Company's financial reporting.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively, "derivatives") and for hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. It requires changes in the fair value of a derivative instrument and the changes in fair value of assets or liabilities hedged by that instrument to be included in earnings. To the extent that the hedge transaction is effective, earnings are equally offset by both investments. Currently the changes in fair value of derivative instruments and hedged items are reported in net unrealized gain (loss) on securities.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of SFAS 133 is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this statement. The Company does not believe the adoption of SFAS 133 will have a material impact on its financial reporting.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT THE MARKET RISK OF FINANCIAL INSTRUMENTS
The Company's Consolidated Balance Sheet includes a substantial amount of assets and liabilities whose fair values are subject to market risks. See "Business -- Investment Policies and Investment Portfolio." The
following sections address the significant market risks associated with the Company's financial activities as of year end 1998.
Interest Rate Risk
The Company's fixed maturity investments and borrowings are subject to interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.
Equity Price Risk
The carrying values of investments subject to equity price risks are based on quoted market prices or management's estimates of fair value as of the balance sheet date. Market prices are subject to fluctuation and, consequently, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions. Furthermore, amounts realized in the sale of a particular security may be affected by the relative quantity of the security being sold.
Caution should be used in evaluating the Company's overall market risk from the information below, since actual results could differ materially because the information was developed using estimates and assumptions as described below, and because insurance liabilities (representing 39.3% of total liabilities) are not included in the hypothetical effects. The LYONs are also excluded as they have been converted or redeemed. See "Recent Developments" and Note H of Notes to Consolidated Financial Statements.
The hypothetical effects of changes in market rates or prices on the fair values of financial instruments would have been as follows as of December 31, 1998:
a. An approximate $12.1 million net increase (decrease) in the fair value of fixed maturity securities would have occurred if interest rates had (decreased) increased by 100 basis points. The change in fair values was determined by estimating the present value of future cash flows using various models, primarily duration modeling.
b. An approximate $10.0 million net increase (decrease) in the fair value of equity securities would have occurred if there was a 20% price increase (decrease) in market prices.
c. It is not anticipated that there would be a significant change in the fair value of other long-term investments or short-term investments if there was a change in market conditions, based on the nature and duration of the financial instruments involved.
d. Interest expense on outstanding debt would have increased (decreased) approximately $1.0 million, if interest rates increased (decreased) 100 basis points.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL INFORMATION
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders Fidelity National Financial, Inc.:
We have audited the Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 1998 and 1997 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, 1998. 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.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998 in conformity with generally accepted accounting principles.
KPMG LLP Los Angeles, California February 17, 1999, except as to Note Q to the Consolidated Financial Statements, which is as of March 25, 1999
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
See Notes to Consolidated Financial Statements.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See Notes to Consolidated Financial Statements.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS (IN THOUSANDS)
- --------------- (1) Net of income tax expense (benefit) of ($1,059), $15,214, and $5,070 for 1998, 1997 and 1996, respectively.
(2) Net of income tax expense of $6,824, $7,207, and $975 for 1998, 1997 and 1996, respectively.
See Notes to Consolidated Financial Statements.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE DATA)
See Notes to Consolidated Financial Statements.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See Notes to Consolidated Financial Statements.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following describes the significant accounting policies of Fidelity National Financial, Inc. ("Fidelity Financial") and its subsidiaries (collectively, the "Company") which have been followed in preparing the accompanying Consolidated Financial Statements.
Description of business
Fidelity National Financial, Inc., through its principal subsidiaries (collectively, the "Company"), is one of the largest national underwriters engaged in the business of issuing title insurance policies and performing other real estate related services such as escrow, collection and trust activities, real estate information and technology services, trustee sale guarantees, credit reporting, attorney services, flood certification, tax monitoring, home warranty insurance, reconveyances, recordings, foreclosure publishing and posting services and exchange intermediary services in connection with real estate transactions. Title insurance services are provided through the Company's direct operations and otherwise through independent title insurance agents who issue title policies on behalf of the underwriting subsidiaries. Title insurance is generally accepted as the most efficient means of determining title to, and the priority of interests in, real estate in nearly all parts of the United States. Today, virtually all real property mortgage lenders require their borrowers to obtain a title insurance policy at the time a mortgage loan is made or to allow the sale of loans in the secondary market.
The Company's principal subsidiaries consist of Fidelity National Title Insurance Company ("Fidelity Title"), Fidelity National Title Insurance Company of New York ("Fidelity New York"), Alamo Title Insurance ("Alamo Title"); (collectively, the "Insurance Subsidiaries"); its wholly-owned underwritten title companies (collectively, the "UTCs"); and its network of wholly-owned title-related ancillary service companies known as Fidelity National Lender Express Network ("FLEXNet"). The Company also originates, funds, purchases, sells, securitizes and services equipment leases for a broad range of businesses through its wholly-owned subsidiary Granite Financial, Inc.
Fidelity Title was the parent company of Fidelity National Title Insurance Company of Tennessee ("Fidelity Tennessee"), Fidelity National Title Insurance Company of California ("Fidelity California") and Nations Title Insurance Company ("Nations Title"). Fidelity Tennessee, Fidelity California and Nations Title were merged into Fidelity Title on December 31, 1998, August 7, 1997 and December 29, 1997, respectively. Fidelity New York is the parent company of Nations Title Insurance of New York Inc. ("Nations New York") and National Title Insurance of New York Inc. ("National"). Fidelity National Title Insurance Company of Pennsylvania ("Fidelity Pennsylvania") was merged into Fidelity New York as of April 11, 1997, which in turn, was the parent company of American Title Insurance Company ("ATIC"), which was merged into Fidelity Pennsylvania as of November 21, 1996.
Nations Title Insurance Company, Nations Title Insurance of New York Inc. and National Title Insurance of New York Inc. were acquired, along with Nations Title Inc. ("NTI," collectively, "Nations Title Inc."), in a transaction which closed on April 1, 1996. Certain of the ancillary service companies were acquired in separate transactions during 1996 and 1997. Granite Financial, Inc. and subsidiaries ("Granite") was acquired in a transaction which closed on February 26, 1998. Alamo Title was acquired in connection with the Company's acquisition of Alamo Title Holding Company and subsidiaries ("Alamo") in a transaction which closed August 20, 1998.
Principles of consolidation and basis of presentation
The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All material intercompany profits, transactions and balances
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
have been eliminated. The Company's investments in non-majority-owned partnerships and subsidiaries are accounted for on the equity method.
On February 26, 1998, the Company, in exchange for approximately 5.0 million shares of Company common stock plus cash in lieu of fractional shares, acquired the common stock of Granite Financial, Inc. and subsidiaries. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $26.08 on February 26, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Granite.
The Company acquired the common stock of Alamo Title Holding Company and subsidiaries on August 20, 1998, in exchange for approximately 2.2 million shares of Company common stock plus cash in lieu of fractional shares. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $33.13 on August 20, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Alamo.
The results of operations of Fidelity, Granite and Alamo separately and the combined amounts presented in the Consolidated Financial Statements for the two years prior to the consummation of the poolings-of-interests are summarized below:
Effective as of October 1, 1997, the Company acquired Bron Research, Inc. ("BRON"), a flood certification company headquartered in Austin, Texas. The purchase price paid by the Company for the acquisition was $9.85 million, paid in 575,599 shares of Company common stock. BRON now operates as Fidelity National Flood, Inc. This transaction has been accounted for as a pooling-of-interests. Prior to 1997, BRON's financial position and results of operations were insignificant, and as such, the 1996 Consolidated Statement of Earnings and Related Notes to Consolidated Financial Statements have not been restated to reflect the inclusion of BRON.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
There have been no adjustments to the total net assets or stockholders' equity of the combining companies as a result of the poolings-of-interests. Certain reclassifications have been made to conform the financial statements of the combining companies to the Consolidated Financial Statements of the Company.
Granite previously reported its results of operations based on a fiscal year ended June 30. Granite's fiscal year has been converted to a calendar year in order to conform to that of the Company.
Cash and cash equivalents
For purposes of reporting cash flows, highly liquid instruments purchased with original maturities of three months or less are considered cash equivalents. The carrying amounts reported in the Consolidated Balance Sheets for these instruments approximate their fair value.
Investments
Fixed maturity securities are purchased to support the investment strategies of the Company, which are developed based on many factors including rate of return, maturity, credit risk, tax considerations and regulatory requirements. Fixed maturity securities which may be sold prior to maturity to support the Company's investment strategies are carried at fair value and are classified as available for sale as of the balance sheet dates. Fair values for fixed maturity securities are principally a function of current interest rates and are based on quoted market prices.
Equity securities are considered to be available for sale and carried at fair value as of the balance sheet dates. Fair values are based on quoted market prices.
Other long-term investments, which consist of a limited partnership investment in an investment fund, as well as certain other debt instruments and equity investments, are carried at cost or on the equity method, as appropriate, which approximates fair value.
Short-term investments, which consist primarily of securities purchased under agreements to resell, commercial paper and money market instruments, which have an original maturity of one year or less, are carried at amortized cost, which approximates fair value.
Investments in real estate and partnerships are generally held for investment purposes and are carried at cost in the absence of any other than temporary impairment in value. Investments in real estate which are held for sale, including real estate acquired through foreclosure of properties in satisfaction of commercial and real estate loans, are carried at the lower of cost or fair value less estimated costs to sell.
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income on a trade date basis. Unrealized gains or losses on bonds and common stocks which are classified as available for sale, net of applicable deferred income taxes (benefits), are excluded from income and credited or charged directly to a separate component of stockholders' equity. If any unrealized losses on bond or common stocks are deemed other than temporary, such unrealized losses are recognized as realized losses.
Leases and Residual Interests in Securitizations
Leases and residual interests in securitizations includes direct financing leases, direct financing leases assigned to lender and residual interests in securitizations. See Note D.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Direct Financing Leases
Granite has entered into various lease agreements which, in accordance with Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 13, "Accounting for Leases," meet the criteria of capitalization and are accounted for as direct financing leases. Under this method, the amount by which gross lease rentals exceed the cost of the related assets, less the estimated recoverable residual value at the expiration of the lease, is recognized as income from direct financing leases over the life of the lease using the interest method. Any permanent reduction in the estimated residual equipment value of leased property is charged to operations in the period it occurs. See Note D.
Sales of Leases
Gains or losses resulting from sales of leases are recognized in the accompanying Consolidated Statements of Earnings at the date of sale and are based on the difference between the selling price of the sales and the carrying value of the related leases sold. Nonrefundable fees and direct costs associated with the origination of leases are deferred and recognized when the leases are sold.
On January 1, 1997, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125"). Under SFAS 125, a transfer of financial assets in which control is surrendered is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. Liabilities and derivatives incurred or obtained by the transfer of financial assets are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the transferred assets must be measured by allocating the previous carrying value between the asset sold and the interest retained, if any, based on their relative fair values at the date of transfer.
Direct Financing Leases Assigned to Lender
SFAS 125 prohibits early application. Prior to January 1, 1997, direct financing leases sold prior to that date as part of a securitization to a special-purpose entity that issued debt securities were accounted for as collateralized borrowings. The leases collateralizing the debt are recorded as direct financing leases assigned to lender. The leases and related debt are reflected in the Consolidated Balance Sheets. See Notes D and H.
Residual Interests in Securitizations
Residual interests in securitizations ("Residuals") of lease receivables in trust are recorded as a result of the sale of lease receivables through securitization. The securitizations are generally structured as follows: First, the Company sells a portfolio of lease receivables to a special purpose entity ("SPE") which has been established for the limited purpose of buying and reselling the Company's lease receivables. Next, the SPE transfers the same lease receivables to a Trust (the "Trust"), and the Trust in turn issues interest-bearing asset-backed securities (the "Bonds and Certificates") generally in an amount equal to the aggregate initial principal balance of the lease receivables, multiplied by an advance rate. The Company typically sells these lease receivables at face value and with limited recourse relating to defaulted loans, prepayments and certain representations and warranties provided by the Company to the Trust. One or more investors purchase these Bonds and Certificates and the proceeds from the sale of the Bonds and Certificates are used as consideration to purchase the lease receivables from the Company.
At the closing of each securitization which is accounted for as a sale the Company removes from its balance sheet the lease receivables held for sale and adds to its balance sheet (i) the cash received and (ii) the allocated cost of the Residuals which consists of (a) cash collateral account and (b) net excess cash flows.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The excess of the cash received by the Company over the allocated cost of the lease receivables sold less transaction costs, equals the net gain on sale recorded by the Company.
The Company allocates its basis in the lease receivables between the portion of the lease receivables sold (the Bonds and Certificates) and the portion retained (the Residuals) based on the relative fair values of those portions on the date of the sale.
The Company may recognize unrealized gains or losses through stockholders' equity attributable to the change in the fair value of the Residuals, which are recorded at estimated fair value and accounted for as available for sale securities. The Company is not aware of an active market for the purchase or sale of Residuals at this time. Accordingly, the Company estimates the fair value of the Residuals by calculating the present value of the estimated expected future excess cash flows received by the Company after being released by the Trust (cash out method) using a discount rate of 12%, which management believes is commensurate with the risks involved.
The Company is entitled to the cash flows from the Residuals that represent collections on the lease receivables in excess of the amounts required to pay the Bonds and Certificate principal and interest, the base servicing fees and certain other fees such as trustee and custodial fees. At the end of each collection period, the aggregate cash collections from the lease receivables are allocated first to the servicing fees and certain other fees such as trustee and custodial fees for the period, then to the Bond and Certificate holders for interest at the pass-through rate on the Bonds and Certificates plus principal as defined in the Trust and Security Agreements. If the amount of cash required for the above allocations exceeds the amount collected during the collection period, the shortfall is drawn from the Cash Collateral Account. If the cash collected during the period exceeds the amount necessary for the above allocations, and there is no shortfall in the related Cash Collateral Account, the excess is released to the Company. If the Cash Collateral Account balance is not at the required credit enhancement level, the excess cash collected is used to build the cash collateral account until the credit enhancement level is achieved. The specified credit enhancement levels are defined in the applicable Trust and Security Agreement which are expressed generally as a percentage of either the original or current collateral principal balance.
The implicit interest rate on the lease receivables is relatively high in comparison to the pass through rate on the Bonds and Certificates. In determining the value of the Residuals described above, the Company estimates the future rates of prepayments, delinquencies, defaults and default loss severity as they impact the amount and timing of the estimated cash flows. The Company has used a zero prepayment estimate because the lease contracts generally require the lessee to pay all or a majority of the lease payments due under the remaining lease term. The Company estimates the timing of the receipt of such prepayments in its estimate of cash flows. The Company's loss estimate is 1.5% to 2.0% of the gross lease payment, which is based on historical loss data for comparable leases and the specific characteristics of the leases originated by the Company. The Company's prepayment and default estimates resulted in a weighted average life of the pool of leases of between approximately 1.5 and 2.0 years.
In future periods, the Company may increase the estimated fair value of the Residuals if the actual performance of the lease receivables is higher than the original estimate. If the actual performance of the lease receivables is lower than the original estimate, then an adjustment to the carrying value of the Residuals may be required if the estimated fair value of the Residuals is less than its carrying value.
The Bond and Certificate holders and their securitization trusts have no recourse to the Company's other assets for failure of lessees to pay when due. The Company's Residuals are subordinate to the Bonds and Certificates until the Bond and Certificate holders are fully paid.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Allowance for Losses on Leases
The Company establishes an allowance for losses to provide for expected losses in the Company's existing portfolio of leases and leases transferred on a recourse basis. The allowance for losses is based on the Company's historical and expected loss experience, industry knowledge and other economic factors. The ultimate obligation for defaults and delinquencies related to leases transferred on a recourse basis is measured and recorded at the time of transfer.
Leases are collateralized by the equipment under lease, and lessees generally are required to personally guarantee lease payments. The Company's risk of loss is partially mitigated by recovering collateral and enforcing guarantees. However, the resale value of leased equipment generally declines at a rate greater than the principal of the lease. As a result, full recovery on defaulted leases is not usually possible.
Lease Acquisition Costs and Broker Commissions
Lease acquisition costs consist of broker bonuses and commissions paid upon the origination of the lease contracts. The costs are included in direct financing leases and are amortized to expense over the life of the related lease contracts on the interest method.
Trade receivables
The carrying values reported in the Consolidated Balance Sheets for trade receivables approximate their fair value.
Fair value of financial instruments
The fair values of financial instruments presented in the applicable notes to the Company's Consolidated Financial Statements are estimates of the fair values at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessarily indicative of amounts the Company could realize or settle currently. The Company does not necessarily intend to dispose of or liquidate such instruments prior to maturity. See Notes C, D, E and H.
Title plants
Title plants are recorded at the cost incurred to construct or obtain and organize historical title information to the point it can be used to perform title searches. Costs incurred to maintain, update and operate title plants are expensed as incurred. Title plants are not amortized as they are considered to have an indefinite life if maintained. Sales of title plants are reported at the amount received net of the adjusted costs of the title plant sold. Sales of title plant copies are reported at the amount received. No cost is allocated to the sale of copies of title plants unless the carrying value of the title plant is diminished or impaired.
Property and equipment
Property and equipment are recorded at cost, less depreciation. Depreciation is computed primarily using the straight-line method based on the estimated useful lives of the related assets which range from three to thirty years. Leasehold improvements are amortized on a straight-line basis over the lesser of the term of the applicable lease or the estimated useful lives of such assets.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Cost in excess of net assets acquired and other intangible assets
Intangible assets include cost in excess of net assets acquired, capitalized software costs, capitalized licensing costs and capitalized debt offering costs and are amortized on a straight line basis over three to forty years. Intangible assets at December 31, 1998 consist of cost in excess of net assets acquired of $60,830,000 less accumulated amortization of $6,916,000, capitalized licensing costs of $2,500,000 less accumulated amortization of $221,000, capitalized software of $13,515,000 less accumulated amortization of $7,085,000 and capitalized debt offering costs of $4,536,000 less accumulated amortization of $2,500,000. At December 31, 1997, intangible assets consist of cost in excess of net assets acquired of $48,026,000 less accumulated amortization of $4,608,000, capitalized licensing costs of $2,500,000 less accumulated amortization of $159,000, capitalized software of $12,326,000 less accumulated amortization of $4,636,000 and capitalized debt offering costs of $6,883,000 less accumulated amortization of $3,625,000.
Impairment of intangible assets is monitored on a continual basis, and is assessed based on an analysis of the cash flows generated by the underlying assets. No impairment of intangible assets has been noted.
Income taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and expected benefits of utilizing net operating loss and credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and reflected in the financial statements in the period enacted.
Reserve for claim losses
The Company's reserve for claim losses includes known claims as well as losses the Company expects to incur, net of recoupments. Each known claim is reserved for on the basis of 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 provided for at the time premium revenue is recognized based on historical loss experience and other factors, including industry averages, claim loss history, current legal environment, geographic considerations and type of policy written. The occurrence of a significant major claim (those greater than $500,000) in any given period could have a material adverse effect on the Company's financial condition and results of operations for such period. See Note J.
If a loss is related to a policy issued by an independent agent, the Company may proceed against the independent agent pursuant to the terms of the agency agreement. In any event, the Company may proceed against third parties who are responsible for any loss under the title insurance policy under rights of subrogation.
The Company also accrues reserves for losses arising from the escrow, closing and disbursement functions due to fraud or operational error based on historical experience.
Reinsurance
In the ordinary course of business, the Company reinsures certain risks with other insurers for the purpose of limiting its maximum loss exposure and also assumes reinsurance for certain risks of other insurers for the purpose of earning additional revenue. The Company cedes or assumes a portion of certain policy liabilities
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
under agent fidelity, excess of loss and case-by-case reinsurance agreements. Reinsurance agreements provide that in the event of a loss (including costs, attorneys' fees and expenses) exceeding the retained amounts, the reinsurer is liable for the excess amount assumed. However, the ceding company remains primarily liable in the event the reinsurer does not meet its contractual obligations. Reinsurance activity is not considered significant.
Title premiums, escrow fees, other fees and revenue and agent commissions
Title insurance premiums, escrow fees and certain other fees and revenue are recognized as revenue at the time of closing of the related transaction as the earnings process is considered complete. Certain other fees and revenue are recognized over the period the related services are provided. Title insurance commissions earned by the Company's agents are recognized as an expense concurrently with premium recognition. Other fees and revenue includes revenue derived from Granite's operations, as well as non-title related revenue from other subsidiaries and other title-related revenue not included in title insurance premiums or escrow fees.
Share and per share restatement
On December 11, 1996, the Company declared a 10% stock dividend to shareholders of record on December 23, 1996, distributed January 7, 1997. The Company declared a 10% stock dividend on December 17, 1997 to shareholders of record on December 29, 1997, distributed January 14, 1998. On December 13, 1998, the Company declared a 10% stock dividend to shareholders of record on December 28, 1998, distributed January 12, 1999. The par value of the additional shares of common stock issued in connection with the stock dividends was credited to common stock and a like amount charged to retained earnings as of December 31, 1998, 1997 and 1996, respectively. Fractional shares were paid in cash.
All data with respect to earnings per share, dividends per share and share information, including price per share where applicable, in the Consolidated Financial Statements and Notes thereto have been retroactively adjusted to reflect all stock dividends and splits. Additionally, all data impacted has been restated to reflect the acquisitions of Granite, Alamo and BRON.
Earnings per share
In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), effective for fiscal years ending after December 15, 1997. The Company retroactively adopted SFAS 128 in 1997.
Basic earnings per share is computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during the period. Dilutive earnings per share is calculated by dividing net earnings available to common shareholders plus the impact of assumed conversions of dilutive potential securities. The Company has granted certain options and warrants which have been treated as common share equivalents for purposes of calculating diluted earnings per share. The Liquid Yield Option Notes ("LYONs") are considered other dilutive securities for purposes of calculating diluted earnings per share to the extent that they are not antidilutive.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The following table sets forth the calculation of basic and diluted earnings per share for each of the years in the three-year period ended December 31, 1998:
Management estimates
The preparation of these Consolidated Financial Statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Certain reclassifications
Certain reclassifications have been made in the 1997 and 1996 Consolidated Financial Statements to conform to the classifications used in 1998.
B. ACQUISITIONS
On April 4, 1996, the Company purchased 17% of the outstanding common stock of National Alliance Marketing Group, Inc. ("National Alliance"), a California corporation, for $567,000; together with a warrant to acquire an additional 14% of National Alliance common stock. In addition, the Company loaned $1,200,000 to National Alliance at closing at a rate of Prime plus one percent. Subsequently, the Company agreed to increase the credit facility from $1,200,000 to $1,700,000. In consideration for the increase in the credit facility National Alliance agreed to increase the warrant shares which the Company could purchase. If the entire $1,700,000 was borrowed the Company could purchase an additional 34% of the outstanding shares of National Alliance. After receiving approval of the transaction from the California Department of Insurance, the transaction closed on July 12, 1996. National Alliance is the parent company of Alliance Home Warranty Company ("Alliance"), a California insurance company. Alliance sells home warranty plans to buyers of resale homes, primarily in the Central and Southern California markets. A home warranty contract generally promises the repair or replacement of major operating systems and built-in appliances inside a home for a period of one year. On July 3, 1997, the Company converted the outstanding note balance in conjunction with the exercise of the warrants and then owned 51% of the outstanding common stock of National Alliance. The outstanding balance of the note receivable due from National Alliance at conversion was approximately $1.6 million. On August 14, 1998, the Company acquired the outstanding minority interest in National Alliance, 49%, for a purchase price of $3,320,000. The Company now owns 100% of National Alliance, which is now known as Fidelity National Home Warranty. Prior to the conversion of the convertible note in July 1997, the Company accounted for its investment in National Alliance on the equity method. Since that time the Company has accounted for National Alliance as a purchase and has consolidated its interest in National Alliance's financial position and results of operations with those of the Company.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the National Alliance acquisition were as follows (dollars in thousands):
Alamo acquired substantially all of the assets of Southwest Land Title Company of Angleton effective January 31, 1997 for $1.1 million cash, and created a new corporation, Alamo Title Company of Brazoria, Inc. ("Brazoria") into which the acquired assets were placed. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of assets acquired, in the Brazoria acquisition were as follows (dollars in thousands):
On March 31, 1997, Granite acquired the assets and liabilities of Global Finance & Leasing, Inc. ("Global"), a micro-ticket leasing company, for a purchase price of $2.3 million in cash. The acquisition
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
agreement provides for additional contingent consideration of $916,000 based on the collection of certain receivables. Granite believes the collection of these receivables is remote. Therefore, no liability has been recorded in the Company's Consolidated Financial Statements. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Global acquisition were as follows (dollars in thousands):
On June 20, 1997, Granite acquired certain assets and liabilities of SFR Funding, Inc. ("SFR"), a small ticket equipment leasing company, for cash of $300,000, a note payable of $250,000 and the assumption of certain liabilities. The SFR transaction resulted in cost in excess of net assets acquired of $681,000. Neither the financial position nor the results of operations of SFR have been significant to the Company or Granite since acquisition. This transaction has been accounted for as a purchase.
On August 22, 1997, the Company acquired the common stock of First Title Corporation ("First Title"), a title company with fourteen offices throughout the southeastern United States. First Title has been merged into a subsidiary of the Company. First Title was acquired for $4.7 million; payable in 80% common stock of the Company (278,738 shares or $3.8 million) and 20% cash (approximately $900,000). This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the First Title Corporation acquisition were as follows (dollars in thousands):
On September 18, 1997, the Company acquired the common stock of Ifland Credit Services ("ICS"), a credit reporting company headquartered in Lexington, Kentucky, for a purchase price of $3.75 million. ICS has been merged with Credit Reports, Inc. ("CRI") and Classified Credit Data, Inc. ("CCD") in order to form Fidelity National Credit Services. The purchase price was payable 80% in common stock of the Company (187,170 shares or $3.0 million) and 20% cash ($750,000). This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Ifland Credit Services acquisition were as follows (dollars in thousands):
On October 9, 1997, the Company acquired the common stock of Credit Reports, Inc., a credit reporting company headquartered in Scottsdale, Arizona, with operations in California, Colorado, Nevada and Oregon.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
CRI has been merged with ICS and CCD in order to form Fidelity National Credit Services. The purchase price for CRI was $200,000, subject to certain purchase price adjustments based on the combined equity of CRI and Express Network, Inc., its affiliate, payable in 12,601 shares of Company common stock. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Credit Reports, Inc. acquisition were as follows (dollars in thousands):
Also on October 9, 1997, the Company acquired the common stock of Express Network, Inc. ("ENI"), a provider of attorney services such as courier, messenger, courthouse filing, process serving, investigation and reprographics. ENI provides services to legal firms in Los Angeles, Orange County, San Diego, Riverside and San Francisco, California. The purchase price for ENI was $10.55 million; subject to certain purchase price adjustments based on the combined equity of ENI and CRI, its affiliate, payable in 50% common stock of the Company (332,374 shares or $5.275 million) and 50% cash (approximately $5.275 million). Approximately $2.8 million of the cash portion of the purchase price will be paid in equal installments over a four-year period. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Express Network, Inc. acquisition were as follows (dollars in thousands):
On October 21, 1997, the Company acquired 100% of the common stock of Classified Credit Data, Inc., a credit reporting company headquartered in Orange County, California, for a purchase price of $300,000, which was paid in cash. CCD was merged with ICS and CRI in order to form Fidelity National Credit Services. This transaction has been accounted for as a purchase.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Classified Credit Data acquisition were as follows (dollars in thousands):
On December 30, 1997, Granite completed the acquisition of 84% of the common stock of North Pacific Funding, Inc. dba C&W Leasing and its wholly-owned subsidiary CKC Corporation dba US Funding (collectively, "C&W Leasing"). The purchase price for this transaction was $5.1 million, in the form of notes payable to the former stockholders. This transaction has been accounted for as a purchase. The remaining 16% of the common stock of C&W Leasing was purchased on January 5, 1998 for additional consideration of $900,000 in promissory notes payable.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the C&W Leasing acquisition were as follows (dollars in thousands):
The Company completed the sale of its wholly-owned subsidiary ACS Systems, Inc. ("ACS") to Micro General Corporation (OTCBB:MGEN) ("Micro General") for 4.6 million shares of Micro General common stock, valued at $1,297,000, on May 14, 1998. ACS provides small to medium size businesses within the real estate industry with software, systems integration and communication services including telecommunications hardware, long distance reselling, computer hardware and system software reselling, consulting services, technical services, internet services, electronic commerce and title and escrow software applications. ACS will continue to provide the above listed services to the Company at preferred customer rates. The Company currently owns 70.6% of Micro General Corporation. This transaction has been accounted for as a reverse merger of Micro General into the Company.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the Micro General acquisition were as follows (dollars in thousands):
Additionally, on November 17, 1998, Micro General acquired LDExchange.com, Inc. ("LDX"), for a purchase price of $3.1 million, payable $1.1 million in cash and $2.0 million in Micro General common stock (1,000,000 shares). LDX is a facilities based, wholesale carrier providing international telecommunication services.
The assets acquired, including cost in excess of net assets acquired, and liabilities assumed in the LDX acquisition were as follows (dollars in thousands):
Effective September 1, 1998, the Company acquired 100% of Lexington Capital Corporation ("Lexington"), a financial services company specializing in financing national and regional franchisee accounts, for a purchase price of $3.5 million, payable in $3.0 million in cash and $500,000 in restricted common stock of the Company (15,129 shares). The acquisition of Lexington resulted in $3,500,000 of cost in excess of net assets acquired. Neither the financial position or the results of operations of Lexington have been material to the Company since acquisition. This transaction has been accounted for as a purchase.
Selected unaudited pro forma combined results of operations for the years ended December 31, 1998, 1997 and 1996, assuming the National Alliance (51%), Brazoria, Global, SFR, First Title, ICS, CRI, ENI, CCD and C&W Leasing acquisitions occurred on January 1, 1997 and 1996, and assuming the Micro General,
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
LDX, National Alliance (49%) and Lexington acquisitions occurred January 1, 1998 and 1997, are presented as follows:
C. INVESTMENTS
The carrying amounts and fair values of the Company's fixed maturity securities at December 31, 1998 and 1997 are as follows:
The change in unrealized gains (losses) on fixed maturities for the years ended December 31, 1998, 1997, and 1996 was $3,170,000, $5,263,000 and ($3,482,000), respectively.
The amortized cost and estimated fair value of fixed maturity securities, which are classified as available for sale at December 31, 1998, by contractual maturity, are shown as follows. Expected maturities may differ
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties:
Fixed maturity securities valued at approximately $18,041,000 and $19,125,000 were on deposit with various governmental authorities at December 31, 1998 and 1997, respectively, as required by law.
Equity securities at December 31, 1998 and 1997 consist of investments in various industry groups as follows:
The carrying value of the Company's investment in equity securities is fair value. As of December 31, 1998, gross unrealized gains and gross unrealized losses on equity securities were $22,464,000 and $10,025,000, respectively. Gross unrealized gains and gross unrealized losses on equity securities were $38,464,000 and $2,582,000, respectively, as of December 31, 1997.
The change in unrealized gains and losses on equity securities for the years ended December 31, 1998, 1997 and 1996 was ($23,443,000), $12,756,000 and $15,214,000, respectively.
Included in equity securities is an investment in a certain equity security, CKE Restaurants, Inc., with a cost basis of $2,341,000 and a fair value of $18,462,000 at December 31, 1998 and a cost basis of $3,366,000 and a fair value of $31,404,000 at December 31, 1997.
On July 22, 1997, the Company purchased 1,000,000 shares of common stock of GB Foods Corporation, now known as Santa Barbara Restaurant Group ("SBRG"), which represented approximately 15.5% of the outstanding common stock of SBRG for a purchase price of $5.0 million. Additionally, the Company purchased warrants to acquire an additional 3,500,000 shares of SBRG at various prices ranging from $5.00 -- $7.50 for a purchase price of $800,000; 1,500,000 warrants exercisable at $5.00 per share, 1,000,000 warrants exercisable at $7.00 per share and 1,000,000 warrants exercisable at $7.50 per share. In conjunction with the common stock purchase, the Company gained control of three seats on the SBRG Board of Directors. During 1998, the Company exercised 1,000,000 of the $5.00 warrants in conjunction with an acquisition by SBRG in order to provide SBRG additional capital. In addition, on December 31, 1998, the Company exchanged certain investments in restaurant common stocks with a combined value of $9.45 million for an additional
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
2,478,000 shares of SBRG. The Company now owns approximately 31.1% of SBRG. The Company's investment in SBRG is accounted for under the equity method.
Effective July 1, 1997, the Company sold a majority interest (60%) of its subsidiary American Title Company ("ATC"), an underwritten title company, to certain members of ATC's management. ATC functions as an exclusive agent of the Company. The sale price of the 60% interest was $6.0 million resulting in a realized gain of approximately $1.3 million before applicable income taxes. As a result of a tax free reorganization of American National Financial, Inc. ("ANFI"), the parent company of ATC and its subsidiaries, in November 1998, the Company's interest in ATC was converted to an ownership interest of approximately 43% of ANFI. Subsequent to ANFI's initial public offering in February 1999, the Company's ownership interest in ANFI became approximately 31.5%. The Company's investment in ANFI is accounted for under the equity method.
Interest and investment income, including realized gains (losses), consists of the following:
Net realized gains included in interest and investment income amounted to $17,190,000, $16,839,000 and $2,476,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 1998 net realized gains include a gain of approximately $9,700,000 related to the conversion of the Company's investment in Data Tree Corporation common stock to common stock of First American Financial Corporation. Included in net realized gains for the year ended December 31, 1997, are net realized gains from the sales of investments of approximately $10,500,000, a net realized gain from the sale of the Company's former home office building of approximately $4,300,000, and net realized gains on the sale of 60% of American Title Company, a former wholly-owned underwritten title company subsidiary, and the sale of FNF Ventures, Inc., a small business investment company subsidiary of approximately $1,300,000 and $800,000, respectively. All amounts are before applicable income taxes.
During the years ended December 31, 1998, 1997 and 1996, gross realized gains on sales of fixed maturity securities considered available for sale were $700,000, $798,000 and $453,000, respectively; and gross realized losses were $268,000, $468,000 and $719,000, respectively. Gross proceeds from the sale of fixed maturity securities considered available for sale amounted to $71,114,000, $143,085,000 and $94,214,000, during the years ended December 31, 1998, 1997 and 1996, respectively.
During the years ended December 31, 1998, 1997 and 1996, gross realized gains on sales of equity securities considered available for sale were $32,603,000, $12,986,000 and $6,186,000, respectively; and gross realized losses were $10,999,000, $2,515,000 and $2,091,000, respectively. Gross proceeds from the sale of equity securities amounted to $108,554,000, $120,094,000 and $94,161,000 during the years ended December 31, 1998, 1997 and 1996, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
D. LEASES AND RESIDUAL INTERESTS IN SECURITIZATIONS
Direct Financing Leases
Granite's direct financing leases at December 31, 1998 and 1997 consist of the following:
Scheduled collections of minimum lease payments receivable are as follows:
At December 31, 1998, the weighted average implicit rate of interest is approximately 13.0%.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The carrying value of the direct financing leases at December 31, 1998 and 1997 approximated fair value because of the short-term period that these leases are held before sale or securitization or, in certain cases, because the interest rate approximates current market rates. The fair value of the direct financing leases assigned to lender at December 31, 1998 and 1997 approximated the carrying value because the interest rate on the related Class A Term Note approximates current market rates.
Asset Securitization
The Company has completed six securitization facilities that provide for aggregate funding limits of approximately $354,000,000. Two of the securitization facilities, GF Funding IV and GF Funding V, are revolving facilities.
In April 1996, the Company's wholly-owned subsidiary, GF Funding I, issued $21,689,000 of 6.33% Class A Lease-Backed Term Note ("GFI Note") due November 20, 2001 in a private placement. The GFI Note is collateralized by (i) payments to be made under leases contributed by Granite Financial, LLC to GF Funding I, (ii) all of GF Funding I's rights and interest in the leased equipment, (iii) a cash collateral account (which generally does not increase the overall level of credit enhancement, but rather accommodates changes that may occur from time to time in the form of credit enhancement from excess implicit principal balance of lease receivables to cash) and (iv) a financial guaranty insurance policy. Under the terms of the insurance policy, the monthly payments of interest and final payment of principal and maturity are unconditionally guaranteed. As this securitization was completed through the issuance of a debt security prior to the adoption of SFAS 125, the transaction is accounted for as a collateralized borrowing. Accordingly, the underlying lease assets, recorded as direct financing leases assigned to lender, and the related limited recourse note payable are reflected in the consolidated balance sheet. The underlying assets are comprised of the Company's net investment in the leases of $5,818,000 and $11,902,000 as of December 31, 1998 and 1997, respectively. The related limited recourse note payable was $5,930,000 and $11,719,000 as of December 31, 1998 and 1997, respectively. See Note H.
In November 1996, GF Funding II was formed to establish the Company's second securitization facility. The facility provided for the issuance of up to $65 million in aggregate principal amount of Class A Lease-Backed Certificates due June 20, 2003 (the "1996 Certificates") in a private placement. For purposes of computing interest, the 1996 Certificates are issued in two tranches, consisting of the Floating Rate Tranche and the Fixed Rate Tranche. The principal amount of the Floating Rate Tranche will generally convert to the Fixed Rate Tranche on a quarterly basis. The Floating Rate Tranche bears interest at an annual rate equal to the LIBOR Rate, as adjusted from time to time, plus .50%. The Fixed Rate Tranche bears interest at an annual rate equal to the Treasury Rate, as adjusted form time to time, plus .70%. The annual interest rate on each tranche is subject to a maximum annual rate of 10%. The 1996 Certificates represent an undivided interest in a trust estate created by GF Funding II comprised of (i) payments to be made under leases contributed to GF Funding II, (ii) all of GF Funding II's right and interest in the leased equipment, (iii) a cash collateral account and (iv) a financial guaranty insurance policy. The securitization was fully funded in December 1997. The Company has recorded gains from the sales of leases with respect to this securitization of $5,656,000 and $864,000, respectively, during the years ended December 31, 1997 and 1996.
In March 1997, GF Funding III was formed to establish the Company's third securitization facility. The facility provides for the issuance of up to $27,500,000 in the aggregate principal amount of 6.82% Class A Lease-Backed Certificates due December 20, 2002 (the "1997 Certificates") in a private placement. The 1997 Certificates represent an undivided interest in a trust estate created by GF Funding III comprised of (i) payments to be made under leases contributed to GF Funding III, (ii) all of GF Funding III's right and interest in the leased equipment, (iii) a cash collateral account, a capitalized interest account, a prefunding account and a collection account and (iv) a financial guaranty insurance policy. This securitization was fully
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
funded in June 1997. The Company has recorded gains from the sales of leases with respect to this securitization of $1,670,000 during the year ended December 31, 1997.
In December 1997, GF Funding IV was formed to establish the Company's fourth securitization facility. The facility provides for the issuance of up to $150 million in aggregate principal amount of Class A Lease-Backed Certificates due September 2004 (the "GFIV Certificates") in a private placement. For purposes of computing interest, the GFIV Certificates are issued in two tranches, consisting of the Floating Rate Tranche and the Fixed Rate Tranche. The principal amount of the Floating Rate Tranche will generally convert to the Fixed Rate Tranche on a quarterly basis. The Floating Rate Tranche bears interest at an annual rate equal to the LIBOR Rate, as adjusted from time to time, plus .50%. The Fixed Rate Tranche bears interest at an annual rate equal to the Treasury Rate, as adjusted from time to time, plus .35%. The GFIV Certificates represent an undivided interest in a trust estate created by GF Funding IV comprised of (i) payments to be made under leases contributed to GF Funding IV, (ii) all of GF Funding IV's rights and interests in the lease equipment and (iii) a financial guaranty insurance policy. The Company is required to sell a minimum of $10,000,000 in leases to the securitization facility per quarter. The Company has recorded gains from the sales of leases with respect to this securitization of $6,456,000 and $1,418,000 during the years ended December 31, 1998 and 1997, respectively.
In March 1998, GF Funding V was formed to establish the Company's fifth securitization facility. The facility provides for the issuance of up to $65 million in aggregate principal amount of Class A Lease-Backed Certificates due April 2005 (the "GFV Certificates") in a private placement. For purposes of computing interest, the GFV Certificates are issued in Fixed Rate Tranches which bear interest at an annual rate equal to the Treasury Rate, as adjusted form time to time, plus 1.20%. The GFV Certificates represent an undivided interest in a trust estate created by GF Funding V comprised of (i) payments to be made under leases contributed to GF Funding V and (ii) all of GF V's rights and interest in the leased equipment. The Company is required to sell a minimum of $15,000,000 in leases to the securitization facility per quarter. The Company has recorded gains from the sales of leases with respect to this securitization of $2,817,000 during the year ended December 31, 1998.
In October 1998, GF Funding VI was formed to establish the Company's sixth securitization facility. The facility provides for the issuance of $30.3 million in Lease-Backed Certificates (the "GFVI Certificates"). The GFVI Certificates represent an undivided interest in a trust estate created by GFVI which is comprised of (i) all rights, title and interest in the subordinated interest in GF Funding I, GF Funding II, GF Funding III, GF Funding IV and GF Funding V, and the related purchase agreements, (ii) a cash collection account and (iii) a cash reserve account. The issuance of the GFVI Class A and Class B Certificates is accounted for as a collateralized borrowing. Accordingly, the subordinated interest, recorded as a residual interest in securitization, and the related Class A and B are reflected in the Company's Consolidated Balance Sheet. The outstanding Class A and B Certificates were $16,006,000 at December 31, 1998.
The amounts due related to the Lease-Backed Notes and Certificates approximate fair value at December 31, 1998 and 1997 due to the fact that the interest rate paid on the Lease-Backed Notes and Certificates approximates market rates.
Sale of Leases
The Company entered into agreements with certain financial institutions to sell, on an ongoing basis, certain leases either on a recourse or non-recourse basis. The purchase price of the leases is determined on a transaction by transaction basis. A gain on sale is recognized on the date of sale based upon the present value of the payments to be received under the lease. The Company retains servicing of all leases under the agreements. During the years ended December 31, 1998, 1997 and 1996, the Company recognized a net gain on sale of leases of $857,000, $1,559,000 and $1,483,000, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Servicing Asset
The Company has not established any servicing asset or liability, although the Company retained the servicing rights on the leases securitized because management has determined that revenues from contractually specified servicing fees and ancillary services are just adequate to compensate the Company for its servicing responsibilities
E. NOTES RECEIVABLE
Notes receivable consist of the following:
The allowance for doubtful receivables is primarily related to certain promissory notes at December 31, 1998 and 1997. Interest income is not recognized on the Company's non-performing notes receivable. There were no non-performing notes receivable at December 31, 1998.
The carrying value and estimated fair values of the Company's notes receivable were as follows at December 31, 1998 and 1997 (dollars in thousands):
The fair values of significant notes receivable are established using discounted cash flow analyses based on current market interest rates and comparison of rates being received to interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. All other notes receivable are not significant individually or in the aggregate, or are current and at market rates, and their carrying value approximates fair value.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
F. INVESTMENTS IN REAL ESTATE AND PARTNERSHIPS
At December 31, 1998 and 1997, the Company had financial interests ranging from 22% to 50% in three real estate partnerships which were accounted for under the equity method. These partnerships are involved in the ownership and management of commercial office buildings, retail facilities and have acquired specific parcels of real property for investment purposes. The Company, through Manchester Development Corporation ("Manchester"), a wholly-owned subsidiary, had a general partnership interest in one of the three real estate partnerships at December 31, 1998 and 1997.
Two of these partnerships, representing raw land investments, also have officers and directors of the Company as partners with ownership interests that are based on cash contributions. These two partnerships require that all of the partners, including the Company, make pro-rata capital contributions should the partnerships require additional funds to pay liabilities. The carrying value of the Company's interests in these partnerships totalled $1,214,000 and $1,208,000 at December 31, 1998 and 1997, respectively.
Summarized combined financial information of the unconsolidated partnerships is as follows:
At December 31, 1998, the Company had a 92.5% interest in a real estate partnership which is consolidated with the Company. At December 31, 1997, the Company had a 92.5% and 76.3% interest in real estate partnerships consolidated with the Company.
Manchester is also presently a partner with Sussex Holdings, Ltd. (an affiliate of Folco) in Folco Mission Valley Partners Limited Partnership, a California limited partnership. Manchester owns a 22% limited partnership interest and Sussex Holdings, Ltd. owns a 78% general partnership interest. Fidelity Title is the sole tenant in the building and received an approximate 30% decrease in its annual rental rate based upon its lease with Folco Mission Valley. Manchester's carrying value of this partnership interest was $224,000 and $3,000 at December 31, 1998 and 1997, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Investments in real estate and partnerships consist of the following:
During 1997 and 1996, the Company sold investments in real estate to third parties at an aggregate purchase price of $6.4 million and $917,000, respectively, which approximated the carrying value of the investments sold. There were no sales in 1998.
G. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
H. NOTES PAYABLE
Notes payable consist of the following (dollars in descriptions in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Principal maturities, including accretion of original issue discount, are as follows (dollars in thousands):
Also included in notes payable in the Consolidated Balance Sheets as of December 31, 1998 and 1997 is the Class A Lease-Backed Term Note due 2001. See Note D. The amount due related to the GFI Class A Lease-Backed Term Note was $5,930,000 and $11,719,000 at December 31, 1998 and 1997, respectively. The GFI note bears interest at 6.33% and is due November 2001. The carrying value of the GFI Class A Lease-Backed term note approximates fair value at December 31, 1998 and 1997 due to the fact that the interest rate paid on the GFI Class A Lease-Backed Note approximates market rates.
Notes payable in the Consolidated Balance Sheet as of December 31, 1998 also includes the GFVI Class A Certificates in the amount of $7,878,000 and the Class B Certificates in the amount of $8,128,000. See Note D. The Class A and Class B Certificates bear interest at 6.20%, and are due in September 2005 and December 2005, respectively. The carrying value of the Class A and Class B Certificates approximates fair value at December 31, 1998 due to the fact that the interest rate paid on the Class A and Class B Certificates approximates market rates.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The carrying value and estimated fair values of the Company's notes payable were as follows at December 31, 1998 and 1997:
Short-term borrowings approximate their fair value. The fair value of the Company's fixed rate and variable rate notes payable is estimated using discounted cash flow analyses based on current market interest rates and comparison of interest rates being paid to the Company's current incremental borrowing rates for similar types of borrowing arrangements. The LYON's fair value is calculated based on quoted market prices.
The Company's credit agreement, dated as of September 21, 1995, included a $22 million term loan and a $13 million revolving credit facility, was secured by the common stock of certain Insurance Subsidiaries. This credit facility was terminated and paid in 1998 with the proceeds from a new revolving credit facility secured by the common stock of certain Insurance Subsidiaries and a certain UTC. Additionally, the Company must comply with certain affirmative and negative covenants related to its bank revolving lines of credit and other debt facilities, which require, among other things, that the Company maintain certain financial ratios related to liquidity, net worth, capitalization, investments, acquisitions, restricted payments and certain dividend restrictions.
In February 1994, the Company issued zero coupon, convertible subordinated Liquid Yield Options Notes due February 2009 ("LYONs") at an interest rate of 5.5% with a principal amount at maturity of $235,750,000. Net proceeds to the Company were approximately $101,000,000. The proceeds were used for investment and general corporate purposes, including the repurchase of treasury shares. The conversion rate of the LYONs is 28.077 shares of common stock per $1,000 maturity value of LYONs. Conversion is at the option of the holder, at any time on or prior to maturity. Each holder, at its option, may put the LYONs to the Company as of February 15, 1999 and February 15, 2004 for a purchase price per LYON of $581.25 and $762.40, respectively. The Company at its option, may elect to pay the put in cash or shares of its common stock. The LYONs are redeemable by the Company for cash on or after February 15, 1999 at a price equal to the issue price of $441.31 plus accrued original issue discount through the date of redemption. The maturity value of LYONs outstanding at December 31, 1998 was approximately $124,113,000.
On October 17, 1997, the Company in a private transaction, purchased $45 million aggregate principal amount at maturity of its outstanding Liquid Yield Option Notes due 2009 from Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") for an aggregate purchase price of $27.2 million (or $605 per $1,000 principal amount at maturity of LYONs). The purchase price was paid in the form of 1,394,381 shares, $26.4 million, of the Company's common stock (the "Exchange Shares"). The Company also paid Merrill Lynch the excess of a base price of $19.53 per Exchange Share over the actual sales price (less $0.05 per share in commissions) realized by Merrill Lynch for sales of up to 607,881 Exchange Shares. The Company also paid Merrill Lynch, for each day, an amount in cash to be determined by multiplying the Net Carry Amount (number of Exchange Shares multiplied by $19.53) by the Applicable Rate (LIBOR plus 2.50%). The Company's payment obligations were subject to reduction for dividends on Exchange Shares received by Merrill Lynch during the period. The Company paid the foregoing amounts to Merrill Lynch in cash of approximately $790,000 on November 7, 1997. The purchase of the LYONs increased stockholders'
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
equity by approximately $24.7 million while reducing outstanding debt by approximately $24.3 million. Additionally, an extraordinary loss due to the early retirement of debt of approximately $1.7 million, net of applicable income taxes, was recorded in the fourth quarter of 1997.
On January 13, 1999, the Company announced that it was going to redeem, pursuant to the terms of the indenture, its outstanding Liquid Yield Option Notes due 2009 for $581.25 per $1,000 maturity value on February 15, 1999. Additionally, the LYONs holders had the right to convert the outstanding LYONs to 28.077 shares of Company common stock per $1,000 maturity value of LYONs at any time. As of February 15, 1999, $123,681,000 maturity value of LYONs had converted to 3,473,000 shares of common stock, adding approximately $70 million to equity while reducing outstanding note payable by a like amount. The remaining $432,000 of maturity value was redeemed for cash of approximately $251,000.
I. INCOME TAXES
Income tax expense (benefit) consists of the following:
Total income tax expense (benefit) for the years ended December 31, 1998, 1997 and 1996 was allocated as follows:
The effective tax rate differs from the statutory income tax rate as follows:
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The deferred tax assets and liabilities at December 31, 1998 consist of the following:
The deferred tax assets and liabilities at December 31, 1997 consist of the following:
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Based upon the Company's current and historical pretax earnings, management believes it is more likely than not that the Company will realize the benefit of its existing deferred tax assets, net of the recorded valuation allowance. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income. However, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years. Certain tax planning or other strategies could be implemented, if necessary, to supplement income from operations to fully realize recorded tax benefits.
The Company's 1995 and 1996 Federal income tax returns are currently under examination by the Internal Revenue Service. Based on information currently available, management does not believe the outcome of these examinations will have a material impact on the financial condition or results of operations of the Company.
J. SUMMARY OF RESERVE FOR CLAIM LOSSES
A summary of the reserve for claim losses follows:
The provision for claim losses includes an estimate of anticipated title claims and major claims. The estimate of anticipated title claims is accrued as a percentage of title premium revenue based on the Company's historical loss experience and other relevant factors. The Company monitors its claims experience on a continual basis and adjusts the provision for claim losses accordingly.
K. COMMITMENTS AND CONTINGENCIES
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 insurance they have issued or other services performed on behalf of insured policyholders and other customers. The Company believes that the reserves reflected in its Consolidated Financial Statements are adequate to pay losses and loss adjustment expenses which may result from such claims and proceedings; however, such estimates may be more or less than the amount ultimately paid when the claims are settled.
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
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
arrangements. The agreements contain non-compete provisions. The terms of the agreements range from three to five years and normally contain extension provisions.
In the ordinary course of business, the Company is involved in various pending and threatened litigation matters related to its operations, some of which include claims for punitive or exemplary damages. Management believes that no actions depart from customary litigation incidental to the business of the Company and that resolution of all such litigation will not have a material adverse effect on the Company.
In conducting its operations, the Company routinely holds customers' assets in trust, pending completion of real estate transactions. Such amounts are maintained in segregated bank accounts and have not been included in the accompanying Consolidated Balance Sheets. The Company has a contingent liability relating to proper disposition of these balances for its customers which amounted to $532.2 million at December 31, 1998.
The Company leases certain of its premises and equipment under leases which expire at various dates. Several of these agreements include escalation clauses and provide for purchases and renewal options for periods ranging from one to five years.
Future minimum operating lease payments are as follows (dollars in thousands):
Rent expense incurred under operating leases during the years ended December 31, 1998, 1997 and 1996 was $32,609,000, $29,730,000 and $28,117,000, respectively. Included in rent expense for 1998, 1997 and 1996 is $485,000, $523,000 and $523,000, respectively paid to related parties.
L. STOCKHOLDERS' EQUITY
Title insurance companies, including underwriters, underwritten title companies and independent agents, are subject to extensive regulation under applicable state laws. Each insurance underwriter is usually 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 requirements, defining suitable investments for reserves, capital and surplus and approving rate schedules. In 1998, the National Association of Insurance Commissioners approved codified accounting practices that changed the definition of what constitutes prescribed statutory accounting practices and will result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements commencing in 2001. The Company is currently evaluating the impact of the rules.
Pursuant to statutory accounting requirements of the various states in which the Insurance Subsidiaries are licensed, they must defer a portion of premiums earned as an unearned premium reserve for the protection of policyholders and must maintain qualified assets in an amount equal to the statutory requirements. The level of unearned premium reserve required to be maintained at any time is determined on a quarterly basis by
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
statutory formula based upon either the age, number of policies and dollar amount of policy liabilities underwritten or the age and dollar amount of statutory premiums written. As of December 31, 1998, the combined statutory unearned premium reserve required and reported for the Insurance Subsidiaries was $207.2 million.
The Insurance Subsidiaries are regulated by the insurance commissioners of their respective states of domicile. Regulatory examinations usually occur at three year intervals. Examinations are currently in progress for Fidelity Title (1998, which was previously scheduled for 1997 but will now be as of 1998), Fidelity New York (1996), Nations New York (1996) and National (1996). The Company has not received preliminary reports of examination for Fidelity Title, Fidelity New York, Nations New York or National, as the examinations are currently ongoing. Additionally, the Auditor Division of the Controller of the State of California is currently conducting an audit of the funds due the State of California under various escheatment regulations for the years ended December 31, 1998 and prior. The Company does not believe that either the audits performed by the insurance regulators or the Controller of the State of California will have a material impact on its financial position, its results of operations or its combined statutory capital and surplus.
Statutorily calculated net worth determines the maximum insurable amount under any single title insurance policy. As of January 1, 1999, the Company's self-imposed single policy maximum insurable amounts, which comply with all statutory limitations, for Fidelity Title, Fidelity New York and Alamo Title were $60.0 million, $90.0 million and $17.5 million, respectively. The self-imposed single policy maximum insurable amounts for Nations New York and National were $19.0 million and $5.0 million, respectively.
The Insurance Subsidiaries are subject to regulations that restrict their ability to pay dividends or make other distributions of cash or property to their immediate parent company without prior approval from the Department of Insurance of their respective states of domicile. In the case of Fidelity Title, the total amount of dividends made in any twelve-month period may not exceed the greater of 10% of the surplus as regards policyholders as of the last day of the preceding year or net earnings for the twelve-month period ending the last day of the preceding year. In the case of Fidelity New York, the total amount of dividends and distributions is limited to surplus as regards policyholders, excluding capital stock and surplus resulting from unrealized gains on investments, less fifty percent of statutory premium reserve as of the last day of the preceding year and capital contributions received in the latest five-year period. In the case of Alamo Title, the total amount of dividends made in any twelve-month period may not exceed the greater of 20% of the surplus as regards policyholders as of the last day of the preceding year or net earnings for the twelve-month period ending the last day of the preceding year. As of January 1, 1999, Fidelity Title could pay dividends or make other distributions to the Company of $10,588,000, Fidelity New York could pay dividends or make other distributions to the Company of $13,325,000 and Alamo Title could pay dividends or make other distributions to the Company of $9,064,000.
The combined statutory capital and surplus of the Insurance Subsidiaries was $164,953,000, $122,107,000 and $97,845,000 as of December 31, 1998, 1997 and 1996, respectively. The combined statutory earnings of the Insurance Subsidiaries were $37,771,000, $26,701,000 and $12,243,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
As a condition to continued authority to underwrite policies in the states in which the Insurance Subsidiaries conduct their business, the Insurance Subsidiaries 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 Insurance Subsidiaries are domiciled, they must maintain certain levels of minimum capital and surplus. Each of the Company's title underwriters have complied with the minimum statutory requirements as of December 31, 1998.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
On March 18, 1998, the Company announced that it had entered into an agreement to sell National Title Insurance of New York Inc. to ATC for $3.25 million, subject to regulatory approval and certain other conditions. The purchase price is structured at a premium to book value. National was acquired in April 1996, as part of the Nations Title Inc. acquisition, and has not been actively underwriting policies since the transaction closed. This transaction has not yet received regulatory approval. See also Note C.
The UTCs are also subject to certain regulation by insurance regulatory or banking authorities, primarily relating to minimum net worth. Minimum net worth of $7.5 million and $2.5 million is required for Fidelity National Title Company ("FNTC") and Fidelity National Title Company of California ("FNCAL"), respectively. FNTC and FNCAL are in compliance with their respective minimum net worth requirements at December 31, 1998.
M. EMPLOYEE BENEFIT PLANS
Employee benefits include an employee stock purchase plan, three stock option plans and a 401(k) plan.
In 1987, stockholders approved the adoption of an Employee Stock Purchase Plan ("ESPP"). Under the terms of the ESPP and subsequent amendments, there are 8,785,000 shares of the Company's common stock available for purchase at current market prices by Company employees who meet certain vesting requirements. Pursuant to the ESPP, Company employees may contribute an amount between 5% and 15% of their base salary and certain commissions. The Company contributes varying amounts as specified in the ESPP. During the years ended December 31, 1998, 1997 and 1996, 282,216, 353,594 and 371,852 shares, respectively, were purchased and allocated to employees, based upon their contributions, at an average price of $29.42, $13.73 and $11.32 per share, respectively. The Company contributed $2.0 million or the equivalent of 67,407 shares for the year ended December 31, 1998, $1.7 million or the equivalent of 122,740 shares for the year ended December 31, 1997 and $1.2 million or the equivalent of 107,218 shares for the year ended December 31, 1996 in accordance with the employer's matching contribution. A total of 7,526,473 shares have been purchased by both the ESPP and employees since the adoption of the ESPP.
In 1987, stockholders also approved the adoption of a Stock Option Plan ("1987 Option Plan"). Under the terms of the 1987 Option Plan, the Company may grant stock options to certain key employees and non-employee directors or officers. The number of shares issuable under the 1987 Option Plan is 1,812,000 shares of common stock at not less than fair market value on the date of grant. Employees are eligible to receive incentive stock options or non-qualified stock options and non-employee directors are eligible to receive non-qualified stock options. Options available to directors or officers may not exceed one-half of the aggregate number of shares available for grant. All options granted become exercisable at the discretion of the Board of Directors and expire five to eleven years from the date of grant. Options that lapse or are cancelled prior to exercise are added to the shares authorized for future grants. The 1987 Option Plan expired December 31, 1997.
In 1992, stockholders approved the adoption of the 1991 Stock Option Plan ("1991 Option Plan"). Under the terms of the 1991 Option Plan, options may be granted to officers and key employees of the Company or any or all of its present or future subsidiaries. The number of shares reserved for issuance under the 1991 Option Plan and subsequent amendments is 1,953,000 shares of common stock, which may be newly issued or treasury shares. The per share option price is determined at the date of grant. The option price may be less than the fair market value of the common stock at the date of grant to reflect the application of the optionee's deferred bonus, if applicable. Options granted under the 1991 Option Plan shall be exercisable in such installments and for such periods as may be fixed at the time of grant, but in no event shall any stock options extend for a period in excess of 12 years from the date of grant.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
This plan allows for exercise prices with a fixed discount from the quoted market price. 115,169 options were granted in 1996 at an exercise price of $9.39 to key employees of the Company who applied deferred bonuses expensed in 1995 amounting to $433,000 to the exercise price, reducing it to $5.64 if exercised within the first year of the grant. The exercise price of these options decreases approximately 5.0% per year through 2001 and $.16 per share from 2002 through 2007, at which time the exercise price will be $3.31. In 1997, 201,169 options were granted at an exercise price of $10.44 to key employees of the Company who applied deferred bonuses expensed in 1996 amounting to $876,000 to the exercise price, reducing it to $6.30 if exercised within the first year of the grant. The exercise price of these options decreases approximately 7% per year through 2002 and $.18 per share from 2003 through 2008, at which time the exercise price will be $3.74. In 1998, 388,123 options were granted at an exercise price of $24.26 to key employees of the Company who applied deferred bonuses expensed in 1997 amounting to $1,764,000 to the exercise price, reducing it to $19.72 if exercised within the first year of the grant. The exercise price of these options decreases approximately 7% per year through 2003 and $.20 per share from 2004 through 2009, at which time the exercise price will be $16.90. Additionally, the Company recorded compensation expense relating to the price decrease of $282,000, 194,000 and $111,000, for the years ended December 31, 1998, 1997 and 1996, respectively.
In 1994, stockholders approved the adoption of the 1993 Stock Plan ("1993 Plan"). Under the terms of the 1993 Plan, options may be granted to officers, key employees and non-employee directors of the Company. The number of shares of common stock reserved for issuance under the 1993 Plan is 1,098,000. The per share option price is determined at the date of grant, provided that the price for incentive stock options shall not be less than 100% of their market value or award stock shares. The 1993 Plan also contains an automatic grant of non-qualified stock options to non-employee directors at an exercise price equal to 100% of fair value at date of grant, and the right to exercise such options shall vest equally over three years. Stock options granted under the 1993 plan are exercisable subject to the terms and conditions set by the Board of Directors, however, options shall be exercisable no earlier than six months nor later than ten years following the grant date.
In 1996, Granite adopted a Stock Option Plan ("Granite Plan", now issuable in Company common stock) allowing for the issuance of qualified and non-qualified stock options to purchase an aggregate of 347,000 shares of common stock to directors, officers, employees, agents and consultants of Granite. The Granite Plan is administered by the Board of Directors. The Granite Plan provides that qualified stock options be granted at an exercise price equal to fair market value of the common shares of Granite on the date of the grant, and must be at least 110% of fair market value when granted to a 10% or more shareholder. The term of all qualified stock options granted under the Granite Plan may not exceed ten years, except the term of qualified stock options granted to a 10% or more shareholder, which may not exceed five years. The Granite Plan provides that non-qualified stock options be granted at an exercise price not less than 85% of the fair market value of the common shares of Granite on the date of grant. The term of all non-qualified stock options granted under the Granite Plan may not exceed ten years, except the term of non-qualified stock options granted to a 10% or more shareholder, which may not exceed five years. In April 1997, the Granite Plan was amended and restated in order to make certain technical modifications thereto and was further amended in June 1997 to increase the shares of common stock reserved for issuance to 695,000.
During 1998, stockholders approved the adoption of the 1998 Stock Incentive Plan ("1998 Plan"). The 1998 Plan authorizes up to 1,100,000 shares of common stock, plus an additional 220,000 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. The authorized number of shares is subject to adjustment in the event of stock splits, stock dividends or certain other similar changes in the capital structure of the Company. The 1998 Plan provides for grants of "incentive stock options" as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), non-qualified stock options and rights to purchase shares of common stock ("Purchase Rights"). Incentive stock options, non-qualified stock options and Purchase Rights may be granted to employees of the Company and its subsidiaries and affiliates. Non-qualified stock options and
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Purchase Rights may be granted to employees of the Company and its subsidiaries and affiliates, non-employee directors and officers, consultants and other service providers.
The Board of Directors, or a committee consisting of two or more members of the Board of Directors, will administer the 1998 Plan (the "Administrator"). The Administrator will have the full power and authority to interpret the 1998 Plan, select the recipients of options and Purchase Rights, determine and authorize the type, terms and conditions of, including vesting provisions, and the number of shares subject to, grants under the 1998 Plan, and adopt, amend and rescind rules relating to the 1998 Plan. The term of options may not exceed 10 years from the date of grant (5 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). 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 options 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 Administrator. The maximum number of shares for which options or Purchase Rights may be granted to any one person during any one calendar year under the 1998 Plan is 300,000 and in no event shall the aggregate number of shares subject to incentive stock options exceed 1,000,000. The aggregate fair market value of the common stock (determined as of the date of grant) with respect to incentive stock options granted under the 1998 Plan or any other stock option plan of the Company that become exercisable for the first time by any optionee during any calendar year may not exceed $100,000.
A summary of the Company's stock option activity, and related information for the years ended December 31, 1998, 1997 and 1996 is as follows:
The weighted average remaining contractual life of the options outstanding at December 31, 1998 is 7.68 years.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
The following table sets forth options outstanding and exercisable by price range as of December 31, 1998:
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("Opinion 25") and related Interpretations in accounting for its employee stock options. As discussed below, in management's opinion, the alternative fair value accounting provided for under Statement of Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under Opinion 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that do not have vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the value of an estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Pro forma information regarding net earnings and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions. The risk free interest rates used in the calculation is the rate on the date the options were granted. The risk free interest rate used for options granted during 1998, 1997 and 1996 were 5.7%, 6.0% and 6.5%, respectively. A volatility factor for the expected market price of the common stock of 50% was used for options granted in 1998, 1997 and 1996. The expected dividend yield used for 1998, 1997 and 1996 was 1.0%, 1.0% and 2.0%, respectively. A weighted average expected life of seven years was used in all years as the Company has little history of options being exercised.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
For purpose of pro forma disclosures, the estimated fair value of the options is amortized into expense over the options' vesting period. The Company's pro forma information follows:
The Company also offers the Fidelity National Financial, Inc. 401(k) Profit Sharing Plan, a qualified voluntary contributory savings plan, available to substantially all employees. Eligible employees may contribute up to 15% of their pretax annual compensation, up to the amount allowed pursuant to the Internal Revenue Code. The Company may elect to make matching contributions. The Company has historically not made matching contributions.
N. SUPPLEMENTARY CASH FLOW INFORMATION
The following supplemental cash flow information is provided with respect to interest and tax payments, as well as certain non-cash investing and financing activities. See Notes B, H and I.
O. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATIONS OF RISK
The Company generates a significant amount of title insurance premiums in California and Texas, 33.1% and 19.6% in 1998, 32.9% and 20.8% in 1997, and 33.1% and 21.1% in 1996, respectively.
Granite's leases are originated through a network of approximately 73 independent lease originators located throughout the United States. No single lease originator accounted for more than 10% of the leases funded by the Company during the years ended December 31, 1998 and 1997. Transactions generated by the Company's ten largest independent lease originators accounted for approximately 26.0% and 53.9% of leases funded during the years ended December 31, 1998 and 1997.
Granite approved contingent fundings of approximately $67,900,000 and $73,200,000 in leases at December 31, 1998 and 1997, respectively.
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments, leases, residual interests in securitizations, trade receivables and notes receivable.
The Company places its cash equivalents and short-term investments with high credit quality financial institutions and, by policy, limits the amount of credit exposure with any one financial institution. Investments in commercial paper of industrial firms and financial institutions are rated A1, P1 or better.
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.
Concentrations of credit risk with respect to notes receivable are limited because a number of diverse entities make up the Company's notes receivable base, thus spreading the credit risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. The Company performs in-depth credit evaluations for all notes and requires guarantees and/or collateral, if deemed necessary.
P. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS 130 requires all items that are necessary to be recognized under accounting standards as components of comprehensive earnings to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 does not require a specific format for that financial statement, but requires that an enterprise display an amount representing total comprehensive earnings for the period covered by that financial statement. SFAS 130 requires an enterprise to (a) classify items of other comprehensive earnings by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS 130 became effective for fiscal years beginning after December 15, 1997. The adoption of SFAS 130 has not had a material impact on the Company's financial reporting.
Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for public business enterprises to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends FASB Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. SFAS 131 requires, among other items, that a public business enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the revenues derived from the enterprise's products or services and major customers. SFAS 131 also requires that the enterprise report descriptive information about the way that the operating segments were determined and the products and services provided by the operating segments. SFAS 131 became effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. SFAS 131 need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
statements for interim periods in the second year of application. The adoption of SFAS 131 has not had a material impact on the Company's financial reporting.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively, "derivatives") and for hedging activities. SFAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. It requires changes in the fair value of a derivative instrument and the changes in fair value of assets or liabilities hedged by that instrument to be included in earnings. To the extent that the hedge transaction is effective, earnings are equally offset by both investments. Currently the changes in fair value of derivative instruments and hedged items are reported in net unrealized gain (loss) on securities.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Earlier application of all of the provisions of SFAS 133 is encouraged, but it is permitted only as of the beginning of any fiscal quarter that begins after issuance of this statement. The Company does not believe the adoption of SFAS 133 will have a material impact on its financial reporting.
Q. SUBSEQUENT EVENTS
The Company's Board of Directors declared a cash dividend of $.07 per share on March 17, 1999, which will be payable on May 28, 1999 to stockholders of record on April 9, 1999.
On March 17, 1999, the Company's Board of Directors approved an increase to the number of shares of outstanding Company common stock authorized for purchase under the Company's previously announced purchase program. The new authorization will permit the Company to purchase up to 4.0 million shares. Through March 25, 1999, the Company has purchased 1,202,050 shares at an average purchase price of $16.61 per share totalling $19,960,000. Purchases may be made from time to time by the Company in the open market or in block purchases or in privately negotiated transactions depending on market conditions and other factors.
Also on March 17, 1999, the Company's Board of Directors approved the adoption of the Fidelity National Financial, Inc. Employee Stock Purchase Loan Plan ("Loan Plan"). The purpose of the Loan Plan is to provide key employees with further incentive to maximize shareholder value. The Company intends to offer an aggregate of $7,750,000 in loans. Loan Plan funds must be used to make private or open market purchases of Company common stock through a broker-dealer designated by the Company. All loans will be full recourse and unsecured, and will have a five year term. Interest will accrue on the loans at a rate of 5% per annum due at maturity. Loans may be prepaid at any time without penalty. Through March 25, 1999, loans have been made in the amount of $5,700,000 to purchase 382,650 shares of Company common stock at an average purchase price of $14.90 per share.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. THROUGH 13.
Within 120 days after the close of its fiscal year, the Company intends to file with the Securities and Exchange Commission a definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 as amended, which will include the election of directors, the report of compensation committee on annual compensation, certain relationships and related transactions and other business.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS. The following is a list of the Consolidated Financial Statements of Fidelity National Financial, Inc. and its subsidiaries included in Item 8 of Part II.
Independent Auditors' Report.
Consolidated Balance Sheets as of December 31, 1998 and 1997 (Restated).
Consolidated Statements of Earnings for the years ended December 31, 1998, 1997 (Restated) and 1996 (Restated).
Consolidated Statements of Comprehensive Earnings for the year ended December 31, 1998, 1997, and 1996.
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 (Restated) and 1996 (Restated)
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 (Restated) and 1996 (Restated)
Notes to Consolidated Financial Statements.
(a)(2) FINANCIAL STATEMENT SCHEDULES. The following is a list of financial statement schedules filed as part of this annual report on Form 10-K.
Schedule II: Fidelity National Financial, Inc. (Parent Company Financial Statements).
Schedule V: Valuation and Qualifying Accounts.
All other schedules are omitted because they are not applicable or not required, or because the required information is included in the Consolidated Financial Statements or notes thereto.
(a)(3) The following exhibits are incorporated by reference or are set forth on pages to this Form 10-K:
(b) REPORTS ON FORM 8-K. The Company filed reports on Form 8-K during the fourth quarter ending December 31, 1998 as follows:
Current report on Form 8-K dated October 22, 1998, relating to the combined financial results of Fidelity National Financial, Inc. and Alamo Title Holding Company for the quarter ended September 30, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIDELITY NATIONAL FINANCIAL, INC.
By: /s/ WILLIAM P. FOLEY, II ------------------------------------ William P. Foley, II Chief Executive Officer
Date: March 17, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEPENDENT AUDITORS' REPORT
The Board of Directors Fidelity National Financial, Inc.:
Under date of February 17, 1999, we reported on the Consolidated Balance Sheets of Fidelity National Financial, Inc. and subsidiaries as of December 31, 1998 and 1997, 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, 1998 which are included in the Annual Report on Form 10-K. In connection with our audits of the aforementioned Consolidated Financial Statements, we also audited the related financial statement schedules in the Annual Report on Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.
In our opinion, such schedules, when considered in relation to the basic Consolidated Financial Statements taken as a whole, present fairly, in all material respects, the information set forth therein.
KPMG LLP
Los Angeles, California February 17, 1999, except as to Note Q to the Consolidated Financial Statements, which is as of March 29, 1999.
SCHEDULE II
FIDELITY NATIONAL FINANCIAL, INC. (PARENT COMPANY)
BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
See Notes to Financial Statements. (Schedule continued on following page.)
FIDELITY NATIONAL FINANCIAL, INC. (PARENT COMPANY)
STATEMENTS OF EARNINGS AND RETAINED EARNINGS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See Notes to Financial Statements. (Schedule continued on following page.)
FIDELITY NATIONAL FINANCIAL, INC. (PARENT COMPANY)
STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See Notes to Financial Statements. (Schedule continued on following page.)
FIDELITY NATIONAL FINANCIAL, INC. (PARENT COMPANY)
NOTES TO FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fidelity National Financial, Inc. (the "Company") transacts substantially all of its business through its subsidiaries. The Parent Company Financial Statements should be read in connection with the aforementioned Consolidated Financial Statements and Notes thereto included elsewhere herein.
On February 26, 1998, the Company, in exchange for approximately 5.0 million shares of Company common stock plus cash in lieu of fractional shares, acquired the common stock of Granite Financial, Inc. and subsidiaries. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $26.08 on February 26, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Granite.
The Company acquired the common stock of Alamo Title Holding Company and subsidiaries on August 20, 1998, in exchange for approximately 2.2 million shares of Company common stock plus cash in lieu of fractional shares. Fidelity National Financial, Inc. common stock, as reported by the New York Stock Exchange, closed at $33.13 on August 20, 1998. The transaction has been accounted for as a pooling-of-interests. Accordingly, the Consolidated Balance Sheet as of December 31, 1997 and the related Consolidated Statements of Earnings, Stockholders' Equity and Cash Flows for each of the years in the two-year period ended December 31, 1997 and the related Notes to Consolidated Financial Statements, have been restated to reflect the inclusion of Alamo.
B. NOTES PAYABLE
Notes payable consist of the following:
The Company guarantees the bank revolving line of credit of a certain subsidiary in the amount of $25.0 million.
FIDELITY NATIONAL FINANCIAL, INC. (PARENT COMPANY)
NOTES TO FINANCIAL STATEMENTS (CONTINUED) AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED)
Principal maturities, including accretion of original issue discount, are as follows (dollars in thousands):
C. SUPPLEMENTARY CASH FLOW INFORMATION
SCHEDULE V
FIDELITY NATIONAL FINANCIAL, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1998, 1997 (RESTATED) AND 1996 (RESTATED) (DOLLARS IN THOUSANDS)
- ---------------
(1) Represents net reserve for claim losses and other allowances assumed from sales and acquisitions during the year.
(2) Represents payments of claim losses, net of recoupments.
(3) Represents uncollectible accounts written off, change in reserve due to reevaluation of specific items and change in reserve due to sale of certain assets.
(4) Represents reduction in the reserve balance due to the sale of a real estate property.
EXHIBIT INDEX