-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MePTQ17bB1NlPd0jafYH8+qzpipEK3fwGjhc/UewV9CgPSV44q0+4Q0iGpkRzwOk 8NKcH1yLMt+ho6YrzcH1Ug== 0001017062-99-000491.txt : 19990323 0001017062-99-000491.hdr.sgml : 19990323 ACCESSION NUMBER: 0001017062-99-000491 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990322 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST AMERICAN FINANCIAL CORP CENTRAL INDEX KEY: 0000036047 STANDARD INDUSTRIAL CLASSIFICATION: TITLE INSURANCE [6361] IRS NUMBER: 951068610 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13585 FILM NUMBER: 99570117 BUSINESS ADDRESS: STREET 1: 114 E FIFTH ST CITY: SANTA ANA STATE: CA ZIP: 92701-4699 BUSINESS PHONE: 7145583211 MAIL ADDRESS: STREET 1: 114 E FIFTH STREET CITY: SANTA ANA STATE: CA ZIP: 92701 FORMER COMPANY: FORMER CONFORMED NAME: FIRST AMERICAN TITLE INSURANCE & TRUST C DATE OF NAME CHANGE: 19690515 10-K 1 FORM 10-K RE FYE 12/31/98 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. EX-3.B 2 BYLAWS OF FIRST AMERICAN FINANCIAL CORP. EXHIBIT (3)(b) BYLAWS OF THE FIRST AMERICAN FINANCIAL CORPORATION ARTICLE I OFFICES Section l. PRINCIPAL OFFICES. The location of the principal executive office of the corporation is 114 East Fifth Street, Santa Ana, California. The board of directors may change the location of the principal executive office to any place within or outside the State of California. If the principal executive office is located outside this state, and the corpor ation has one or more business offices in this state, the board of directors shall fix and designate a principal business office in the State of California. Section 2. OTHER OFFICES. The board of directors may at any time establish branch or subordinate offices at any place or places where the corporation is qualified to do business. ARTICLE II MEETINGS OF SHAREHOLDERS Section l. PLACE OF MEETINGS. Meetings of shareholders shall be held at any place within or outside the State of California designated by the board of directors. In the absence of any such designation, shareholders' meetings shall be held at the principal executive office of the corporation. Section 2. ANNUAL MEETING. The annual meeting of shareholders shall be held each year on a date and at a time designated by the board of directors. At each annual meeting, directors shall be elected, and any other proper business may be transacted. Section 3. SPECIAL MEETING. A special meeting of the shareholders may be called at any time by the board of directors, or by the chairman of the board, or by the president, or by one or more shareholders holding shares in the aggregate entitled to cast not less than 10% of the votes at that meeting. If a special meeting is called by any person or persons other than the board of directors, the request shall be in writing, specifying the time of such meeting and the general nature of the business proposed to be transacted, and shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the chairman of the 1 board, the president, any vice president, or the secretary of the corporation. The officer receiving the request shall cause notice to be promptly given to the shareholders entitled to vote, in accordance with the provisions of Sections 4 and 5 of this Article II, that a meeting will be held at the time requested by the person or persons calling the meeting, not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after receipt of the request, the person or persons requesting the meeting may give notice. Nothing contained in this paragraph of this Section 3 shall be construed as limiting, fixing or affecting the time when a meeting of shareholders called by action of the board of directors may be held. Section 4. NOTICE OF SHAREHOLDERS' MEETING. All notices of meetings of shareholders shall be sent or otherwise given in accordance with Section 5 of this Article II not less than ten (10) nor more than sixty (60) days before the date of the meeting. The notice shall specify the place, date and hour of the meeting and (i) in the case of a special meeting, the general nature of the business to be transacted, or (ii) in the case of the annual meeting, those matters which the board of directors, at the time of giving the notice, intends to present for action by the shareholders. The notice of any meeting at which directors are to be elected shall include the name of any nominee or nominees whom, at the time of the notice, management intends to present for election. If action is proposed to be taken at any meeting for approval of (i) a contract or transaction in which a director has a direct or indirect financial interest, pursuant to Section 310 of the Corporations Code of California, (ii) an amendment of the articles of incorporation, pursuant to Section 902 of that Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of that Code, (iv) a voluntary dissolution of the corporation, pursuant to Section 1900 of that code, or (v) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, pursuant to Section 2007 of that Code, the notice shall also state the general nature of that proposal. Section 5. MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE. Notice of any meeting of shareholders shall be given either personally or by first-class mail or telegraphic or other written communication, charges prepaid, addressed to the shareholder at the address of that shareholder appearing on the books of the corporation or given by the shareholder to the corporation for the purpose of notice. If no such address appears on the corporation's books or is given, notice shall be deemed to have been given if sent to that shareholder by first- class mail or telegraphic or other written communication to the corporation's principal executive office, or if published at least once in a newspaper of general circulation in the county where that office is located. Notice shall be deemed to have been given at the time when delivered personally or deposited in the mail or sent by telegram or other means of written communication. If any notice addressed to a shareholder at the address of that shareholder appearing on the books of the corporation is returned to the corporation by the United States Postal Service marked to indicate that the United States Postal Service is unable to deliver the notice to the shareholder at that address, all future notices or reports shall be deemed to have 2 been given without further mailing if these shall be available to the shareholder on written demand of the shareholder at the principal executive office of the corporation for a period of one year from the date of the giving of the notice. An affidavit of the mailing or other means of giving any notice of any shareholders' meeting shall be executed by the secretary, assistant secretary, or any transfer agent of the corporation giving the notice, and shall be filed and maintained in the minute book of the corporation. Section 6. QUORUM. The presence in person or by proxy of the holders of a majority of the shares entitled to vote at any meeting of shareholders shall constitute a quorum for the transaction of business. The shareholders present at a duly called or held meeting at which a quorum is present may continue to do business until adjournment, notwithstanding the withdrawal of enough shareholders to leave less than a quorum, if any action taken (other than adjournment) is approved by at least a majority of the shares required to constitute a quorum. Section 7. ADJOURNED MEETING NOTICE. Any shareholders' meeting, annual or special, whether or not a quorum is present, may be adjourned from time to time by the vote of the majority of the shares represented at that meeting, either in person or by proxy, but in the absence of a quorum, no other business may be transacted at that meeting, except as provided in Section 6 of this Article II. When any meeting of shareholders, either annual or special, is adjourned to another time or place; notice need not be given of the adjourned meeting if the time and place are announced at a meeting at which the adjournment is taken, unless a new record date for the adjourned meeting is fixed, or unless the adjournment is for more than forty-five (45) days from the date set forth for the original meeting, in which case the board of directors shall set a new record date. Notice of any such adjourned meeting shall be given to each shareholder of record entitled to vote at the adjourned meeting in accordance with the provisions of Sections 4 and 5 of this Article II. At any adjourned meeting the corporation may transact any business which might have been transacted at the original meeting. Section 8. VOTING. The shareholders entitled to vote at any meeting of shareholders shall be determined in accordance with the provisions of Section ll of this Article II, subject to the provisions of Sections 702 to 704 inclusive, of the Corporations Code of California (relating to voting shares held by a fiduciary in the name of a corporation, or in joint ownership). The shareholders' vote may be by voice vote or by ballot; provided however, that any election for directors must be by ballot if demanded by any shareholder before the voting has begun. On any matter other than elections of directors, any shareholder may vote part of the shares in favor of the proposal and refrain from voting the remaining shares or vote them against the proposal, but, if the shareholder fails to specify the number of shares which the shareholder is voting affirmatively, it will be conclusively presumed that the shareholder's approving vote is with respect to all shares that the shareholder is entitled to vote. If a quorum is present, the affirmative vote of the 3 majority of the shares represented at the meeting and entitled to vote on any matter (other than the election of directors) shall be the act of the shareholders, unless the vote of a greater number or voting by classes is required by California General Corporation Law or by the articles of incorporation. At a shareholders' meeting at which directors are to be elected, no shareholder shall be entitled to cumulate votes (i.e., cast for any one or more candidates a number of votes greater than the number of the shareholder's shares) unless the candidates' names have been placed in nomination prior to commencement of the voting and a shareholder has given notice prior to commencement of the voting of the shareholder's intention to cumulate votes. If any shareholder has given such a notice, then every shareholder entitled to vote may cumulate votes for candidates in nomination and give one candidate a number of votes equal to the number of directors to be elected multiplied by the number of votes to which that shareholder's shares are entitled, or distribute the shareholder's votes on the same principle among any or all of the candidates, as the shareholder thinks fit. The candidates receiving the highest number of votes, up to the number of directors to be elected, shall be elected. Section 9. WAIVER OF NOTICE OR CONSENT BY ABSENT SHARE HOLDERS. The transactions of any meeting of shareholders, either annual or special, however called and noticed, and wherever held, shall be as valid as though had at a meeting duly held after regular call and notice, if a quorum be present either in person or by proxy, and if, either before or after the meeting, each person entitled to vote, who was not present in person or by proxy, signs a written waiver of notice or a consent to a holding of the meeting, or an approval of the minutes. The waiver of notice or consent need not specify either the business to be transacted or the purpose of any annual or special meeting of shareholders, except that if action is taken or proposed to be taken for approval of any of those matters specified in the second paragraph of Section 4 of this Article II, the waiver of notice or consent shall state the general nature of the proposal. All such waivers, consents or approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Attendance by a person at a meeting shall also constitute a waiver of notice of that meeting, except when the person objects, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened, and except that attendance at a meeting is not a waiver of any right to object to the consideration of matters not included in the notice of the meeting if that objection is expressly made at the meeting. Section 10. SHAREHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING. Any action which may be taken at any annual or special meeting of shareholders may be taken without a meeting and without prior notice, if a consent in writing, setting forth the action so taken, is signed by the holders of outstanding shares having not less than the minimum number of votes that would be necessary to authorize or take that action at a meeting at which all shares entitled to vote on that action were present and voted. In the case of election of directors, such a consent shall be effective only if 4 signed by the holders of all outstanding shares entitled to vote for the election of directors; provided, however, that a director may be elected at any time to fill a vacancy on the board of directors that has not been filled by the directors, by the written consent of the holders of a majority of the outstanding shares entitled to vote for the election of directors. All such consents shall be filed with the secretary of the corporation and shall be maintained in the corporate records. Any shareholder giving a written consent, or the shareholder's proxy holders, or a transferee of the shares or a personal representative of the shareholder or their respective proxy holders, may revoke the consent by a writing received by the secretary of the corporation before written consents of the number of shares required to authorize the proposed action have been filed with the secretary. If the consents of all shareholders entitled to vote have not been solicited in writing, and if the unanimous written consent of all such shareholders shall not have been received, the secretary shall give prompt notice of the corporate action approved by the shareholders without a meeting. This notice shall be given in the manner specified in Section 5 of this Article II. In the case of approval of (i) contracts or transactions in which a director has a direct or indirect financial interest, pursuant to Section 310 of the Corporations Code of California, (ii) indemnification of agents of the corporation, pursuant to Section 317 of that Code, (iii) a reorganization of the corporation, pursuant to Section 1201 of that Code, and (iv) a distribution in dissolution other than in accordance with the rights of outstanding preferred shares, pursuant to Section 2007 of that Code, the notice shall be given at least ten (10) days before the consummation of any action authorized by that approval. Section ll. RECORD DATE FOR SHAREHOLDER NOTICE, VOTING, AND GIVING CONSENTS. For purposes of determining the shareholders entitled to notice of any meeting or to vote or entitled to give consent to corporate action without a meeting, the board of directors may fix, in advance, a record date, which shall not be more than sixty (60) days nor less than ten (10) days before the date of any such meeting nor more than sixty (60) days before any such action without a meeting, and in this event only shareholders of record on the date so fixed are entitled to notice and to vote or to give consents, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date, except as otherwise provided in the California General Corporation Law. If the board of directors does not so fix a record date: (a) The record date for determining shareholders entitled to notice of or to vote at a meeting of shareholders shall be at the close of business on the business day next preceding the day on which notice is given or, if notice is waived, at the close of business on the business day next preceding the day on which the meeting is held. (b) The record date for determining shareholders entitled to give consent to corporate action in writing without a meeting, (i) when no prior action by the board has been taken, shall be the day on which the first written consent is given, or (ii) when prior action of the board has been taken, shall be at the close of business on the day on which the board 5 adopts the resolution relating to that action, or the sixtieth (60th) day before the date of such other action, whichever is later. Section 12. PROXIES. Every person entitled to vote for directors or on any other matter shall have the right to do so either in person or by one or more agents authorized by a written proxy signed by the person and filed with the secretary of the corporation. A proxy shall be deemed signed if the shareholder's name is placed on the proxy (whether by manual signature, typewriting, telegraphic transmission, or otherwise) by the shareholder or the shareholder's attorney in fact. A validly executed proxy which does not state that it is irrevocable shall continue in full force and effect unless (i) revoked by the person executing it, before the vote pursuant to that proxy, by a writing delivered to the corporation stating that the proxy is revoked, or by a subsequent proxy executed by, or attendance at the meeting and voting in person by, the person executing the proxy; or (ii) written notice of the death or incapacity of the maker of that proxy is received by the corporation before the vote pursuant to that proxy is counted; provided, however, that no proxy shall be valid after the expiration of eleven (ll) months from the date of the proxy, unless otherwise provided in the proxy. The revocability of a proxy that states on its face that it is irrevocable shall be governed by the provisions of Sections 705(e) and 705(f) of the Corporations Code of California. Section 13. INSPECTORS OF ELECTION. Before any meeting of shareholders, the board of directors may appoint any persons other than nominees for office to act as inspectors of election at the meeting or its adjournment. If no inspectors of election are so appointed, the chairman of the meeting may, and on the request of any shareholder or a shareholder's proxy shall, appoint inspectors of election at the meeting. The number of inspectors shall be either one (l) or three (3). If inspectors are appointed at a meeting on the request of one or more shareholders or proxies, the holders of a majority of shares or their proxies present at the meeting shall determine whether one (l) or three (3) inspectors are to be appointed. If any person appointed as inspector fails to appear or fails or refuses to act, the chairman of the meeting may, and upon the request of any shareholder or a shareholder's proxy shall, appoint a person to fill that vacancy. These inspectors shall: (a) Determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, and the authenticity, validity, and effect of proxies; (b) Receive votes, ballots, or consents; (c) Hear and determine all challenges and questions in any way arising in connection with the right to vote; (d) Count and tabulate all votes or consents; 6 (e) Determine when the polls shall close; (f) Determine the result; and (g) Do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. ARTICLE III DIRECTORS Section l. POWERS. Subject to the provisions of the California General Corporation Law and any limitations in the articles of incorporation and these bylaws relating to action required to be approved by the shareholders or by the outstanding shares, the business and affairs of the corporation shall be managed and all corporate powers shall be exercised by or under the direction of the board of directors. Without prejudice to these general powers, and subject to the same limitations, the directors shall have the power to: (a) Select and remove all officers, agents, and employees of the corporation; prescribe any powers and duties for them that are consistent with law, with the articles of incorporation, and with these bylaws; fix their compensation; and require from them security for faithful service. (b) Change the principal executive office or the principal business office in the State of California from one location to another; cause the corporation to be qualified to do business in any other state, territory, dependency, or country and to conduct business within or without the State of California; and designate any place within or without the State of California for the holding of any shareholders' meeting, or meetings, including annual meetings. (c) Adopt, make, and use a corporate seal; prescribe the forms of certificates of stock; and alter the form of the seal and certificates. (d) Authorize the issuance of shares of stock of the corporation on any lawful terms, in consideration of money paid, labor done, services actually rendered, debts or securities cancelled, or tangible or intangible property actually received. (e) Borrow money and incur indebtedness on behalf of the corporation, and cause to be executed and delivered for the corporation's purposes, in the corporate name, promissory notes, bonds, debentures, deeds of trust, mortgages, pledges, hypothecations, and other evidences of debt and securities. 7 Section 2. NUMBER AND QUALIFICATION OF DIRECTORS. The number of directors of the corporation shall be no less than 9 nor more than 17. The exact number of directors shall be 14 until changed, within the limits specified above, by a bylaw amending this Section 2, duly adopted by the board of directors or by the shareholders. The indefinite number of directors may be changed, or a definite number fixed without provision for an indefinite number, by a duly adopted amendment to the articles of incorporation; provided, however, that an amendment reducing the number or the minimum number of directors to a number less than five cannot be adopted if the votes cast against its adoption at a meeting of the shareholders, or the shares not consenting in the case of action by written consent, are equal to more than 16 2/3% of the outstanding shares entitled to vote. No amendment may change the stated maximum number of authorized directors to a number greater than two times the stated minimum number of directors minus one. Section 3. ELECTION AND TERM OF OFFICE OF DIRECTORS. Directors shall be elected at each annual meeting of the shareholders to hold office until the next annual meeting. Each director, including a director elected to fill a vacancy, shall hold office until the expiration of the term for which elected and until a successor has been elected and qualified. Section 4. VACANCIES. Vacancies in the board of directors may be filled by a majority of the remaining directors, though less than a quorum, or by a sole remaining director, except that a vacancy created by the removal of a director by the vote or written consent of the shareholders or by court order may be filled only by the vote of a majority of the shares entitled to vote represented at a duly held meeting at which a quorum is present, or by the written consent of holders of a majority of the outstanding shares entitled to vote. Each director so elected shall hold office until the next annual meeting of the shareholders and until a successor has been elected and qualified. A vacancy or vacancies in the board of directors shall be deemed to exist in the event of the death, resignation, or removal of any director, or if the board of directors by resolution declares vacant the office of a director who has been declared of unsound mind by an order of court or convicted of a felony, or if the authorized number of directors is increased, or if the shareholders fail, at any meeting of shareholders at which any director or directors are elected, to elect the number of directors to be voted for at that meeting. The shareholders may elect a director or directors at any time to fill any vacancy or vacancies not filled by the directors, but any such election by written consent shall require the consent of a majority of the outstanding shares entitled to vote. Any director may resign effective on giving written notice to the chairman of the board, the president, the secretary, or the board of directors, unless the notice specifies a later time for that resignation to become effective. If the resignation of a director is effective at a future time, the board of directors may elect a successor to take office when the resignation becomes effective. 8 No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. Section 5. PLACE OF MEETINGS AND MEETINGS BY TELEPHONE. Regular meetings of the board of directors may be held at any place within or outside the State of California that has been designated from time to time by resolution of the board. In the absence of such a designation, regular meetings shall be held at the principal executive office of the corporation. Special meetings of the board shall be held at any place within or outside the State of California that has been designated in the notice of the meeting or, if not stated in the notice or there is no notice, at the principal executive office of the corporation. Any meeting, regular or special, may be held by conference telephone or similar communication equipment, so long as all directors participating in the meeting can hear one another, and all such directors shall be deemed to be present in person at the meeting. Section 6. ANNUAL MEETING. Immediately following each annual meeting of shareholders, the board of directors shall hold a regular meeting for the purpose of organization, any desired election of officers, and the transaction of other business. Notice of this meeting shall not be required. Section 7. OTHER REGULAR MEETINGS. Other regular meetings of the board of directors shall be held without call at such time as shall from time to time be fixed by the board of directors. Such regular meetings may be held without notice. Section 8. SPECIAL MEETINGS. Special meetings of the board of directors for any purpose or purposes may be called at any time by the chairman of the board or the president or the secretary or any two directors. Notice of the time and place of special meetings shall be delivered personally or by telephone to each director or sent by first-class mail or telegram, charges prepaid, addressed to each director at that director's address as it is shown on the records of the corporation. In case the notice is mailed, it shall be deposited in the United States mail at least four (4) days before the time of the holding of the meeting. In case the notice is delivered personally, or by telephone or telegram, it shall be delivered personally or by telephone or to the telegraph company at least forty-eight (48) hours before the time of the holding of the meeting. Any oral notice given personally or by telephone may be communicated either to the director or to a person at the office of the director who the person giving the notice has reason to believe will promptly communicate it to the director. The notice need not specify the purpose of the meeting nor the place if the meeting is to be held at the principal executive office of the corporation. Section 9. QUORUM. A majority of the authorized number of directors shall constitute a quorum for the transaction of business, except to adjourn as provided in Section ll of this Article III. Every act done or decision made by a majority of the directors present at a meeting duly held at which a quorum is present shall be regarded as the act of the board of directors, subject to the provisions of Section 310 of the Corporations Code of California 9 (as to approval of contracts or transactions in which a director has a direct or indirect material financial interest), Section 311 of that Code (as to appointment of committees), and Section 317(e) of that Code (as to indemnification of directors). A meeting at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority of the required quorum for that meeting. Section 10. WAIVER OF NOTICE. The transactions of any meeting of the board of directors, however called and noticed or wherever held, shall be as valid as though had at a meeting duly held after regular call and notice if a quorum is present and if, either before or after the meeting, each of the directors not present signs a written waiver of notice, a consent to holding the meeting or an approval of the minutes. The waiver of notice or consent need not specify the purpose of the meeting. All such waivers, consents, and approvals shall be filed with the corporate records or made a part of the minutes of the meeting. Notice of a meeting shall also be deemed given to any director who attends the meeting without protesting before or at its commencement, the lack of notice to that director. Section ll. ADJOURNMENT. A majority of the directors present, whether or not constituting a quorum, may adjourn any meeting to another time and place. Section 12. NOTICE OF ADJOURNMENT. Notice of the time and place of holding an adjourned meeting need not be given, unless the meeting is adjourned for more than twenty-four hours, in which case notice of the time and place shall be given before the time of the adjourned meeting, in the manner specified in Section 8 of this Article III, to the directors who were not present at the time of the adjournment. Section 13. ACTION WITHOUT MEETING. Any action required or permitted to be taken by the board of directors may be taken without a meeting, if all members of the board shall individually or collectively consent in writing to that action. Such action by written consent shall have the same force and effect as a unanimous vote of the board of directors. Such written consent or consents shall be filed with the minutes of the proceedings of the board. Section 14. FEES AND COMPENSATION OF DIRECTORS. Directors and members of committees may receive such compensation, if any, for their services, and such reimbursement of expenses, as may be fixed or determined by resolution of the board of directors. This Section 14 shall not be construed to preclude any director from serving the corporation in any other capacity as an officer, agent, employee, or otherwise, and receiving compensation for those services. 10 ARTICLE IV COMMITTEES Section l. COMMITTEES OF DIRECTORS. The board of directors may, by resolution adopted by a majority of the authorized number of directors, designate one or more committees, each consisting of two or more directors, to serve at the pleasure of the board. The board may designate one or more directors as alternate members of any committee who may replace any absent member at any meeting of the committee. Any com mittee, to the extent provided in the resolution of the board, shall have all the authority of the board, except with respect to: (a) the approval of any action which, under the General Corporation Law of California, also requires shareholders' approval or approval of the outstanding shares; (b) the filling of vacancies on the board of directors or in any committee; (c) the fixing of compensation of the directors for serving on the board or on any committee; (d) the amendment or repeal of bylaws or the adoption of new bylaws; (e) the amendment or repeal of any resolution of the board of directors which by its express terms is not so amendable or repealable; (f) a distribution to the shareholders of the corporation, except at a rate or in a periodic amount or within a price range determined by the board of directors; or (g) the appointment of any other committees of the board of directors or the members of these committees. Section 2. MEETINGS AND ACTION OF COMMITTEES. Meetings and action of committees shall be governed by, and held and taken in accordance with, the provisions of Article III of these bylaws, Sections 5 (place of meetings), 7 (regular meetings), 8 (special meetings and notice), 9 (quorum), 10 (waiver of notice), 11 (adjournment), 12 (notice of adjournment), and 13 (action without meeting), with such changes in the context of those bylaws as are necessary to substitute the committee and its members for the board of directors and its members, except that the time of regular meetings of committees may be determined either by resolution of the board of directors or by resolution of the committee; special meetings of committees may also be called by resolution of the board of directors; and notice of special meetings of committees shall also be given to all alternate members, who shall have the right to attend all meetings of the committee. The board of directors may adopt rules for the government of any committee not inconsistent with the provisions of these bylaws. 11 ARTICLE V OFFICERS Section l. OFFICERS. The officers of the corporation shall be a president, a secretary, and a chief financial officer. The corporation may also have, at the discretion of the board of directors, a chairman of the board, one or more vice presidents, one or more assistant secretaries, one or more assistant treasurers, and such other officers as may be appointed in accordance with the provisions of Section 3 of this Article V. Any number of offices may be held by the same person. Section 2. ELECTION OF OFFICERS. The officers of the corporation, except such officers as may be appointed in accordance with the provisions of Section 3 or Section 5 of this Article V, shall be chosen by the board of directors, and each shall serve at the pleasure of the board, subject to the rights, if any, of any officer under any contract of employment. Section 3. SUBORDINATE OFFICERS. The board of directors may appoint, and may empower the president to appoint, such other officers as the business of the corporation may require, each of whom shall hold office for such period, have such authority and perform such duties as are provided in the bylaws or as the board of directors may from time to time determine. Section 4. REMOVAL AND RESIGNATION OF OFFICERS. Subject to the rights, if any, of any officer under any contract of employment, any officer may be removed, either with or without cause, by the board of directors, at any regular or special meeting of the board, or, except in the case of an officer chosen by the board of directors, by an officer upon whom such power of removal may be conferred by the board of directors. Any officer may resign at any time by giving written notice to the corporation. Any resignation shall take effect at the date of the receipt of that notice or at any later time specified in that notice; and unless otherwise specified in that notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. Section 5. VACANCIES IN OFFICES. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in these bylaws for regular appointments to that office. Section 6. CHAIRMAN OF THE BOARD. The chairman of the board, if such an officer be elected, shall, if present, preside at meetings of the board of directors and exercise and perform such powers and duties as may be from time to time assigned to him by the board of directors or prescribed by the bylaws. If there is no president, the chairman of the 12 board shall, in addition be the chief executive officer of the corporation and shall have the powers and duties prescribed in Section 7 of this Article V. Section 7. PRESIDENT. Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board, if there be such an officer, the president shall be the chief executive officer of the corporation and shall, subject to the control of the board of directors, have general supervision, direction, and control of the business and the officers of the corporation. He shall preside at all meetings of the shareholders and, in the absence of the chairman of the board, or if there be none, at all meetings of the board of directors. He shall have the general powers and duties of management usually vested in the office of president of a corporation, and shall have such other powers and duties as may be prescribed by the board of directors or by the bylaws. Section 8. VICE PRESIDENT. In the absence or disability of the president, the vice presidents, if any, in order of their rank as fixed by the board of directors or, if not ranked, a vice president designated by the board of directors, shall perform all the duties of the president, and when so acting shall have all the powers of, and be subject to all the restrictions upon, the president. The vice presidents shall have such other powers and perform other duties as from time to time may be prescribed for them respectively by the board of directors or the bylaws, and the president, or the chairman of the board. Section 9. SECRETARY. The secretary shall keep or cause to be kept, at the principal executive office or such other place as the board of directors may direct, a book of minutes of all meetings and actions of directors, committees of directors, and shareholders, with the time and place of holding, whether regular or special, and, if special, how authorized, the notice given, the names of those present at directors' meetings or committee meetings, the number of shares present or represented at shareholders' meetings, and the proceedings. The secretary shall keep, or cause to be kept, at the principal executive office or at the office of the corporation's transfer agent or registrar, as determined by resolution of the board of directors, a share register, or a duplicate share register, showing the names of all shareholders and their addresses, the number of classes of shares held by each, the number and date of certificates issued for the same, and the number and date of cancellation of every certificate surrendered for cancellation. The secretary shall give, or cause to be given, notice of all meetings of the shareholders and of the board of directors required by the bylaws or by law to be given, and he shall keep the seal of the corporation if one be adopted, in safe custody, and shall have such other powers and perform such other duties as may be prescribed by the board of directors or by the bylaws. Section 10. CHIEF FINANCIAL OFFICER. The chief financial officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the corporation, including 13 accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, retained earnings and shares. The books of the account shall at all reasonable times be open to inspection by any director. The chief financial officer shall deposit moneys and other valuables in the name and to the credit of the corporation with such depositaries as may be designated by the board of directors. He shall disburse the funds of the corporation as may be ordered by the board of directors, shall render to the president and directors, whenever they request it, an account of all his transactions as chief financial officer and of the financial condition of the corporation, and shall have other powers and perform such other duties as may be prescribed by the board of directors or the bylaws. ARTICLE VI INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND OTHER AGENTS; INSURANCE OF DIRECTORS AND OFFICERS Section 1. INDEMNIFICATION. (i) The corporation shall indemnify its Officers and Directors to the fullest extent permitted by law, including those circumstances in which indemnification would otherwise be discretionary; (ii) the corporation is required to advance expenses to its Officers and Directors as incurred, including expenses relating to obtaining a determination that such Officers and Directors are entitled to indemnification, provided that they undertake to repay the amount advanced if it is ultimately determined that they are not entitled to indemnification; (iii) an Officer or Director may bring suit against the corporation if a claim for indemnification is not timely paid; (iv) the corporation may not retroactively amend this Section 1 in a way which is adverse to its Officers and Directors; (v) the provisions of subsections (i) through (iv) above shall apply to all past and present Officers and Directors of the corporation. Indemnification of Agents of the corporation who are not its Officers and Directors shall be in accordance with the provisions of Section 317 of the Corporations Code of California. The corporation may enter into indemnification agreements with its Directors, Officers and other Agents upon such terms and conditions as are deemed to be in the best interests of the corporation by its board of directors. The other provisions of this Section 1 to the contrary notwithstanding, the corporation shall not be obligated: (a) to indemnify or advance expenses to an Officer, Director or Agent with respect to proceedings or claims initiated or brought voluntarily by such Officer, Director or Agent and not by way of defense, except with respect to proceedings brought to establish or enforce a right to indemnification under an indemnification agreement or any statute or 14 law or otherwise as required under Section 317 of the Corporations Code of California, but such indemnification or advancement of expenses may be provided by the corporation in specific cases if the board of directors has approved the bringing of such suit; (b) to indemnify an Officer, Director or Agent for any expenses incurred with respect to any proceeding instituted by such Officer, Director or Agent to enforce or interpret provisions of an indemnity agreement or this Section 1, if a court of competent jurisdiction determines that each of the material assertions made by the Officer, Director or Agent in such proceeding was not made in good faith or was frivolous; (c) to indemnify an Officer, Director or Agent for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes or penalties, and amounts paid in settlement) which have been paid or satisfied by an insurance carrier under a policy of officers' and directors' liability insurance maintained by the corporation; provided that the corporation shall be obligated to remit to the Officer, Director or Agent any insurance proceeds received in respect of expenses or liabilities previously paid or satisfied by such Officer, Director or Agent; (d) to indemnify an Officer, Director or Agent for expenses, judgments, fines or penalties sustained, or for an accounting of profits made from, the purchase and sale by such Officer, Director or Agent of securities of the corporation in violation of the provisions of Section 16(b) of the Securities Exchange Act of 1934, as amended, the rules and regulations promulgated thereunder, any amendments thereto or any similar provisions of any federal, state or local statutory law; or (e) in the event a court of competent jurisdiction finally determines that such indemnification is unlawful. The term "Officer" as used in this Section 1 shall mean each person who is, or was, appointed to the office of Chairman of the Board, President, Vice President, Secretary, Assistant Secretary, Chief Financial Officer, Treasurer, Assistant Treasurer, and such other office of the corporation as the board shall designate from time to time. The term "Director" as used in this Section 1 shall mean any person who is, or was, appointed to serve on the board of directors either by the shareholders or the remaining board members. The term "Agent" as used in this Section 1 shall have the same meaning as that set forth in Section 317(a) of the Corporations Code of California, except that it shall not include Officers and Directors. Section 2. INSURANCE. The corporation may purchase and maintain insurance on behalf of its Directors, Officers and Agents, against any liability asserted against, or incurred by, any of them by reason of the fact that such person is, or was, a Director, Officer or Agent of the corporation, whether or not the corporation would have the power to indemnify such persons against such liability under the General Corporation Law of California. 15 ARTICLE VII RECORDS AND REPORTS Section l. MAINTENANCE AND INSPECTION OF SHARE REGISTER. The corporation shall keep at its principal executive office, or at the office of its transfer agent or registrar, if either be appointed and as determined by resolution of the board of directors, a record of its shareholders, giving the names and addresses of all shareholders and the number and class of shares held by each shareholder. A shareholder or shareholders of the corporation holding at least five percent (5%) in the aggregate of the outstanding voting shares of the corporation may (i) inspect and copy the records of shareholders' names and addresses and shareholdings during usual business hours on five days prior written demand on the corporation, and (ii) obtain from the transfer agent of the corporation, on written demand and on the tender of such transfer agent's usual charges for such list, a list of the shareholders' names and addresses, who are entitled to vote for the election of directors, and their shareholdings, as of the most recent record date for which that list has been compiled or as of a date specified by the shareholder after the date of demand. This list shall be made available to any such shareholder by the transfer agent on or before the latter of five (5) days after the demand is received or the date specified in the demand as the date as of which the list is to be compiled. The record of shareholders shall be open to inspection on the written demand of any shareholder or holder of a voting trust certificate, at any time during the usual business hours, for a purpose reasonably related to the holder's interests as a shareholder or as the holder of a voting trust certificate. Any inspection and copying under this Section l may be made in person or by an agent or attorney of the shareholder or holder of a voting trust certificate making the demand. Section 2. MAINTENANCE AND INSPECTION OF BYLAWS. The corporation shall keep at its principal executive office or, if its principal executive office is not in the State of California, at its principal business office in this state, the original or a copy of the bylaws as amended to date, which shall be open to inspection by the shareholders at all reasonable times during office hours. If the principal executive office of the corporation is outside the State of California and the corporation has no principal business office in this state, the Secretary shall, upon the written request of any shareholder, furnish to that shareholder a copy of the bylaws as amended to date. Section 3. MAINTENANCE AND INSPECTION OF OTHER CORPORATE RECORDS. The accounting books and records and minutes of proceedings of the shareholders and the board of directors and any committee or committees of the board of directors shall be kept at such place or places designated by the board of directors or, in the absence of such designation, at the principal executive office of the corporation. The minutes shall be kept in written form and the accounting books and records shall be kept either in written form or in any other form capable of being converted into written form. The minutes and accounting books and records shall be open to inspection upon the written 16 demand of any shareholder or holder of a voting trust certificate, at any reasonable time during the usual business hours, for a purpose reasonably related to the holder's interests as a shareholder or as the holder of a voting trust certificate. The inspection may be made in person or by an agent or attorney, and shall include the right to copy and make extracts. These rights of inspection shall extend to the records of each subsidiary corporation of the corporation. Section 4. INSPECTION BY DIRECTORS. Every director shall have the absolute right at any reasonable time to inspect all books, records, and documents of every kind and the physical properties of the corporation and each of its subsidiary corporations. This inspection by a director may be made in person, or by an agent or attorney and the right of inspection includes the right to copy and make extracts of documents. Section 5. ANNUAL REPORT TO SHAREHOLDERS. The board of directors shall cause an annual report to be sent to the shareholders not later than one hundred twenty days (120) after the close of the fiscal year adopted by the corporation. This report shall be sent at least fifteen (15) days before the annual meeting of shareholders to be held during the next fiscal year and in the manner specified in Section 5 of Article II of these bylaws for giving notice to shareholders of the corporation. The annual report shall contain a balance sheet as of the end of the fiscal year and an income statement and statement of changes in financial position for the fiscal year, accompanied by any report of independent accountants or, if there is no such report, the certificate of an authorized officer of the corporation that the statements were prepared without audit from the books and records of the corporation. Section 6. FINANCIAL STATEMENTS. A copy of any annual financial statement and any income statement of the corporation for each fiscal year, and any accompanying balance sheet of the corporation as of the end of each such period that has been prepared by the corporation, shall be kept on file in the principal executive office of the corporation for twelve (12) months and each such statement shall be exhibited at any reasonable time to any shareholder demanding an examination of any such statement or a copy shall be mailed to any such shareholder. If a shareholder or shareholders holding at least five percent (5%) of the outstanding shares of any class of stock of the corporation makes a written request to the corporation for an income statement of the corporation for the three-month, six-month or nine-month period of the then current fiscal year ended more than thirty (30) days before the date of the request, and a balance sheet of the corporation as of the end of that period, the chief financial officer shall cause that statement to be prepared, if not already prepared, and shall deliver personally or mail that statement or statements to the person making the request within thirty (30) days after the receipt of the request. If the corporation has not sent to the shareholders its annual report for the last fiscal year, this report shall likewise be delivered or mailed to the shareholder or shareholders within thirty (30) days after the request. 17 The corporation shall also, on the written request of any shareholder, mail to the shareholder a copy of the last annual, semi-annual or quarterly income statement which it has prepared, and a balance sheet as of the end of that period. The quarterly income statements and balance sheets referred to in this section shall be accompanied by the report, if any, of any independent accountants engaged by the corporation or the certificate of an authorized officer of the corporation that the financial statements were prepared without audit from the books and records of the corporation. Section 7. ANNUAL STATEMENT OF GENERAL INFORMATION. The corporation shall, during the period commencing on April l and ending on September 30 in each year, file with the Secretary of State of the State of California, on the prescribed form, a statement setting forth the authorized number of directors, the names and complete business or residence addresses of the chief executive officer, secretary and chief financial officer, the street address of its principal executive office or principal business office in this state and the general type of business activity of the corporation, together with a designation of the agent of the corporation for the purpose of service of process, all in compliance with Section 1502 of the Corporations Code of California. ARTICLE VIII GENERAL CORPORATE MATTERS Section l. RECORD DATE FOR PURPOSES OTHER THAN NOTICE AND VOTING. For purposes of determining the shareholders entitled to receive payment of any dividend or other distribution or allotment of any rights or entitled to exercise any rights in respect of any other lawful action (other than action by shareholders by written consent without a meeting), the board of directors may fix, in advance, a record date, which shall not be more than sixty (60) days before any such action, and in that case only shareholders of record on the date so fixed are entitled to receive the dividend, distribution, or allotment of rights or to exercise the rights, as the case may be, notwithstanding any transfer of any shares on the books of the corporation after the record date so fixed, except as otherwise provided in the California General Corporation Law. If the board of directors does not so fix a record date, the record date for determining shareholders for any such purpose shall be at the close of business on the day on which the board adopts the applicable resolution or the sixtieth (60th) day before the date of that action, whichever is later. Section 2. CHECKS, DRAFTS, EVIDENCES OF INDEBTEDNESS. All checks, drafts, or other orders for payment of money, notes, or other evidences of indebtedness, issued in the name of or payable to the corporation, shall be signed or endorsed by such person or persons and in such manner as, from time to time, shall be determined by resolution of the board of directors. 18 Section 3. CORPORATE CONTRACTS AND INSTRUMENTS; HOW EXECUTED. The board of directors, except as otherwise provided in these bylaws, may authorize any officer or officers, agent or agents, to enter into any contract or execute any instrument in the name of and on behalf of the corporation, and this authority may be general or confined to specific instances; and, unless so authorized or ratified by the board of directors or within the agency power of an officer, no officer, agent or employee shall have any power or authority to bind the corporation by any contract or engagement or to pledge its credit or to render it liable for any purpose or for any amount. Section 4. CERTIFICATES FOR SHARES. A certificate or certificates for shares of the capital stock of the corporation shall be issued to each shareholder when any of these shares are fully paid, and the board of directors may authorize the issuance of certificates or shares as partly paid provided that these certificates shall state the amount of the consideration to be paid for them and the amount paid. All certificates shall be signed in the name of the corporation by the chairman of the board or vice chairman of the board or president or vice president and by the chief financial officer or an assistant treasurer or the secretary or an assistant secretary, certifying the number of shares and the class or series of shares owned by the shareholder. Any or all of the signatures on the certificates may be facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed on a certificate shall have ceased to be that officer, transfer agent, or registrar before that certificate is issued, it may be issued by the corporation with the same effect as if that person were an officer, transfer agent, or registrar at the date of issue. Section 5. LOST CERTIFICATES. Except as provided in this Section 5, no new certificates for shares shall be issued to replace an old certificate unless the latter is surrendered to the corporation and cancelled at the same time. The board of directors may, in case any share certificate or certificate for any other security is lost, stolen, or destroyed, authorize the issuance of a replacement certificate on such terms and conditions as the board may require, including provision for indemnification of the corporation secured by a bond or other adequate security sufficient to protect the corporation against any claim that may be made against it, including any expense or liability, on account of the alleged loss, theft, or destruction of the certificate or the issuance of the replacement certificate. Section 6. REPRESENTATION OF SHARES OF OTHER CORPORATIONS. The chairman of the board, the president, or any vice president, or any other person authorized by resolution of the board of directors or by any of the foregoing designated officers, is authorized to vote on behalf of the corporation any and all shares of any other corporation or corporations, foreign or domestic, standing in the name of the corporation. The authority granted to these officers to vote or represent on behalf of the corporation any and all shares held by the corporation in any other corporation or corporations may be exercised by any of these officers in person or by any person authorized to do so by a proxy duly executed by these officers. Section 7. CONSTRUCTION AND DEFINITIONS. Unless the context requires otherwise, the general provisions, rules of construction, and definitions in the California 19 General Corporation Law shall govern the construction of these bylaws. Without limiting the generality of this provision, the singular number includes the plural, the plural number includes the singular, and the term "person" includes both a corporation and a natural person. ARTICLE IX AMENDMENTS Section l. AMENDMENT BY SHAREHOLDERS. New bylaws may be adopted or these bylaws may be amended or repealed by the vote or written consent of holders of a majority of the outstanding shares entitled to vote; provided, however, that if the articles of incorporation of the corporation set forth the number of authorized directors of the corporation, the authorized number of directors may be changed only by an amendment of the articles of incorporation. Section 2. AMENDMENT BY DIRECTORS. Subject to the rights of the shareholders as provided in Section l of this Article IX to adopt, amend or repeal bylaws, bylaws may be adopted, amended or repealed by the board of directors; provided, however, that the board of directors may adopt a bylaw or amendment of a bylaw changing the authorized number of directors only for the purpose of fixing the exact number of directors within the limits specified in the articles of incorporation or in Section 2 of Article III of these bylaws. 20 EX-10.D 3 AMEND. NO. 3 TO EXECUTIVE SUPPLEMENTAL BENEFIT PLAN EXHIBIT (10)(d) Composite Conformed Copy AMENDMENT NO. 3 TO The First American Financial Corporation EXECUTIVE SUPPLEMENTAL BENEFIT PLAN This Amendment No. 3 to The First American Financial Corporation Executive Supplemental Benefit Plan (hereinafter referred to as the "Plan") is effective as of January 1, 1998 and modifies such Plan as set forth below: Section 2(q) of the Plan is amended to read in full as follows: (q) "Joint and Survivor Annuity" means an annuity for the life of the Participant and, after his death, a reduced annuity ("survivor annuity") for the life of the Participant's surviving spouse, if any. "Surviving spouse" means the Participant's spouse to whom the Participant was married at the time benefits began and who is living at the time of the Participant's death after the benefit commenced. The monthly payment under the survivor annuity shall be equal to 50% of the amount of the monthly payment made to the Participant during their joint lives if the surviving spouse is not more than five years younger, or is older, than the Participant at the time benefits begin. If the surviving spouse is more than five years younger than the Participant, the survivor annuity will be determined with reference to the actual age of the surviving spouse at the time benefits begin and reduced to produce the actuarial equivalent of a 50% survivor annuity for a surviving spouse who is five years younger than the Participant. Section 3(b) of the Plan is amended to add the following sentence at the end thereof: Notwithstanding the foregoing, a Participant's Retirement Income Benefit shall be offset by the amount of any payments that are required to be made pursuant to: (1) a valid state domestic relations order that is a judgment, decree, or order under state community property or domestic relations law that relates to the provision of child support, alimony, or marital property rights of a Participant's spouse, child or other dependent, or (2) in the event of divorce and after the divorce decree has been issued, a property settlement signed by the Participant, the Participant's former spouse, and any other individual named within the agreement to receive Plan funds. ________________________________________________________________________________ 1 Section 11(b) of the Plan is amended to add the following sentence at the end thereof: Notwithstanding the foregoing, payments shall be made pursuant to a valid state domestic relations order that is a judgment, decree, order under state community property or domestic relations law that relates to the provision of child support, alimony, or marital property rights of a Participant's spouse, child or other dependent, or, in the event of divorce and after the divorce decree has been issued, a property settlement signed by the Participant, the Participant's former spouse and any other individual named within the agreement to receive Plan funds. Executed at Santa Ana, California, this 7th of July, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy --------------------------------------- Its President By: /s/ Mark R Arnesen --------------------------------------- Its Secretary & Counsel ________________________________________________________________________________ 2 EX-10.F 4 AMEND. NO. 1 TO MANAGEMENT SUPPLEMENTAL BENEFIT PLAN EXHIBIT (10)(f) Composite Conformed Copy AMENDMENT NO. 1 TO The First American Financial Corporation MANAGEMENT SUPPLEMENTAL BENEFIT PLAN This Amendment No. 1 to The First American Financial Corporation Management Supplemental Benefit Plan (hereinafter referred to as the "Plan") is effective as of January 1, 1998, and modifies such Plan as set forth below: Section 2(q) of the Plan is amended to read in full as follows: (q) "Joint and Survivor Annuity" means an annuity for the life of the Participant and, after his death, a reduced annuity ("survivor annuity") for the life of the Participant's surviving spouse, if any. "Surviving spouse" means the Participant's spouse to whom the Participant was married at the time benefits began and who is living at the time of the Participant's death after the benefit commenced. The monthly payment under the survivor annuity shall be equal to 50% of the amount of the monthly payment made to the Participant during their joint lives if the spouse is not more than five years younger, or is older, than the Participant at the time benefits begin. If the spouse is more than five years younger than the Participant at the time benefits begin, the survivor annuity will be determined with reference to the actual age of the spouse at the time benefits begin and reduced to produce the actuarial equivalent of a 50% survivor annuity for a spouse who is five years younger than the Participant. Section 3(b) of the Plan is amended to add the following sentence at the end thereof: Notwithstanding the foregoing, a Participant's Retirement Income Benefit shall be offset by the amount of any payments that are required to be made pursuant to: (1) a valid state domestic relations order that is a judgment, decree, or order under state community property or domestic relations law that relates to the provision of child support, alimony, or marital property rights of a Participant's spouse, child or other dependent, or (2) in the event of divorce and after the divorce decree has been issued, a property settlement signed by the Participant, the Participant's former spouse, and any other individual named within the agreement to receive Plan funds. ________________________________________________________________________________ 1 Section 11(b) of the Plan is amended to add the following sentence at the end thereof: Notwithstanding the foregoing, payments shall be made pursuant to a valid state domestic relations order that is a judgment, decree, order under state community property or domestic relations law that relates to the provision of child support, alimony, or marital property rights of a Participant's spouse, child or other dependent, or, in the event of divorce and after the divorce decree has been issued, a property settlement signed by the Participant, the Participant's former spouse and any other individual named within the agreement to receive Plan funds. Executed at Santa Ana, California, this 7th of July, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy ------------------------------------------ Its President By: /s/ Mark R Arnesen ----------------------------------------- Its Secretary & Counsel ________________________________________________________________________________ 2 EX-10.I 5 AMEND. NO. 1 TO 1996 STOCK OPTION PLAN EXHIBIT (10)(i) AMENDMENT NO. 1 TO THE FIRST AMERICAN FINANCIAL CORPORATION 1996 STOCK OPTION PLAN This Amendment No. 1 to The First American Financial Corporation 1996 Stock Option Plan (the "Plan") was adopted by the board of directors of The First American Financial Corporation (the "Company") on February 26, 1998, and is effective as of January 1, 1998. Section 5.1 of the Plan is amended to read in full as follows: "Number. Subject to the provisions of Section 5.3, the number of shares of Stock subject to Options under the Plan may not exceed 1,875,000 shares. The shares to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock, not reserved for any other purpose." IN WITNESS WHEREOF, the Company's duly authorized officers have executed this amendment at Santa Ana, California, on February 26, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy ----------------------------------------- Parker S. Kennedy, President By: /s/ Mark R Arnesen ----------------------------------------- Mark R Arnesen, Secretary EX-10.J 6 AMEND. NO. 2 TO 1996 STOCK OPTION PLAN EXHIBIT (10)(j) Composite Conformed Copy AMENDMENT NO. 2 TO THE FIRST AMERICAN FINANCIAL CORPORATION 1996 STOCK OPTION PLAN This Amendment No. 2 to The First American Financial Corporation 1996 Stock Option Plan (the "Plan") was adopted by the board of directors of The First American Financial Corporation (the "Company") on February 26, 1998, was approved by the shareholders of the Company on April 23, 1998, and is effective as of the latter date. Section 5.1 of the Plan is amended to read in full as follows: "Number. Subject to the provisions of Section 5.3, the number of shares of Stock subject to Options under the Plan may not exceed 2,875,000 shares. The shares to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock, not reserved for any other purpose." IN WITNESS WHEREOF, the Company's duly authorized officers have executed this amendment at Santa Ana, California, on June 22, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy --------------------------------------- Parker S. Kennedy, President By: /s/ Mark R Arnesen --------------------------------------- Mark R Arnesen, Secretary EX-10.K 7 AMEND. NO. 3 TO 1996 STOCK OPTION PLAN EXHIBIT (10)(k) Composite Conformed Copy AMENDMENT NO. 3 TO THE FIRST AMERICAN FINANCIAL CORPORATION 1996 STOCK OPTION PLAN This Amendment No. 3 to The First American Financial Corporation 1996 Stock Option Plan (the "Plan") was adopted by the board of directors of The First American Financial Corporation (the "Company") on June 25, 1998, and is effective as of July 7, 1998. Section 5.1 of the Plan is amended to read in full as follows: "Number. Subject to the provisions of Section 5.3, the number of shares of Stock subject to Options under the Plan may not exceed 8,625,000 shares. The shares to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock, not reserved for any other purpose." IN WITNESS WHEREOF, the Company's duly authorized officers have executed this amendment at Santa Ana, California, on July 7, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy ---------------------------------------- Parker S. Kennedy, President By: /s/ Mark R Arnesen ---------------------------------------- Mark R Arnesen, Secretary EX-10.M 8 AMEND. NO. 1 TO 1997 DIRECTORS' STOCK PLAN EXHIBIT (10)(m) Composite Conformed Copy AMENDMENT NO. 1 TO THE FIRST AMERICAN FINANCIAL CORPORATION 1997 DIRECTORS' STOCK PLAN This Amendment No. 1 to The First American Financial Corporation 1997 Directors' Stock Plan (the "Plan") was adopted by the board of directors of The First American Financial Corporation (the "Company") on February 26, 1998, and is effective as of January 1, 1998. Section 5.1 of the Plan is amended to read in full as follows: "Grants of Options. The Committee may, if it so determines, grant Options to Non-Employee Directors, provided that, (a) if any of Options is so made, -------- such Option shall (i) be granted to all individual who are Non-Employee Directors at the time of such grant and (ii) contain identical terms (including, without limitation, the number of shares of Stock that may be purchased pursuant thereto), and (b) the number of shares of Stock that may be purchased pursuant to the Options granted to any Non-Employee Director under this Plan shall not exceed 2,250 shares during any twelve consecutive month period. Notwithstanding any other provision of this Plan, no Option shall be granted hereunder unless sufficient shares of Stock are available under Section 7." Section 7.1 of the Plan is amended to read in full as follows: "Number. Subject to the provisions of Section 7.3, the number of shares of Stock subject to Options under Section 5.1 of the Plan and issued in lieu of cash compensation under Section 6 of the Plan may not exceed 600,000 shares. The shares to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock, not reserved for any other purpose." IN WITNESS WHEREOF, the Company's duly authorized officers have executed this amendment at Santa Ana, California, on February 26, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy ------------------------------------ Parker S. Kennedy, President By: /s/ Mark R Arnesen ------------------------------------ Mark R Arnesen, Secretary EX-10.N 9 AMEND. NO. 2 TO 1997 DIRECTORS' STOCK PLAN EXHIBIT (10)(n) Composite Conformed Copy AMENDMENT NO. 2 TO THE FIRST AMERICAN FINANCIAL CORPORATION 1997 DIRECTORS' STOCK PLAN This Amendment No. 2 to The First American Financial Corporation 1997 Directors' Stock Plan (the "Plan") was adopted by the board of directors of The First American Financial Corporation (the "Company") on June 25, 1998, and is effective as of July 7, 1998. Section 5.1 of the Plan is amended to read in full as follows: "Grants of Options. The Committee may, if it so determines, grant Options to Non-Employee Directors, provided that, (a) if any of Options is so made, -------- such Option shall (i) be granted to all individual who are Non-Employee Directors at the time of such grant and (ii) contain identical terms (including, without limitation, the number of shares of Stock that may be purchased pursuant thereto), and (b) the number of shares of Stock that may be purchased pursuant to the Options granted to any Non-Employee Director under this Plan shall not exceed 6,750 shares during any twelve consecutive month period. Notwithstanding any other provision of this Plan, no Option shall be granted hereunder unless sufficient shares of Stock are available under Section 7." Section 7.1 of the Plan is amended to read in full as follows: "Number. Subject to the provisions of Section 7.3, the number of shares of Stock subject to Options under Section 5.1 of the Plan and issued in lieu of cash compensation under Section 6 of the Plan may not exceed 1,800,000 shares. The shares to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock, not reserved for any other purpose." IN WITNESS WHEREOF, the Company's duly authorized officers have executed this amendment at Santa Ana, California, on July 7, 1998. THE FIRST AMERICAN FINANCIAL CORPORATION By: /s/ Parker S. Kennedy --------------------------------------- Parker S. Kennedy, President By: /s/ Mark R Arnesen --------------------------------------- Mark R Arnesen, Secretary EX-10.P 10 DEFERRED COMPENSATION PLAN EXHIBIT (10)(p) Composite Conformed Copy THE FIRST AMERICAN FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN TABLE OF CONTENTS ----------------- Page ---- ARTICLE I TITLE AND DEFINITIONS............................................ 1 1.1 Title.......................................................... 1 1.2 Definitions.................................................... 1 ARTICLE II PARTICIPATION.................................................... 3 ARTICLE III DEFERRAL ELECTIONS............................................... 4 3.1 Elections to Defer Compensation................................ 4 3.2 Investment Elections........................................... 5 ARTICLE IV DEFERRAL ACCOUNTS AND TRUST FUNDING.............................. 5 4.1 Deferral Accounts.............................................. 5 4.2 Trust Funding.................................................. 6 ARTICLE V VESTING.......................................................... 6 ARTICLE VI DISTRIBUTIONS.................................................... 7 6.1 Distribution of Deferred Compensation and Discretionary Company Contributions.......................................... 7 6.2 Early Distributions............................................ 9 6.3 Inability to Locate Participant................................ 10 6.4 Payment of Policy Premiums..................................... 10 ARTICLE VII ADMINISTRATION................................................... 10 7.1 Committee...................................................... 10 7.2 Committee Action............................................... 10 7.3 Powers and Duties of the Committee............................. 11 7.4 Construction and Interpretation................................ 11 7.5 Information.................................................... 12 7.6 Compensation, Expenses and Indemnity........................... 12 7.7 Quarterly Statements........................................... 12 7.8 Disputes....................................................... 12 ARTICLE VIII MISCELLANEOUS.................................................. 13 8.1 Unsecured General Creditor..................................... 13 8.2 Restriction Against Assignment................................. 13 8.3 Withholding.................................................... 14 8.4 Amendment, Modification, Suspension or Termination............. 14 8.5 Governing Law.................................................. 14 8.6 Receipt or Release............................................. 14 8.7 Payments on Behalf of Persons Under Incapacity................. 14 8.8 Limitation of Rights and Employment Relationship............... 15 8.9 Headings....................................................... 15 -i- THE FIRST AMERICAN FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN WHEREAS, The First American Financial Corporation (the "Company") desires to establish The First American Financial Corporation Deferred Compensation Plan to provide supplemental retirement income benefits for a select group of management and highly compensated employees through deferrals of salary, commissions and bonuses effective as of January 1, 1998; NOW, THEREFORE, effective as of January 1, 1998, the Plan is hereby adopted to read as follows: ARTICLE I TITLE AND DEFINITIONS 1.1 Title. ----- This Plan shall be known as The First American Financial Corporation Deferred Compensation Plan. 1.2 Definitions. ----------- Whenever the following words and phrases are used in this Plan, with the first letter capitalized, they shall have the meanings specified below. (a) "Account" or "Accounts" shall mean a Participant's Deferral Account. (b) "Base Salary" shall mean a Participant's annual base salary, excluding bonus, incentive and all other remuneration for services rendered to Company and prior to reduction for any salary contributions to a plan established pursuant to Section 125 of the Code or qualified pursuant to Section 401(k) of the Code. (c) "Beneficiary" or "Beneficiaries" shall mean the person or persons, including a trustee, personal representative or other fiduciary, last designated in writing by a Participant in accordance with procedures established by the Committee to receive the benefits specified hereunder in the event of the Participant's death (other than the death benefits described in Section 6.1(b)(1) unless such person is designated as a beneficiary under the Policy described therein). No beneficiary designation shall become effective until it is filed with the Committee. Any designation shall be revocable at any time through a written instrument filed by the Participant with the Committee with or without the consent of the previous Beneficiary. If there is no Beneficiary designation in effect, then the person designated to receive the death benefit specified in Section 6.1(c)(1) shall be the Beneficiary. However, no designation of a Beneficiary other than the Participant's spouse shall be valid unless consented to in writing by such spouse. If there is no such designation or if there is no surviving designated Beneficiary, then the Participant's surviving spouse shall be the Beneficiary. If there is no surviving spouse to receive any benefits payable in accordance with the preceding sentence, the duly appointed and currently acting personal representative of the Participant's estate (which shall include either the Participant's probate estate or living trust) shall be the Beneficiary. In any case where there is no such personal representative of the Participant's estate duly appointed and acting in that capacity within 90 days after the Participant's death (or such extended period as the Committee determines is reasonably necessary to allow such personal representative to be appointed, but not to exceed 180 days after the Participant's death), then Beneficiary shall mean the person or persons who can verify by affidavit or court order to the satisfaction of the Committee that they are legally entitled to receive the benefits specified hereunder. In the event any amount is payable under the Plan to a minor, payment shall not be made to the minor, but instead be paid (a) to that person's living parent(s) to act as custodian, (b) if that person's parents are then divorced, and one parent is the sole custodial parent, to such custodial parent, or (c) if no parent of that person is then living, to a custodian selected by the Committee to hold the funds for the minor under the Uniform Transfers or Gifts to Minors Act in effect in the jurisdiction in which the minor resides. If no parent is living and the Committee decides not to select another custodian to hold the funds for the minor, then payment shall be made to the duly appointed and currently acting guardian of the estate for the minor or, if no guardian of the estate for the minor is duly appointed and currently acting within 60 days after the date the amount becomes payable, payment shall be deposited with the court having jurisdiction over the estate of the minor. Payment by Company pursuant to any unrevoked Beneficiary designation, or to the Participant's estate if no such designation exists, of all benefits owed hereunder shall terminate any and all liability of Company. (d) "Board of Directors" or "Board" shall mean the Board of Directors of The First American Financial Corporation. (e) "Bonuses" shall mean such additional amounts of income as Company may determine to pay to an employee, as determined in the sole and absolute discretion of Company. (f) "Code" shall mean the Internal Revenue Code of 1986, as amended. (g) "Committee" shall mean the Committee appointed by the Board to administer the Plan in accordance with Article VII. (h) "Commissions" shall mean a Participant's remuneration earned from Company which is dependent on sales activity and is not related to Base Salary or Bonuses. (i) "Company" shall mean The First American Financial Corporation and any successor corporations. Company shall include each corporation which is a member of a controlled group of corporations (within the meaning of Section 414(b) of the Code) of which The First American Financial Corporation is a component member, if the Board provides that such corporation shall participate in the Plan. (j) "Compensation" shall mean Base Salary, Commissions and Bonuses that the Participant is entitled to receive for services rendered to the Company. (k) "Deferral Account" shall mean the bookkeeping account maintained by the Committee for each Participant that is credited with amounts equal to (1) the portion of the Participant's Compensation that he or she elects to defer, and (2) interest pursuant to Section 4.1. (l) "Distributable Amount" shall mean the balance in the Participant's Deferral Account. -2- (m) "Early Distribution" shall mean an election by a Participant in accordance with Section 6.2 to receive a withdrawal of amounts from his or her Deferral Account prior to the time in which such Participant would otherwise be entitled to such amounts. (n) "Effective Date" shall mean January 1, 1998. (o) "Eligible Employee" shall mean such management and highly compensated employees as are designated by the Company for participation in this Plan. (p) "Fund" or "Funds" shall mean one or more of the investment funds selected by the Committee pursuant to Section 3.2(b). (q) "Initial Election Period" for an Eligible Employee shall mean the 30-day period immediately prior to November 14, 1997 or the 30-day period following the time an employee shall be designated by the Company as an Eligible Employee. (r) "Interest Rate" shall mean, for each Fund, an amount equal to the net rate of gain or loss on the assets of such Fund during each month. (s) "Participant" shall mean any Eligible Employee who becomes a Participant in accordance with Section 2.1. (t) "Payment Date" shall mean the time as soon as practicable after the earlier of (1) the first day of the month following the end of the calendar quarter in which the Participant's employment terminates for any reason, or (2) the Scheduled Withdrawal Date. (u) "Plan" shall mean The First American Financial Corporation Deferred Compensation Plan set forth herein, now in effect, or as amended from time to time. (v) "Plan Year" shall mean the 12 consecutive month period beginning on each January 1 and ending on December 31. (w) "Policy" shall mean an insurance policy purchased in accordance with the terms of this Plan. (x) "Scheduled Withdrawal Date" shall mean the distribution date elected by the Participant for an in-service withdrawal of all amounts of Compensation deferred in a given Plan Year, and earnings and losses attributable thereto, as set forth on the election form for such Plan Year. (y) "Trust" shall mean The First American Financial Corporation Deferred Compensation Plan Trust. ARTICLE II PARTICIPATION ------------- An Eligible Employee shall become a Participant in the Plan by (1) electing to defer a portion of his or her Compensation in accordance with Section 3.1, (2) filing a life insurance application form along with his or her deferral election form, and (3) complying with such medical underwriting -3- requirements as determined by the life insurance carrier selected by the Company. An Eligible Employee who completes the requirements of the preceding sentence shall commence participation in this Plan as of the first day of the month in which Compensation is deferred. In the event it is determined by the Committee, that the proposed life insurance policy cannot be obtained in a cost efficient manner after medical underwriting requirements have been met, the Participant shall not be eligible to receive death benefits in accordance with Section 6.1(c) of the Plan. Notwithstanding any provision to the contrary, if it is determined or reasonably believed, based on a judicial or administrative determination or an opinion of Company's legal counsel that a Plan Participant is not a management or highly compensated employee, such individual shall cease to be a Participant and his Distributable Amount shall be paid to him in a lump sum as soon as practicable after the determination is made that he is not a management or highly compensated employee. ARTICLE III DEFERRAL ELECTIONS ------------------ 3.1 Elections to Defer Compensation. A Participant who has elected to ------------------------------- suspend his deferrals or Base Salary or Commissions may make deferrals in future Plan Years in accordance with this Section 3.1. (a) Initial Election Period. Subject to the provisions of Article II, ----------------------- each Eligible Employee may elect to defer Base Salary, Bonuses and/or Commissions by filing with the Committee an election that conforms to the requirements of this Section 3.1, on a form provided by the Committee, no later than the last day of his or her Initial Election Period. (b) General Rule. The amount of Compensation which an Eligible ------------ Employee may elect to defer is such Compensation earned on or after the time at which the Eligible Employee elects to defer in accordance with Sections 1.2(q) and 3.1(a) and shall be a flat dollar amount or percentage which shall not exceed 100% of the Eligible Employee's Base Salary, Bonuses and Commissions, provided that the total amount deferred by a Participant shall be limited in any calendar year, if necessary, to satisfy Social Security tax (including Medicare), income tax and employee benefit plan withholding requirements as determined in the sole and absolute discretion of the Committee. The minimum contribution which may be made in any Plan Year by an Eligible Employee shall not be less than $5,000, provided such minimum contribution can be satisfied from either Base Salary and/or Bonus and/or Commission deferrals. (c) Duration of Compensation Deferral Election. An Eligible ------------------------------------------ Employee's initial election to defer Base Salary and Commissions must be filed before November 14, 1997 and is to be effective January 1, 1998. A Participant may elect to suspend his election to defer Base Salary or Commissions once during any Plan Year with respect to amounts of Base Salary or Commissions which have not been paid, provided said Participant gives the Company 20 days prior written notice of his election. A Participant may increase, decrease or terminate a deferral election with respect to Base Salary or Commissions for any subsequent Plan Year by filing a new election on or before November 1, which election shall be effective on the first day of the next following Plan Year. An Eligible Employee's Initial Election to defer Bonuses must be filed by November 14, 1997. Any subsequent election with respect to Bonuses must be filed by November 1 of the year prior to the year that the Bonus is earned. Bonuses are deemed earned at such time as Company communicates its determination of Bonuses to the affected Eligible Employee. All elections with respect to Bonuses are for one Plan -4- Year. In the case of an employee who becomes an Eligible Employee after November 1, 1997, such Eligible Employee shall have 30 days from the date he or she has become an Eligible Employee to make an Initial Election with respect to Base Salary, Bonuses and/or Commissions. Such election shall be for the remainder of the Plan Year, in the event the Plan Year has commenced. (d) Elections other than Elections during the Initial Election ---------------------------------------------------------- Period. Subject to the limitations of Section 3.1(b) above, any Eligible - ------ Employee who fails to elect to defer Compensation during his or her Initial Election Period may subsequently become a Participant, and any Eligible Employee who has terminated a prior Compensation deferral election may elect to again defer Compensation, by filing an election, on a form provided by the Committee, to defer Compensation as described in Sections 3.1(b) and 3.1(c) above. An election to defer Compensation must be filed in a timely manner in accordance with Section 3.1(c). 3.2 Investment Elections. -------------------- (a) At the time of making the deferral elections described in Section 3.1, the Participant shall designate, on a form provided by the Committee, the types of investment funds the Participant's Account will be deemed to be invested in for purposes of determining the amount of earnings to be credited to that Account. In making the designation pursuant to this Section 3.2, the Participant may specify that all or any multiple of his Deferral Account (equal to or greater than 10% in whole percentage increments) be deemed to be invested in one or more of the types of investment funds provided under the Plan as communicated from time to time by the Committee. Effective as of the end of any calendar month, a Participant may change the designation made under this Section 3.2 by filing an election, on a form provided by the Committee, at least 30 days prior to the end of such quarter. If a Participant fails to elect a type of fund under this Section 3.2, he or she shall be deemed to have elected the Money Market type of investment fund. (b) Although the Participant may designate the type of investments, , the Committee shall not be bound by such designation. The Committee shall select from time to time, in its sole discretion, commercially available investments of each of the types communicated by the Committee to the Participant pursuant to Section 3.2(a) above to be the Funds. The Interest Rate of each such commercially available investment fund shall be used to determine the amount of earnings or losses to be credited to Participant's Account under Article IV. ARTICLE IV DEFERRAL ACCOUNTS AND TRUST FUNDING ----------------------------------- 4.1 Deferral Accounts. ----------------- The Committee shall establish and maintain a Deferral Account for each Participant under the Plan. Each Participant's Deferral Account shall be further divided into separate subaccounts ("investment fund subaccounts"), each of which corresponds to an investment fund elected by the Participant pursuant to Section 3.2(a). A Participant's Deferral Account shall be credited as follows: (a) As of the last day of each month, the Committee shall credit the investment fund subaccounts of the Participant's Deferral Account with an amount equal to Compensation deferred by the Participant during each pay period ending in that month in accordance with the Participant's election -5- under Section 3.2(a); that is, the portion of the Participant's deferred Compensation that the Participant has elected to be deemed to be invested in a certain type of investment fund shall be credited to the investment fund subaccount corresponding to that investment fund; (b) As of the last day of each month, each investment fund subaccount of a Participant's Deferral Account shall be credited with earnings or losses in an amount equal to that determined by multiplying the balance credited to such investment fund subaccount as of the last day of the preceding month by the Interest Rate for the corresponding fund selected by the Company pursuant to Section 3.2(b). (c) In the event that a Participant elects for a given Plan Year's deferral of Compensation to have a Scheduled Withdrawal Date, all amounts attributed to the deferral of Compensation for such Plan Year shall be accounted for in a manner which allows separate accounting for the deferral of Compensation and investment gains and losses associated with such Plan Year's deferral of Compensation. 4.2 Trust Funding. ------------- The Company has created a Trust with First American Trust Company serving as initial trustee. The Company shall cause the Trust to be funded each year. The Company shall contribute to the Trust an amount equal to the amount deferred by each Participant for the Plan Year. The Company may also contribute such additional amounts as it shall deem necessary or appropriate. Although the principal of the Trust and any earnings thereon shall be held separate and apart from other funds of Company and shall be used exclusively for the uses and purposes of Plan Participants and Beneficiaries as set forth therein, neither the Participants nor their Beneficiaries shall have any preferred claim on, or any beneficial ownership in, any assets of the Trust prior to the time such assets are paid to the Participants or Beneficiaries as benefits and all rights created under this Plan shall be unsecured contractual rights of Plan Participants and Beneficiaries against the Company. Any assets held in the Trust will be subject to the claims of Company's general creditors under federal and state law in the event of insolvency as defined in Section 4.2(a) of the Trust. The assets of the Plan and Trust shall never inure to the benefit of the Company and the same shall be held for the exclusive purpose of providing benefits to Participants and their beneficiaries, deferring reasonable expenses of administering the Plan and Trust. ARTICLE V VESTING ------- A Participant's Deferral Account shall be 100% vested at all times. -6- ARTICLE VI DISTRIBUTIONS ------------- 6.1 Distribution of Deferred Compensation and Discretionary Company --------------------------------------------------------------- Contributions. - ------------- (a) Distribution Without Scheduled Withdrawal Date. In the case of a ---------------------------------------------- Participant who terminates employment with Company and has an Account balance of $25,000 or more, the Distributable Amount shall be paid to the Participant (and after his or her death to his or her Beneficiary) from among the following optional forms of benefit as elected by the Participant on the form provided by Company during his or her Initial Election Period: (1) A lump sum distribution beginning on the Participant's Payment Date. (2) Substantially equal quarterly installments over five (5) years beginning on the Participant's Payment Date. (3) Substantially equal quarterly installments over ten (10) years beginning on the Participant's Payment Date. (4) Substantially equal quarterly installments over fifteen (15) years beginning on the Participant's Payment Date. A Participant may modify the optional form of benefit that he or she has previously elected, provided such modification occurs at least one (1) year before the Participant terminates employment with Company. In the event a Participant fails to elect an optional form of benefit during his or her Initial Election Period, the Participant's Distributable Amount will be distributed in a lump sum beginning on his or her Payment Date. In the case of a Participant who terminates with Company and has an Account balance of less than $25,000, the Distributable Amount shall be paid to the Participant (and after his or her death to his or her Beneficiary) in a lump sum distribution on the Participant's Payment Date. The Participant's Account shall continue to be credited with earnings pursuant to Section 4.1 of the Plan until all amounts credited to his or her Account under the Plan have been distributed. (b) Distribution With Scheduled Withdrawal Date. In the case of a ------------------------------------------- Participant who has elected a Scheduled Withdrawal Date for a distribution while still in the employ of the Company, such Participant shall receive his or her Distributable Amount, but only with respect to those deferrals of Compensation and earnings on such deferrals of Compensation as shall have been elected by the Participant to be subject to the Scheduled Withdrawal Date in accordance with Section 1.2(x) of the Plan. A Participant's Scheduled Withdrawal Date with respect to amounts of Compensation deferred in a given Plan Year can be no earlier than two years from the last day of the Plan Year for which the deferrals of Compensation are made. A Participant may extend the Scheduled Withdrawal Date for the deferral of Compensation for any Plan Year, provided such extension occurs at least one year before the Scheduled Withdrawal Date and is for a period of not less than two years from the Scheduled -7- Withdrawal Date. The Participant shall have the right to twice modify any Scheduled Withdrawal Date, provided the second such modification shall only be effective if consented to by Company. In the event a Participant terminates employment with Company prior to a Scheduled Withdrawal Date, other than by reason of death, the portion of the Participant's Account associated with Scheduled Withdrawal Dates which have not occurred prior to such termination shall be distributed in a lump sum. (c) Death Benefit. In the case of a Participant who dies while ------------- employed by the Company, the following benefits shall be provided: (1) that portion of the death benefit of any life insurance policy purchased by the Company to insure the life of the Participant and which is subject to a "Split-Dollar Life Insurance Agreement" (as described therein) (the "Policy") which is equal to the following amounts: (i) If a Participant elects during his first twelve months of Plan Participation (whether or not such election occurs during more than one Plan Year) to defer Base Salary only, such Participant's death benefit shall equal his Base Salary deferrals annualized over the first twelve months of Plan Participation multiplied by fifteen. This amount shall constitute the Participant's death benefit for the remainder of his participation in the Plan. (ii) If a Participant elects during his first twelve months of Plan Participation (whether or not such election occurs during more than one Plan Year) to defer Bonuses and/or Commissions only, such Participant's death benefit during the first twelve months of Plan Participation shall be $0. At the end of the initial twelve month period (which may or may not span more than one Plan Year) the amount of the Participant's deferral of Bonuses and/or Commissions shall be aggregated and multiplied by fifteen, which amount shall constitute the Participant's death benefit for the remainder of his or her participation in this Plan. (iii) If a Participant elects during his first twelve months of Plan Participation (whether or not such election occurs during more than one Plan Year) to defer Base Salary and Bonuses and/or Commissions, then the Participant's death benefit during his first twelve months of Plan Participation shall equal his Base Salary deferrals annualized over twelve months multiplied by fifteen. At the end of the initial twelve month period (which may or may not span more than one Plan Year) the Participant's death benefit shall equal the amount of Base Salary deferrals annualized during the first twelve months multiplied by fifteen plus the aggregate amount of all deferrals of Bonuses and/or Commissions which occurred during the first twelve months multiplied by fifteen. This amount shall constitute the Participant's death benefit for the remainder of his participation in the Plan. Any such Policy shall be subject to certain conditions set forth in a "split-dollar life insurance agreement" between the Participant, Trustee and the Company, pursuant to which the Participant may designate a beneficiary with respect to the portion of the Policy proceeds described in this Section 6.1(c)(1) in the event the Participant dies prior to terminating employment with the Company. The Participant shall have the right to designate and change such beneficiary (which need not be his or her Beneficiary) at any time on a form provided by and filed with the insurance company. If no such form is on file with the insurance company, the insurance proceeds designated in this paragraph (1) shall be paid to the Beneficiary. The benefit payable pursuant to this paragraph (1) shall only be paid if the insurance company agrees that the Participant is insurable and shall be subject to all conditions and exceptions set forth in the applicable insurance policy. Notwithstanding the provision of this Plan or any other -8- document to the contrary, the Company shall not have any obligation to pay the Participant or his or her beneficiary any amounts described in Section 6.1(c)(1); all such amounts due pursuant to Section 6.1(c)(1) shall be payable solely from the proceeds of the Policy, if any. Furthermore, the Company is not obligated to maintain the Policy; no death benefit shall be payable hereunder if the Company has discontinued the Policy for the Participant. In addition, no Policy shall be allocated to any Account. (2) The Account Balance in a lump sum or installments as previously elected by the Participant. (d) Death After Benefit Commencement. In the event a Participant dies -------------------------------- after he has retired from the employ of the Company and still has a balance in his or her Account, the balance shall continue to be paid in quarterly installments for the remainder of the period as elected by the Participant. (e) Death Benefit Reduction. In the event a Participant elects an ----------------------- Early Distribution from his or her Deferral Account, the Participant's death benefit as computed in accordance with Section 6.1(c)(1) of the Plan shall be reduced by multiplying said death benefit by a fraction the numerator of which shall be the sum of the Participant's Early Distributions and the denominator of which shall be the Participant's Deferral Account plus Early Distributions. For purposes of calculating the denominator of the fraction set forth above, a Participant's Early Distributions shall be credited with earnings in accordance with Section 4.1 of the Plan. In the event a Participant suspends contributions of Base Salary during the first twelve (12) months of Plan participation, then the Participant's death benefit calculated in accordance with Sections 6.1(c)(1)(i) and (iii) shall be determined by multiplying the actual amount of Base Salary deferred during the initial twelve (12) month period multiplied by fifteen (15). 6.2 Early Distributions. ------------------- A Participant shall be permitted to elect an Early Distribution from his or her Deferral Account prior to the Payment Date, subject to the following restrictions: (a) The election to take an Early Distribution shall be made by filing a form provided by and filed with the Committee prior to the end of any calendar month. (b) The amount of the Early Distribution shall in all cases be an amount not less than the greater of 50% of the Deferral Account as of the end of the calendar month as of which the distribution is to be made, or $25,000. (c) The amount described in subsection (b) above shall be paid in a single cash lump sum as soon as practicable after the end of the calendar month in which the Early Distribution election is made. (d) If a Participant receives an Early Distribution of his entire Deferral Account, the remaining balance of his or her Deferral Account (10% of the Deferral Account) shall be permanently forfeited and the Company shall have no obligation to the Participant or his Beneficiary with respect to such forfeited amount. If a Participant receives an Early Distribution of 50% or more of his Deferral -9- Account, such Participant shall forfeit 10% of the gross amount to be distributed from the Participant's Deferral Account. (e) If a Participant receives an Early Distribution of either all or a part of his Deferral Account, the following rules will apply for the balance of the Plan Year and for the following Plan Year: (i) the Participant will be ineligible to participate in the Plan, and (ii) neither the Participant (nor his Beneficiary or beneficiaries) shall be entitled to death benefits under Section 6.1(c)(1) or (2). 6.3 Inability to Locate Participant. ------------------------------- In the event that the Committee is unable to locate a Participant or Beneficiary within two years following the required Payment Date, the amount allocated to the Participant's Deferral Account, shall be forfeited. If, after such forfeiture, the Participant or Beneficiary later claims such benefit, such benefit shall be reinstated without interest or earnings. 6.4 Payment of Policy Premiums. -------------------------- So long as the Company maintains a Policy for a Participant, the Company shall pay to the Trustee amounts necessary to pay premiums on the Policy insuring the Participant's life from as soon as practical after the end of each Plan Year, or such earlier time as the Company shall determine (but no later than the tax return due date for the Company for such year), in amounts equal to the amount deferred by the Participant for the Plan Year. ARTICLE VII ADMINISTRATION -------------- 7.1 Committee. --------- A committee shall be appointed by, and serve at the pleasure of, the Board of Directors. The number of members comprising the Committee shall be determined by the Board which may from time to time vary the number of members. A member of the Committee may resign by delivering a written notice of resignation to the Board. The Board may remove any member by delivering a certified copy of its resolution of removal to such member. Vacancies in the membership of the Committee shall be filled promptly by the Board. 7.2 Committee Action. ---------------- The Committee shall act at meetings by affirmative vote of a majority of the members of the Committee. Any action permitted to be taken at a meeting may be taken without a meeting if, prior to such action, a written consent to the action is signed by all members of the Committee and such written consent is filed with the minutes of the proceedings of the Committee. A member of the Committee shall not vote or act upon any matter which relates solely to himself or herself as a Participant. The Chairman or any other member or members of the Committee designated by the Chairman may execute any certificate or other written direction on behalf of the Committee. -10- 7.3 Powers and Duties of the Committee. ---------------------------------- (a) The Committee, on behalf of the Participants and their Beneficiaries, shall enforce the Plan in accordance with its terms, shall be charged with the general administration of the Plan, and shall have all powers necessary to accomplish its purposes, including, but not by way of limitation, the following: (1) To select the Funds in accordance with Section 3.2(b) hereof; (2) To construe and interpret the terms and provisions of this Plan; (3) To compute and certify to the amount and kind of benefits payable to Participants and their Beneficiaries; (4) To maintain all records that may be necessary for the administration of the Plan; (5) To provide for the disclosure of all information and the filing or provision of all reports and statements to Participants, Beneficiaries or governmental agencies as shall be required by law; (6) To make and publish such rules for the regulation of the Plan and procedures for the administration of the Plan as are not inconsistent with the terms hereof; (7) To appoint a plan administrator or any other agent, and to delegate to them such powers and duties in connection with the administration of the Plan as the Committee may from time to time prescribe; (8) To take all actions necessary for the administration of the Plan, including determining whether to hold or discontinue the Policies; and (9) If a Policy is discontinued or a Participant has terminated employment with the Company for a reason other than death, (A) to notify the insurance company that no death benefits are payable to the beneficiaries of the applicable Participant under the Policy (and that neither the Participant nor his or her beneficiary has any rights under the Policy or to any benefits under the Policy) and (B) to file a new beneficiary designation with the insurance company naming the Company as beneficiary or to cash in the Policy. 7.4 Construction and Interpretation. ------------------------------- The Committee shall have full discretion to construe and interpret the terms and provisions of this Plan, which interpretations or construction shall be final and binding on all parties, including but not limited to the Company and any Participant or Beneficiary. The Committee shall administer such terms and provisions in a uniform and nondiscriminatory manner and in full accordance with any and all laws applicable to the Plan. -11- 7.5 Information. ----------- To enable the Committee to perform its functions, the Company shall supply full and timely information to the Committee on all matters relating to the Compensation of all Participants, their death or other events which cause termination of their participation in this Plan, and such other pertinent facts as the Committee may require. 7.6 Compensation, Expenses and Indemnity. ------------------------------------ (a) The members of the Committee shall serve without compensation for their services hereunder. (b) The Committee is authorized at the expense of the Company to employ such legal counsel as it may deem advisable to assist in the performance of its duties hereunder. Expenses and fees in connection with the administration of the Plan shall be paid by the Company. (c) To the extent permitted by applicable state law, the Company shall indemnify and save harmless the Committee and each member thereof, the Board of Directors and any delegate of the Committee who is an employee of the Company against any and all expenses, liabilities and claims, including legal fees to defend against such liabilities and claims arising out of their discharge in good faith of responsibilities under or incident to the Plan, other than expenses and liabilities arising out of willful misconduct. This indemnity shall not preclude such further indemnities as may be available under insurance purchased by the Company or provided by the Company under any bylaw, agreement or otherwise, as such indemnities are permitted under state law. 7.7 Quarterly Statements. -------------------- Under procedures established by the Committee, a Participant shall receive a statement with respect to such Participant's Accounts on a quarterly basis as of each March 31, June 30, September 30 and December 31. 7.8 Disputes. -------- (a) Claim. ----- A person who believes that he or she is being denied a benefit to which he or she is entitled under this Agreement (hereinafter referred to as "Claimant") must file a written request for such benefit with the Company, setting forth his or her claim. The request must be addressed to the President of the Company at its then principal place of business. (b) Claim Decision. -------------- Upon receipt of a claim, the Company shall advise the Claimant that a reply will be forthcoming within ninety (90) days and shall, in fact, deliver such reply within such period. The Company may, however, extend the reply period for an additional ninety (90) days for special circumstances. If the claim is denied in whole or in part, the Company shall inform the Claimant in writing, using language calculated to be understood by the Claimant, setting forth: (A) the specified -12- reason or reasons for such denial; (B) the specific reference to pertinent provisions of this Agreement on which such denial is based; (C) a description of any additional material or information necessary for the Claimant to perfect his or her claim and an explanation of why such material or such information is necessary; (D) appropriate information as to the steps to be taken if the Claimant wishes to submit the claim for review; and (E) the time limits for requesting a review under subsection (c). (c) Request For Review. ------------------ Within sixty (60) days after the receipt by the Claimant of the written opinion described above, the Claimant may request in writing that the Committee review the determination of the Company. Such request must be addressed to the Secretary of the Company, at its then principal place of business. The Claimant or his or her duly authorized representative may, but need not, review the pertinent documents and submit issues and comments in writing for consideration by the Committee. If the Claimant does not request a review within such sixty (60) day period, he or she shall be barred and estopped from challenging the Company's determination. (d) Review of Decision. ------------------ Within sixty (60) days after the Committee's receipt of a request for review, after considering all materials presented by the Claimant, the Committee will inform the Participant in writing, in a manner calculated to be understood by the Claimant, the decision setting forth the specific reasons for the decision containing specific references to the pertinent provisions of this Agreement on which the decision is based. If special circumstances require that the sixty (60) day time period be extended, the Committee will so notify the Claimant and will render the decision as soon as possible, but no later than one hundred twenty (120) days after receipt of the request for review. ARTICLE VIII MISCELLANEOUS 8.1 Unsecured General Creditor. -------------------------- Participants and their Beneficiaries, heirs, successors, and assigns shall have no legal or equitable rights, claims, or interest in any specific property or assets of the Company. No assets of the Company shall be held in any way as collateral security for the fulfilling of the obligations of the Company under this Plan. Any and all of the Company's assets shall be, and remain, the general unpledged, unrestricted assets of the Company. The Company's obligation under the Plan shall be merely that of an unfunded and unsecured promise of the Company to pay money in the future, and the rights of the Participants and Beneficiaries shall be no greater than those of unsecured general creditors. It is the intention of the Company that this Plan be unfunded for purposes of the Code and for purposes of Title 1 of ERISA. 8.2 Restriction Against Assignment. ------------------------------ The Company shall pay all amounts payable hereunder only to the person or persons designated by the Plan and not to any other person or corporation. No part of a Participant's Accounts shall be liable for the debts, contracts, or engagements of any Participant, his or her Beneficiary, or successors in interest, nor shall a Participant's Accounts be subject to execution by levy, attachment, or -13- garnishment or by any other legal or equitable proceeding, nor shall any such person have any right to alienate, anticipate, sell, transfer, commute, pledge, encumber, or assign any benefits or payments hereunder in any manner whatsoever. If any Participant, Beneficiary or successor in interest is adjudicated bankrupt or purports to anticipate, alienate, sell, transfer, commute, assign, pledge, encumber or charge any distribution or payment from the Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel such distribution or payment (or any part thereof) to or for the benefit of such Participant, Beneficiary or successor in interest in such manner as the Committee shall direct. 8.3 Withholding. ----------- There shall be deducted from each payment made under the Plan or any other Compensation payable to the Participant (or Beneficiary) all taxes which are required to be withheld by the Company in respect to such payment or this Plan. The Company shall have the right to reduce any payment (or compensation) by the amount of cash sufficient to provide the amount of said taxes. 8.4 Amendment, Modification, Suspension or Termination. -------------------------------------------------- The Committee may amend, modify, suspend or terminate the Plan in whole or in part, except that no amendment, modification, suspension or termination shall have any retroactive effect to reduce any amounts allocated to a Participant's Accounts (neither the Policies themselves, nor the death benefit described in Section 6.1(c)(1) shall be treated as allocated to Accounts). In addition, the Committee has the right to amend or terminate Section 6.1(c)(1). In the event that this Plan is terminated, the amounts allocated to a Participant's Accounts shall be distributed to the Participant or, in the event of his or her death, his or her Beneficiary in a lump sum within thirty (30) days following the date of termination. 8.5 Governing Law. ------------- This Plan shall be construed, governed and administered in accordance with the laws of the State of California. 8.6 Receipt or Release. ------------------ Any payment to a Participant or the Participant's Beneficiary in accordance with the provisions of the Plan shall, to the extent thereof, be in full satisfaction of all claims against the Committee and the Company. The Committee may require such Participant or Beneficiary, as a condition precedent to such payment, to execute a receipt and release to such effect. 8.7 Payments on Behalf of Persons Under Incapacity. ---------------------------------------------- In the event that any amount becomes payable under the Plan to a person who, in the sole judgment of the Committee, is considered by reason of physical or mental condition to be unable to give a valid receipt therefore, the Committee may direct that such payment be made to any person found by the Committee, in its sole judgment, to have assumed the care of such person. Any payment made pursuant to such determination shall constitute a full release and discharge of the Committee and the Company. -14- 8.8 Limitation of Rights and Employment Relationship ------------------------------------------------ Neither the establishment of the Plan and Trust nor any modification thereof, nor the creating of any fund or account, nor the payment of any benefits shall be construed as giving to any Participant or other person any legal or equitable right against the Company or the trustee of the Trust except as provided in the Plan and Trust; and in no event shall the terms of employment of any Employee or Participant be modified or in any way be affected by the provisions of the Plan and Trust. 8.9 Headings. -------- Headings and subheadings in this Plan are inserted for convenience of reference only and are not to be considered in the construction of the provisions hereof. IN WITNESS WHEREOF, the Company has caused this document to be executed by its duly authorized officer on this 1st day of October, 1997. THE FIRST AMERICAN FINANCIAL CORPORATION By /s/ Parker S. Kennedy -------------------------------- Its: President --------------------------- -15- EX-10.Q 11 DEFERRED COMPENSATION PLAN TRUST EXHIBIT (10)(q) Composite Conformed Copy THE FIRST AMERICAN FINANCIAL CORPORATION DEFERRED COMPENSATION PLAN TRUST AGREEMENT TABLE OF CONTENTS ----------------- Page ---- ARTICLE I. TITLE AND DEFINITIONS............................................ 1 Section 1.1 Title.................................................... 1 Section 1.2 Definitions.............................................. 1 ARTICLE II. ADMINISTRATION.................................................. 2 Section 2.1 Trustee Responsibility................................... 2 Section 2.2 Maintenance of Records................................... 2 ARTICLE III. FUNDING........................................................ 2 Section 3.1 Contributions............................................ 2 Section 3.2 Subtrusts................................................ 3 ARTICLE IV. PAYMENTS FROM TRUST FUND........................................ 4 Section 4.1 Payments to Trust Beneficiaries.......................... 4 Section 4.2 Trustee Responsibility Regarding Payments to Trust Beneficiaries When the Company Is Insolvent.............. 5 Section 4.3 Payments to the Company.................................. 5 Section 4.4 Trustee Compensation and Expenses; Other Fees and Expenses........................................ 6 Section 4.5 Taxes.................................................... 6 Section 4.6 Alienation............................................... 6 Section 4.7 Disputes................................................. 6 ARTICLE V. INVESTMENT OF TRUST ASSETS....................................... 6 Section 5.1 Investment of Subtrust Assets............................ 6 Section 5.2 Disposition of Income.................................... 7 ARTICLE VI. TRUSTEE......................................................... 7 Section 6.1 General Powers and Duties................................ 7 Section 6.2 Records.................................................. 8 Section 6.3 Third Persons............................................ 8 Section 6.4 Limitation on Obligation of Trustee...................... 8 ARTICLE VII. RESIGNATION AND REMOVAL OF TRUSTEE............................. 9 Section 7.1 Method and Procedure..................................... 9 ARTICLE VIII. AMENDMENT AND TERMINATION..................................... 9 Section 8.1 Amendments............................................... 9 Section 8.2 Duration and Termination................................. 10 Section 8.3 Distribution upon Termination............................ 10 ARTICLE IX. MISCELLANEOUS................................................... 11 -i- TABLE OF CONTENTS (CONT'D) ----------------- Page ---- Section 9.1 Limitation on Participants' Rights....................... 11 Section 9.2 Receipt or Release....................................... 11 Section 9.3 Governing Law............................................ 11 Section 9.4 Headings, etc., No Part of Agreement..................... 11 Section 9.5 Instrument in Counterparts............................... 11 Section 9.6 Successors and Assigns................................... 12 Section 9.7 Indemnity................................................ 12 -ii- DEFERRED COMPENSATION PLAN TRUST AGREEMENT This Trust Agreement made and entered into this 1st day of October, --- ------- 1997, by and between The First American Financial Corporation (hereinafter called the "Company") and FIRST AMERICAN TRUST COMPANY (hereinafter called "Trustee"), evidences the terms of a trust for the benefit of certain employees, former employees and their designated beneficiaries (hereinafter collectively called "Trust Beneficiaries") who will be entitled to receive benefits under The First American Financial Corporation Deferred Compensation Plan ("Plan"). This Trust is intended to be a grantor trust, of which the Company is the grantor, within the meaning of subpart E, part I, subchapter J, Chapter 1, subtitle A of the Internal Revenue Code of 1986, as amended, and shall be construed accordingly. W I T N E S S E T H: WHEREAS, the Company wishes to establish an irrevocable trust (hereinafter called the "Trust") and to transfer to the Trust assets which shall be held therein, subject to the claims of the Company's creditors in the event of the Company's insolvency, until paid to the Trust Beneficiaries as benefits in such manner and at such times as required hereunder; and WHEREAS, it is the intention of the parties that this Trust shall constitute an unfunded arrangement and shall not affect the status of the Plan as an unfunded plan maintained for the purpose of providing deferred compensation for a select group of management or highly compensated employees for purposes of Title I of the Employee Retirement Income Security Act of 1994, as amended ("ERISA"); NOW, THEREFORE, it is mutually understood and agreed as follows: ARTICLE I. TITLE AND DEFINITIONS Section 1.1 Title. ----- This Trust Agreement shall be known as The First American Financial Corporation Deferred Compensation Plan Trust Agreement. Section 1.2 Definitions. ----------- The following words, when used in this Trust Agreement with initial letter capitalized, shall have the meanings set forth below: "Company" shall mean The First American Financial Corporation, and any successor corporations. It shall also include each corporation which is a member of a controlled group of corporations (within the meaning of Section 414(b) of the Code) of which Company is a component member if the Board of Directors designates that such corporation shall participate in the Plan. "General Fund" shall mean that portion of the Trust fund which is not allocated to a Subtrust. "Plan" shall mean The First American Financial Corporation Deferred Compensation Plan. "Policy" shall mean an insurance policy purchased in accordance with the terms of the Plan. "Subtrust" shall mean a separate subtrust established for a Participant pursuant to Section 3.2. Capitalized terms not defined above shall be defined in accordance with the Plan. ARTICLE II. ADMINISTRATION Section 2.1 Trustee Responsibility. ---------------------- By its acceptance of this Trust, Trustee agrees to make payments under this Trust to Trust Beneficiaries in accordance with the provisions of this Trust Agreement. Section 2.2 Maintenance of Records. ---------------------- The Committee shall have the duty and responsibility to maintain all individual Trust Beneficiary records and to prepare and file all reports and other information required by any federal or state law or regulation relating to the Trust and the Trust assets. ARTICLE III. FUNDING Section 3.1 Contributions. ------------- (a) The Company hereby deposits with the Trustee in trust the sum of $100.00 to be held in the General Fund of the Trust. (b) The Company shall contribute to the Trust an amount equal to the amount deferred by each Participant for the Plan Year; in no event shall these contributions be made after the Company's tax return due date for that Plan Year. The Company may also contribute cash to the Trust in an amount approximately equal to the "cost of insurance" (as defined in the Policies) needed to fund the death benefits described in Section 6.1(c) (l) of the Plan; provided that such obligation shall not apply with respect to a Policy if (l) the Committee has directed the Trustee to -2- discontinue the Policy, (2) the applicable Participant is no longer employed by the Company, or (3) the applicable Participant is not entitled to a death benefit under the Policy because he has taken an early distribution (as described in Section 6.2 of the Plan). The Committee may direct the Trustee to discontinue the Policy for any reason, without regard to whether Section 6.l(c)(l) of the Plan is in effect, whether the Participant is employed or otherwise. (c) Except as provided otherwise herein, all contributions received pursuant to (a) and (b) above, together with the income therefrom and any increment thereon, shall be held, managed and administered by Trustee as a single Trust pursuant to the terms of this Trust Agreement without distinction between principal and income. (d) The principal of the Trust, and any earnings thereon shall be held separate and apart from other funds of Company and shall be used exclusively for the uses and purposes of Plan Participants and general creditors as herein set forth. Trust Beneficiaries shall not have any preferred claim on, or any beneficial ownership interest in, any assets of the Trust prior to the time such assets are paid to Trust Beneficiaries as benefits as provided in Section 4.1, and all rights created under this Trust Agreement shall be mere unsecured contractual rights of Trust Beneficiaries against the Company or Trust. Any assets held by the Trust will be subject to the claims of Company's general creditors under federal and state law in the event of Insolvency, as defined in Section 4:2(a) herein. Section 3.2 Subtrusts. --------- (a) If directed by the Committee, the Trustee shall establish a separate Subtrust for that Participant and credit the amount of such contribution to that Participant's Subtrust. Each Subtrust shall reflect an individual interest in the assets of the Trust fund and shall not require any segregation of particular assets. (b) Following the allocation of assets to Subtrusts pursuant to Section 3.2(a), the Trustee shall allocate investment earnings and losses of the Trust fund among the Subtrusts in accordance with Section 5.2. Payments to general creditors pursuant to Section 4.2 hereof shall be charged against the Subtrusts in proportion to their account balances, except that the payment of benefits to a Trust Beneficiary shall be charged against the Subtrust established or maintained for such Trust Beneficiary. (c) Amounts allocated to a Participant's Subtrust may not be utilized to pay benefits to another Participant or Beneficiary of another Participant. Following payment of a Participant's entire benefit under the Plan, including payment of an early distribution under Section 6.2 of the Plan (whether by the Trustee pursuant to the terms of this Trust Agreement or by the Company or by a combination thereof), any amounts remaining allocated to that Participant's Subtrust (and any Policy held with respect to such Participant) shall be transferred by the Trustee to the Company. In lieu of transferring the Policy, the Committee may direct the Trustee to designate a new beneficiary (which may be the Company) under the Policy or cash in the applicable Policy and transfer the proceeds to the Company. -3- ARTICLE IV. PAYMENTS FROM TRUST FUND Section 4.1 Payments to Trust Beneficiaries. ------------------------------- (a) The Committee shall direct the Trustee to pay (or to commence to pay) to a Participant (or, in the case of the Participant's death, to the Participant's Beneficiary) the benefit, excluding amounts described in Section 6.1(c)(l) of the Plan, payable to such Participant under the Plan (the "Benefit Amount") as soon as practicable following the Participant's Payment Eligibility Date (as defined in the Plan). If Subtrusts are established, the Trustee shall make such payment only from funds allocated to the Participant's Subtrust plus the General Fund, if any. (b) The Committee shall have full authority and responsibility to determine the correct time and amount of payment of the Benefit Amount. In making such determination, the Committee shall be governed by the terms of the Plan and this Trust Agreement. (c) Any obligation to a Trust Beneficiary under this Trust Agreement is also an obligation of the Company to the extent not paid from the Trust. Accordingly, to the extent payments to a Trust Beneficiary are discontinued pursuant to Section 4.2, the Company shall be obligated to pay the Trust Beneficiary the same amount (plus applicable interest from its general fund). If the amount credited to the Trust (or a Subtrust if applicable) is not sufficient to make the payment of the Benefit Amount to a Trust Beneficiary in accordance with the determination by the Committee, the Company agrees that it shall make the balance of such payment. Notwithstanding the foregoing, neither the Trustee nor the Company shall have any obligation to pay any amounts described in Section 6.l(c)(l) of the Plan; all such amounts shall be payable solely from the proceeds of the Policy, if any. (d) Unless a Trust Beneficiary furnishes documentation in form and substance satisfactory to Trustee that no withholding is required with respect to a payment of benefits from the Trust, Trustee shall deduct from any such Benefit Payment any federal, state or local taxes required by law to be withheld by Trustee and shall be responsible for payment and reporting of such withheld taxes to the appropriate taxing authorities. The Trustee shall inform the Company of the amounts so remitted. (e) Trustee shall provide the Company and the Committee with written confirmation of the fact and time of any payment hereunder within ten business days after making any payment to a Trust Beneficiary. (f) Following payment of a Participant's entire benefit under the Plan, including payment of an early distribution under Section 6.2 (whether by the Trustee pursuant to the terms of this Trust Agreement or by the Company or by a combination thereof), the Trustee shall, at the direction of the Committee, either (l) transfer ownership of the applicable Policy to the Company, (2) designate a new beneficiary named by the Committee (which may include the Company), or (3) cash in the applicable Policy and transfer the proceeds to the Company. In -4- addition, any cash previously received with respect to such Policy not used to pay benefits to the Participant shall be transferred to the Company. Section 4.2 Trustee Responsibility Regarding Payments to Trust Beneficiaries ---------------------------------------------------------------- When the Company Is Insolvent. ----------------------------- (a) The Company shall be considered "Insolvent" for purposes of this Trust Agreement if (i) the Company is unable to pay its debts as they become due, or (ii) is subject to a pending proceeding as a debtor under the United States Bankruptcy Code. (b) At all times during the continuance of the Trust, the principal and income of the Trust shall be subject to claims of general creditors of the Company as hereinafter set forth, and at any time Trustee has actual knowledge, or has determined, that the Company is Insolvent, Trustee shall deliver any undistributed principal and income in the Trust to satisfy such claims as a court of competent jurisdiction may direct. The Company, through its Board of Directors or any of its executive officers, shall advise Trustee promptly in writing of the Company's Insolvency. If Trustee receives such notice, or otherwise receives written notice from a third party which Trustee, in its sole discretion, deems reliable and responsible, Trustee shall discontinue payments to Trust Beneficiaries, shall hold the Trust assets for the benefit of the Company's general creditors, and shall resume payments to Trust Beneficiaries in accordance with Section 4.1 of this Trust Agreement only after Trustee has determined that the Company is not Insolvent or is no longer Insolvent. Unless Trustee has actual knowledge of the Company's Insolvency or has received notice from the Company or a third party alleging the Company is Insolvent, Trustee shall have no duty to inquire whether the Company is Insolvent. Trustee may in all events rely on such evidence concerning the solvency of the Company as may be furnished to Trustee which will give Trustee a reasonable basis for making a determination concerning its solvency. Nothing in this Trust Agreement shall in any way diminish any rights of Trust Beneficiaries to pursue their rights as general creditors of the Company with respect to benefits payable hereunder or otherwise. (c) If Trustee discontinues payments of benefits from the Trust pursuant to Section 4.2(b) and subsequently resumes such payments, the first payment following such discontinuance shall include the aggregate amount of all payments which would have been made to Trust Beneficiaries together with interest at the Pension Benefit Guaranty Corporation rate applicable to immediate annuities on the amount delayed during the period of such discontinuance, less the aggregate amount of payments made to Trust Beneficiaries by the Company in lieu of the payments provided for hereunder during any such period of discontinuance. Section 4.3 Payments to the Company. ----------------------- Except as provided in Sections 3.2(c), 4.1(f) or 4.2, the Company shall have no right or power to direct Trustee to return to the Company or to divert to others any of the Trust assets before the Trust is terminated pursuant to Section 8.2. -5- Section 4.4 Trustee Compensation and Expenses; Other Fees and Expenses. ---------------------------------------------------------- The Company shall pay the Trustee such reasonable compensation for its services as shall be agreed upon from time to time by the Company and Trustee, and Trustee shall be reimbursed by the Company for its expenses that are reasonably necessary and incident to its administration of the Trust. Following reasonable consultation with the Company such expenses shall include fees of counsel and other advisors, if any, incurred by Trustee for the purpose of determining its responsibilities under the Trust. Such compensation, expenses or fees, as well as all other administrative fees and expenses, shall be paid from Trust assets unless paid directly by the Company. Section 4.5 Taxes. ----- Trustee shall not be personally liable for any real and personal property taxes, income taxes and other taxes of any kind levied or assessed under the existing or future laws against the Trust assets. Such taxes shall be paid directly from the Trust assets unless paid by the Company, in the discretion of the Company. Section 4.6 Alienation. ---------- The benefits, proceeds, payments or claims of Trust Beneficiaries payable from the Trust assets shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution or levy of any kind, either voluntary or involuntary. Any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, garnish, levy or otherwise dispose of or execute upon any right or benefits payable hereunder shall be void. The Trust assets shall not in any manner be liable for or subject to the debts, contracts, liabilities, engagements or torts of any Trust Beneficiary entitled to benefits hereunder and such benefits shall not be considered an asset of Trust Beneficiary in the event of his insolvency or bankruptcy. Section 4.7 Disputes. -------- All disputes, other than disputes between the Trustee and the Committee or Company, shall be resolved in accordance with Section 7.8 of the Plan. ARTICLE V. INVESTMENT OF TRUST ASSETS Section 5.1 Investment of Subtrust Assets. ----------------------------- The Trustee shall invest and manage the assets of the Trust (and each Subtrust, if any) in accordance with written directions from the Committee. -6- Section 5.2 Disposition of Income. --------------------- All income received by the Trust shall be reinvested. Any income that is attributable to the amount credited to a Subtrust in accordance with Section 3.2, and income thereon, shall be credited to such Subtrust and reinvested. ARTICLE VI. TRUSTEE Section 6.1 General Powers and Duties. ------------------------- Subject to written directions from the Committee regarding the investment of Trust assets, Trustee, on behalf of Trust Beneficiaries, shall have all powers necessary to administer the Trust, including, but not by way of limitation, the following powers in addition to other powers as are set forth herein or conferred by law: (a) To hold, invest and reinvest the principal or income of the Trust in bonds, common or preferred stock, other securities, or other personal, real or mixed tangible or intangible property (including investment in deposits with Trustee which bear a reasonable interest rate, including without limitation investments in trust savings accounts, certificates of deposit, time certificates or similar investments or deposits maintained by the Trustee); (b) To hold, invest and reinvest the principal or income of the Trust in the Policies, direct investments under the Policies and take any other action regarding the Policies, as specifically directed by the Committee (including those specified by Sections 3.1(b), 3.2(c) or 4.1(f)) and to enter into split dollar life insurance agreements with Participants pursuant to which each Participant designates the beneficiary to receive the portion of the death benefits described in Section 6.1(c)(1) of the Plan; (c) If (i) directed by the Company or Committee to discontinue a Policy or (ii) notified by the Committee or Company that a Participant has terminated employment for a reason other than death, to immediately notify the insurance company that no death benefits are payable to the beneficiaries of the applicable Participant under the Policy (and that neither the Participant nor his beneficiary has any rights under the Policy or the benefits under the Policy) and to file a new beneficiary designation with the Insurance Company naming the Trust as beneficiary, unless directed by the Committee to cash in the Policy; (d) To pay and provide for the payment of all reasonable and necessary expenses of administering the affairs of the Trust, subject to reimbursement of such expenses within 30 days by the Company in accordance with Section 4.4; (e) To pay and provide for the payment of all benefits to Trust Beneficiaries in accordance with the provisions of this Trust Agreement; -7- (f) To retain noninterest bearing deposits or a cash balance with Trustee of so much of the funds as may be determined to be temporarily held awaiting investment or payment of benefits or expenses; (g) To compromise, arbitrate or otherwise adjust claims in favor of or against the Trust and to institute, compromise and defend actions and proceedings; (h) To vote any stock, bonds or other securities of any corporation or other issuer at any time held in the Trust; to otherwise consent to or request any action on the part of any such corporation or other issuer; to give general or special proxies or powers of attorney, with or without power of substitution; to participate in any reorganization, recapitalization, consolidation, merger or similar transaction with respect to such stocks, bonds or other securities and to deposit such stocks, bonds or other securities in any voting trust, or with any protective or like committee, or with a trustee, or with the depositories designated thereby; to exercise any subscription rights and conversion privileges; and to generally exercise any of the powers of an owner with respect to the stocks, bonds or other securities or properties in the Trust; and (i) Generally, to do all such acts, execute all such instruments, take all such proceedings, and exercise all such rights and privileges with relation to the property constituting the Trust as if Trustee were the absolute owner thereof. Section 6.2 Records. ------- Trustee shall keep a full, accurate and detailed record of all transactions of the Trust which the Company shall have the right to examine at any time during Trustee's regular business hours. Within 90 days after the close of each calendar year and within 15 days after the removal or resignation of Trustee, Trustee shall furnish the Company with a statement of account with respect to the Trust. This account shall set forth all receipts, disbursements and other transactions (including sales and purchases) effected by Trustee during said year (or until its removal or resignation), shall show the investments at the end of the year (or date of removal or resignation), including the cost and fair market value of each item, and the amounts allocated to each Subtrust. Section 6.3 Third Persons. ------------- A third person dealing with Trustee shall not be required to make any inquiry as to whether the Company or the Committee has instructed Trustee, or Trustee is otherwise authorized, to take or omit any action, and shall not be required to follow the application by Trustee of any money or property which may be paid or delivered to Trustee. Section 6.4 Limitation on Obligation of Trustee. ----------------------------------- Trustee shall have no responsibility for the validity of the Plan or of the Trust and does not guarantee the payment of any amount which may become payable to any Trust Beneficiary under the terms hereof. -8- ARTICLE VII. RESIGNATION AND REMOVAL OF TRUSTEE Section 7.1 Method and Procedure. -------------------- (a) Trustee may resign at any time by delivering to the Company a written notice of resignation, to take effect on a date specified therein, which shall be not less than 30 days after the delivery thereof, unless such notice shall be waived. (b) The Company may remove Trustee at any time by delivering to Trustee a written notice of removal, to take effect on a date specified therein, which shall be not less than 30 days after the delivery thereof, unless such notice shall be waived. (c) In case of the resignation or removal of Trustee, Trustee shall have a right to a settlement of its accounts, which may be made, at the option of Trustee, either (1) by a judicial settlement in an action instituted by Trustee in a court of competent jurisdiction, or (2) by an agreement of settlement between Trustee and the Company. (d) Upon such settlement, all right, title and interest of such Trustee in the assets of the Trust, and all rights and privileges under the Trust theretofore vested in such Trustee shall vest in the successor Trustee, and thereupon all liabilities of such Trustee shall terminate; provided, however, that Trustee shall execute, acknowledge and deliver all documents and written instruments which are necessary to transfer and convey all the right, title and interest in the assets of the Trust, and all rights and privileges in the Trust to the successor Trustee. (e) The Company, upon receipt of or giving notice of the resignation or removal of Trustee, shall promptly appoint a successor Trustee. The successor Trustee shall be a bank or trust company qualified and authorized to do trust business in the State of California and having on the date of appointment total assets of at least $10,000,000 and a credit rating from Moody's of A or better. In the event of the failure or refusal of the Company to appoint such a successor Trustee within 30 days after the notice of resignation or removal, Trustee may secure, at the expense of the Company, the appointment of such successor Trustee by an appropriate action in a court of competent jurisdiction. Any successor Trustee so appointed may qualify by executing and delivering to the Company an instrument accepting such appointment and, upon delivery, such successor, without further act, shall become vested with all the right, title and interest, and all rights and privileges of the predecessor Trustee with like effect as if originally named as Trustee herein. ARTICLE VIII. AMENDMENT AND TERMINATION Section 8.1 Amendments. ---------- The Company shall have the right to amend (but not terminate) the Trust from time to time and to amend further or cancel any such amendment. Any amendment shall be stated -9- in an instrument in writing executed by the Company and Trustee, and this Trust Agreement shall be amended in the manner and at the time therein set forth, and the Company and Trustee shall be bound thereby; provided, however: (a) No amendment shall have any retroactive effect so as to deprive any Trust Beneficiary of any benefits already vested under the Plan, or create a reversion of Trust assets to the Company except as already provided in this Trust Agreement, other than such changes, if any, as may be required in order for the Trust to be considered a component of a plan described in Section 9.3; (b) No amendment shall make the Trust revocable; and (c) No amendment shall increase the duties or liabilities of Trustee without its written consent. Section 8.2 Duration and Termination. ------------------------ This Trust shall not be revocable and shall continue until the earliest of (a) the accomplishment of the purpose for which it was created, (b) the exhaustion of all appeals of a final determination of a court of competent jurisdiction that the interest in the Trust of Trust Beneficiaries is includable for federal income tax purposes in the gross income of such Trust Beneficiaries, without such determination having been reversed (or the earlier expiration of the time to appeal), (c) if required to comply with California rules regulating the maximum length for which trusts may be established, the expiration of twenty years and six months after the death of the last surviving Trust Beneficiary who is living and is a Trust Beneficiary on the date this Trust is established, (d) a determination of the Company to terminate the Trust because applicable law requires it to be amended in a way that could make it taxable and failure to so amend the Trust would subject the Company to material penalties, or (e) the dissolution or liquidation of the Company. Section 8.3 Distribution upon Termination. ----------------------------- Upon termination of this Trust, Trustee shall liquidate the Trust fund and provide a final account to the Company and the Committee. To the extent Trust assets are sufficient, the Trustee shall pay to each Participant the appropriate Benefit Amount. After its final account has been settled as provided in Section 7.1(c), Trustee shall return to the Company any assets remaining after the distributions described in this Section 8.3. Upon making such distributions, Trustee shall be relieved from all further liability. The powers of Trustee hereunder shall continue so long as any assets of the Trust fund remain in its hands. -10- ARTICLE IX. MISCELLANEOUS Section 9.1 Limitation on Participants' Rights. ---------------------------------- Participation in the Trust shall not give Participants the right to be retained in the Company's employ or any right or interest in the Trust other than as herein provided. The Company reserves the right to dismiss Participants without any liability for any claim either against the Trust, except to the extent provided herein, or against the Company. All benefits payable hereunder shall be provided solely from the assets of the Trust, except as otherwise provided in the Plan. Section 9.2 Receipt or Release. ------------------ Any payment to a Trust Beneficiary in accordance with the provisions of the Trust shall, to the extent thereof, be in full satisfaction of all claims against Trustee and the Company, and Trustee may require such Trust Beneficiary, as a condition precedent to such payment, to execute a receipt and release to such effect. Section 9.3 Governing Law. ------------- This Trust Agreement and the Trust hereby created shall be construed, administered and governed in all respects under applicable federal law, and to the extent that federal law is inapplicable, under the laws of the State of California; provided, however, that if any provision is susceptible to more than one interpretation, such interpretation shall be given thereto as is consistent with the Trust being (a) classified as a grantor trust as defined in Sections 671 et seq. of the Code, and (b) classified as a component of an unfunded plan -- --- maintained primarily to provide deferred compensation for a select group of management or highly compensated employees, as described in Section 201(2) of the Employee Retirement Income Security Act of 1974, as amended. If any provision of this instrument shall be held by a court of competent jurisdiction to be invalid or unenforceable, the remaining provisions hereof shall continue to be fully effective. Section 9.4 Headings, etc., No Part of Agreement. ------------------------------------ Headings and subheadings in this Trust Agreement are inserted for convenience of reference only and are not to be considered in the construction of the provisions hereof. Section 9.5 Instrument in Counterparts. -------------------------- This Trust Agreement may be executed in several counterparts, each of which shall be deemed an original, and said counterparts shall constitute but one and the same instruments, which may be sufficiently evidenced by any one counterpart. -11- Section 9.6 Successors and Assigns. ---------------------- This Trust Agreement shall inure to the benefit of, and be binding upon, the parties hereto and their successors and assigns. Section 9.7 Indemnity. --------- (a) Except in the case of liabilities and claims arising out of Trustee's willful misconduct or gross negligence, Company shall indemnify and hold Trustee harmless from and against all liabilities and claims (including reasonable attorney's fees and expenses in defense thereof) arising out of or in any way connected with the Plan or the Trust fund or the management, operation, administration or control thereof and based in whole or in part on: (l) Any act or inaction of Company or Committee (which term includes, in this paragraph, any actual or ostensible agent of Company) or (2) Any act or inaction of Trustee resulting from the absence of proper directions hereunder, or in accordance with any directions, purported or real, from Company or Committee, whether or not proper hereunder, if relied upon in good faith by Trustee. (b) The Trustee does not warrant and shall not be liable for any tax consequences associated with the Trust or the Plans. (c) The Trustee shall not be liable for the inadequacy of the Trust to pay all amounts due under the Plans. IN WITNESS WHEREOF the undersigned have executed this Trust Agreement as of the date first written above. THE FIRST AMERICAN FINANCIAL CORPORATION By /s/ Parker S. Kennedy ------------------------- Its: President ---------------------- FIRST AMERICAN TRUST CO. By /s/ H. B. Benjamin ------------------------- Its: Sr. Vice Pres. ---------------------- -12- EX-21 12 SUBSIDIARIES OF THE COMPANY EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT
PERCENT OF STOCK OWNED BENEFICIALLY STATE OR COUNTRY UNDER BY COMPANY OR NAME OF SUBSIDIARY LAWS OF WHICH SUBSIDIARY ORGANIZED - ----------------------------------------------------------------------------------------------------------------- Consolidated subsidiaries of: Registrant CIC, Inc. Florida 100% Contour Software, Inc. California 100% Credit Net Communication, Inc. Oregon 75% First American Loan Servicing Corporation Texas 100% First American Management Company Washington 100% First American Property Data Services, Inc. California 100% First American Real Estate Information Services, Inc. California 100% First American Registry, Inc. Nevada 100% First American Title Insurance Company California 100% First American Trust Company California 100% First American Capital Management, Inc. California 100% Market Data Center, LLC Georgia 100% SMS Settlement Services, Inc. California 100% Strategic Mortgage Services, Inc. Ohio 100% Consolidated subsidiaries of First American Title Insurance Company-- Alachua County Abstract Company Florida 100% Albany County Title, Inc. Wyoming 100% American Title Corporation Wisconsin 100% Attorneys Abstract, Inc. New York 100% Attorneys Title Corporation District of Columbia 100% Bienville Properties, Inc. Louisiana 100% Burton Abstract & Title Company Michigan 100% Consolidated Title and Abstract Co. Minnesota 100% Eaton County Abstract & Title Company Michigan 100% EHG, Incorporated Illinois 100% Eureka Title Company California 100% First American Abstract Company Mississippi 100% First American Abstract Company of Louisiana Louisiana 100% First American Abstract Company of South Carolina, Inc. South Carolina 100% First American Affiliates, Inc. Florida 100% First American Equity Loan Services, Inc. Ohio 100% First American Exchange Corporation of California California 100% First American Exchange Corporation of the Southeast Louisiana 100% First American Holdings CBA, Inc. Minnesota 100% First American Title Agency, Inc. Virginia 100% First American Title Company California 100% First American Title Company of Alaska Alaska 100% First American Title Company of Bellingham Washington 100% First American Title Company of Clark County Washington 100% First American Title Company of Colorado Colorado 100% First American Title Company of Dallas Texas 100% First American Title Company of Florida, Inc. Florida 100%
EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT (Continued)
PERCENT OF STOCK OWNED BENEFICIALLY STATE OR COUNTRY UNDER BY COMPANY OR NAME OF SUBSIDIARY LAWS OF WHICH SUBSIDIARY ORGANIZED - ------------------------------------------------------------------------------------------------------------------ First American Title Company of Idaho, Inc. Idaho 100% First American Title Company of Modesto California 100% First American Title Company of Nevada Nevada 100% First American Title Company of New Mexico New Mexico 100% First American Title Company of St. Lucie County, Inc. Florida 100% First American Title Company of Thurston County Washington 100% First American Title Guaranty Holding Company California 100% First American Title Ins. Company of Australia Pty. Ltd. Australia 100% First American Title Ins. Company of Mason County Washington 100% First American Title Ins. Company of North Carolina North Carolina 100% First American Title Insurance Agency of Coconino, Inc. Arizona 100% First American Title Insurance Agency of Gila, Inc. Arizona 100% First American Title Insurance Agency of Yuma, Inc. Arizona 100% First American Title Insurance Company Ltd. (UK) England 100% First American Title Insurance Company of New York New York 100% First American Title Insurance Company of Texas Texas 100% First American Title of Kansas City, Inc. Missouri 100% First American Title of St. Louis, Inc. Missouri 100% First Australian Title Company Pty. Ltd. Australia 100% First Canadian Title Company Limited Canada 100% First Exchange Corporation California 100% First Exchange of Arizona, Inc. Arizona 100% Fremont County Title Company Wyoming 100% Grand Valley Title Company Michigan 100% Greater Louisiana Title Ins. Company Louisiana 100% Guardian Title Company of Maryland Maryland 100% Illini Title Services, Inc. Illinois 100% Kings County Title Company California 100% Land Title Associates, Inc. Oklahoma 100% Land Title Company of St. Louis, Inc. Missouri 100% Latin Title, Inc. Florida 100% Louisiana First Title Ins. Company Louisiana 100% Massachusetts Abstract Company, Inc. Massachusetts 100% Memphis Title Company Tennessee 100% Midland Title Security, Inc. Ohio 100% Miller Abstract Company, Inc. Missouri 100% Mineral Point Title Company, Ltd. Wisconsin 100% Monroe Title Company Florida 100% National Lenders Title Guaranty Co. Inc. Illinois 100% New York Abstract Company, Inc. New York 100% Northern Michigan Title Company of Emmet County Michigan 100% Ohio Title Corporation Ohio 100% Orange County Title Company California 100% Pekin Abstract & Title Company Illinois 100% Pioneer of Philadelphia, Ltd., Inc. Pennsylvania 100% Port Lawrence National Agency, Inc. Ohio 100% Potter Title Company Michigan 100% Republic Title of Texas, Inc. Texas 100%
EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT (CONTINUED)
PERCENT OF STOCK STATE OR COUNTRY UNDER OWNED BENEFICIALLY LAWS OF WHICH BY COMPANY OR NAME OF SUBSIDIARY ORGANIZED SUBSIDIARY - ------------------------------------------------------------------------------------------------------------------ San Mateo County Title Company California 100% Service Standard Title & Trust, Ltd. Virgin Islands 100% Settlers Abstract Company, L.P. Pennsylvania 100% Settlers Title Agency, Inc. New Jersey 100% Standard Title Insurance Company, Inc. Oklahoma 100% Sterling Title Company of Sandoval County New Mexico 100% The Inland Empire Service Corporation California 100% The Port Lawrence Agency, Inc. Ohio 100% The Port Lawrence Title and Trust Company Ohio 100% Ticore, Inc. Oregon 100% Universal Title Company Minnesota 100% Utah First Exchange Utah 100% Waco-McLennan County Abstract & Title Co. Texas 100% Warren County Abstract Iowa 100% Washakie Abstract Company Wyoming 100% Woodford County Abstract & Title Company, Inc. Illinois 100% First American Auto Title Transfer, L.L.C. Louisiana 99% First American Title & Trust Company Oklahoma 99% Land Title Insurance Company of St. Louis Missouri 99% Peoples Abstract Company Iowa 99% First American Title Insurance Agency of Pinal Arizona 98% First American Title Guaranty Agency of Cheyenne Wyoming 93% First American Home Buyers Protection Corporation California 92% First American Title Company of Laramie County Wyoming 92% First American Title Insurance Agency of Mohave, Inc. Arizona 88% First American Abstract & Title Services, Inc. South Carolina 85% First American Title Insurance Agency, Inc. (Navajo) Arizona 85% First American Title Insurance Agency of Yavapai, Inc. Arizona 84% Converse Land Title Company (a partnership) Wyoming 80% First American Long & Melone Title Company, Ltd. Hawaii 80% First American Title Company of Spokane Washington 80% First American Title Guaranty of Hot Springs Wyoming 80% Territorial Abstract and Title Company, Inc. New Mexico 80% First American Title Guaranty of Carbon County Wyoming 79% First American Title Guaranty of Sublette County Wyoming 79% First American Title Guaranty Agency of Crook County Wyoming 78% Teton Land Title Company Wyoming 76% Muni-Law, Inc. Massachusetts 75% Goshen County Abstract & Title Wyoming 73% First American Title Company of Magic Valley, Inc. Idaho 70% Big Horn Land Title Company Wyoming 62% Mid Valley Title and Escrow Company California 59% Campbell County Abstract Company Wyoming 58% Wyoming Land Title Company Wyoming 56% First American Title Company of Mendocino County California 54% Grand Valley Title Company Wyoming 52% Shoshone Title Insurance and Abstract Company Wyoming 52% Johnson County Title Company, Inc. Wyoming 51%
EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT (CONTINUED)
PERCENT OF STOCK STATE OR COUNTRY UNDER OWNED BENEFICIALLY LAWS OF WHICH BY COMPANY OR NAME OF SUBSIDIARY ORGANIZED SUBSIDIARY - -------------------------------------------------------------------------------------------------------------------- First American Homebuyers Protection Corp. Delaware 50% North American Title Insurance Company California 50% Consolidated subsidiaries of First American Real Estate Information Services, Inc. -- Data Tree Corporation California 100% Excelis, Inc. Florida 100% First American Real Estate Solutions, LLC California 80% Realty Tax & Service Company California 100% Consolidated subsidiary of Mid Valley Title & Escrow Company - Mt. Shasta Title & Escrow Company California 65% Consolidated subsidiaries of Ticore, Inc. -- Eagle Exchange Corporation Oregon 100% Escrow Automated Systems, Inc. Oregon 100% Title Insurance Company of Oregon Oregon 100% Consolidated subsidiaries of Title Insurance Company of Oregon -- Deschutes County Title Company Oregon 100% Willamette Valley Title Company Oregon 100% Consolidated subsidiary of Massachusetts Abstract Comp., Inc. -- Massachusetts Title Insurance Company Massachusetts 91% Consolidated subsidiary of First American Abstract Company of Louisiana Abstracts by Godail Louisiana 100% Consolidated subsidiaries of First American Title Guaranty Holding Company -- First Escrow Accounting Services Company California 100% First Guaranty Bancorp California 100% First Guaranty Exchange Company California 100% Superior Trustee's Services Company, Inc. California 100% First American Title Guaranty Company California 99% Harrison-Webster Investment Group (a partnership) California 75% Stanley Building Associates (a partnership) California 75% Consolidated subsidiary of First American Title Insurance Company of North Carolina Fidelity Title and Guaranty Co. Florida 100% Consolidated subsidiary of Land Title Associates, Inc. -- First American Title & Abstract Co. Oklahoma 100%
EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT (CONTINUED)
PERCENT OF STOCK OWNED BENEFICIALLY STATE OR COUNTRY UNDER BY COMPANY OR NAME OF SUBSIDIARY LAWS OF WHICH SUBSIDIARY ORGANIZED - ----------------------------------------------------------------------------------------------------------------- Consolidated subsidiaries of Midland Title Security, Inc. -- Colonial Title Company Ohio 100% Commerce Title Agency, Inc. Ohio 100% Lawyers Mortgage and Title Company, Inc. Ohio 100% Midland Exchange Services, Inc. Ohio 100% National Survey Services, Inc. Delaware 100% R.E. Services, Inc. Ohio 100% MCM Title Services, Inc. Ohio 67% Environmental Title Services, Inc. Ohio 50% Consolidated subsidiary of First American Home Buyers Protection Company -- First American Home Buyers Protection Corp. Delaware 50% Consolidated subsidiary of Land Title Insurance Company of St. Louis -- Property Data, Inc. Missouri 100% The Trust Company of St. Louis County Missouri 99% Consolidated subsidiaries of First American Title Insurance Company of Texas -- Corpus Christi Title Company Texas 100% Fort Bend Title Company Texas 100% The Donegan Abstract Company Texas 100% Consolidated subsidiaries of First American Title Insurance Company of New York -- First American Exchange Corporation New York 100% L & H Abstract New York 100% Mortgage Guarantee & Title Company Rhode Island 100% Preferred Land Title Services, Inc. New York 100% Consolidated subsidiaries of Republic Title of Texas, Inc. -- American Escrow Company Texas 100% Texas Escrow Company Texas 100% Title Software Corporation Texas 100% Consolidated subsidiary of First American Title & Trust Comp. -- Southwest Title Land Company Oklahoma 100% Consolidated subsidiaries of Territorial Abstract and Title Company, Inc. Territorial Escrow Services New Mexico 100% Title de Santa Fe New Mexico 100% Consolidated subsidiary of Universal Title Company Universal Partnerships, Inc. Minnesota 100%
EXHIBIT (21) SUBSIDIARIES OF THE REGISTRANT (CONTINUED)
PERCENT OF STOCK OWNED BENEFICIALLY STATE OR COUNTRY UNDER BY COMPANY OR NAME OF SUBSIDIARY LAWS OF WHICH SUBSIDIARY ORGANIZED - ------------------------------------------------------------------------------------------------------------------ Consolidated subsidiary of First American Long and Melone Title Company, Ltd. First American Long & Melone Exchange, Ltd. Hawaii 100% Consolidated subsidiary of First American Title Company of Nevada (Reno) First American Title Company of Nevada (Zephyr Cove) Nevada 100% Consolidated subsidiary of First American Equity Loan Services, Inc. (OH) Docu-Search, Inc. Kentucky 100% First American Equity Loan Services, Inc. (DE) Delaware 100% Consolidated subsidiary of EHG, Incorporated Midwest Title Insurance Company Illinois 100% Consolidated subsidiary of First American Real Estate Solutions, LLC Data Tree, LLC California 80% First American Real Estate Flood & Tax Solutions, LLC Delaware 100%
EX-23 13 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the registration statements on Form S-8 (Nos. 333-19065, 333-32871, 333-41993 and 333-67451), Form S-4 (Nos. 333-45459, 333-49687, 333-52031, 333-53681 and 333-66431) and Form S-3 (Nos. 333-56521, 333-58865, 333-67633 and 333-74703) of The First American Financial Corporation of our report dated February 9, 1999 appearing on page 21 of this Form 10-K. /s/ PricewaterhouseCoopers LLP Costa Mesa, California March 22, 1999 EX-27 14 FINANCIAL DATA SCHEDULE - ARTICLE 7
7 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 227,685,000 0 0 27,338,000 0 0 351,241,000 375,440,000 0 0 1,784,790,000 270,436,000 0 0 0 130,193,000 0 0 60,332,000 671,583,000 1,784,790,000 2,802,190,000 39,761,000 35,377,000 0 118,763,000 0 0 326,410,000 127,700,000 198,710,000 0 0 0 198,710,000 3.46 3.32 250,826,000 114,812,000 3,951,000 48,228,000 44,133,000 270,436,000 0
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