SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to __________________ Commission file number 0-3658 THE FIRST AMERICAN FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Incorporated in California 95-1068610 ------------------------------- ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 114 East Fifth Street, Santa Ana, California 92701-4642 - -------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (714) 558-3211 Securities registered pursuant to Section 12(b) of the Act: Common New York Stock Exchange Rights to Purchase Series A Junior Participating Preferred New York Stock Exchange ----------------------------------- ----------------------- (Title of each class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 C.F.R. 229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] On March 4, 1999, the aggregate market value of voting stock held by non- affiliates was $1,166,806,506. On March 4, 1999, there were 60,656,670 shares of Common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement are incorporated by reference in Part III of this report. The definitive proxy statement will be filed no later than 120 days after the close of Registrant's fiscal year. This report includes 53 pages. PART I ------ Item 1. Business. - ------------------ The Company - ----------- The First American Financial Corporation (the "Company") was organized in 1894 as Orange County Title Company, succeeding to the business of two title abstract companies founded in 1889 and operating in Orange County, California. In 1924, the Company commenced issuing title insurance policies. In 1986, the Company began a diversification program by acquiring and developing financial service businesses closely related to the real estate transfer and closing process. The Company is a California corporation and has its executive offices at 114 East Fifth Street, Santa Ana, California 92701-4642. The Company's telephone number is (714) 558-3211. Unless the context otherwise indicates, the "Company," as used herein, refers to The First American Financial Corporation and its subsidiaries. General - ------- The Company, through its subsidiaries, is engaged in the business of providing real estate-related financial and information services to real property buyers and mortgage lenders. These services include title insurance, tax monitoring, mortgage credit reporting, property data services, flood certification, field inspection services, appraisal services, mortgage loan origination and servicing systems, mortgage document preparation and home warranty services. In addition, credit and various database-related services are provided to automotive dealers, consumer lenders, employers and property management companies. The Company also provides investment, trust and thrift services. Financial information regarding each of the Company's primary business segments is included in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Item 8. Financial Statements and Supplementary Data" of Part II of this report. The Company believes that its subsidiary, First American Title Insurance Company ("First American"), is the largest title insurer in the United States, based on operating revenues, and its subsidiary, First American Real Estate Information Services, Inc., is the nation's largest provider of flood zone determinations, based on the number of flood zone determination reports issued, the nation's largest mortgage credit reporting service, based on the number of credit reports issued, and the nation's second largest provider of tax monitoring services, based on the number of loans under service. The Company also believes that its subsidiary, First American Home Buyers Protection Corporation, was the second largest provider of home warranties in the United States, based on the number of home protection contracts under service. Substantially all of the Company's title insurance, tax monitoring, credit reporting, flood zone determination and property information business results from resales and refinancings of real estate, including residential and commercial properties, and from the construction and sale of new properties. The Company's home warranty business results from residential resales and does not benefit from refinancings or commercial transactions. Resales and refinancings of residential properties constitute the major source of the Company's revenues. Real estate activity is cyclical in nature and is affected greatly by the cost and availability of long term mortgage funds. Real estate activity and, in turn, the Company's revenue base, can be adversely affected during periods of high interest rates and/or limited money supply. However, this adverse effect is mitigated in part by the continuing diversification of the Company's operations into areas outside of its traditional title insurance business. Overview of Title Insurance Industry - ------------------------------------ Title to, and the priority of interests in, real estate are determined in accordance with applicable laws. In most real estate transactions, mortgage lenders and purchasers of real estate want to be protected from loss or damage in the event that title is not as represented. In most parts of the United States, title insurance has become accepted as the most efficient means of providing such protection. Title Policies. Title insurance policies insure the interests of owners and their lenders in the title to real property against loss by reason of adverse claims to ownership of, or to defects, liens, encumbrances or other matters affecting such title which exist at the time a title insurance policy is issued and which were not excluded from the coverage of a title insurance policy. Title insurance policies are issued on the basis of a title report, which is prepared after a search of the public records, maps, documents and prior title policies to ascertain the existence of easements, restrictions, rights of way, conditions, encumbrances or other matters affecting the title to, or use of, real property. In certain instances, a visual inspection of the property is also made. To facilitate the preparation of title reports, copies of public records, maps, documents and prior title policies may be compiled and indexed to specific properties in an area. This compilation is known as a "title plant." 1 The beneficiaries of title insurance policies are generally real estate buyers and mortgage lenders. A title insurance policy indemnifies the named insured and certain successors in interest against title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from its provisions. The policy typically provides coverage for the real property mortgage lender in the amount of its outstanding mortgage loan balance and for the buyer in the amount of the purchase price of the property, but in some cases might insure for a greater amount where the buyer anticipates constructing improvements on the property. Coverage under a title insurance policy issued to a real property mortgage lender generally terminates upon the sale of the insured property unless the owner carries back a mortgage or makes certain warranties as to the title. Before issuing title policies, title insurers seek to limit their risk of loss by accurately performing title searches and examinations. The major expenses of a title company relate to such searches and examinations, the preparation of preliminary reports or commitments and the maintenance of title plants, and not from claim losses as in the case of property and casualty insurers. The Closing Process. Title insurance is essential to the real estate closing process in most transactions involving real property mortgage lenders. In a typical residential real estate sale transaction, title insurance is generally ordered on behalf of an insured by a real estate broker, lawyer, developer, lender or closer involved in the transaction. Once the order has been placed, a title insurance company or an agent conducts a title search to determine the current status of the title to the property. When the search is complete, the title company or agent prepares, issues and circulates a commitment or preliminary title report ("commitment") to the parties to the transaction. The commitment summarizes the current status of the title to the property, identifies the conditions, exceptions and/or limitations that the title insurer intends to attach to the policy and identifies items appearing on the title that must be eliminated prior to closing. The closing function, sometimes called an escrow in western states, is often performed by a lawyer, an escrow company or a title insurance company or agent (such person or entity, the "closer"). Once documentation has been prepared and signed, and mortgage lender payoff demands are in hand, the transaction is "closed." The closer records the appropriate title documents and arranges the transfer of funds to pay off prior loans and extinguish the liens securing such loans. Title policies are then issued insuring the priority of the mortgage of the real property mortgage lender in the amount of its mortgage loan and the buyer in the amount of the purchase price. The time lag between the opening of the title order and the issuance of the title policy is usually between 30 and 90 days. The seller and the buyer bear the risk during this time lag. Any matter affecting title which is discovered during this period would have to be dealt with to the title insurers' satisfaction or the insurer would except the matter from the coverage afforded by the title policy. Before a closing takes place, however, the closer would request that the title insurer provide an update to the commitment to discover any adverse matters affecting title and, if any are found, would work with the seller to eliminate them so that the title insurer would issue the title policy subject only to those exceptions to coverage which are acceptable to the buyer and the buyer's lender. Issuing the Policy: Direct vs. Agency. A title policy can be issued directly by a title insurer or indirectly on behalf of a title insurer through agents which are not themselves licensed as insurers. Where the policy is issued by a title insurer, the search is performed by or at the direction of the title insurer, and the premium is collected and retained by the title insurer. Where the policy is issued by an agent, the agent performs the search, examines the title, collects the premium and retains a portion of the premium. The remainder of the premium is remitted to the title insurer as compensation for bearing the risk of loss in the event a claim is made under the policy. The percentage of the premium retained by an agent varies from region to region. A title insurer is obligated to pay title claims in accordance with the terms of its policies, regardless of whether it issues its policy directly or indirectly through an agent. Premiums. The premium for title insurance is due and earned in full when the real estate transaction is closed. Premiums are generally calculated with reference to the policy amount. The premium charged by a title insurer or an agent is subject to regulation in most areas. Such regulations vary from state to state. The Company's Title Insurance Operations - ---------------------------------------- Overview. The Company, through First American Title Insurance Company and its subsidiaries, transacts the business of title insurance through a network of more than 300 branch offices and over 4,000 independent agents. Through its branch office and agent network, the Company issues policies in all states (except Iowa), the District of Columbia, Puerto Rico, Guam, the U.S. Virgin Islands, the Bahama Islands, Canada, Mexico, Bermuda, the United Kingdom and Australia. In Iowa, the Company provides abstracts of title only, because title insurance is not permitted. Through acquisitions and start-ups during the mid- 1980s, the Company has grown from a large regional company to a nationwide company, becoming less dependent on operating revenues from any one state or region. Based on industry statistics showing premiums written in the major areas in which the Company operates, in 1997, the Company had the largest or second largest share of the title insurance market in 29 states and in the District of 2 Columbia. In addition, the Company's national market share grew from 20.4% in 1996 to 21.5% in 1997. Industry statistics for 1998 are not currently available. The Company plans to continue increasing its share of the title insurance market through strategic acquisitions and further development of its existing branch office and agency operations. The Company also will continue to focus on expanding its share of the higher margin title insurance business conducted on behalf of commercial clients. The Company believes its national commercial market share has grown through programs directed at major developers, lenders and law firms. Sales and Marketing. The Company markets its title insurance services to a broad range of customers. The Company believes that its primary source of business is from referrals from persons in the real estate community, such as independent escrow companies, real estate brokers, developers, mortgage brokers, mortgage bankers, financial institutions and attorneys. In addition to the referral market, the Company markets its title insurance services directly to large corporate customers and certain mortgage lenders. As title agents contribute a large portion of the Company's revenues, the Company also markets its title insurance services to independent agents. The Company's marketing efforts emphasize the quality and timeliness of its services and its national presence. While virtually all personnel in the Company's title insurance business assist in marketing efforts, the Company maintains a sales force of approximately 1,000 persons dedicated solely to marketing. This sales force is located throughout the Company's branch office network. The Company provides its sales personnel with training in selling techniques, and each branch manager is responsible for hiring the sales staff and ensuring that sales personnel under his or her supervision are properly trained. In addition to this sales force, the Company has approximately 20 sales personnel in its national accounts department. One of the responsibilities of the national accounts department sales personnel is the coordination of marketing efforts directed at large real estate lenders and companies developing, selling, buying or brokering properties on a multistate basis. The Company also supplements the efforts of its sales force through general advertising in various trade and professional journals. The Company's increased commercial sales effort during the past decade has enabled the Company to expand its commercial business base. Because commercial transactions involve higher coverage amounts and yield higher premiums, commercial title insurance business generates greater profit margins than does residential title insurance business. Accordingly, the Company plans to continue to emphasize its commercial sales program. Although sales outside of the United States account for a small percentage of the Company's revenues, the Company believes that the acceptance of title insurance in foreign markets has increased in recent years. Accordingly, the Company plans to continue its international sales efforts, particularly in Canada, the United Kingdom and Australia. Underwriting. Before a title insurance policy is issued, a number of underwriting decisions are made. For example, matters of record revealed during the title search may require a determination as to whether an exception should be taken in the policy. The Company believes that it is important for the underwriting function to operate efficiently and effectively at all decision making levels so that transactions may proceed in a timely manner. To perform this function, the Company has underwriters at the branch level, the regional level and the national level. Agency Operations. 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 title insurance policies 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 error of the agent. Such agency agreements typically have a term of one to five years and are terminable immediately for cause. Due to the high incidence of agency fraud in the title insurance industry during the late 1980s, the Company instituted measures to strengthen its agent selection and audit programs. In determining whether to engage an independent agent, the Company investigates the agent's experience, background, financial condition and past performance. The Company maintains loss experience records for each agent and conducts periodic audits of its agents. The Company has also increased the number of agent representatives and agent auditors that it employs. Agent representatives periodically visit agents and examine their books and records. In addition to periodic audits, a full agent audit will be triggered if certain "warning signs" are evident. Warning signs that can trigger an audit include the failure to implement Company-required accounting controls, shortages of escrow funds and failure to remit underwriting fees on a timely basis. Since strengthening its agent selection and audit programs, the Company's average annual losses resulting from agent defalcations have decreased by approximately 60%. Title Plants. The Company's network of title plants constitutes one of its principal assets. A title search is conducted by searching the public records or utilizing a title plant. While public records are indexed by reference to the names of the parties to a given recorded document, most title plants arrange their records on a geographic basis. Because of this difference, records of a title plant are generally easier to search. Most title plants also index prior policies, adding to searching efficiency. Many title plants are computerized. Certain offices of the Company utilize 3 jointly owned plants or utilize a plant under a joint user agreement with other title companies. The Company believes its title plants, whether wholly or partially owned or utilized under a joint user agreement, are among the best in the industry. With the formation of a limited liability corporation ("LLC") with Experian Group on January 1, 1998, the Company enhanced its investment in title plants. Experian Group contributed to the LLC its real estate information division, which the Company believes is the nation's leading operator of title plants, with the second largest repository of imaged title documents. The Company's title plants are carried on its balance sheet at original cost, which includes the cost of producing or acquiring interests in title plants or the appraised value of subsidiaries' title plants at dates of acquisition for companies accounted for as purchases. Thereafter, the cost of daily maintenance of these plants is charged to expense as incurred. A properly maintained title plant has an indefinite life and does not diminish in value with the passage of time. Therefore, in accordance with generally accepted accounting principles, no provision is made for depreciation of these plants. Since each document must be reviewed and indexed into the title plant, such maintenance activities constitute a significant item of expense. The Company is able to offset title plant maintenance costs at its plants through joint ownership and access agreements with other title insurers and title agents. Reserves for Claims and Losses. The Company provides for title insurance losses based upon its historical experience by a charge to expense when the related premium revenue is recognized. The resulting reserve for known claims and incurred but not reported claims reflects management's best estimate of the total costs required to settle all claims reported to the Company and claims incurred but not reported, and is considered by the Company to be adequate for such purpose. In settling claims, the Company occasionally purchases and ultimately sells the interest of the insured in the real property or the interest of the claimant adverse to the insured. The assets so acquired are carried at the lower of cost or fair value, less costs to sell. Notes, real estate and other assets purchased or otherwise acquired in settlement of claims, net of valuation reserves, totaled $11.8 million, $4.9 million and $0.3 million, respectively, as of December 31, 1998. Reinsurance and Coinsurance. The Company assumes and distributes large title insurance risks through mechanisms of reinsurance and coinsurance. In reinsurance agreements, in consideration for a portion of the premium, the reinsurer accepts that part of the risk which the primary insurer cedes to the reinsurer over and above the portion retained by the primary insurer. The primary insurer, however, remains liable for the total risk in the event that the reinsurer does not meet its obligation. As a general rule, the Company does not retain more than $40 million of coverage on any single policy. Under coinsurance agreements, each coinsurer is jointly and severally liable for the risk insured, or for so much thereof as is agreed to by the parties. The Company's reinsurance activities account for less than 1% of its total title insurance operating revenues. Competition. The title insurance business is highly competitive. The number of competing companies and the size of such companies varies in the different areas in which the Company conducts business. Generally, in areas of major real estate activity, such as metropolitan and suburban localities, the Company competes with many other title insurers. Approximately 90 title insurance underwriters are members of the American Land Title Association, the title insurance industry's national trade association. The Company's major nationwide competitors in its principal markets include Chicago Title and Trust Company (which also includes Ticor Title Insurance Company and Security Union Title Insurance Company), Land America Title Insurance Company, Stewart Title Guaranty Company, Old Republic Title Insurance Group and Fidelity National Title Insurance Company. In addition to these nationwide competitors, numerous agency operations throughout the country provide aggressive competition on the local level. The Company believes that competition for title insurance business is based primarily on the quality and timeliness of service because parties to real estate transactions are usually concerned with time schedules and costs associated with delays in closing transactions. In those states where prices are not established by regulatory authorities, the price of title insurance policies is also an important competitive factor. The Company believes that it provides quality service in a timely manner at competitive prices. The Company's Related Businesses - -------------------------------- As an adjunct to its title insurance business, in 1986 the Company embarked on a diversification program by acquiring and developing financial service businesses closely related to the real estate transfer and closing process. To date, these businesses include tax monitoring, credit reporting, property data services, flood certification, field inspection services, appraisal services, mortgage loan servicing systems, mortgage document preparation and home warranty services. The development of these businesses has allowed the Company to become the nation's leading 4 company offering a full range of services to real property buyers and mortgage lenders. The Company also provides investment, trust and thrift services. The Real Estate Information Service Business. The real estate information service business encompasses tax monitoring, mortgage credit reporting, flood certification, mortgage loan origination and servicing systems, mortgage document preparation and other property information services. The tax monitoring service, established by the Company in 1987, advises real property mortgage lenders of the status of property tax payments due on real estate securing their loans. With the acquisition of TRTS Data Services, Inc., (now named First American Real Estate Information Services, Inc.) in November 1991, the Company believes that it is the second largest provider of tax monitoring services in the United States. Under a typical contract, a tax service provider monitors, on behalf of a mortgage lender, the real estate taxes owing on properties securing such lender's mortgage loans for the life of such loans. In general, providers of tax monitoring services, such as the Company's tax service, indemnify mortgage lenders against losses resulting from a failure to monitor delinquent taxes. Where a mortgage lender requires that tax payments be impounded on behalf of borrowers, providers of tax monitoring services, such as the Company's tax service, may be required to monitor and oversee the transfer of these monies to the taxing authorities and provide confirmation to lenders that such taxes have been paid. The Company's tax service business markets its product through a nationwide sales staff which calls on servicers and originators of mortgage loans. The Company's primary source of tax service business is from large multistate mortgage lenders. The Company's only major nationwide competitor in the tax service business is Transamerica Real Estate Tax Service. Because of its broad geographic coverage and the large number of mortgage loans not being serviced by a third party tax service provider, the Company believes that it is well positioned to increase its market share in the tax service market. The fee charged to service each mortgage loan varies from region to region, but generally falls within the $44 to $95 price range and is paid in full at the time the contract is executed. The Company recognizes revenues from tax service contracts over the estimated duration of the contracts as the related servicing costs are estimated to occur. However, income taxes are paid on the entire fee in the year the fee is received. Historically, the Company has maintained minimal reserves for losses relating to its tax monitoring service because its losses have been negligible. Given the uncertainties related to the Company's ability, as well as the ability of its significant vendors, suppliers and customers, to become Year 2000 compliant, losses relating to the Company's tax monitoring service may increase. The Company's credit reporting service provides credit information reports for mortgage lenders throughout the United States. These reports are derived from two or more credit bureau sources and are summarized and prepared in a standard form acceptable to mortgage loan originators and secondary mortgage purchasers. The credit reporting service also provides prequalifying reports, merged credit data, resident screening services, business reports, credit scoring tools and personal credit reports. It also has recently branched into the consumer lending and risk scoring areas, providing credit reporting and information management services to automobile dealers, consumers and home equity lenders nationwide. The Company's credit reporting service has grown primarily through acquisitions. In 1994, the Company acquired all of the minority interests in its lower tier subsidiaries Metropolitan Credit Reporting Services, Inc., and Metropolitan Property Reporting Services, Inc. In 1994, the Company also acquired California Credit Data, Inc., and Prime Credit Reports, Inc., and in 1995, the Company acquired Credco, Inc. (now named First American Credco, Inc.). With the acquisition of First American Credco, Inc., the Company believes that it is now the largest mortgage credit reporting service in the United States. In January 1995, the Company acquired Flood Data Services, Inc. (now named First American Flood Data Services, Inc.). This business furnishes to mortgage lenders flood zone determination reports, which provide information on whether or not property securing a loan is in a governmentally delineated special flood hazard area. Federal legislation passed in 1994 requires that most mortgage lenders obtain a determination of the current flood zone status at the time each loan is originated and obtain updates during the life of the loan. First American Flood Data Services, Inc., is the largest provider of flood zone determinations in the United States. In April 1996, the Company acquired the Excelis Mortgage Loan Servicing System (MLS), now known as Excelis, Inc. Excelis MLS is the only commercially available real-time on-line servicing system that has been developed since 1990 to meet increasingly sophisticated market demands. The software employs rules- based technology which enables the user to customize the system to fit its individual servicing criteria and policies. In December 1996, the Company acquired Ward Associates, now known as First American Field Services. The company was combined with First American's existing field services company to provide comprehensive inspection and property preservation services to mortgage lenders nationwide. With the acquisition, the Company believes that it is now the second largest field services company in the United States. In May 1997, the Company purchased all of the operations of SMS, other than SMS' flood zone determination business. SMS is a leading provider of real estate information services to the U.S. mortgage and title insurance industries. The acquired businesses include SMS' credit division, which the Company believes is the third largest 5 provider of U.S. mortgage credit information; SMS' property appraisal division, which the Company believes is the second largest provider of U.S. appraisal services; SMS' title division, which provides title and closing services throughout the United States, servicing primarily home equity mortgage institutions; SMS' settlement services business, which provides title plant systems and accounting services, as well as escrow closing software, to the title industry; and a controlling interest in what is believed by the Company to be the largest mortgage document preparation firm. On January 1, 1998, the Company and its real estate information service subsidiaries (other than Excelis, Inc.) (the "Real Estate Information Subsidiaries") consummated a business transaction with Experian Group ("Experian"), pursuant to which First American Real Estate Solutions LLC ("FARES") was established. Under the transaction, the Real Estate Information subsidiaries contributed substantially all of their assets and liabilities to FARES in exchange for an 80% ownership interest and Experian transferred substantially all of the assets and liabilities of its Real Estate Solutions division ("RES") to FARES in exchange for a 20% ownership interest. RES is believed to be the nation's foremost supplier of core real estate data, providing, among other things, property valuation information, title information, tax information and imaged title documents. As a result of this transaction, the Company believes that FARES will become the nation's largest and most diverse provider of information technology and decision support solutions for the mortgage and real estate industries. In April 1998, the Company acquired Contour Software. This business supplies mortgage loan origination software to the mortgage industry. Contour offers a complete line of software products for every facet of mortgage lending, from qualification to servicing. In June 1998, the Company acquired Data Tree Corporation. Data Tree is a supplier of database management and document imaging systems to county recorders, other governmental agencies and the title industry. In July 1998, the Company acquired ShadowNet Mortgage Technologies, LLC. ShadowNet is a provider of electronic mortgage preparation and delivery systems and now conducts business under the First American Nationwide Documents brand- name. The Consumer Risk Management Business. In 1998 the Company created this business segment by merging certain operations of the Company's existing mortgage credit reporting business with the operations of recently acquired CIC, Inc. and The Registry. This business segment provides non-cyclical, high margin services to a customer base outside the Company's traditional clientele and is designed to expand the Company's opportunities for revenue consistency. The Consumer risk management business markets a variety of services including automotive credit reporting, direct-to-consumer credit reporting, multi-family resident screening and pre-employment screening. The automotive and sub-prime automotive credit reporting service provides auto dealers and lenders with consumer credit reports tailored to the specific needs of the automotive market. This credit reporting service also offers credit reports directly to the consumer, accessing information from the nation's three largest credit bureaus. The multi-family resident screening service provides landlords with information regarding a housing applicant's rental payment history, occupancy responsibilities, eviction actions, credit information and similar background data. The pre-employment screening service offers employers a variety of reports on prospective employees, providing information on criminal records, warrants, motor vehicle reports, credit reports, drug screens, education, prior employment, professional licenses and more. The Home Warranty Business. The Company's home warranty business commenced operations in 1984, in part with the proceeds of a $1.5 million loan from the Company which was, in 1986, converted to a majority equity interest. The Company currently owns 90% of its home warranty business, which is operated as a second tier subsidiary, with the balance owned by management of that subsidiary. The Company's home warranty business issues one-year warranties which protect homeowners against defects in household systems and appliances, such as plumbing, water heaters and furnaces. The Company's home warranty subsidiary currently charges approximately $245 to $335 for its basic home warranty contract. Optional coverage is available for air conditioners, pools, spas, washers, dryers and refrigerators for charges ranging from approximately $25 to $125. For an additional charge, coverage is renewable annually at the option of the homeowner upon approval by the home warranty subsidiary. Fees for the warranties are paid at the closing of the home purchase and are recognized monthly over a 12-month period. Home warranties are marketed through real estate brokers and agents. This business is conducted in certain counties of Arizona, California, Georgia, Nevada, North Carolina, South Carolina, Texas, Utah and Washington. The principal competitor of the Company's home warranty business is American Home Shield, a subsidiary of Service Master L.P. The Trust Business. Since 1960, the Company has conducted a general trust business in California, acting as trustee when so appointed pursuant to court order or private agreement. In 1985, the Company formed a banking subsidiary into which its subsidiary trust operation was merged. As of December 31, 1998, the trust operation was administering fiduciary and custodial assets having a market value in excess of $1.8 billion. 6 The Thrift Business. During 1988, the Company, through a majority owned subsidiary, acquired an industrial loan corporation (the "Thrift") that accepts thrift deposits and uses deposited funds to originate and purchase loans secured by commercial properties in Southern California. As of December 31, 1998, the Thrift had approximately $67.4 million of demand deposits and $72.0 million of loans outstanding. The loans made or acquired by the Thrift currently range in amount from $6,700 to $1,200,000 with an average loan balance of $270,700. Loans are made only on a secured basis, at loan-to-value percentages no greater than 75%. The Thrift specializes in making commercial real estate loans. In excess of 94% of the Thrift's loans are made on a variable rate basis. The average yield on the Thrift's loan portfolio as of December 31, 1998, was 10%. A number of factors are included in the determination of average yield, principal among which are loan fees and closing points amortized to income, prepayment penalties recorded as income, and amortization of discounts on purchased loans. The Thrift's primary competitors in the Southern California commercial real estate lending market are local community banks, other thrift and loan companies and, to a lesser extent, commercial banks. The Company believes that many borrowers who might be eligible for loans from commercial banks use thrift and loan companies, such as the Thrift, because, in general, thrift and loan companies offer longer maturity loans than do commercial banks, which typically offer one-year renewable loans. There is, however, a higher degree of risk associated with longer term loans than shorter term loans. The Thrift's average loan is 60 months in duration. The performance of the Thrift's loan portfolio is evaluated on an ongoing basis by management of the Thrift. The Thrift places a loan on nonaccrual status when two payments become past due. When a loan is placed on nonaccrual status, the Thrift's general policy is to reverse from income previously accrued but unpaid interest. Income on such loans is subsequently recognized only to the extent that cash is received and future collection of principal is probable. Interest income on nonaccrual loans which would have been recognized during the year ended December 31, 1998, if all of such loans had been current in accordance with their original terms, totaled $96,000. Interest income actually recognized on these nonaccrual loans for the year ended December 31, 1998, was $18,000. The following table sets forth the amount of the Thrift's nonperforming loans as of the dates indicated. Year Ended December 31 ---------------------------------------------------------------------------- (in thousands) 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ Nonperforming Assets: Loans accounted for on a nonaccrual basis $ 898 $ 287 $ 166 $1,956 $1,741 Accruing loans past due 90 or more days Troubled debt restructurings ------------ ------------ -------------- ------------ ------------ Total $ 898 $ 287 $ 166 $1,956 $1,741 ============ ============ ============== ============ ============ Based on a variety of factors concerning the creditworthiness of its borrowers, the Thrift determined that it had $1,063,000 of potential problem loans in existence as of December 31, 1998. The Thrift's allowance for loan losses is established through charges to earnings in the form of provision for loan losses. Loan losses are charged to, and recoveries are credited to, the allowance for loan losses. The provision for loan losses is determined after considering various factors, such as loan loss experience, maturity of the portfolio, size of the portfolio, borrower credit history, the existing allowance for loan losses, current charges and recoveries to the allowance for loan losses, the overall quality of the loan portfolio, and current economic conditions, as determined by management of the Thrift, regulatory agencies and independent credit review specialists. While many of these factors are essentially a matter of judgment and may not be reduced to a mathematical formula, the Company believes that, in light of the collateral securing its loan portfolio, the Thrift's current allowance for loan losses is an adequate allowance against foreseeable losses. 7 The following table provides certain information with respect to the Thrift's allowance for loan losses as well as charge-off and recovery activity. Year Ended December 31 -------------------------------------------------------------------------------- (in thousands, except percentages) 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ Allowance for Loan Losses: Balance at beginning of year $1,185 $1,050 $1,344 $ 950 $ 750 ------------ ------------ ------------ ------------ ------------ Charge-Offs: Real estate-mortgage (164) (136) (766) (194) (311) Assigned lease payments (34) (5) (9) (9) (198) (136) (771) (203) (320) ----------- ------------ ------------ ------------ ------------ Recoveries: Real estate-mortgage 0 6 26 0 55 Assigned lease payments 4 22 18 35 28 4 28 44 35 83 ----------- ------------ ------------ ------------ ------------ Net charge-offs (194) (108) (727) (168) (237) Provision for losses 159 243 433 562 437 ----------- ------------ ------------ ------------ ------------ Balance at end of year $1,150 $1,185 $1,050 $1,344 $ 950 ----------- ------------ ------------ ------------ ------------ Ratio of net charge-offs during the year to average loans outstanding during the year .3% .2% 1.4% .4% .6% =========== ============ ============ ============ ============ The adequacy of the Thrift's allowance for loan losses is based on formula allocations and specific allocations. Formula allocations are made on a percentage basis which is dependent on the underlying collateral, the type of loan and general economic conditions. Specific allocations are made as problem or potential problem loans are identified and are based upon an evaluation by the Thrift's management of the status of such loans. Specific allocations may be revised from time to time as the status of problem or potential problem loans changes. The following table shows the allocation of the Thrift's allowance for loan losses and the percent of loans in each category to total loans at the dates indicated. Year Ended December 31 ------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------------------------------------------------------------------------------------------------- (in thousands, except % of % of % of % of % of percentages) Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans ------------------------------------------------------------------------------------------------------- Loan Categories: Real estate-mortgage $1,100 100 $1,116 100 $1,015 100 $1,300 99 $ 879 99 Real estate-construction 3 1 Assigned lease payments - 39 34 41 71 1 Other 50 30 1 ------ ---- ------ ---- ------ ---- ------ ---- ----- ---- $1,150 100 $1,185 100 $1,050 100 $1,344 100 $ 950 100 ------ ---- ------ ---- ------ ---- ------ ---- ----- ---- Acquisitions - ------------ Commencing in the 1960s, the Company initiated a growth program with a view to becoming a nationwide provider of title insurance. This program included expansion into new geographic markets through internal growth and selective acquisitions. In 1986 the Company began expanding into other real estate- related financial services. In 1998 the Company launched its Consumer Risk Management Division where a unique mix of products and services is directed toward non-real estate related markets. To date, the Company has made numerous strategic acquisitions designed to expand not only its direct title operations, but also the range of services it can provide to its customers. 8 During the current year, some of the key acquisitions made by the Company in furtherance of this strategy were: Acquired Entity Principal Market(s) - -------------------------------------------------------------------------------- Title Insurance: Waco-McLennan County Abstract & Title Company Texas Evans Title Companies, Inc. Wisconsin Florida Title & Abstract Company Florida Real Estate Information Services: (1) Real Estate Solutions (1) Nationwide Data Tree Corporation Nationwide Contour Software, Inc. Nationwide RELS LLC (2) Nationwide Consumer Risk Management: C.I.C., Inc. Nationwide The Registry, Inc. Nationwide - -------------------------------------------------------------------------------- (1) On January 1, 1998, the Company formed a limited liability company (FARES LLC) with Experian Group (Experian). The purpose of FARES LLC is to combine certain operations of the Company's subsidiary, First American Real Estate Information Services, Inc., with Experian's Real Estate Solutions division (RES). FARES LLC is 80% owned by the Company and 20% owned by Experian. (2) On November 1, 1998, the Company, through FARES LLC, formed a limited liability company (RELS LLC) with Norwest Mortgage. The purpose of RELS LLC is to provide appraisal services and specialized credit information to the real estate mortgage lending industry. RELS LLC is 50% owned by FARES LLC and 50% owned by Norwest Mortgage. Regulation - ---------- The title insurance business is heavily regulated by state insurance regulatory authorities. These authorities generally possess broad powers with respect to the licensing of title insurers, the types and amounts of investments that title insurers may make, insurance rates, forms of policies and the form and content of required annual statements, as well as the power to audit and examine title insurers. Under state laws, certain levels of capital and surplus must be maintained and certain amounts of securities must be segregated or deposited with appropriate state officials. Various state statutes require title insurers to defer a portion of all premiums in a reserve for the protection of policyholders and to segregate investments in a corresponding amount. Further, most states restrict the amount of dividends and distributions a title insurer may make to its shareholders. The Company's home warranty business also is subject to regulation by insurance authorities in the states in which it conducts such business. The Company's trust company and industrial loan company are both subject to regulation by the Federal Deposit Insurance Corporation. In addition, the Company's trust company is regulated by the California Superintendent of Banks and the Company's industrial loan company is regulated by the California Commissioner of Corporations. Investment Policies - ------------------- The Company invests primarily in cash equivalents, federal and municipal governmental securities, mortgage loans and investment grade debt and equity securities. The largely fixed income portfolio is classified in the Company's financial statements as "available for sale." In addition to the Company's investment strategy, state laws impose certain restrictions upon the types and amounts of investments that may be made by the Company's regulated subsidiaries. 9 Employees - --------- The following table provides a summary of the total number of employees of the Company as of December 31, 1998: Business Number of Employees -------- ------------------- Title insurance 14,277 Real estate information services 4,570 Home warranty 369 Consumer risk management 335 Trust and banking 118 ------ Total 19,669 ====== Item 2. Properties. - -------------------- The Company owns two adjacent office buildings in Santa Ana, California, which house its executive offices, its trust and banking subsidiary and the Orange County title insurance branch operations. This complex, which contains approximately 105,000 square feet of floor space and an enclosed parking area, comprises one city block. The Company has acquired approximately 31 acres of land at MacArthur Place in Santa Ana, California, to meet its current and potential future expansion requirements. The Company is currently constructing three office buildings in a campus environment, totaling approximately 210,000 square feet. The buildings are scheduled to be completed in 1999 and will be occupied by the Company's executive offices, Orange County title insurance branch operations and certain other operations. After the move to the new facility, it is anticipated that the two existing office buildings in Santa Ana, California, will continue to be occupied by the trust and banking subsidiary along with certain other operations of the Company. The Company also owns an 18,000 square foot office building located across the street from its main offices. This building is used primarily for storage. The Company's title insurance subsidiary, First American, and its subsidiaries, own or lease buildings or office space in more than 400 locations throughout the United States and Canada, principally for their respective title operations. The Company's real estate information subsidiary, First American Real Estate Information Services, Inc. ("FAREISI"), houses its national operations in a leased 231,000 square foot office building in Dallas, Texas. FAREISI's corporate headquarters are housed in a leased office building located in St. Petersburg, Florida. The Company has acquired approximately 17 acres of land in Poway, California, and is constructing two office buildings totaling approximately 152,000 square feet. It is anticipated that the buildings will be completed in March, 1999 and will be occupied primarily by various subsidiaries of FAREISI. In addition, FAREISI and its subsidiaries lease office space in more than 75 locations throughout the United States, principally for their respective operations. The Company's home warranty subsidiary owns 1.7 acres of land in Van Nuys, California, which contains a 20,000 square foot office building, a 7,000 square foot warehouse and a parking lot. Each of the office facilities occupied by the Company or its subsidiaries is in good condition and adequate for its intended use. Item 3. Legal Proceedings. - --------------------------- The Company is involved in numerous routine legal proceedings incidental to the businesses described in Item 1 above. Some of these proceedings involve claims for damages in material amounts. At this time, however, the Company does not anticipate that the resolution of any of these proceedings will have a materially adverse effect on its financial condition. Item 4. Submission of Matters to a Vote of Security Holders. - ------------------------------------------------------------- No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. 10 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder - ------------------------------------------------------------------------- Matters. -------- Common Stock Market Prices and Dividends - ---------------------------------------- The Company's common stock trades on the New York Stock Exchange (ticker symbol FAF). The approximate number of record holders of common stock on February 25, 1999, was 3,345. High and low stock prices and dividends for the last two years were (Note A): 1998 1997 ---------------------------- ---------------------------- Cash Cash Quarter Ended High-Low Range Dividends High-Low Range Dividends - ------------- ---------------- --------- ---------------- --------- March 31 $22.88 - $16.08 $.05 $ 9.92 - $ 8.36 $.037 June 30 $30.75 - $21.08 $.05 $ 8.86 - $ 6.97 $.037 September 30 $41.25 - $25.75 $.06 $13.40 - $ 8.67 $.043 December 31 $36.06 - $24.94 $.06 $16.42 - $13.28 $.043 While the Company expects to continue its policy of paying regular quarterly cash dividends, future dividends will be dependent on future earnings, financial condition and capital requirements. The payment of dividends is subject to the restrictions described in Note 2 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of Part II of this report. Recent Sales of Unregistered Securities - --------------------------------------- In the last three years, the Company has issued unregistered shares of its common stock to the sellers of the businesses in the acquisitions listed below. The exemptions relied upon for these issuances were Section 4(2) of the Securities Act and Rule 506 of Regulation D. Sellers were either accredited investors or were sophisticated as to business or financial matters. Number of Shares Consideration Date of Sale (Note A) Received - -------------------------------------------------------------------------------- September 13, 1996 294,189 $ 2,173,719 December 10, 1996 752,145 $ 5,417,149 July 8, 1997 21,600 $ 192,600 November 17, 1997 23,265 $ 315,047 December 31, 1997 2,475 $ 40,630 April 15, 1998 726,564 $15,500,000 May 6, 1998 125,775 $ 2,587,167 May 7, 1998 27,090 $ 435,698 May 29, 1998 111,039 $ 2,850,000 September 15, 1998 17,925 $ 525,000 All consolidated results have been restated to reflect the 1998 acquisitions accounted for under the pooling-of-interests method of accounting. Note A -- After adjustment for 3-for-1 stock split effected July 17, 1998 11 Item 6. Selected Financial Data. - --------------------------------- The selected consolidated financial data for the Company for the five-year period ended December 31, 1998, has been derived from the audited Consolidated Financial Statements. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, "Item 1 -- Business -- Acquisitions," and "Item 7 -- Management's Discussion and Analysis -- Results of Operations." The First American Financial Corporation and Subsidiary Companies - ----------------------------------------------------------------- (in thousands, except percentages, Year Ended December 31 per share amounts and employee data) 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------- Revenues $2,877,328 $1,908,923 $1,614,293 $1,257,267 $1,381,971 Net income $ 198,710 $ 64,499 $ 54,492 $ 7,798 $ 19,698 Total assets $1,784,790 $1,153,635 $ 963,444 $ 855,156 $ 805,350 Notes and contracts payable $ 130,193 $ 42,119 $ 71,428 $ 77,430 $ 89,631 Mandatorily redeemable preferred securities (Note A) $ 100,000 $ 100,000 Stockholders' equity $ 731,915 $ 415,003 $ 356,379 $ 305,778 $ 293,056 Return on average stockholders' equity 34.7% 16.7% 16.5% 2.8% 6.9% Cash dividends on common shares $ 12,628 $ 8,931 $ 7,928 $ 6,850 $ 6,869 Per share of common stock (Notes B & C)-- Net income Basic $ 3.46 $ 1.18 $ 1.01 $ .16 $ .37 Diluted $ 3.32 $ 1.16 $ 1.00 $ .16 $ .37 Stockholders' equity $ 12.13 $ 7.62 $ 6.56 $ 5.69 $ 5.46 Cash dividends $ .22 $ .16 $ .15 $ .13 $ .13 Number of common shares outstanding (Note B)-- Weighted average during the year Basic 57,450 54,448 53,899 53,677 53,875 Diluted 59,822 55,717 54,337 53,677 53,875 End of year 60,332 54,484 54,355 53,713 53,641 Title orders opened (Note D) 1,585 1,173 1,027 894 873 Title orders closed (Note D) 1,210 886 775 667 723 Number of employees 19,669 13,156 11,611 10,149 9,033 All consolidated results have been restated to reflect the 1998 acquisitions accounted for under the pooling-of-interests method of accounting. Note A -- Mandatorily redeemable preferred securities of First American Capital Trust I, a Delaware business trust controlled by the Company, whose sole assets are $100,000,000 aggregate principal amount of the Company's 8.5% deferrable interest debentures due 2012. Note B -- After adjustment for 3-for-1 stock split effected July 17, 1998. Note C -- Per share information relating to net income is based on the weighted average number of shares outstanding for the years presented. Per share information relating to stockholders' equity is based on shares outstanding at the end of each year. Note D -- Title order volumes are those processed by the direct title operations of the Company and do not include orders processed by agents. 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations. -------------- Any statements in this document looking forward in time involve risks and uncertainties, including but not limited to the following: the effect of interest rate fluctuations; changes in the performance of the real estate markets; the effect of changing economic conditions; the demand for and the acceptance of the Company's products; and contingencies associated with the Year 2000 issue. Results of Operations - --------------------- Overview - As with all providers of real estate-related information products and services, the Company's revenues depend, in large part, upon the level of real estate activity and the cost and availability of mortgage funds. The majority of the Company's revenues for the title insurance and real estate information segments result from resales and refinancings of residential real estate and, to a lesser extent, from commercial transactions and the construction and sale of new housing. Revenues for the Company's home warranty segment result primarily from residential resale activity and do not benefit from refinancings. Traditionally, the greatest volume of real estate activity, particularly residential resale, has occurred in the spring and summer months. However, in recent years, interest rate adjustments by the Federal Reserve Board, as well as other economic factors, have caused fluctuations in the traditional pattern of real estate activity. Mortgage interest rates peaked in January 1995 and decreased throughout the remainder of the year prompted by Federal Reserve Board actions to stimulate the economy. This resulted in a resurgence of real estate activity in the last half of 1995, and generated a high inventory of open transactions going into 1996. This, together with an improving national real estate economy (including the beginnings of a recovery in California) and the Company's successful integration of its diverse businesses, resulted in strong revenues and profits for 1996. These favorable conditions continued throughout 1997. Stability in the real estate marketplace coupled with increasing prices prompted a resurgence in refinance and home equity transactions, primarily towards the latter part of the year. These factors, as well as market share increases in all of the Company's primary business segments, culminated in a record-setting 1997. Further rate declines started in the fourth quarter of 1997 and continued throughout 1998. This, coupled with higher consumer confidence, led to nationwide record-setting residential resale and refinance transactions in 1998. These factors, including a particularly strong California real estate market, contributed to record- setting revenues and net income for the Company in 1998. Operating revenues - A summary by segment of the Company's operating revenues is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % ----------------------------------------------------------- Title Insurance: Direct Operations $1,097,989 39 $ 761,774 41 $ 626,314 40 Agency Operations 965,228 35 700,193 37 641,919 40 ----------------------------------------------------------- 2,063,217 74 1,461,967 78 1,268,233 80 Real Estate Information 598,832 21 311,838 17 239,434 15 Home Warranty 58,204 2 46,859 2 38,351 2 Consumer Risk 57,186 2 40,995 2 24,038 2 Trust and Banking 24,751 1 20,007 1 17,839 1 ----------------------------------------------------------- $2,802,190 100 $1,881,666 100 $1,587,895 100 =========================================================== Operating revenues from direct title operations increased 44.1% in 1998 over 1997 and 21.6% in 1997 over 1996. These increases were attributable to increases in the number of title orders closed by the Company's direct operations as well as increases in the average revenues per order closed. The Company's direct operations closed 1,210,200, 885,600 and 775,100 title orders during 1998, 1997 and 1996, respectively, representing increases of 36.7% in 1998 over 1997 and 14.3% in 1997 over 1996. These increases were primarily due to the continuation of lower mortgage interest rates which led to an increase in overall transaction volume nationwide (including California, a state highly concentrated with direct operations) and increases in the Company's national market share. The average revenues per order closed were $907, $860 and $808 for 1998, 1997 and 1996, respectively, representing increases of 5.5% in 1998 over 1997 and 6.4% in 1997 over 1996. These increases were primarily attributable to appreciating home values, an increased mix of resale activity and a resurgence in commercial real estate transactions. Operating revenues from agency operations increased 37.9% in 1998 over 1997 and 9.1% in 1997 over 1996. These fluctuations were primarily attributable to the same factors affecting direct operations mentioned above, compounded by the inherent delay in the reporting of transactions by agents. 13 Real estate information operating revenues increased 92.0% in 1998 over 1997 and 30.2% in 1997 over 1996. These increases were primarily attributable to the same factors affecting title insurance mentioned above and $144.5 million and $53.8 million of operating revenues contributed by new acquisitions in 1998 and 1997, respectively. Effective January 1, 1999, the Company will implement a change to its revenue recognition accounting policy for tax service contracts. The new policy provides for a more ratable recognition of revenues, reducing the amount recognized at the inception of the contract and recognizing it over the expected service period. The Company estimates that adoption of this new policy will reduce the revenue recognized in 1999 from new tax service orders by approximately 50%. See Note 1 to the consolidated financial statements for a more detailed description of the accounting change. Home warranty operating revenues increased 24.2% in 1998 over 1997 and 22.2% in 1997 over 1996. These increases were primarily attributable to improvements in certain of the residential resale markets in which this segment operates, successful geographic expansion, increased consumer awareness and increases in the number of annual renewals. Consumer risk management operating revenues increased 39.5% in 1998 over 1997 and 70.5% in 1997 over 1996. These increases were primarily attributable to an increased awareness and acceptance of this business segment's products as well as increased market share. Investment and other income - Investment and other income increased $47.9 million in 1998 over 1997. This increase was primarily attributable to an investment gain of $32.4 million recognized in the first quarter of 1998 relating to the joint venture agreement with Experian, as well as a 36.9% increase in the average investment portfolio balance due to the investment of excess cash flow from operations and a portion of the proceeds from the Company's $100 million senior debentures (see Note 8 to consolidated financial statements). Investment and other income increased a marginal 3.3% in 1997 over 1996. This increase was primarily attributable to a 4.8% increase in the average investment portfolio balance and increased equity in earnings of unconsolidated subsidiaries, offset in part by an increase of $0.9 million in losses from the sales of fixed assets. See Note 9 to the consolidated financial statements for further details of the composition of investment and other income. Salaries and other personnel costs - A summary by segment of the Company's salaries and other personnel costs is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % ----------------------------------------------------- Title Insurance $659,289 72 $498,424 76 $413,164 77 Real Estate Information 201,398 22 117,350 18 92,905 17 Home Warranty 13,765 2 11,430 2 9,075 2 Consumer Risk 18,323 2 14,081 2 6,389 1 Trust and Banking 7,721 1 7,061 1 6,621 1 Corporate 13,562 1 10,979 1 11,831 2 ----------------------------------------------------- $914,058 100 $659,325 100 $539,985 100 ===================================================== The Company's title insurance segment (primarily direct operations) is labor intensive; accordingly, a major variable expense component is salaries and other personnel costs. This expense component is affected by two competing factors: the need to monitor personnel changes to match corresponding or anticipated new orders, and the need to provide quality service. In addition, the Company's growth in operations that specialize in builder and lender business has created ongoing fixed costs required to service accounts. Title insurance personnel expenses increased 32.3% in 1998 over 1997 and 20.6% in 1997 over 1996. These increases were primarily attributable to the costs incurred servicing the increasing volume of title orders at the Company's direct operations and, to a lesser extent, acquisition activity and salary increases, offset in part by productivity gains as measured by new orders per person. Contributing to the increases for 1998 and 1997 was an increased volume of labor intensive residential resale transactions. The Company's direct operations opened 1,585,400, 1,173,300 and 1,026,900 title orders in 1998, 1997, and 1996, respectively, representing increases of 35.1% in 1998 over 1997 and 14.3% in 1997 over 1996. Real estate information personnel expenses increased 71.6% in 1998 over 1997 and 26.3% in 1997 over 1996. These increases were primarily attributable to costs incurred servicing the increase in business volume, $63.0 million and $20.7 million of costs attributable to company acquisitions for 1998 and 1997, respectively, as well as higher overhead costs attributable to the integration of new acquisitions and transitioning new accounts. Contributing to the increases were costs associated with in-house development of new electronic communication delivery systems for information-based products to interface with customer needs. Home warranty personnel expenses increased 20.4% in 1998 over 1997 and 26.0% in 1997 over 1996. These increases were primarily due to the additional personnel required to service the increased business volume in the states this segment currently services, as well as new geographic expansion and modest salary increases. 14 Consumer risk management personnel expenses increased 30.1% in 1998 over 1997 and 120.4% in 1997 over 1996. These increases were primarily attributable to additional personnel required to service the increased business volume. Premiums retained by agents - A summary of agent retention and agent revenues is as follows: (in thousands, except percentages) 1998 1997 1996 -------- -------- -------- Agent Retention $773,030 $563,137 $516,593 ======== ======== ======== Agent Revenues $965,228 $700,193 $641,919 ======== ======== ======== % Retained by Agents 80.1% 80.4% 80.5% ======== ======== ======== The premium split between underwriter and agents is in accordance with their respective agency contracts and can vary from region to region due to divergencies in real estate closing practices, as well as rating structures. As a result, the percentage of title premiums retained by agents may vary due to the geographical mix of revenues from agency operations. Other operating expenses - A summary by segment of the Company's other operating expenses is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % -------- ------- -------- ------ -------- ------ Title Insurance $307,055 50 $247,579 59 $216,514 66 Real Estate Information 251,376 41 132,927 32 83,489 25 Home Warranty 3,726 1 2,071 - 1,323 - Consumer Risk 25,481 4 19,795 5 14,576 5 Trust and Banking 9,270 2 8,093 2 6,982 2 Corporate 14,424 2 10,591 2 6,641 2 -------- ------- -------- ------ -------- ------ $611,332 100 $421,056 100 $329,525 100 ======== ======= ======== ====== ======== ====== Title insurance other operating expenses (principally direct operations) increased 24.0% in 1998 over 1997 and 14.3% in 1997 over 1996. These increases were primarily the result of the impact created by the changes in incremental costs (i.e., office supplies, document reproduction, messenger services, plant maintenance and title search costs) associated with the relative changes in title order volume. Also contributing to the increases were marginal price level increases and acquisitions, offset in part by successful cost-containment programs. Real estate information other operating expenses increased 89.1% in 1998 over 1997 and 59.2% in 1997 over 1996. These increases were primarily attributable to costs incurred servicing the increased business activity, as well as $62.4 million and $33.5 million of other operating costs relating to acquisitions in 1998 and 1997, respectively, offset in part by cost-containment programs. Contributing to the increases were costs associated with assimilating and expanding this segment's increased operations. Provision for title losses and other claims - A summary by segment of the Company's provision for title losses and other claims is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % -------- ----- ------- ----- ------- ----- Title Insurance $ 68,697 58 $52,924 59 $58,909 68 Real Estate Information 17,428 15 9,874 11 4,453 5 Home Warranty 32,686 27 27,338 30 23,055 27 Trust and Banking (48) - 187 - 70 - -------- ----- ------- ----- ------- ----- $118,763 100 $90,323 100 $86,487 100 ======== ===== ======= ===== ======= ===== The provision for title insurance losses expressed as a percentage of title insurance operating revenues was 3.3% in 1998, 3.6% in 1997 and 4.6% in 1996. These decreases reflect ongoing improvement in the Company's claims experience. The provision for home warranty losses as a percentage of home warranty operating revenues was 56.2% in 1998, 58.3% in 1997 and 60.1% in 1996. These fluctuations were primarily attributable to the relative changes in the average number of claims per contract experienced during these periods. Depreciation and amortization - Depreciation and amortization as well as capital expenditures are summarized in Note 18 to the consolidated financial statements. 15 Premium taxes - A summary by pertinent segment of the Company's premium taxes is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % -------- ----- -------- ----- ------- ----- Title Insurance $19,959 95 $16,034 95 $15,927 96 Home Warranty 953 5 870 5 749 4 ------- ----- -------- ----- ------- ----- $20,912 100 $16,904 100 $16,676 100 ======= ===== ======== ===== ======= ===== Insurers are generally not subject to state income or franchise taxes. However, in lieu thereof, a "premium" tax is imposed on certain operating revenues, as defined by statute. Tax rates and bases vary from state to state; accordingly, the total premium tax burden is dependent upon the geographical mix of title insurance and home warranty operating revenues. The Company's underwritten title company (non-insurance) subsidiaries are subject to state income tax and do not pay premium tax. Accordingly, the Company's total tax burden at the state level is composed of a combination of premium taxes and state income taxes. Premium taxes as a percentage of title insurance operating revenues were 1.0% in 1998, 1.1% in 1997 and 1.3% in 1996. These decreases were attributable to changes in the geographical mix of title insurance revenues, as well as changes in the Company's non-insurance subsidiaries' contribution to revenues. Interest - Interest expense increased 79.8% in 1998 over 1997 and 108.3% in 1997 over 1996. The increase for 1998 was primarily due to $5.5 million of interest expense related to the senior debentures as well as incremental interest expense of $2.8 million related to the mandatorily redeemable preferred securities (outstanding for full year). The increase in 1997 was primarily due to $5.7 million of interest expense related to the mandatorily redeemable preferred securities (outstanding for eight months), offset in part by a 23.7% reduction in the average outstanding debt balance. See Note 8 to the consolidated financial statements for a description of the Company's borrowings under its bank credit agreement and its senior debentures and Note 14 to the consolidated financial statements for the description of the mandatorily redeemable preferred securities. Income before income taxes and minority interests - A summary by segment of the Company's income before income taxes and minority interests is as follows: (in thousands, except percentages) 1998 % 1997 % 1996 % -------- ----- -------- ----- -------- ----- Title Insurance $227,906 63 $ 79,602 58 $ 50,129 44 Real Estate Information 103,057 28 38,139 28 50,531 44 Home Warranty 11,406 3 8,871 6 7,429 6 Consumer Risk 13,276 4 6,968 5 2,953 3 Trust and Banking 7,156 2 4,062 3 3,728 3 -------- ---- -------- ---- -------- ---- 362,801 100 137,642 100 114,770 100 ======== ==== ======== ==== ======== ==== Corporate (1,379) (27,967) (22,054) -------- -------- -------- $361,422 $109,675 $ 92,716 ======== ======== ======== The Company's profit margins vary according to a number of factors, including the volume, composition (residential or commercial) and type (resale, refinancing or new construction) of real estate activity. For example, in title insurance operations, commercial transactions tend to generate higher revenues and greater profit margins than residential transactions. Further, profit margins from refinancing activities are lower than those from resale activities because in many states there are premium discounts on, and cancellation rates are higher for, refinancing transactions. Cancellations of title orders adversely affect profits because costs are incurred in opening and processing such orders but revenues are not generated. Also, the Company's direct title insurance business has significant fixed costs in addition to its variable costs. Accordingly, profit margins from the Company's direct title insurance business improve as the volume of title orders closed increases. Title insurance profit margins are also affected by the percentage of operating revenues generated by agency operations. Profit margins from direct operations are generally higher than from agency operations due primarily to the large portion of the premium that is retained by the agent. Real estate information profits are generally unaffected by the type of real estate activity but increase as the volume of residential real estate loan transactions increases. Home warranty profits improve as the volume of residential resales increases. 16 Consumer risk management profits increase as the volume of transactions increase. In general, the title insurance business is a lower margin business when compared to the Company's other segments. The lower margins reflect the high fixed cost of producing title evidence whereas the corresponding revenues are subject to regulatory and competitive pricing constraints. The decrease in corporate expenses for 1998 from 1997 was primarily due to an investment gain of $32.4 million (see Note 17 to the consolidated financial statements). The increase in corporate expense for 1997 over 1996 was primarily attributable to increased costs associated with supporting the overall growth of the Company's businesses, as well as additional unallocated interest expense associated with the Company's mandatorily redeemable preferred securities. Income taxes - The Company's effective income tax rate, which includes a provision for state income and franchise taxes for non-insurance subsidiaries, was 35.3%, 37.8% and 38.4% for 1998, 1997 and 1996, respectively. The differences in effective rate were primarily due to changes in the ratio of permanent differences to income before income taxes and minority interests and changes in state income and franchise taxes resulting from fluctuations in the Company's non-insurance subsidiaries' contribution to pretax profits. Information regarding items included in the reconciliation of the effective rate with the federal statutory rate is contained in Note 10 to the consolidated financial statements. Minority interests - Minority interests in net income of consolidated subsidiaries increased $31.3 million in 1998 over 1997 and $1.1 million in 1997 over 1996. The increase for 1998 was primarily due to the strong operating results of the Company's joint venture with Experian. Net income - Net income and per share information, which has been restated for the 3-for-1 stock split effected July 17, 1998, are summarized as follows: (in thousands, except per share amounts) 1998 1997 1996 -------- ------- ------- Net income $198,710 $64,499 $54,492 ======== ======= ======= Net income per share: Basic $ 3.46 $ 1.18 $ 1.01 ======== ======= ======= Diluted $ 3.32 $ 1.16 $ 1.00 ======== ======= ======= Weighted average shares: Basic 57,450 54,448 53,899 ======== ======= ======= Diluted 59,822 55,517 54,337 ======== ======= ======= Liquidity and Capital Resources - ------------------------------- Cash provided by operating activities amounted to $361.6 million, $112.4 million and $114.3 million for 1998, 1997 and 1996, respectively, after claim payments of $95.4 million, $81.6 million and $78.0 million, respectively. The principal nonoperating uses of cash and cash equivalents for the three-year period ended December 31, 1998, were for additions to the investment portfolio, capital expenditures, company acquisitions in 1997 and 1996 and the repayment of debt. The most significant nonoperating sources of cash and cash equivalents were proceeds from the sales and maturities of certain investments, proceeds in 1998 from the issuance of senior debentures and proceeds in 1997 from the issuance of mandatorily redeemable preferred securities. The net effect of all activities on total cash and cash equivalents were increases of $193.2 million, $8.4 million and $27.5 million for 1998, 1997 and 1996, respectively. On April 7, 1998, the Company issued and sold $100.0 million of 7.55% senior debentures, due April 1, 2028. The Company used a portion of the net proceeds from the sale to repay certain obligations and purchase land for the Company's new corporate facilities. The remaining proceeds were invested in debt and equity securities. Notes and contracts payable as a percentage of total capitalization as of December 31, 1998, was 12.3% as compared with 7.2% as of the prior year end. This increase was primarily attributable to the issuance and sale of the $100.0 million senior debentures, offset in part by an increase in the capital base primarily due to shares issued in connection with company acquisitions, increased minority interests and net income for the period. The Company maintains a $75.0 million line of credit which remained unused as of December 31, 1998. Notes and contracts payable are more fully described in Note 8 to the consolidated financial statements. Pursuant to various insurance and other regulations, the maximum amount of dividends, loans and advances available to the Company in 1999 from its principal subsidiary, First American Title Insurance Company, is $158.5 17 million. Such restrictions have not had, nor are they expected to have, an impact on the Company's ability to meet its cash obligations. Due to the Company's significant liquid asset position and its consistent ability to generate cash flows from operations, management believes that its resources are sufficient to satisfy its anticipated operational cash requirements. The Company's strong financial position will enable management to react to future opportunities for acquisitions or other investments in support of the Company's continued growth and expansion. Year 2000 Issue - --------------- Overview - With the help of an outside consulting firm, in January 1997 the Company created a Year 2000 Program Management Office and adopted a five-step plan to address the Year 2000 Problem. The five steps of the plan are: (1) awareness, (2) inventory/assessment, (3) renovation, (4) testing, and (5) implementation. To implement the plan, the Company was divided into business units comprised of: (a) the reporting regions of the title insurance subsidiaries, (b) the subsidiary companies of the real estate information services business, (c) the home warranty subsidiaries, (d) the trust and banking subsidiaries and (e) various other subsidiaries. The awareness phase involves communicating the nature and scope of the Year 2000 Problem to the management of the business units in order to engender strong management support for its resolution. The inventory/assessment phase involves the identification of information systems and non-information systems that require renovation or replacement to become Year 2000 compliant. The renovation phase involves the repair and/or replacement of the systems identified in the prior phase. The testing phase involves the testing of repaired and replaced systems. The implementation phase involves the integration of tested systems into daily operations. All phases of the plan are currently active. The awareness phase will continue throughout 1999. June 30, 1998 was the target date for completion of the inventory/assessment phase; that phase is substantially complete. However, all of the phases of the plan must be revisited each time the Company acquires a new business. Accordingly, the inventory/assessment phase remains active. December 31, 1998 was the initial target date for completion of renovation. As of such date, 79% of the business units had completed 80% or more of their renovations, 61% of the business units had completed 90% or more of their renovations and 24% had met the target date and completed 100% of their renovations. The Company plans to complete the renovation phase as soon as practicable. Based on current knowledge, the Company has established the following general target dates for the remaining phases: April 30, 1999 for completion of testing and June 30, 1999 for completion of implementation. In each case, completion of the applicable phase is subject to the limitation noted above for newly acquired businesses. Additionally, a limited number of business units have target dates for renovation, testing and implementation that are later than the general dates described above. The Company makes no assurance that it will be able to meet these target dates. The Company's efforts to survey the Year 2000 readiness of its significant vendors, suppliers and customers continues. To date, the Company has not received sufficient information from these parties about their Year 2000 plans to predict the outcome of their efforts. Even after responses are received, there can be no assurance that the systems of significant vendors, suppliers and customers will be timely renovated. Costs for the year 2000 problem - To date the Company has spent approximately $11.6 million in implementing the Year 2000 plan. The Company expects to incur an additional $15 million to $25 million in completing the Year 2000 plan. About half the costs will be for hardware and software replacement and about half will be for labor. The costs for hardware and software will be capitalized and amortized over their estimated useful lives. Labor costs will be expensed as incurred. Year 2000 plan costs are being funded through operating cash flow. Contingency plans - Company-wide and business unit contingency plans for unexpected systems failures as a result of the Year 2000 problem were targeted to be in effect by the end of 1998. The company-wide plan and the contingency plans for 82% of the Company's business units have been completed. The Company is currently working to complete the balance of the business unit contingency plans. Review of the year 2000 plan - The Company engaged a consultant to review its Year 2000 plan. Under the terms of this engagement, the consultant (1) reviewed the operations of the Year 2000 Program Management Office, (2) reviewed the Company's Year 2000 plan, and (3) reviewed the implementation of the Year 2000 plan at selected locations. From time to time during the review, the consultant reported its findings to the Audit Committee of the Company's Board of Directors and appropriate actions were taken by the Company in response. Assurances - The costs to implement the Year 2000 plan and the target dates for completion of the various phases of the Year 2000 plan are based on current estimates. These estimates reflect numerous assumptions about future events, including the continued availability of certain resources, the timing and effectiveness of third party renovation plans and 18 other factors. The Company can give no assurance that these estimates will be achieved, and actual results could differ materially from these estimates. Item 7a. Quantitative and Qualitative Disclosures about Market Risk - -------------------------------------------------------------------- The Company's primary exposure to market risk relates to interest rate risk associated with certain other financial instruments. Although the Company monitors its risk associated with fluctuations in interest rates, it does not currently use derivative financial instruments to hedge these risks. The table below provides information about certain assets and liabilities that are sensitive to changes in interest rates and presents cash flows and the related weighted average interest rates by expected maturity dates. The Company is also subject to equity price risk as related to its equity securities. At December 31, 1998, the Company had equity securities with a book value of $18.8 million and a fair value of $27.3 million. Although the Company has operations in certain foreign countries, these operations, in the aggregate, are not material to the Company's financial condition or results of operations. Fair (in thousands, except percentages) 1999 2000 2001 2002 2003 Thereafter Total Value - ----------------------------------------------------------------------------------------------- --------------------- Interest-Rate Sensitive Assets - ------------------------------ Deposits with Savings and Loan Associations and Banks Book Value $28,028 $ 4,946 $ 32,974 $ 32,974 Average Interest Rate 4.01% 4.67% 100% Debt Securities Book Value $19,284 $22,008 $10,940 $23,553 $29,385 $117,481 $222,651 $227,685 Average Interest Rate 6.53% 5.69% 5.88% 5.95% 5.61% 5.93% 102.26% Loans Receivable Book Value $ 3,707 3,415 5,214 2,825 3,097 55,942 $ 72,035 $ 72,200 Average Interest Rate 10.34% 9.71% 10.64% 9.48% 9.30% 9.78% 100.23% Interest-Rate Sensitive Liabilities - ----------------------------------- Variable Rate Demand Deposits Book Value $12,502 $ 12,502 $ 12,502 Average Interest Rate 4.60% 100.90% Fixed Rate Demand Deposits Book Value $33,980 $12,964 $ 3,852 $ 1,629 $ 2.477 $ 54,902 $ 55.400 Average Interest Rate 5.93% 6.06% 6.10% 6.49% 6.20% 100.90% Notes and Contracts Payable Book Value $12,664 $ 6,484 $ 5,001 $ 1,750 $ 629 $103,665 $130,193 $130,900 Average Interest Rate 7.51% 7.53% 7.57% 7.60% 7.65% 7.65% 100.54% Mandatorily Redeemable Preferred Securities Book Value $100,000 $100,000 $100,000 Average Interest Rate 8.50% 100.00% 19 Item 8. Financial Statements and Supplementary Data. - ----------------------------------------------------- Separate financial statements for subsidiaries not consolidated and 50% or less owned persons accounted for by the equity method have been omitted because, if considered in the aggregate, they would not constitute a significant subsidiary. INDEX ----- Page No. -------- Report of Independent Accountants 21 Financial Statements: Consolidated Balance Sheets 22 Consolidated Statements of Income 24 Consolidated Statements of Stockholders' Equity 25 Consolidated Statements of Cash Flows 26 Notes to Consolidated Financial Statements 27 Unaudited Quarterly Financial Data 42 Financial Statement Schedules: I. Summary of Investments - Other than Investments in Related Parties 43 III. Supplementary Insurance Information 44 IV. Reinsurance 46 V. Valuation and Qualifying Accounts 47 Financial statement schedules not listed are either omitted because they are not applicable or the required information is shown in the consolidated financial statements or in the notes thereto. 20 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of The First American Financial Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of The First American Financial Corporation and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP Costa Mesa, California February 9, 1999 21 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED BALANCE SHEETS ASSETS December 31 1998 1997 - --------------------------------------------------------------------------------------------- Cash and Cash Equivalents $ 375,440,000 $ 182,234,000 - --------------------------------------------------------------------------------------------- Accounts and Accrued Income Receivable, less allowances ($10,715,000 and $7,602,000) 191,122,000 130,863,000 - --------------------------------------------------------------------------------------------- Investments: Deposits with savings and loan associations and banks 32,974,000 29,029,000 Debt securities 227,685,000 151,503,000 Equity securities 27,338,000 13,904,000 Other long-term investments 63,244,000 35,047,000 - --------------------------------------------------------------------------------------------- 351,241,000 229,483,000 - --------------------------------------------------------------------------------------------- Loans Receivable 72,035,000 63,378,000 - --------------------------------------------------------------------------------------------- Property and Equipment, at cost: Land 34,578,000 17,059,000 Buildings 110,133,000 84,935,000 Furniture and equipment 335,342,000 222,897,000 Less - accumulated depreciation (166,414,000) (123,462,000) - --------------------------------------------------------------------------------------------- 313,639,000 201,429,000 - --------------------------------------------------------------------------------------------- Title Plants and Other Indexes 216,711,000 100,626,000 - --------------------------------------------------------------------------------------------- Assets Acquired in Connection with Claim Settlements 17,051,000 21,119,000 - --------------------------------------------------------------------------------------------- Deferred Income Taxes 12,859,000 31,563,000 - --------------------------------------------------------------------------------------------- Goodwill and Other Intangibles, less accumulated amortization ($19,017,000 and $13,093,000) 171,790,000 132,361,000 - --------------------------------------------------------------------------------------------- Other Assets 62,902,000 60,579,000 - --------------------------------------------------------------------------------------------- $1,784,790,000 $1,153,635,000 See Notes to Consolidated Financial Statements 22 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY December 31 1998 1997 - ------------------------------------------------------------------------------------------------------- Demand Deposits $ 67,404,000 $ 62,475,000 - ------------------------------------------------------------------------------------------------------- Accounts Payable and Accrued Liabilities: Accounts payable 21,249,000 12,550,000 Salaries and other personnel costs 88,314,000 55,973,000 Pension costs 50,100,000 39,431,000 Other 97,044,000 61,633,000 - ------------------------------------------------------------------------------------------------------- 256,707,000 169,587,000 - ------------------------------------------------------------------------------------------------------- Deferred Revenue 105,496,000 84,424,000 - ------------------------------------------------------------------------------------------------------- Reserve for Known and Incurred But Not Reported Claims 270,436,000 250,826,000 - ------------------------------------------------------------------------------------------------------- Income Taxes Payable 22,734,000 3,987,000 - ------------------------------------------------------------------------------------------------------- Notes and Contracts Payable 130,193,000 42,119,000 - ------------------------------------------------------------------------------------------------------- Minority Interests in Consolidated Subsidiaries 99,905,000 25,214,000 - ------------------------------------------------------------------------------------------------------- Commitments and Contingencies (Note 13) - ------------------------------------------------------------------------------------------------------- Mandatorily Redeemable Preferred Securities of the Company's Subsidiary Trust Whose Sole Assets Are the Company's $100,000,000 8.5% Deferrable Interest Subordinated Notes Due 2012 (Note 14) 100,000,000 100,000,000 - ------------------------------------------------------------------------------------------------------- Stockholders' Equity: Preferred stock, $1 par value Authorized - 500,000 shares; Outstanding - None Common stock, $1 par value (Note 15) Authorized - 108,000,000 shares Outstanding - 60,332,000 and 54,484,000 shares 60,332,000 54,484,000 Additional paid-in capital 129,664,000 6,864,000 Retained earnings 534,297,000 348,215,000 Accumulated other comprehensive income (Note 16) 7,622,000 5,440,000 - ------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 731,915,000 415,003,000 - ------------------------------------------------------------------------------------------------------- $1,784,790,000 $1,153,635,000 See Notes to Consolidated Financial Statements 23 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------ Revenues Operating revenues $2,802,190,000 $1,881,666,000 $1,587,895,000 Investment and other income 75,138,000 27,257,000 26,398,000 - ------------------------------------------------------------------------------------------------------------- 2,877,328,000 1,908,923,000 1,614,293,000 - ------------------------------------------------------------------------------------------------------------- Expenses Salaries and other personnel costs 914,058,000 659,325,000 539,985,000 Premiums retained by agents 773,030,000 563,137,000 516,593,000 Other operating expenses 611,332,000 421,056,000 329,525,000 Provision for title losses and other claims 118,763,000 90,323,000 86,487,000 Depreciation and amortization 59,804,000 38,489,000 27,503,000 Premium Taxes 20,912,000 16,904,000 16,676,000 Interest 18,007,000 10,014,000 4,808,000 - ------------------------------------------------------------------------------------------------------------- 2,515,906,000 1,799,248,000 1,521,577,000 - ------------------------------------------------------------------------------------------------------------- Income before income taxes and minority interests 361,422,000 109,675,000 92,716,000 Income taxes 127,700,000 41,500,000 35,600,000 - ------------------------------------------------------------------------------------------------------------- Income before minority interests 233,722,000 68,175,000 57,116,000 Minority interests 35,012,000 3,676,000 2,624,000 - ------------------------------------------------------------------------------------------------------------- Net income $ 198,710,000 $ 64,499,000 $ 54,492,000 Other comprehensive income (loss), net of tax (Note 16) 2,182,000 2,703,000 (1,256,000) - ------------------------------------------------------------------------------------------------------------- Comprehensive income 200,892,000 67,202,000 53,236,000 Net income per common share (Note 1): Basic $ 3.46 $ 1.18 $ 1.01 Diluted $ 3.32 $ 1.16 $ 1.00 Weighted average common shares outstanding (Note 1): Basic 57,450,000 54,448,000 53,899,000 Diluted 59,822,000 55,717,000 54,337,000 See Notes to Consolidated Financial Statements 24 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Accumulated Additional other Common paid-in Retained comprehensive Shares Stock capital earnings income - -------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1995 53,713,000 $53,713,000 $ 1,989,000 $246,083,000 $ 3,993,000 Net income for 1996 54,492,000 Cash dividends on common shares (7,928,000) Shares issued in connection with company acquisitions 900,000 900,000 6,658,000 Shares issued in connection with benefit and savings plans 225,000 225,000 1,045,000 Purchase of Company shares (483,000) (483,000) (3,052,000) Other comprehensive income (1,256,000) - -------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 54,355,000 54,355,000 6,640,000 292,647,000 2,737,000 Net income for 1997 64,499,000 Cash dividends on common shares (8,931,000) Shares issued in connection with company acquisitions 48,000 48,000 500,000 Shares issued in connection with benefit and savings plan 627,000 627,000 4,341,000 Purchase of Company shares (546,000) (546,000) (4,617,000) Other comprehensive income 2,703,000 - -------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 54,484,000 54,484,000 6,864,000 348,215,000 5,440,000 Net income for 1998 198,710,000 Cash dividends on common shares (12,628,000) Shares issued in connection with company acquisitions 4,458,000 4,458,000 100,854,000 Shares issued in connection with benefit and savings plan 1,390,000 1,390,000 21,946,000 Other comprehensive income 2,182,000 - -------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 60,332,000 $60,332,000 $129,664,000 $534,297,000 $ 7,622,000 See Notes to Consolidated Financial Statements. 25 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 198,710,000 $ 64,499,000 $ 54,492,000 Adjustments to reconcile net income to cash provided by operating activities- Provision for title losses and other claims 118,763,000 90,323,000 86,487,000 Depreciation and amortization 59,804,000 38,489,000 27,503,000 Minority interests in net income 35,012,000 3,676,000 2,624,000 Investment gain (32,449,000) Other, net 2,226,000 933,000 (366,000) Changes in assets and liabilities excluding effects of company acquisitions and noncash transactions- Claims paid, including assets acquired, net of recoveries (95,440,000) (81,603,000) (78,048,000) Net change in income tax accounts 34,730,000 11,974,000 381,000 Increase in accounts and accrued income receivable (41,966,000) (26,014,000) (11,887,000) Increase in accounts payable and accrued liabilities 70,845,000 18,708,000 34,561,000 Increase (decrease) in deferred revenue 10,433,000 (9,000) (426,000) Other, net 964,000 (8,571,000) (1,061,000) - ---------------------------------------------------------------------------------------------------------------- Cash provided by operating activities 361,632,000 112,405,000 114,260,000 - ---------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Net cash effect of company acquisitions 11,562,000 (49,336,000) (12,097,000) Net increase in deposits with banks (3,771,000) (7,355,000) (3,037,000) Purchases of debt and equity securities (134,348,000) (80,241,000) (68,498,000) Proceeds from sales of debt and equity securities 27,512,000 39,240,000 46,506,000 Proceeds from maturities of debt securities 22,434,000 18,842,000 31,291,000 Net increase in other long-term investments (1,580,000) (1,117,000) (2,575,000) Net increase in loans receivable (8,657,000) (9,122,000) (8,122,000) Capital expenditures (155,642,000) (75,007,000) (49,076,000) Net proceeds from sale of property and equipment 3,361,000 1,646,000 3,245,000 - ---------------------------------------------------------------------------------------------------------------- Cash used for investing activities (239,129,000) (162,450,000) (62,363,000) - ---------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Net increase in demand deposits 4,929,000 11,154,000 7,903,000 Repayment of debt (26,990,000) (40,965,000) (19,749,000) Proceeds from issuance of senior debentures 99,456,000 Proceeds from the issuance of mandatorily redeemable preferred securities 100,000,000 Purchase of Company shares (5,163,000) (3,535,000) Proceeds from exercise of stock options 2,554,000 1,653,000 Proceeds from issuance of stock to employee savings plan 18,144,000 980,000 Distributions to minority shareholders (14,762,000) (299,000) (1,121,000) Cash dividends (12,628,000) (8,931,000) (7,928,000) - ---------------------------------------------------------------------------------------------------------------- Cash provided by (used for) financing activities 70,703,000 58,429,000 (24,430,000) - ---------------------------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 193,206,000 8,384,000 27,467,000 Cash and cash equivalents - Beginning of year 182,234,000 173,850,000 146,383,000 - ---------------------------------------------------------------------------------------------------------------- Cash and cash equivalents - End of year $ 375,440,000 $ 182,234,000 $173,850,000 - ---------------------------------------------------------------------------------------------------------------- Supplemental information: Cash paid during the year for: Interest $ 16,309,000 $ 8,243,000 $ 5,056,000 Premium taxes $ 18,433,000 $ 18,103,000 $ 14,146,000 Income taxes $ 96,440,000 $ 31,292,000 $ 36,682,000 Noncash investing and financing activities: Shares issued for benefits plans $ 2,638,000 $ 2,335,000 $ 1,270,000 Company acquisitions in exchange for common stock $ 105,312,000 $ 548,000 $ 7,558,000 Liabilities in connection with company acquisitions $ 118,718,000 $ 48,294,000 $ 32,180,000 See Notes to Consolidated Financial Statements 26 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. Description of the Company: The First American Financial Corporation (the Company), through its subsidiaries, is engaged in the business of providing real estate-related financial and information services to real property buyers and mortgage lenders. These services include title insurance, tax monitoring, mortgage credit reporting, property data services, flood certification, field inspection services, appraisal services, mortgage loan servicing systems, mortgage document preparation and home warranties. In addition, credit and various database- related services are provided to automotive dealers, consumer lenders, employers and property management companies. The Company also provides investment, trust and thrift services. Significant Accounting Policies: Principles of consolidation The consolidated financial statements include the accounts of The First American Financial Corporation and all majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. All consolidated results have been restated to reflect the 1998 acquisitions of three separate entities accounted for under the pooling-of-interests method of accounting. Certain 1996 and 1997 amounts have been reclassified to conform with the 1998 presentation. Cash equivalents The Company considers cash equivalents to be all short-term investments which have an initial maturity of 90 days or less and are not restricted for statutory deposit or premium reserve requirements. The carrying amount for cash equivalents is a reasonable estimate of fair value due to the short-term maturity of these investments. Investments Deposits with savings and loan associations and banks are short-term investments with initial maturities of more than 90 days. The carrying amount of these investments is a reasonable estimate of fair value due to their short- term nature. Debt securities are carried at fair value and consist primarily of investments in obligations of the United States Treasury, various corporations and certain state and political subdivisions. Equity securities are carried at fair value and consist primarily of investments in marketable common stocks of corporate entities in which the Company's ownership does not exceed 20%. Other long-term investments consist primarily of investments in affiliates, which are accounted for under the equity method of accounting, and notes receivable, which are carried at the lower of cost or fair value less costs to sell. The Company classifies its debt and equity securities portfolio as available-for-sale and, accordingly, includes unrealized gains and losses, net of related tax effects, as a component of other comprehensive income. Realized gains and losses on investments are determined using the specific identification method. Property and equipment Furniture and equipment includes computer software acquired and developed for internal use and for use with the Company's products. Software development costs are capitalized from the time technological feasibility is established until the software is ready for use. Capitalized development costs for internal-use software include only incremental payments to third parties. Depreciation on buildings and on furniture and equipment is computed using the straight-line method over estimated useful lives of 25 to 45 and 3 to 10 years, respectively. Capitalized software costs are amortized using the straight-line method over estimated useful lives of 3 to 10 years. Effective January 1, 1999, the Company will adopt Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1 will require the Company to capitalize interest costs incurred and certain payroll-related costs of employees directly associated with developing software, in addition to incremental payments to third parties. The Company does not believe that the adoption of SOP 98-1 will have a material effect on its financial condition or results of operations. 27 Title plants and other indexes Title plants and other indexes are carried at original cost. Appraised values are used in conjunction with the acquisition of purchased subsidiaries. The costs of daily maintenance (updating) of these plants and other indexes are charged to expense as incurred. Because properly maintained title plants and other indexes have indefinite lives and do not diminish in value with the passage of time, no provision has been made for depreciation. Assets acquired in connection with claim settlements In connection with settlement of title insurance and other claims, the Company sometimes purchases mortgages, deeds of trust, real property, or judgment liens. These assets, sometimes referred to as "salvage assets," are carried at the lower of cost or fair value less costs to sell. Goodwill and other intangibles Goodwill recognized in business combinations is amortized over its estimated useful life ranging from 20 to 40 years. Other intangibles, which include customer lists, covenants not to compete and organization costs, are amortized over their estimated useful lives, ranging from 3 to 20 years. The Company periodically evaluates the amortization period assigned to each intangible asset to ensure that there have not been any events or circumstances that warrant revised estimates of useful lives. Impairment of goodwill, loans receivable and other long-lived assets The Company periodically reviews the carrying value of goodwill, loans receivable and other long-lived assets for impairment when events or circumstances warrant such a review. To the extent that the undiscounted cash flows related to the businesses underlying the goodwill are less than the carrying value of the related goodwill, such goodwill will be reduced to the amount of the undiscounted cash flows. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans receivable are measured at the present value of expected future cash flows discounted at the loan's effective interest rate. As a practical expedient, the loan may be valued based on its observable market price or the fair value of the collateral, if the loan is collateral dependent. To the extent that the undiscounted cash flows related to other long- lived assets are less than the assets' carrying value, the carrying value of such assets is reduced to the assets' fair value. Reserve for known and incurred but not reported claims The Company provides for title insurance losses based upon its historical experience by a charge to expense when the related premium revenue is recognized. Title insurance losses and other claims associated with ceded reinsurance are provided for as the Company remains contingently liable in the event that the reinsurer does not satisfy its obligations. The reserve for known and incurred but not reported claims reflects management's best estimate of the total costs required to settle all claims reported to the Company and claims incurred but not reported. The process applied to estimate claims costs is subject to many variables, including changes and trends in the type of title insurance policies issued, the real estate market and the interest rate environment. It is reasonably possible that a change in the estimate will occur in the future. The Company provides for claim losses relating to its home warranty business based on the average cost per claim as applied to the total of new claims incurred. The average cost per claim is calculated using the average of the most recent 12 months of claims experience. Operating revenues Title premiums on policies issued directly by the Company are recognized on the effective date of the title policy and escrow fees are recorded upon close of the escrow. Revenues from title policies issued by independent agents are recorded when notice of issuance is received from the agent. The Company recognized revenues from tax service contracts over the estimated duration of the contracts as the related servicing costs were estimated to occur. The majority of the servicing costs, approximately 70%, are incurred in the year the contract is executed, with the remaining 30% incurred over the remaining service life of the contract. Effective January 1, 1999, the Company will implement a change to the accounting policy for tax service contracts. The new accounting policy will be adopted prospectively and will apply to all new loans serviced beginning January 1, 1999. The new policy provides for a more ratable recognition of revenues, reducing the amount recognized at the inception of the contract and recognizing it over the expected service period. The amortization rates applied to recognize the revenues assume a 10-year contract life and are adjusted to reflect prepayments. The resulting rates by year (starting with year one) are 32%, 24%, 14%, 9%, 7%, 5%, 4%, 2%, 2% and 1%. The Company periodically reviews its tax service contract portfolio to determine if there have been changes in contract lives and/or changes in the 28 number and/or timing of prepayments; accordingly, the Company may adjust the rates to reflect current trends. The Company estimates that adoption of this new policy will result in a decrease in diluted earnings per share for 1999 of $0.25 to $0.35. This estimate is heavily dependent on the volume of tax service contracts entered into in 1999. Assuming the new accounting policy had been consistently applied in prior years, the Company would have reported diluted earnings per share of $3.10, $1.02, $0.90, $0.17 and $0.42 for the years ended December 31, 1998, 1997, 1996, 1995 and 1994, respectively. Revenues from home warranty contracts are recognized ratably over the 12-month duration of the contracts. Interest on loans with the Company's thrift subsidiary is recognized on the outstanding principal balance on the accrual basis. Loan origination fees and related direct loan origination costs are deferred and recognized over the life of the loan. Premium taxes Title insurance and home warranty companies, like other types of insurers, are generally not subject to state income or franchise taxes. However, in lieu thereof, most states impose a tax based primarily on insurance premiums written. This premium tax is reported as a separate line item in the consolidated statements of income in order to provide a more meaningful disclosure of the taxation of the Company. Income taxes Taxes are based on income for financial reporting purposes and include deferred taxes applicable to temporary differences between the financial statement carrying amount and the tax basis of certain of the Company's assets and liabilities. Earnings per share In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." SFAS No. 128 became effective for 1997 and requires the presentation of basic and diluted earnings per share on the face of the income statement. Basic earnings per share are computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding. The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the weighted-average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if potential dilutive common shares had been issued. The Company's only potential dilutive common shares are stock options (see Note 12). Stock options are reflected in diluted earnings per share by application of the treasury stock method. All earnings per share amounts presented have been restated to reflect the adoption of SFAS No. 128. Risk of real estate market Real estate activity is cyclical in nature and is affected greatly by the cost and availability of long-term mortgage funds. Real estate activity and, in turn, the Company's revenues, can be adversely affected during periods of high interest rates and/or limited money supply. Use of estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the statements. Actual results could differ from the estimates and assumptions used. Fiduciary assets and liabilities Assets and liabilities of the trusts and escrows administered by the Company are not included in the consolidated balance sheets. NOTE 2. Statutory Restrictions on Stockholders' Equity and Investments: Pursuant to insurance and other regulations of the various states in which the Company's title insurance subsidiary, First American Title Insurance Company (FATICO), operates, the amount of dividends, loans and advances available to the parent company from FATICO is limited, principally for the protection of policyholders. Under such statutory regulations, the maximum amount of dividends, loans and advances available to the parent company from FATICO in 1999 is $158.5 million. Investments carried at $17.3 million were on deposit with state treasurers in accordance with statutory requirements for the protection of policyholders at December 31, 1998. 29 FATICO maintained statutory capital and surplus of $301.6 million and $210.3 million at December 31, 1998 and 1997, respectively. Statutory net income for the years ended December 31, 1998, 1997 and 1996 was $137.3 million, $35.9 million and $34.6 million, respectively. NOTE 3. Debt and Equity Securities: The amortized cost and estimated fair value of investments in debt securities are as follows: Amortized Gross Unrealized Estimated (in thousands) Cost Gains Losses Fair Value - ------------------------------------------------------------------------------- December 31, 1998 - ----------------- U.S. Treasury securities $ 36,875 $1,158 $ (11) $ 38,022 Corporate securities 74,546 1,736 (25) 76,257 Obligations of states and political subdivisions 89,825 2,215 (48) 91,992 Mortgage-backed securities 21,405 77 (68) 21,414 - ------------------------------------------------------------------------------- $222,651 $5,186 $(152) $227,685 - ------------------------------------------------------------------------------- December 31, 1997 - ----------------- U.S. Treasury securities $ 38,972 $ 792 $ (46) $ 39,718 Corporate securities 54,884 717 (22) 55,579 Obligations of states and political subdivisions 38,977 1,092 - 40,069 Mortgage-backed securities 16,186 36 (85) 16,137 - ------------------------------------------------------------------------------- $149,019 $2,637 $(153) $151,503 - ------------------------------------------------------------------------------- The amortized cost and estimated fair value of debt securities at December 31, 1998, by contractual maturities, are as follows: Amortized Estimated (in thousands) Cost Fair Value - ------------------------------------------------------------------------------- Due in one year or less $ 19,284 $ 19,438 Due after one year through five years 85,886 88,498 Due after five years through ten years 68,892 70,655 Due after ten years 27,184 27,680 - ------------------------------------------------------------------------------ 201,246 206,271 Mortgage-backed securities 21,405 21,414 - ------------------------------------------------------------------------------ $222,651 $227,685 - ------------------------------------------------------------------------------ The cost and estimated fair value of investments in equity securities are as follows: Gross Unrealized Estimated (in thousands) Cost Gains Losses Fair Value - -------------------------------------------------------------------------------- December 31, 1998 - ----------------- Common stocks: Corporate securities $18,576 $9,429 $(996) $27,009 Other 214 115 - 329 - -------------------------------------------------------------------------------- $18,790 $9,544 $(996) $27,338 - -------------------------------------------------------------------------------- December 31, 1997 - ----------------- Common stocks: Corporate securities $ 7,941 $5,856 $ (82) $13,715 Other 78 111 - 189 - -------------------------------------------------------------------------------- $ 8,019 $5,967 $ (82) $13,904 - -------------------------------------------------------------------------------- 30 Sales of debt and equity securities resulted in realized gains of $1.3 million, $0.7 million and $3.3 million and realized losses of $0.2 million, $0.3 million and $0.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. The fair value of debt and equity securities was estimated using quoted market prices. NOTE 4. Loans Receivable: Loans receivable are summarized as follows: December 31 (in thousands) 1998 1997 - -------------------------------------------------------------------------------- Real estate-mortgage $74,093 $65,384 Other 107 86 - -------------------------------------------------------------------------------- 74,200 65,470 - -------------------------------------------------------------------------------- Unearned income on lease contracts (15) (18) Allowance for loan losses (1,150) (1,185) Participations sold (770) (481) Deferred loan fees, net (230) (408) - -------------------------------------------------------------------------------- $72,035 $63,378 - -------------------------------------------------------------------------------- Real estate loans are secured by properties located in California. The average yield on the Company's loan portfolio was 10% and 11% for the years ended December 31, 1998 and 1997, respectively. Average yields are affected by amortization of discounts on loans purchased from other institutions, prepayment penalties recorded as income, loan fees amortized to income and the market interest rates charged by thrift and loan institutions. The fair value of loans receivable was $72.2 million and $64.2 million at December 31, 1998 and 1997, respectively, and was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality. The allowance for loan losses is maintained at a level that is considered appropriate by management to provide for known and inherent risks in the portfolio. NOTE 5. Assets Acquired in Connection with Claim Settlements: December 31 (in thousands) 1998 1997 - -------------------------------------------------------------------------------- Notes receivable $11,833 $12,177 Real estate 4,880 5,013 Judgments and other 338 3,929 - -------------------------------------------------------------------------------- $17,051 $21,119 - -------------------------------------------------------------------------------- The above amounts are net of valuation reserves of $12.3 million and $11.1 million at December 31, 1998 and 1997, respectively. The fair value of notes receivable was $12.2 million and $12.5 million at December 31, 1998 and 1997, respectively, and was estimated based on the discounted value of the future cash flows using the current rates at which similar loans would be made to borrowers of similar credit quality. The activity in the valuation reserve is summarized as follows: December 31 (in thousands) 1998 1997 - ------------------------------------------------------------------------------- Balance at beginning of year $11,135 $10,278 Provision for losses 3,951 4,678 Dispositions (2,830) (3,821) - ------------------------------------------------------------------------------- Balance at end of year $12,256 $11,135 - ------------------------------------------------------------------------------- 31 NOTE 6. Demand Deposits: Passbook and investment certificate accounts are summarized as follows: December 31 (in thousands) 1998 1997 - ------------------------------------------------------------------------------- Passbook accounts $12,502 $13,209 - ------------------------------------------------------------------------------- Certificate accounts: Less than one year 33,980 28,798 One to five years 20,922 20,468 - ------------------------------------------------------------------------------- 54,902 49,266 - ------------------------------------------------------------------------------- $67,404 $62,475 - ------------------------------------------------------------------------------- Annualized interest rates: Passbook accounts 4%-5% 5% Certificate accounts 5%-8% 6%-8% The carrying value of the passbook accounts approximates fair value due to the short-term nature of this liability. The fair value of investment certificate accounts was $55.4 million and $49.4 million at December 31, 1998 and 1997, respectively, and was estimated based on the discounted value of the future cash flows using a discount rate approximating current market for similar liabilities. NOTE 7. Reserve for Known and Incurred But Not Reported Claims: Activity in the reserve for known and incurred but not reported claims is summarized as follows: December 31 (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Balance at beginning of year $250,826 $245,245 $238,161 - ------------------------------------------------------------------------------- Provision related to: Current year 114,812 85,645 81,539 Prior years 3,951 4,678 4,948 - ------------------------------------------------------------------------------- 118,763 90,323 86,487 - ------------------------------------------------------------------------------- Payments related to: Current year 48,228 39,934 29,680 Prior years 44,133 39,745 43,967 - ------------------------------------------------------------------------------- 92,361 79,679 73,647 - ------------------------------------------------------------------------------- Other (6,792) (5,063) (5,756) - ------------------------------------------------------------------------------- Balance at end of year $270,436 $250,826 $245,245 - ------------------------------------------------------------------------------- "Other" primarily represents reclassifications to the reserve for assets acquired in connection with claim settlements. Claims activity associated with reinsurance is not material and, therefore, not presented separately. NOTE 8. Notes and Contracts Payable: December 31 (in thousands) 1998 1997 - ------------------------------------------------------------------------------ 7.55% senior debentures, due April, 2028 $ 99,468 - Secured notes payable pursuant to amended credit agreement 2,040 $ 5,320 Trust deed notes with maturities through 2007, secured by land and buildings with a net book value of $4,931, average rate of 10 1/4% 3,952 7,359 Other notes and contracts payable with maturities through 2007, average rate of 6 3/4% 24,733 29,440 - ------------------------------------------------------------------------------ $130,193 $42,119 - ------------------------------------------------------------------------------ 32 In April 1998, the Company issued and sold $100.0 million of 7.55% senior debentures, due April 2028. The 30-year bonds were issued at 99.456% of the principal amount. In April 1997, the Company paid off the variable rate indebtedness portion of the amended credit agreement with proceeds received from its mandatorily redeemable preferred securities (see Note 14). At December 31, 1998, the Company's remaining borrowings under its amended bank credit agreement consisted of fixed rate indebtedness of $2.0 million, maturing in April 1999 and bearing interest at 9.38% per annum. During July 1997, the Company amended the credit agreement to relax and/or eliminate certain restrictive covenants and increase the revolving line of credit to $75.0 million which was unused as of December 31, 1998. In November 1997, the Company further amended the credit agreement to issue a letter of credit to secure its fixed rate obligation and release as security the capital stock of its wholly owned subsidiaries. Pursuant to the terms of the credit agreement, the Company is required to maintain minimum levels of capital and earnings and meet predetermined debt to capitalization ratios. The aggregate annual maturities for notes and contracts payable in each of the five years after December 31, 1998, are as follows: (in thousands) - ----------------------------------------------------------------- 1999 $12,664 2000 $ 6,484 2001 $ 5,001 2002 $ 1,750 2003 $ 629 The fair value of notes and contracts payable was $130.9 million and $44.3 million at December 31, 1998 and 1997, respectively, and was estimated based on the current rates offered to the Company for debt of the same remaining maturities. The weighted average interest rate for the Company's notes and contracts payable was 7 1/2% and 8% at December 31, 1998 and 1997, respectively. NOTE 9. Investment and Other Income: The components of investment and other income are as follows: (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Interest: Cash equivalents and deposits with savings and loan associations and banks $10,293 $ 6,396 $ 4,742 Debt securities 13,395 10,307 7,887 Other long-term investments 7,023 3,550 3,161 - -------------------------------------------------------------------------------- 30,711 20,253 15,790 - -------------------------------------------------------------------------------- Investment gain on Experian joint venture 32,449 - - Dividends on equity securities 409 469 554 Equity in earnings of unconsolidated affiliates 4,614 2,304 1,043 Net gain on sales of debt and equity securities 1,074 358 2,611 Other 5,881 3,873 6,400 - -------------------------------------------------------------------------------- $75,138 $27,257 $26,398 - -------------------------------------------------------------------------------- 33 NOTE 10. Income Taxes: Income taxes are summarized as follows: (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- Current: Federal $100,251 $27,234 $28,535 State 12,411 3,925 6,038 112,662 31,159 34,573 - ------------------------------------------------------------------------------- Deferred: Federal 13,759 9,747 232 State 1,279 594 795 15,038 10,341 1,027 - ------------------------------------------------------------------------------- $127,700 $41,500 $35,600 - ------------------------------------------------------------------------------- Income taxes differ from the amounts computed by applying the federal income tax rate of 35%. A reconciliation of this difference is as follows: (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Taxes calculated at federal rate $114,244 $37,173 $31,216 Tax exempt interest income (1,503) (651) (669) Tax effect of minority interests 1,273 1,286 918 State taxes, net of federal benefit 8,898 3,706 4,442 Exclusion of certain meals and entertainment expenses 3,794 2,889 2,429 Other items, net 994 (2,903) (2,736) - -------------------------------------------------------------------------------- $127,700 $41,500 $35,600 - -------------------------------------------------------------------------------- The primary components of temporary differences which give rise to the Company's net deferred tax asset are as follows: December 31 (in thousands) 1998 1997 - -------------------------------------------------------------------------------- Deferred tax assets: Deferred revenue $21,987 $23,066 Employee benefits 14,407 11,021 Claims and related salvage 3,102 6,943 Bad debt reserves 7,412 4,952 Acquisition reserve 520 3,970 State taxes 2,262 346 Other 5,471 3,249 - -------------------------------------------------------------------------------- 55,161 53,547 - -------------------------------------------------------------------------------- Deferred tax liabilities: Depreciable and amortizable assets 21,179 15,116 Investment gain 11,357 - Accumulated other comprehensive income 4,754 2,929 Sale leaseback - 1,327 Other 5,012 2,612 - -------------------------------------------------------------------------------- 42,302 21,984 - -------------------------------------------------------------------------------- Net deferred tax asset $12,859 $31,563 - -------------------------------------------------------------------------------- 34 NOTE 11. Employee Benefit Plans: The Company has pension and other retirement benefit plans covering substantially all employees. The Company's principal pension plan, amended to be noncontributory effective January 1, 1995, is a qualified defined benefit plan with benefits based on the employee's years of service and the highest five consecutive years' compensation during the last 10 years of employment. The Company's policy is to fund all accrued pension costs. Contributions are intended to provide not only for benefits attributable to past service, but also for those benefits expected to be earned in the future. The Company also has nonqualified unfunded supplemental benefit plans covering certain key management personnel. Benefits under these plans are intended to be funded with proceeds from life insurance policies purchased by the Company on the lives of the executives. Effective January 1, 1998 the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 revises employers' disclosures about pension and other postretirement benefit plans but does not change the measurement or recognition of those plans. Net periodic pension cost for the Company's pension and other retirement benefit plans includes the following components: (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Expense: Service Cost $14,863 $10,550 $ 9,186 Interest Cost 13,067 11,178 9,764 Actual Return on Plan Assets (9,196) (7,421) (10,477) Amortization of net transition obligation 309 309 309 Amortization of prior service cost 143 143 143 Amortization of net loss 1,408 945 5,318 - -------------------------------------------------------------------------------- $20,594 $15,704 $ 14,243 - -------------------------------------------------------------------------------- 35 The following table provides a reconciliation of benefit obligations, plan assets and funded status of the plans at: December 31 (in thousands) 1998 1997 - ------------------------------------------------------------------------------------------------ Unfunded Unfunded Funded Supplemental Funded Supplemental Pension Benefit Pension Benefit Plans Plans Plans Plans - ----------------------------------------------------------------------------------------------- Change in benefit obligation: Benefit obligation at beginning of year $141,689 $ 32,134 $111,678 $ 29,240 Service costs 13,772 1,091 9,731 819 Interest costs 10,586 2,481 8,939 2,239 Actuarial losses 23,590 3,895 17,504 1,012 Benefits paid (5,240) (1,425) (6,163) (1,176) - ------------------------------------------------------------------------------------------------ Projected benefit obligation at end of year 184,397 38,176 141,689 32,134 - ------------------------------------------------------------------------------------------------ Change in plan assets: Plan assets at fair value at beginning of year 109,358 - 87,096 - Actual return on plan assets 26,857 - 20,475 - Company contributions 10,258 - 7,949 - Benefits paid (5,240) - (6,163) - - ------------------------------------------------------------------------------------------------ Plan assets at fair value at end of year 141,233 - 109,357 - - ------------------------------------------------------------------------------------------------ Reconciliation of funded status: Funded status of the plans (43,164) (38,176) (32,332) (32,134) Unrecognized net actuarial loss 23,543 9,856 18,682 6,280 Unrecognized prior service cost (412) 1,426 (457) 1,614 Unrecognized net transition (asset) obligation (204) 1,081 (255) 1,441 - ------------------------------------------------------------------------------------------------ Accrued pension cost (20,237) (25,813) (14,362) (22,799) - ------------------------------------------------------------------------------------------------ Amounts recognized in the statement of financial position consist of: Accrued benefit liability (20,237) (29,863) (14,362) (25,069) Intangible asset - 2,194 - 2,270 Minimum pension liability adjustment - 1,856 - - - ------------------------------------------------------------------------------------------------ $(20,237) $(25,813) $(14,362) $(22,799) - ------------------------------------------------------------------------------------------------ The rate of increase in future compensation levels for the plans of 4 1/2% and the weighted average discount rates of 6 3/4% and 7 1/4% were used in determining the actuarial present value of the projected benefit obligation at December 31, 1998 and 1997, respectively. The majority of pension plan assets are invested in U.S. government securities, time deposits and common stocks with projected long-term rates of return of 9%. The Company's principal profit sharing plan was amended effective January 1, 1995, to discontinue future contributions. The plan holds 6,081,000 and 6,576,000 shares of the Company's common stock, representing 10% and 12% of the total shares outstanding at December 31, 1998, and 1997 respectively. The Company also has a Stock Bonus Plan for key employees pursuant to which 186,000, 258,000 and 225,000 common shares were awarded for 1998, 1997 and 1996, respectively, resulting in a charge to operations of $2.7 million, $2.2 million and $1.3 million, respectively. The Plan, as amended December 9, 1992, provides that a total of up to 1,350,000 common shares may be awarded in any one year. Effective January 1, 1995, the Company adopted The First American Financial Corporation 401(k) Savings Plan (The Savings Plan), which is available to substantially all employees. The Savings Plan allows for employee elective contributions up to the maximum deductible amount as determined by the Internal Revenue Code. 36 NOTE 12. Stock Option Plans: On April 24, 1996, the Company implemented The First American Financial Corporation 1996 Stock Option Plan (the Stock Option Plan). Under the Stock Option Plan, options are granted to certain employees to purchase the Company's common stock at a price no less than the market value of the shares on the date of the grant. The maximum number of shares that may be subject to options is 8,625,000. Currently outstanding options become exercisable one to five years, and expire 10 years, from the grant date. On April 24, 1997, the Company implemented The First American Financial Corporation 1997 Directors' Stock Plan (the Directors' Plan). The Directors' Plan is similar to the employees' Stock Option Plan, except that the maximum number of shares that may be subject to options is 1,800,000 and the maximum number of shares that may be purchased pursuant to options granted shall not exceed 6,750 shares during any 12-consecutive-month period. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." In accounting for its plan, the Company, in accordance with the provisions of SFAS No. 123, applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." As a result of this election, the Company does not recognize compensation expense for its stock option plans. Had the Company determined compensation cost based on the fair value for its stock options at grant date, as set forth under SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts as follows: (in thousands, except per share amounts) 1998 1997 1996 - ---------------------------------------------------------------------------- Net income: As reported $198,710 $64,499 $54,492 Pro forma $181,632 $63,699 $53,973 Earnings per share: As reported Basic $ 3.46 $ 1.18 $ 1.01 Diluted $ 3.32 $ 1.16 $ 1.00 Pro forma Basic $ 3.16 $ 1.17 $ 1.00 Diluted $ 3.04 $ 1.14 $ 0.99 The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively; dividend yield of 1.0%, 1.2% and 1.9%; expected volatility of 36.0%, 38.1% and 41.0%; risk-free interest rate of 5.7%, 6.3% and 6.5%; and expected life of six years. The weighted-average fair value of options granted during 1998, 1997 and 1996 was $9.71, $4.26 and $2.19, respectively. Transactions involving stock options are summarized as follows: Weighted Average Number Exercise (in thousands, except weighted-average exercise price) Outstanding Price - -------------------------------------------------------------------------------------------------- Balance at December 31, 1995 - - Granted during 1996 3,015 $ 5.69 Forfeited during 1996 - - - -------------------------------------------------------------------------------------------------- Balance at December 31, 1996 3,015 $ 5.69 Granted during 1997 207 $10.50 Exercised during 1997 (291) $ 5.69 Forfeited during 1997 (132) $ 5.69 - -------------------------------------------------------------------------------------------------- Balance at December 31, 1997 2,799 $ 6.05 Granted during 1998 4,158 $23.64 Exercised during 1998 (478) $ 5.90 Forfeited during 1998 (183) $14.20 - -------------------------------------------------------------------------------------------------- Balance at December 31, 1998 6,296 $17.48 - -------------------------------------------------------------------------------------------------- 37 At December 31, 1998, the range of exercise prices was $5.69 - $32.00 and the weighted-average remaining contractual life of outstanding options was six years. The number of options exercisable was 593,046 and the weighted- average exercise price of those options was $6.05. NOTE 13. Commitments and Contingencies: The Company leases certain office facilities, automobiles and equipment under operating leases, which for the most part are renewable. The majority of these leases also provide that the Company will pay insurance and taxes. In 1998, the Company satisfied its obligation under the terms of a sale- leaseback agreement with regard to certain furniture and equipment. Future minimum rental payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1998, are as follows: (in thousands) 1999 $ 75,628 2000 58,134 2001 42,501 2002 31,314 2003 24,828 Later Years 47,706 - ------------------------------------ $280,111 - ------------------------------------ Total rental expense for all operating leases and month-to-month rentals was $107.5 million, $78.3 million and $63.9 million for 1998, 1997, and 1996, respectively. The Company is involved in various routine legal proceedings related to its operations. While the ultimate disposition of each proceeding is not determinable, the Company does not believe that any of such proceedings will have a materially adverse effect on its financial condition or results of operations. NOTE 14. Mandatorily Redeemable Preferred Securities: On April 22, 1997, the Company issued and sold $100.0 million of 8.5% trust preferred securities, due in 2012, through its wholly owned subsidiary, First American Capital Trust. In connection with the subsidiary's issuance of the preferred securities, the Company issued to the subsidiary trust 8.5% subordinated interest notes, due 2012. The sole assets of the subsidiary are and will be the subordinated interest notes. The Company's obligations under the subordinated interest notes and related agreements, taken together, constitute a full and unconditional guarantee by the Company of the subsidiary's obligations under the preferred securities. Distributions payable on the securities are included as interest expense in the Company's consolidated income statement. NOTE 15. Stockholders' Equity: On October 23, 1997, the Company adopted a Shareholder Rights Plan. Under the Rights Plan, after the close of business on November 15, 1997, each holder of the Company's common shares received a dividend distribution of one Right for each common share held. Each Right entitles the holder thereof to buy a preferred share fraction equal to 1/100,000 of a share of Series A Junior Participating Preferred Shares of the Company at an exercise price of $265 per preferred share fraction. Each fraction is designed to be equivalent in voting and dividend rights to one common share. The Rights will be exercisable and will trade separately from the common shares only if a person or group, with certain exceptions, acquires beneficial ownership of 15% or more of the Company's common shares or commences a tender or exchange offer that would result in such person or group beneficially owning 15% or more of the common shares then outstanding. The Company may redeem the Rights at $0.001 per Right at any time prior to the occurrence of one of these events. All Rights expire on October 23, 2007. Each Right will entitle its holder to purchase, at the Right's then- current exercise price, preferred share fractions (or other securities of the Company) having a value of twice the Right's exercise price. This amounts to the right to buy preferred share fractions of the Company at half price. Rights owned by the party triggering the exercise of Rights will be void and therefore will not be exercisable. In addition, if after any person has become a 15%-or-more stockholder, the Company is involved in a merger or other business combination transaction with another person in which the Company's common shares are changed or converted, or if the Company sells 50% or more of its assets or earning power to another person, each Right will entitle 38 its holder to purchase, at the Right's then-current exercise price, common stock of such other person (or its parent) having a value of twice the Right's exercise price. On January 15, 1998, the Company distributed a 3-for-2 common stock split in the form of a 50% stock dividend. This resulted in an increase of 5,791,492 common shares outstanding with the par value of these additional shares being capitalized by a transfer from additional paid-in capital to the common stock account. All references to common stock, additional paid-in capital, number of shares of common stock and per share amounts for this stock split were restated in the Company's consolidated financial statements for the year ended December 31, 1997. On July 17, 1998, the Company distributed a 3- for-1 common stock split in the form of a 200% stock dividend. This resulted in an increase of 37,895,936 common shares outstanding with the par value of these additional shares being capitalized by a transfer from additional paid-in capital to the common stock account. This stock split has been reflected in the consolidated statements of stockholder's equity on a retroactive basis as of December 31, 1995. In order to effect the stock split, the Company increased its authorized shares from 36,000,000 to 108,000,000. All references in the consolidated financial statements with regards to common stock, additional paid- in capital, number of shares of common stock and per share amounts have been restated to reflect the July 17, 1998 stock split. NOTE 16. Other Comprehensive Income: On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires the reporting of comprehensive income in addition to net income. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Prior year financial statements have been reclassified to conform to the SFAS 130 requirements. Components of other comprehensive income are as follows: Minimum Accumulated Unrealized Pension Other Gains on Liability Comprehensive (in thousands) Securities Adjustment Income - ------------------------------------------------------------------------------------------------- Balance at December 31, 1995 $ 3,993 - $ 3,993 Before tax change (1,932) - (1,932) Tax benefit 676 - 676 - ------------------------------------------------------------------------------------------------- Balance at December 31, 1996 2,737 - 2,737 Before tax change 4,158 - 4,158 Tax expense (1,455) - (1,455) - ------------------------------------------------------------------------------------------------- Balance at December 31, 1997 5,440 - 5,440 Before tax change 5,213 $(1,856) 3,357 Tax (expense) benefit (1,825) 650 (1,175) - ------------------------------------------------------------------------------------------------- Balance at December 31, 1998 $ 8,828 $(1,206) $ 7,622 - ------------------------------------------------------------------------------------------------- The change in other unrealized gains (losses) on debt and equity securities includes reclassification adjustments of $1.1 million, $0.4 million and $2.6 million of realized gains for the years ended December 31, 1998, 1997 and 1996, respectively. NOTE 17. Business Combinations: On January 1, 1998, the Company formed a limited liability corporation (LLC) with Experian Group (Experian). The purpose of the LLC is to combine certain operations of the Company's subsidiary, First American Real Estate Information Services, Inc. (FAREISI), with Experian's Real Estate Solutions division (RES). The LLC is 80% owned by the Company and 20% owned by Experian. RES is a supplier of core real estate data, providing, among other things, property valuation information, title and tax information and imaged title documents. The Company treated the transaction as an acquisition of the assets and liabilities of RES in consideration of a 20% interest in FAREISI. This business combination has been accounted for under the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on the estimated fair values at January 1, 1998. In addition, as a result of the transaction, the Company recognized an investment gain of $32.4 million in the first quarter 1998. The operating results of the LLC are included in the Company's consolidated financial statements commencing January 1, 1998. Assuming the combination had occurred January 1, 1997, pro forma revenues, net income and net income per diluted share would have been $2,001.6 million, $69.6 million and 39 $1.25, respectively, for the year ended December 31, 1997. Pro forma results for the year ended December 31, 1998 are not presented because the combination occurred January 1, 1998. In addition, during the year ended December 31, 1998, the Company also acquired 27 companies. The purchase method of accounting was used for 24 of the acquisitions and the pooling of interests method was used for three. The 24 acquisitions accounted for under the purchase method of accounting were individually not material and all in the title insurance or real estate information services business. Their aggregate purchase price was $8.8 million in cash, $1.5 million in notes and 3,114,508 shares of the Company's stock. The purchase price for each was allocated to the assets acquired and liabilities assumed based on estimated fair values and approximately $30.8 million in goodwill was recorded. Goodwill is being amortized on a straight- line basis over its estimated useful life ranging from 20 to 30 years. The operating results of these acquired companies were included in the Company's consolidated financial statements from their respective acquisition dates. Assuming these acquisitions had occurred January 1, 1997, pro forma revenues, net income and net income per diluted share would have been $2,908.9 million, $199.8 million and $3.27, respectively, for the year ended December 31, 1998, and $2,045.7 million, $71.7 million and $1.22, respectively, for the year ended December 31, 1997 (the 1997 pro forma results include the business combination with Experian mentioned above). All pro forma results include amortization of goodwill and interest expense on acquisition debt. The pro forma results are not necessarily indicative of the operating results that would have been obtained had the acquisitions occurred at the beginning of the periods presented, nor are they necessarily indicative of future operating results. The three acquisitions accounted for under the pooling of interests method of accounting were individually not material. In the aggregate, the Company issued 2,362,178 shares of its common stock in exchange for 100% of the outstanding stock of each acquired company. Two of the companies are in the consumer risk management business and one is in the real estate information business. The Company has restated prior year results to reflect these three acquisitions. Costs incurred to consummate the acquisitions were not material. Combined and separate results of First American and the three acquisitions during the periods preceding the acquisitions were as follows: Nine Months Ended Year Ended Year Ended (in thousands) September 30, 1998 December 31, 1997 December 31, 1996 - ---------------------------------------------------------------------------------------------- Revenues: First American $2,062,633 $1,887,461 $1,597,566 Acquisitions 17,414 21,462 16,727 - ---------------------------------------------------------------------------------------------- $2,080,047 $1,908,923 $1,614,293 - ---------------------------------------------------------------------------------------------- Net income: First American $ 145,919 $ 64,709 $ 53,589 Acquisitions (227) (210) 903 - ---------------------------------------------------------------------------------------------- $ 145,692 $ 64,499 $ 54,492 - ---------------------------------------------------------------------------------------------- Net income (loss) per diluted share: First American $ 2.56 $ 1.21 $ 1.03 Acquisitions (0.09) (0.05) (0.03) - ---------------------------------------------------------------------------------------------- $ 2.47 $ 1.16 $ 1.00 - ---------------------------------------------------------------------------------------------- In November 1998, the Company entered into a definitive merger agreement with National Information Group (NAIG). Under the terms of the agreement, which the boards of directors of both companies unanimously approved, the NAIG shareholders will receive .67 of a share of the Company's common stock for each NAIG common share they own. In the merger, the Company expects to issue approximately 3.2 million shares of its common stock. This business combination will be accounted for under the pooling of interests method of accounting and is expected to close by the end of the second quarter 1999. NAIG provides insurance tracking services for mortgage and auto lenders and auto leasing companies. NAIG also provides outsourcing services, lender-placed insurance products, flood zone determinations and real estate tax services. NOTE 18. Segment Financial Information: In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement is effective for 1998 and requires certain information about a company's operating segments and products and services. The Company's operations include five reportable segments: title insurance, real estate information, home warranty, consumer risk management and trust and banking. The title insurance segment issues policies which are insured statements of the condition of title to real property. The real estate information segment provides to lender customers the status of tax payments on real property securing their loans, mortgage credit information derived from at 40 least two credit bureau sources, flood zone determination reports that provide information on whether or not a property is in a special flood hazard area, as well as other real estate-related information services. The home warranty segment issues one-year warranties which protect homeowners against defects in home fixtures. The consumer risk management segment provides credit and various database-related services primarily to automotive dealers, consumer lenders, employers and property management companies. The trust and banking segment provides full-service trust and depository services, accepts deposits and makes real estate-secured loans. The title insurance and real estate information segments operate through networks of offices nationwide. The Company provides its title services through both direct operations and agents throughout the United States. It also offers title services abroad in Australia, the Bahama Islands, Canada, England, Guam, Ireland, Mexico, Puerto Rico, Scotland, South Korea, and the U.S. Virgin Islands. Home warranty services are available in Arizona, California, Georgia, Nevada, North Carolina, South Carolina, Texas, Utah and Washington. The consumer risk management segment serves customers nationwide. The trust, banking and thrift businesses are located in Southern California; its investment services are offered across the U. S. Selected financial information about the Company's operations by segment for each of the past three years is as follows: Income (Loss) Before Income Depreciation Taxes and and Capital (in thousands) Revenues Minority Interests Assets Amortization Expenditures - ------------------------------------------------------------------------------------------------------------------ 1998 - ------------------------------------------------------------------------------------------------------------------ Title Insurance $2,087,106 $227,906 $ 858,326 $29,375 $100,560 Real Estate Information 601,413 103,057 597,629 26,710 53,374 Home Warranty 63,020 11,406 95,605 484 445 Consumer Risk 57,408 13,276 4,182 295 290 Trust and Banking 24,751 7,156 98,113 652 973 Corporate 43,630 (1,379) 130,935 2,288 - - ------------------------------------------------------------------------------------------------------------------ $2,877,328 $361,422 $1,784,790 $59,804 $155,642 - ------------------------------------------------------------------------------------------------------------------ 1997 - ------------------------------------------------------------------------------------------------------------------ Title Insurance $1,482,993 $ 79,602 $ 656,622 $23,501 $ 39,190 Real Estate Information 311,545 38,139 295,123 12,504 33,518 Home Warranty 51,005 8,871 81,444 424 768 Consumer Risk 41,069 6,968 3,034 205 605 Trust and Banking 20,007 4,062 83,423 604 676 Corporate 2,304 (27,967) 33,989 1,251 250 - ------------------------------------------------------------------------------------------------------------------ $1,908,923 $109,675 $1,153,635 $38,489 $ 75,007 - ------------------------------------------------------------------------------------------------------------------ 1996 - ------------------------------------------------------------------------------------------------------------------ Title Insurance $1,288,947 $ 50,129 $ 584,800 $17,236 $ 30,082 Real Estate Information 240,432 50,531 207,013 8,367 16,927 Home Warranty 41,927 7,429 67,622 296 277 Consumer Risk 24,105 2,953 2,164 175 424 Trust and Banking 17,839 3,728 72,473 438 1,366 Corporate 1,043 (22,054) 29,372 991 - - ------------------------------------------------------------------------------------------------------------------ $1,614,293 $ 92,716 $ 963,444 $27,503 $ 49,076 - ------------------------------------------------------------------------------------------------------------------ Corporate consists primarily of unallocated interest expense, minority interests, equity in earnings of affiliated companies and personnel and other operating expenses associated with the Company's home office facilities. 41 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES Quarterly Financial Data (Unaudited) Quarter Ended (in thousands, except per share amounts) March 31 June 30 September 30 December 31 - ----------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1998 - ---------------------------- Revenues $612,237 $709,776 $758,034 $797,281 Income before income taxes and minority interests $ 81,886 $ 84,017 $100,952 $ 94,567 Net income $ 44,733 $ 45,699 $ 55,260 $ 53,018 Net income per share (Note A): Basic $ 0.82 $ 0.82 $ 0.94 $ 0.88 Diluted $ 0.79 $ 0.79 $ 0.89 $ 0.85 - ----------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 - ---------------------------- Revenues $387,979 $456,176 $507,802 $556,966 Income before income taxes and minority interests $ 5,426 $ 31,918 $ 35,364 $ 36,967 Net income $ 3,214 $ 19,235 $ 21,372 $ 20,678 Net income per share (Note A): Basic $ 0.06 $ 0.35 $ 0.39 $ 0.38 Diluted $ 0.06 $ 0.35 $ 0.38 $ 0.37 The company's primary business segments are cyclical in nature, with the spring an summer months historically being the strongest. However, interest rate adjustments by the Federal Reserve Board, as well as other economic factors, can cause unusual fluctuations in the Company's quarterly operating results. See Management's Discussion and Analysis on pages 20-23 for further discussion of the Company's results of operations. All consolidated results have been restated to reflect the 1998 acquisitions of three separate entities accounted for under the pooling-of-interest method of accounting. Note A - After adjustment for 3-for-1 stock split effected July 17, 1998. 42 SCHEDULE I 1 OF 1 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 Column A Column B Column C Column D - --------------------------------------------------------- ------------- ------------- --------------- Amount at which shown in the Type of Investment Cost Market Value balance sheet - --------------------------------------------------------- ------------- ------------- --------------- Deposits with savings and loan associations and banks: Registrant $ 50,000 $ 50,000 $ 50,000 ------------ ------------ ------------ Consolidated $ 32,974,000 $ 32,974,000 $ 32,974,000 ------------ ------------ ------------ Debt securities: Registrant - Obligations of states and political subdivisions $ 45,050,000 $ 45,928,000 $ 45,928,000 ------------ ------------ ------------ Consolidated - U.S. Treasury securities $ 36,875,000 $ 38,022,000 $ 38,022,000 Corporate securities 74,546,000 76,257,000 76,257,000 Obligations of states and political subdivisions 89,824,000 91,992,000 91,992,000 Mortgage-backed securities 21,405,000 21,414,000 21,414,000 ------------ ------------ ------------ $222,650,000 $227,685,000 $227,685,000 ------------ ------------ ------------ Equity securities: Registrant - None Consolidated $ 18,790,000 $ 27,338,000 $ 27,338,000 ------------ ------------ ------------ Other long-term investments: Registrant - None Consolidated $ 63,244,000 $ 63,244,000 $ 63,244,000 ------------ ------------ ------------ Total Investments: Registrant $ 45,100,000 $ 45,978,000 $ 45,978,000 ============ ============ ============ Consolidated $337,658,000 $351,241,000 $351,241,000 ============ ============ ============ 43 SCHEDULE III 1 OF 2 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES SUPPLEMENTARY INSURANCE INFORMATION BALANCE SHEET CAPTIONS Column A Column B Column C Column D - -------- -------- -------- -------- Deferred Policy Claims Deferred Segment Acquisition Costs Reserves Revenues ------- ----------------- -------- -------- 1998 - ---- Title Insurance $248,723,000 Real Estate Information 17,857,000 75,540,000 Home Warranty 5,392,000 3,856,000 29,956,000 Consumer Risk Trust and Banking Corporate ---------- ------------ ------------ Total $5,392,000 $270,436,000 $105,496,000 ========== ============ ============ 1997 - ---- Title Insurance $238,141,000 $ 2,151,000 Real Estate Information 9,238,000 55,691,000 Home Warranty 5,316,000 3,357,000 26,582,000 Consumer Risk Trust and Banking 90,000 Corporate ----------- ------------ ------------ Total $ 5,316,000 $250,826,000 $ 84,424,000 =========== ============ ============ 44 SCHEDULE III 2 OF 2 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES SUPPLEMENTARY INSURANCE INFORMATION INCOME STATEMENT CAPTIONS Column A Column F Column G Column H Column I Column J -------- -------------- ------------ ------------- ------------ ------------- Amortization of Deferred Net Policy Other Operating Investment Loss Acquisition Operating Segment Revenues Income Provision Costs Expenses ------- -------------- ------------ ------------- ------------ ------------- 1998 - ---- Title Insurance $2,063,217,000 $23,889,000 $ 68,697,000 $307,055,000 Real Estate Information 598,832,000 2,581,000 17,428,000 251,376,000 Home Warranty 58,204,000 4,816,000 32,686,000 1,375,000 2,351,000 Consumer Risk 57,186,000 222,000 25,481,000 Trust and Banking 24,751,000 (48,000) 9,270,000 Corporate 43,630,000 14,424,000 -------------- ----------- ------------ ---------- ------------ Total $2,802,190,000 $75,138,000 $118,763,000 $1,375,000 $609,957,000 ============== =========== ============ ========== ============ 1997 - ---- Title Insurance $1,461,967,000 $21,026,000 $ 52,924,000 $247,579,000 Real Estate Information 311,838,000 (293,000) 9,874,000 132,927,000 Home Warranty 46,859,000 4,146,000 27,338,000 562,000 1,509,000 Consumer Risk 40,995,000 73,000 19,795,000 Trust and Banking 20,007,000 187,000 8,093,000 Corporate 2,304,000 10,591,000 -------------- ----------- ------------ ---------- ------------ Total $1,881,666,000 $27,256,000 $ 90,323,000 $ 562,000 $420,494,000 ============== =========== ============ ========== ============ 1996 - ---- Title Insurance $1,268,233,000 $20,714,000 $ 58,909,000 $216,091,000 Real Estate Information 239,434,000 998,000 4,453,000 83,489,000 Home Warranty 38,351,000 3,576,000 23,055,000 665,000 658,000 Consumer Risk 24,038,000 67,000 14,576,000 Trust and Banking 17,839,000 70,000 6,982,000 Corporate 1,043,000 7,064,000 -------------- ----------- ------------ ---------- ------------ Total $1,587,895,000 $26,398,000 $ 86,487,000 $ 665,000 $328,860,000 ============== =========== ============ ========== ============ 45 SCHEDULE IV 1 OF 1 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES REINSURANCE Title insurance Percentage operating Ceded to Assumed Title insurance of amount revenues before other from other operating assumed to Segment reinsurance companies companies revenues operating revenues - ------- --------------- ----------- ----------- --------------- ------------------ 1998 $2,062,679,000 $4,151,000 $4,689,000 $2,063,217,000 0.2% ============== ========== ========== ============== ==== 1997 $1,461,551,000 $3,609,000 $4,025,000 $1,461,967,000 0.3% ============== ========== ========== ============== ==== 1996 $1,267,309,000 $2,094,000 $3,018,000 $1,268,233,000 0.2% ============== ========== ========== ============== ==== 46 SCHEDULE V 1 OF 3 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS Year Ended December 31, 1998 Column A Column B Column C Column D Column E - ------------------------ ------------- ----------------------------- ------------ ------------- Additions ----------------------------- Balance at Charged to Charged Deductions Balance beginning costs and to other from at end Description of period expenses accounts reserve of period - ------------------------ ------------- ------------- ------------ ------------ ------------- Reserve deducted from accounts receivable: Registrant - None Consolidated $ 7,602,000 $ 11,095,000 $ 7,982,000(A) $ 10,715,000 ============ ============ =========== ============ Reserve for title losses and other claims: Registrant - None Consolidated $250,826,000 $118,763,000 $(3,596,000)(B) $95,557,000(C) $270,436,000 ============ ============ =========== =========== ============ Reserve deducted from loans receivable: Registrant - None Consolidated $ 1,185,000 $ 159,000 $ 194,000(A) $ 1,150,000 ============ ============ =========== ============ Reserve deducted from assets acquired in connection with claim settlements: Registrant - None Consolidated $ 11,135,000 $ 3,951,000 $ 2,830,000(D) $ 12,256,000 ============ =========== =========== ============ Reserve deducted from other assets: Registrant - None Consolidated $ 1,807,000 $ 263,000 $ 136,000(D) $ 1,934,000 ============ ============ =========== ============ Note A - Amount represents accounts written off, net of recoveries. Note B - Amount represents $355,000 in purchase accounting adjustments, net of a reclassification of $3,951,000 to the reserve for assets acquired in connection with claim settlements. Note C - Amount represents claim payments, net of recoveries. Note D - Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E - Amount represents elimination of reserve in connection with the expiration of the related temporary differences. 47 SCHEDULE V 2 OF 3 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS Year Ended December 31, 1997 Column A Column B Column C Column D Column E - --------------------------- ------------- -------------------------------- ------------ ------------- Additions -------------------------------- Balance at Charged to Charged Deductions Balance beginning costs and to other from at end Description of period expenses accounts reserve of period - --------------------------- ------------- ------------- ------------ ------------ ------------- Reserve deducted from accounts receivable: Registrant - None Consolidated $ 5,351,000 $ 4,510,000 $ 2,259,000(A) $ 7,602,000 ============ =========== =========== ============ Reserve for title losses and other claims: Registrant - None Consolidated $245,245,000 $90,323,000 $(4,633,000)(B) $80,109,000(C) $250,826,000 ============ =========== =========== =========== ============ Reserve deducted from loans receivable: Registrant - None Consolidated $ 1,050,000 $ 243,000 $ 108,000(A) $ 1,185,000 ============ =========== =========== ============ Reserve deducted from assets acquired in connection with claim settlements: Registrant - None Consolidated $ 10,278,000 $ 4,678,000 $ 3,821,000(D) $ 11,135,000 ============ =========== =========== ============ Reserve deducted from deferred income taxes: Registrant - None Consolidated $ 438,000 $ 438,000(E) ============ =========== Reserve deducted from other assets: Registrant - None Consolidated $ 1,387,000 $ 640,000 $ 220,000(D) $ 1,807,000 ============ =========== =========== ============ Note A - Amount represents accounts written off, net of recoveries. Note B - Amount represents $45,000 in purchase accounting adjustments, net of a reclassification of $4,678,000 to the reserve for assets acquired in connection with claim settlements. Note C - Amount represents claim payments, net of recoveries. Note D - Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E - Amount represents elimination of reserve in connection with the expiration of the related temporary differences. 48 SCHEDULE V 3 OF 3 THE FIRST AMERICAN FINANCIAL CORPORATION AND SUBSIDIARY COMPANIES VALUATION AND QUALIFYING ACCOUNTS Year Ended December 31, 1996 Column A Column B Column C Column D Column E - --------------------------- -------------- ------------------------------- ------------ ------------ Additions ------------------------------- Balance at Charged to Charged Deductions Balance beginning costs and to other from at end of Description of period expenses accounts reserve period - --------------------------- ------------ ------------ ------------ ------------ ------------ Reserve deducted from accounts receivable: Registrant - None Consolidated $ 5,970,000 $ 4,386,000 $ 5,005,000(A) $ 5,351,000 ============ =========== =========== ============ Reserve for title losses and other claims: Registrant - None Consolidated $238,161,000 $86,487,000 $(4,915,000)(B) $74,488,000(C) $245,245,000 ============ =========== =========== =========== ============ Reserve deducted from loans receivable: Registrant - None Consolidated $ 1,344,000 $ 433,000 $ 727,000(A) $ 1,050,000 ============ =========== =========== ============ Reserve deducted from other investments: Registrant - None Consolidated $ 353,000 $ 353,000(D) ============ =========== Reserve deducted from assets acquired in connection with claim settlements: Registrant - None Consolidated $ 11,246,000 $ 4,948,000 $ 5,916,000(D) $ 10,278,000 ============ =========== =========== ============ Reserve deducted from deferred income taxes: Registrant - None Consolidated $ 856,000 $ 418,000(E) $ 438,000 ============ =========== ============ Reserve deducted from other assets: Registrant - None Consolidated $ 1,420,000 $ 2,000 $ 35,000(D) $ 1,387,000 ============ =========== =========== ============ Note A - Amount represents accounts written off, net of recoveries. Note B - Amount represents $33,000 in purchase accounting adjustments, net of a reclassification of $4,948,000 to the reserve for assets acquired in connection with claim settlements. Note C - Amount represents claim payments, net of recoveries. Note D - Amount represents elimination of reserve in connection with disposition and/or revaluation of the related asset. Note E - Amount represents elimination of reserve in connection with the expiration of the related temporary differences. 49 Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure. - --------------------- None PART III -------- The information required by Items 10 through 13 of this report is set forth in the sections entitled "Security Ownership of Certain Beneficial Owners," "Election of Directors," "Transactions with Management and Others," "Security Ownership of Management," "Executive Compensation," "Report of the Compensation Committee on Executive Compensation," "Comparative Cumulative Total Return to Shareholders," "Executive Officers" and "Compliance With Section 16(a) of the Securities Exchange Act of 1934" in the Company's definitive proxy statement, which sections are incorporated in this report and made a part hereof by reference. The definitive proxy statement will be filed no later than 120 days after close of Registrant's fiscal year. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.+ ----------------------------------------------------------------- (a) 1.& 2. Financial Statements and Financial Statement Schedules The Financial Statements and Financial Statement Schedules filed as part of this report are listed in the accompanying index at page 17 in Item 8 of Part II of this report. 3. Exhibits (Each management contract or compensatory plan or arrangement in which any director or named executive officer of The First American Financial Corporation, as defined by Item 402(a)(3) of Regulation S-K (17 C.F.R. (S)229.402(a)(3)), participates that is included among the exhibits listed below is identified by an asterisk (*).) (2) Agreement and Plan of Merger, dated as of November 17, 1998, among The First American Financial Corporation, National Insurance Group, and Pea Soup Acquisition Corp., incorporated by reference herein from Exhibit 2.1 of Form 8-K filed by National Information Group on November 25, 1998. (3)(a) Restated Articles of Incorporation of The First American Financial Corporation dated July 14, 1998, incorporated by reference herein from Exhibit 3.1 of Amendment No. 1, dated July 28, 1998 to the Company's Registration Statement No. 333-53681 on Form S-4. (3)(b) Bylaws of The First American Financial Corporation, as amended. (4)(a) Rights Agreement, dated as of October 23, 1997, incorporated by reference herein from Exhibit 4 of Registration Statement on Form 8-A dated November 7, 1997. (4)(b) Junior Subordinated Indenture, dated as of April 22, 1997, incorporated by reference herein from Exhibit (4.2) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (4)(c) Form of New 8.50% Junior Subordinated Deferrable Interest Debenture, incorporated by reference herein from Exhibit 4.2 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(d) Certificate of Trust of First American Capital Trust I, incorporated by reference herein from Exhibit 4.3 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(e) Amended and Restated Declaration of Trust of First American Capital Trust I dated as of April 22, 1997, incorporated by reference herein from Exhibit (4.3) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (4)(f) Form of New 8.50% Capital Security (Liquidation Amount $1,000 per Capital Security), incorporated by reference herein from Exhibit 4.6 of Registration Statement No. 333- 35945 on Form S-4 dated September 18, 1997. (4)(g) Form of New Guarantee Agreement, incorporated by reference herein from Exhibit 4.7 of Registration Statement No. 333- 35945 on Form S-4 dated September 18, 1997. 50 (4)(h) Senior Indenture, dated as of April 7, 1998, between The First American Financial Corporation and Wilmington Trust Company as Trustee, incorporated by reference herein from Exhibit (4) of the Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. *(10)(a) Description of Stock Bonus Plan, as amended, incorporated by reference herein from Exhibit (10)(a) of Annual Report on Form 10-K for the fiscal year ended December 31, 1992. *(10)(b) Executive Supplemental Benefit Plan dated April 10, 1986, and Amendment No. 1 thereto dated October 1, 1986, incorporated by reference herein from Exhibit (10)(b) of Annual Report on Form 10-K for the fiscal year ended December 31, 1988. *(10)(c) Amendment No. 2, dated March 22, 1990, to Executive Supplemental Benefit Plan, incorporated by reference herein from Exhibit (10)(c) of Annual Report on Form 10-K for the fiscal year ended December 31, 1989. *(10)(d) Amendment No. 3, dated July 7, 1998, to Executive Supplemental Benefit Plan. *(10)(e) Management Supplemental Benefit Plan dated July 20, 1988, incorporated by reference herein from Exhibit (10) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. *(10)(f) Amendment No. 1, dated July 7, 1998, to Management Supplemental Benefit Plan. *(10)(g) Pension Restoration Plan (effective as of January 1, 1994), incorporated by reference herein from Exhibit (10)(e) of Annual Report on Form 10-K for the fiscal year ended December 31, 1996. *(10)(h) 1996 Stock Option Plan, incorporated by reference herein from Exhibit 4 of Registration Statement No. 333-19065 on Form S-8 dated December 30, 1996. *(10)(i) Amendment No. 1, dated February 26, 1998, to 1996 Stock Option Plan. *(10)(j) Amendment No. 2, dated June 22, 1998, to 1996 Stock Option Plan. *(10)(k) Amendment No. 3, dated July 7, 1998, to 1996 Stock Option Plan. *(10)(l) 1997 Directors' Stock Plan, incorporated by reference herein from Exhibit 4.1 of Registration Statement No. 333-41993 on Form S-8 dated December 11, 1997. *(10)(m) Amendment No. 1 to 1997 Directors' Stock Plan dated February 26, 1998. *(10)(n) Amendment No. 2 to 1997 Directors' Stock Plan dated July 7, 1998. (10)(o) Registration Rights Agreement, dated April 22, 1997, incorporated by reference herein from Exhibit (10.1) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (10)(p) The First American Financial Corporation Deferred Compensation Plan dated October 1, 1997. (10)(q) The First American Financial Corporation Deferred Compensation Plan Trust 51 Agreement dated as of October 1, 1997. (10)(r) Contribution and Joint Venture Agreement By and Among The First American Financial Corporation and Experian Information Solutions, Inc., et al., dated November 30, 1997, incorporated by reference herein from Exhibit (10)(a) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(s) Operating Agreement for First American Real Estate Solutions LLC, a California Limited Liability Company, By and Among First American Real Estate Information Services, Inc., and Experian Information Solutions, Inc., et al., dated November 30, 1997, incorporated by reference herein from Exhibit (10)(b) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(t) Data License Agreement dated November 30, 1997, incorporated by reference herein from Exhibit (10)(d) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(u) Experian Transition Agreement dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(f) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(v) Reseller Services Agreement dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(g) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(w) Amendment to Reseller Services Agreement For Resales to Consumers dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(h) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(x) Trademark License Agreement, dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(i) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(Y) Amended and Restated Credit Agreement dated as of July 29, 1997, incorporated by reference herein from Exhibit (4.4) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (10)(Z) Amendment No.1 dated as of November 10, 1997, to Amended and Restated Credit Agreement dated as of July 29, 1997, incorporated by reference herein from Exhibit (4.1) of Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (21) Subsidiaries of the registrant. (23) Consent of Independent Accountants. (27) Financial Data Schedule. (b) Reports on Form 8-K During the last quarter of the period covered by this report, the Company filed a current report on Form 8-K dated October 22, 1998, reporting on certain information and issues involving the "Year 2000 Problem." + An instrument defining the rights of security holders has been omitted in accordance with Item 601(b)(4)(iii)(A) of Regulation S-K. The Company agrees to furnish a copy of this instrument to the SEC upon request. 52 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE FIRST AMERICAN FINANCIAL CORPORATION (Registrant) By /S/ PARKER S. KENNEDY -------------------------------------------------------------------- Parker S. Kennedy, President (Principal Executive Officer) Date: March 18, 1999 -------------------------------------------------------------------- By: /S/ THOMAS A. KLEMENS -------------------------------------------------------------------- Thomas A. Klemens, Executive Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) Date: March 18, 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 date indicated. By: /S/ D.P. KENNEDY By: ------------------------------- ------------------------------- D.P. Kennedy Paul B. Fay, Jr., Director Chairman and Director Date: March 18, 1999 Date: ------------------------------- ------------------------------- By: /S/ PARKER S. KENNEDY By: /S/ ANTHONY R. MOISO ------------------------------- ------------------------------- Parker S. Kennedy, Anthony R. Moiso, Director President and Director Date: March 18, 1999 Date: March 18, 1999 ------------------------------- ------------------------------- By: /S/ THOMAS A. KLEMENS By: ------------------------------- ------------------------------- Thomas A. Klemens Frank O'Bryan, Director Executive Vice President, Chief Financial Officer Date: March 18, 1999 Date: ------------------------------- ------------------------------- By: By: /S/ ROSLYN B. PAYNE ------------------------------- ------------------------------- George L. Argyros, Director Roslyn B. Payne, Director Date: Date: March 18, 1999 ------------------------------- ------------------------------- By: By: ------------------------------- ------------------------------- Gary J. Beban, Director D. Van Skilling, Director Date: Date: ------------------------------- ------------------------------- By: /S/ J. DAVID CHATHAM By: /S/ VIRGINIA UEBERROTH ------------------------------- ------------------------------- J. David Chatham, Director Virginia Ueberroth, Director Date: March 18, 1999 Date: March 18, 1999 ------------------------------- ------------------------------- By: /S/ WILLIAM G. DAVIS ------------------------------- ------------------------------- William G. Davis, Director Date: March 18, 1999 ------------------------------- ------------------------------- By: /S/ JAMES L. DOTI ------------------------------- ------------------------------- James L. Doti, Director Date: March 18, 1999 ------------------------------- ------------------------------- By: /S/ LEWIS W. DOUGLAS, JR. ------------------------------- ------------------------------- Lewis W. Douglas, Jr., Director Date: March 18, 1999 ------------------------------- ------------------------------- 53 EXHIBIT INDEX Sequentially Exhibit No. Description Numbered Page - ----------- ----------- ------------- (2) Agreement and Plan of Merger, dated as of November 17, 1998, among The First American Financial Corporation, National Insurance Group, and Pea Soup Acquisition Corp., incorporated by reference herein from Exhibit 2.1 of Form 8-K filed by National Information Group on November 25, 1998. (3)(a) Restated Articles of Incorporation of The First American Financial Corporation dated July 14, 1998, incorporated by reference herein from Exhibit 3.1 of Amendment No. 1, dated July 28, 1998 to the Company's Registration Statement No. 333-53681 on Form S-4. (3)(b) Bylaws of The First American Financial Corporation, as amended. (4)(a) Rights Agreement, dated as of October 23, 1997, incorporated by reference herein from Exhibit 4 of Registration Statement on Form 8-A dated November 7, 1997. (4)(b) Junior Subordinated Indenture, dated as of April 22, 1997, incorporated by reference herein from Exhibit (4.2) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (4)(c) Form of New 8.50% Junior Subordinated Deferrable Interest Debenture, incorporated by reference herein from Exhibit 4.2 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(d) Certificate of Trust of First American Capital Trust I, incorporated by reference herein from Exhibit 4.3 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(e) Amended and Restated Declaration of Trust of First American Capital Trust I dated as of April 22, 1997, incorporated by reference herein from Exhibit (4.3) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (4)(f) Form of New 8.50% Capital Security (Liquidation Amount $1,000 per Capital Security), incorporated by reference herein from Exhibit 4.6 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(g) Form of New Guarantee Agreement, incorporated by reference herein from Exhibit 4.7 of Registration Statement No. 333-35945 on Form S-4 dated September 18, 1997. (4)(h) Senior Indenture, dated as of April 7, 1998, between The First American Financial Corporation and Wilmington Trust Company as Trustee, incorporated by reference herein from Exhibit (4) of the Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. *(10)(a) Description of Stock Bonus Plan, as amended, incorporated by reference herein from Exhibit (10)(a) of Annual Report on Form 10-K for the fiscal year ended December 31, 1992. *(10)(b) Executive Supplemental Benefit Plan dated April 10, 1986, and Amendment No. 1 thereto dated October 1, 1986, incorporated by reference herein from Exhibit (10)(b) of Annual Report on Form 10-K for the fiscal year ended December 31, 1988. *(10)(c) Amendment No. 2, dated March 22, 1990, to Executive Supplemental Benefit Plan, incorporated by reference herein from Exhibit (10)(c) of Annual Report on Form 10-K for the fiscal year ended December 31, 1989. *(10)(d) Amendment No. 3, dated July 7, 1998, to Executive Supplemental Benefit Plan. *(10)(e) Management Supplemental Benefit Plan dated July 20, 1988, incorporated by reference herein from Exhibit (10) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1992. *(10)(f) Amendment No. 1, dated July 7, 1998, to Management Supplemental Benefit Plan. *(10)(g) Pension Restoration Plan (effective as of January 1, 1994), incorporated by reference herein from Exhibit (10)(e) of Annual Report on Form 10-K for the fiscal year ended December 31, 1996. *(10)(h) 1996 Stock Option Plan, incorporated by reference herein from Exhibit 4 of Registration Statement No. 333-19065 on Form S-8 dated December 30, 1996. *(10)(i) Amendment No. 1, dated February 26, 1998, to 1996 Stock Option Plan. *(10)(j) Amendment No. 2, dated June 22, 1998, to 1996 Stock Option Plan. *(10)(k) Amendment No. 3, dated July 7, 1998, to 1996 Stock Option Plan. *(10)(l) 1997 Directors' Stock Plan, incorporated by reference herein from Exhibit 4.1 of Registration Statement No. 333-41993 on Form S-8 dated December 11, 1997. *(10)(m) Amendment No. 1 to 1997 Directors' Stock Plan dated February 26, 1998. *(10)(n) Amendment No. 2 to 1997 Directors' Stock Plan dated July 7, 1998. (10)(o) Registration Rights Agreement, dated April 22, 1997, incorporated by reference herein from Exhibit (10.1) of Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (10)(p) The First American Financial Corporation Deferred Compensation Plan dated October 1, 1997. (10)(q) The First American Financial Corporation Deferred Compensation Plan Trust Agreement dated as of October 1, 1997. (10)(r) Contribution and Joint Venture Agreement By and Among The First American Financial Corporation and Experian Information Solutions, Inc., et al., dated November 30, 1997, incorporated by reference herein from Exhibit (10)(a) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(s) Operating Agreement for First American Real Estate Solutions LLC, a California Limited Liability Company, By and Among First American Real Estate Information Services, Inc., and Experian Information Solutions, Inc., et al., dated November 30, 1997, incorporated by reference herein from Exhibit (10)(b) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(t) Data License Agreement dated November 30, 1997, incorporated by reference herein from Exhibit (10)(d) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(u) Experian Transition Agreement dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(f) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(v) Reseller Services Agreement dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(g) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(w) Amendment to Reseller Services Agreement For Resales to Consumers dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(h) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(x) Trademark License Agreement, dated as of November 30, 1997, incorporated by reference herein from Exhibit (10)(i) of the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. (10)(y) Amendment and Restated Credit Agreement dated as of July 29, 1997, incorporated by reference herein from Exhibit (4.4) of Quarterly Report on Form 10- Q for the quarter ended June 30, 1997. (10)(Z) Amendment No.1 dated as of November 10, 1997 to Amended and Restated Credit Agreement dated as of July 29, 1997, incorporated by reference herein from Exhibit (4.1) of Quarterly Report on Form 10- Q for the quarter ended September 30, 1997. (21) Subsidiaries of the registrant. (23) Consent of Independent Accountants. (27) Financial Data Schedule.