First Acceptance Corporation
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the quarterly period ended March 31, 2008
or
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o |
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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: 001-12117
First Acceptance Corporation
(Exact name of registrant as specified in its charter)
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Delaware
(State or other jurisdiction
of incorporation or organization)
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75-1328153
(I.R.S. Employer
Identification No.) |
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3322 West End Ave, Suite 1000
Nashville, Tennessee
(Address of principal executive offices)
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37203
(Zip Code) |
(615) 844-2800
(Registrants telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the 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 þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company.
See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o Accelerated filer
þ
Non-accelerated filer
o
Smaller reporting company
o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
As of
May 12, 2008, there were 48,039,526 shares outstanding of the registrants common stock, par
value $0.01 per share.
FIRST ACCEPTANCE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2008
INDEX
i
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
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March 31, |
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June 30, |
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2008 |
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2007 |
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(Unaudited) |
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ASSETS |
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Fixed maturities, available-for-sale at fair value (amortized
cost of $187,452 and $179,328, respectively) |
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$ |
190,320 |
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$ |
176,555 |
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Cash and cash equivalents |
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39,473 |
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34,161 |
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Premiums and fees receivable, net of allowance of $581 and $606 |
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74,268 |
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71,771 |
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Receivable for securities |
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19,973 |
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Deferred tax asset |
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17,000 |
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30,936 |
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Other assets |
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10,921 |
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11,722 |
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Property and equipment, net |
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4,612 |
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4,116 |
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Deferred acquisition costs |
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5,114 |
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5,166 |
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Goodwill |
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138,082 |
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138,082 |
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Identifiable intangible assets |
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6,373 |
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6,410 |
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TOTAL ASSETS |
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$ |
486,163 |
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$ |
498,892 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Loss and loss adjustment expense reserves |
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$ |
98,343 |
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$ |
91,446 |
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Unearned premiums and fees |
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88,937 |
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88,831 |
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Notes payable and capitalized lease obligations |
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4,614 |
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23,490 |
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Debentures payable |
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41,240 |
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41,240 |
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Payable for securities |
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1,490 |
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999 |
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Other liabilities |
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15,626 |
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13,402 |
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Total liabilities |
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250,250 |
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259,408 |
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Stockholders equity: |
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Preferred stock, $.01 par value, 10,000 shares authorized |
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Common stock, $.01 par value, 75,000 shares authorized;
48,040 and 47,615 shares issued and outstanding,
respectively |
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480 |
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476 |
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Additional paid-in capital |
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462,033 |
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460,968 |
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Accumulated other comprehensive income (loss) |
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1,789 |
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(2,652 |
) |
Accumulated deficit |
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(228,389 |
) |
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(219,308 |
) |
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Total stockholders equity |
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235,913 |
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239,484 |
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
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$ |
486,163 |
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$ |
498,892 |
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See notes to consolidated financial statements.
1
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)
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Three Months Ended |
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Nine Months Ended |
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March 31, |
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March 31, |
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2008 |
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2007 |
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2008 |
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2007 |
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Revenues: |
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Premiums earned |
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$ |
72,209 |
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$ |
79,842 |
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$ |
217,496 |
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$ |
220,630 |
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Fee income |
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9,311 |
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9,852 |
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27,596 |
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27,675 |
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Investment income |
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2,687 |
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2,292 |
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8,573 |
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6,336 |
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Other |
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(222 |
) |
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(3 |
) |
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(181 |
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765 |
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83,985 |
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91,983 |
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253,484 |
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255,406 |
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Costs and expenses: |
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Losses and loss adjustment expenses |
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55,319 |
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60,202 |
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167,336 |
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167,508 |
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Insurance operating expenses |
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24,936 |
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25,244 |
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74,102 |
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71,082 |
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Other operating expenses |
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487 |
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560 |
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1,751 |
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2,186 |
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Stock-based compensation |
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310 |
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295 |
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988 |
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752 |
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Depreciation and amortization |
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454 |
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404 |
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1,202 |
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1,192 |
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Interest expense |
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1,192 |
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445 |
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3,822 |
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1,275 |
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82,698 |
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87,150 |
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249,201 |
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243,995 |
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Income before income taxes |
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1,287 |
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4,833 |
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4,283 |
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11,411 |
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Provision for income taxes |
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529 |
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1,767 |
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13,364 |
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4,150 |
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Net income (loss) |
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$ |
758 |
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$ |
3,066 |
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$ |
(9,081 |
) |
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$ |
7,261 |
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Net income (loss) per share: |
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Basic |
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$ |
0.02 |
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$ |
0.06 |
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$ |
(0.19 |
) |
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$ |
0.15 |
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Diluted |
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$ |
0.02 |
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$ |
0.06 |
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$ |
(0.19 |
) |
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$ |
0.15 |
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Number of shares used to calculate net
income (loss) per share: |
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Basic |
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47,640 |
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47,603 |
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47,624 |
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47,578 |
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Diluted |
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48,831 |
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49,691 |
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47,624 |
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49,666 |
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Reconciliation of net income (loss) to
comprehensive income (loss): |
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Net income (loss) |
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$ |
758 |
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$ |
3,066 |
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$ |
(9,081 |
) |
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$ |
7,261 |
|
Unrealized change in investments |
|
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1,251 |
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568 |
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5,641 |
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3,628 |
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Other |
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5 |
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(245 |
) |
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2,014 |
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3,634 |
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(3,685 |
) |
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10,889 |
|
Applicable provision for income taxes |
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434 |
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955 |
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Comprehensive income (loss) |
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$ |
1,580 |
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$ |
3,634 |
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$ |
(4,640 |
) |
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$ |
10,889 |
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See notes to consolidated financial statements.
2
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
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Nine Months Ended |
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March 31, |
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2008 |
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2007 |
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Cash flows from operating activities: |
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Net income (loss) |
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$ |
(9,081 |
) |
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$ |
7,261 |
|
Adjustments to reconcile net income (loss) to cash provided by
operating activities: |
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Depreciation and amortization |
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1,202 |
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|
1,192 |
|
Stock-based compensation |
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|
988 |
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|
752 |
|
Deferred income taxes |
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|
12,982 |
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|
3,574 |
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Other |
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245 |
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|
259 |
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Change in: |
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Premiums and fees receivable |
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(2,497 |
) |
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(19,602 |
) |
Deferred acquisition costs |
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52 |
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(722 |
) |
Loss and loss adjustment expense reserves |
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6,897 |
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|
14,197 |
|
Unearned premiums and fees |
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|
106 |
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|
24,334 |
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Other |
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3,006 |
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3,494 |
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Net cash provided by operating activities |
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13,900 |
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|
34,739 |
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Cash flows from investing activities: |
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Purchases of fixed maturities, available-for-sale |
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(33,126 |
) |
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(79,849 |
) |
Maturities and paydowns of fixed maturities, available-for-sale |
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11,330 |
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|
5,119 |
|
Sales of fixed maturities, available-for-sale |
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13,458 |
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|
43,932 |
|
Net change in receivable/payable for securities |
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20,464 |
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(4,940 |
) |
Capital expenditures |
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(1,693 |
) |
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(1,305 |
) |
Other |
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(226 |
) |
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(1,184 |
) |
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Net cash provided by (used in) investing activities |
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10,207 |
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(38,227 |
) |
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Cash flows from financing activities: |
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Proceeds from borrowings |
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5,000 |
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Payments on borrowings |
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(18,876 |
) |
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(4,252 |
) |
Net proceeds from issuance of common stock |
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|
81 |
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|
728 |
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Net cash provided by (used in) financing activities |
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(18,795 |
) |
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|
1,476 |
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Net increase (decrease) in cash and cash equivalents |
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5,312 |
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|
(2,012 |
) |
Cash and cash equivalents, beginning of period |
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|
34,161 |
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|
31,534 |
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Cash and cash equivalents, end of period |
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$ |
39,473 |
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$ |
29,522 |
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|
See notes to consolidated financial statements.
3
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
1. General
The consolidated financial statements of First Acceptance Corporation (the Company) included
herein have been prepared without audit pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). Accordingly, certain information and disclosures normally included in
financial statements prepared in accordance with accounting principles generally accepted in the
United States of America have been omitted. In the opinion of management, the consolidated
financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary
for a fair statement of the interim periods. Certain reclassifications have been made to the prior
years consolidated financial statements to conform with the current year presentation.
The results of operations for the interim periods are not necessarily indicative of the
results of operations to be expected for the full year. These consolidated financial statements
should be read in conjunction with the Companys audited consolidated financial statements included
in its Annual Report on Form 10-K for the fiscal year ended June 30, 2007.
2. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income (loss) per
share:
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Three Months Ended |
|
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Nine Months Ended |
|
|
|
March 31, |
|
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March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
(in thousands, except per share data) |
|
|
|
|
|
Net income (loss) |
|
$ |
758 |
|
|
$ |
3,066 |
|
|
$ |
(9,081 |
) |
|
$ |
7,261 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common basic shares |
|
|
47,640 |
|
|
|
47,603 |
|
|
|
47,624 |
|
|
|
47,578 |
|
Effect of dilutive securities |
|
|
1,191 |
|
|
|
2,088 |
|
|
|
|
|
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|
2,088 |
|
|
|
|
|
|
|
|
|
|
|
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|
Weighted average common dilutive
shares |
|
|
48,831 |
|
|
|
49,691 |
|
|
|
47,624 |
|
|
|
49,666 |
|
|
|
|
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|
|
|
|
|
|
|
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|
Basic net income (loss) per share |
|
$ |
0.02 |
|
|
$ |
0.06 |
|
|
$ |
(0.19 |
) |
|
$ |
0.15 |
|
|
|
|
|
|
|
|
|
|
|
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|
Diluted net income (loss) per share |
|
$ |
0.02 |
|
|
$ |
0.06 |
|
|
$ |
(0.19 |
) |
|
$ |
0.15 |
|
|
|
|
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|
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|
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|
|
For the nine months ended March 31, 2008, options to purchase approximately 5.6 million shares
of common stock, a dilutive effect of approximately 1.6 million shares, and 0.4 million shares of
restricted common stock were not included in the computation of diluted loss per share as their
inclusion would have been anti-dilutive.
3. Stock-Based Compensation
During the nine months ended March 31, 2008, the Company issued options to purchase 935,000
shares of common stock to employees under its 2002 Long Term Incentive Plan, as amended (the
Plan). In July 2007, the Company issued options to purchase 30,000 shares at an exercise price of
$10.08 per share, and in March 2008 the Company issued options to purchase 905,000 shares at an exercise
price of $3.04 per share. The options expire at the end of ten years and vest equally in annual
installments with options to purchase 610,000 shares vesting over five years and options to
purchase 325,000 shares vesting over four years. Compensation expense related to these options was
$1.8 million, of which $0.1 million will be amortized through June 2008 and the remaining $1.7
million will be amortized through March 2013. None of these options were exercisable at March 31,
2008. There were no options exercised during the nine months ended March 31, 2008; however,
options to purchase 80,000 shares of common stock were forfeited in July 2007.
In March 2008, the Company issued 400,000 shares of restricted common stock (Restricted Stock
Award) to an executive officer pursuant to the Plan and a Restricted Stock Award Agreement.
Pursuant to the Restricted Stock Award Agreement, 160,000 shares will vest on July 1, 2009 and
80,000 shares will vest on each subsequent October 1st through October 1, 2011.
Compensation expense related to the issuance of this Restricted Stock Award was $1.2 million, of
which $0.2 million will be amortized through June 2008 and the remaining $1.0 million will be
amortized through September 2011.
4
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
3. Stock-Based Compensation (continued)
At March 31, 2008 there were 6.4 million outstanding share issuances under the Plan and 2.1
million shares remaining available for issuance.
4. Income Taxes
After considering the recent declines in premiums written, premiums earned and policies in
force, the Company assessed the realization of its net operating loss (NOL) carryforwards, which
comprises the majority of its deferred tax asset. The Company concluded at December 31, 2007 that
it was appropriate to increase its valuation allowance for the deferred tax asset related to the
NOL carryforwards that expire in fiscal years 2008 and 2009 by $11.6 million, or $0.24 per share on
a basic and diluted basis. As in its prior assessments, the Company considered its historical and
expected taxable income to determine the sufficiency of its valuation allowance. Management remains
optimistic about the Companys future outlook and expects to generate taxable income sufficient to
realize its remaining net deferred tax asset. However, the Companys evaluation includes multiple
assumptions and estimates that may change over time. If future taxable income is less than current
projections, an additional valuation allowance may become necessary that could have a materially
adverse impact on our results of operations and financial position. The Companys updated
evaluation at March 31, 2008 resulted in no adjustment to the valuation allowance. At March 31,
2008, the total gross deferred tax asset was $54.7 million, and the valuation allowance was $37.7
million.
5. Goodwill and Identifiable Intangible Assets
After considering the recent declines in premiums written, premiums earned and policies in
force, the Company conducted an interim impairment test in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets
(SFAS 142). In the event that facts and circumstances indicate that goodwill and other
identifiable intangible assets may be impaired, SFAS 142 requires an evaluation of the
recoverability of such assets. The estimated future discounted cash flows associated with these
assets are compared with their carrying amounts to determine if a
write down to market value or
discounted cash flow value is necessary. The Company evaluated the recent trends in its historical
results and expected future discounted cash flows and concluded that goodwill and other
identifiable intangible assets were fully realizable as of March 31, 2008. However, the Companys
evaluation includes multiple assumptions, including estimated discounted cash flows and estimates
that may change over time. If future discounted cash flows become less than those projected by the
Company, an impairment charge may become necessary that could have a materially adverse impact on
our results of operations and financial position.
6. Notes Payable
In January 2008, the Company made a principal prepayment of $5.0 million on its credit
facility. The unpaid balance under the Companys credit agreement as of March 31, 2008 was $4.3
million. The Company entered into an amendment to its credit agreement, dated February 6, 2008,
that contains less restrictive financial covenants for future periods. At March 31, 2008, the
Company was in compliance with its financial covenants.
7. Severance
On December 31, 2007, the Company entered into a separation agreement with an executive
officer who resigned from the Company. Under terms of the agreement, the officer will receive
severance and related benefits for the period from December 31, 2007 through December 31, 2009, as
well as accelerated vesting of all outstanding stock options held by the former officer as of
December 31, 2007. Accordingly, the Company incurred a charge of approximately $0.8 million,
comprised of $0.7 million in accrued severance and benefits and a $0.1 million non-cash charge
related to the vesting of remaining unvested stock options. The remaining severance and benefit
accrual of $0.6 million as of March 31, 2008 is classified within other liabilities on the
Companys consolidated balance sheet. The severance and benefits charge is included in insurance
operating expenses and the non-cash charge related to the vesting of remaining unvested stock
options is included within stock-based compensation expense in the consolidated statements of
operations. The insurance operations segment includes the accrued severance and benefits charge,
and the real estate and corporate segment includes the accelerated vesting charge (see Note 8).
5
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
8. Segment Information
The Company operates in two business segments: (1) insurance operations and (2) real estate
and corporate. The Companys primary focus is the selling, servicing and underwriting of
non-standard personal automobile insurance. The real estate and corporate segment consists of
activities related to the disposition of foreclosed real estate held for sale, interest expense
associated with all debt and other general corporate overhead expenses.
The following table presents selected financial data by business segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance |
|
$ |
83,953 |
|
|
$ |
91,977 |
|
|
$ |
253,341 |
|
|
$ |
255,244 |
|
Real estate and corporate |
|
|
32 |
|
|
|
6 |
|
|
|
143 |
|
|
|
162 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated total |
|
$ |
83,985 |
|
|
$ |
91,983 |
|
|
$ |
253,484 |
|
|
$ |
255,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance |
|
$ |
3,241 |
|
|
$ |
6,123 |
|
|
$ |
10,692 |
|
|
$ |
15,445 |
|
Real estate and corporate |
|
|
(1,954 |
) |
|
|
(1,290 |
) |
|
|
(6,409 |
) |
|
|
(4,034 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated total |
|
$ |
1,287 |
|
|
$ |
4,833 |
|
|
$ |
4,283 |
|
|
$ |
11,411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
June 30, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Total assets: |
|
|
|
|
|
|
|
|
Insurance |
|
$ |
468,116 |
|
|
$ |
463,502 |
|
Real estate and corporate |
|
|
18,047 |
|
|
|
35,390 |
|
|
|
|
|
|
|
|
Consolidated total |
|
$ |
486,163 |
|
|
$ |
498,892 |
|
|
|
|
|
|
|
|
9. Investments
Included in other revenues during the three months ended March 31, 2008 is $0.3 million of
charges related to the other-than-temporary impairment of certain non-agency mortgage-backed
securities. Managements assessment of whether an impairment is other-than-temporary includes an
evaluation of factors such as the credit quality of the investment, the duration of the impairment,
our ability and intent to hold the investment until recovery or maturity and overall economic
conditions. If management determines that the value of any investment is other-than-temporarily
impaired, the impairment would be charged against earnings and a new cost basis for the security
would be established. Due to the deterioration in liquidity in the credit markets during the first
calendar quarter of 2008, yields on certain non-agency mortgage-backed securities declined below
projected book yield requiring the $0.3 million impairment of these securities under the guidance
set forth in Emerging Issues Task Force Issue No. 99-20 Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a
Transferor in Securitized Financial Assets.
6
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
10. Litigation
The Company is named as a defendant in various lawsuits, arising in the ordinary course of
business, generally relating to its insurance operations. All legal actions relating to claims made
under insurance policies are considered by the Company in establishing its loss and loss adjustment
expense reserves. The Company also faces lawsuits that seek damages beyond policy limits, commonly
known as bad faith claims, as well as class action and individual lawsuits that involve issues
arising in the course of the Companys business. The Company continually evaluates potential
liabilities and reserves for litigation of these types using the criteria established by SFAS
No. 5, Accounting for Contingencies (SFAS 5). Pursuant to SFAS 5, reserves for a loss may only be
recorded if the likelihood of occurrence is probable and the amount can be reasonably estimated. If
a loss, while not probable, is judged to be reasonably possible, management will disclose, if it
can be estimated, a possible range of loss or state that an estimate cannot be made. Management
considers each legal action using SFAS 5 and records reserves for losses as warranted by
establishing a reserve within its consolidated balance sheet in loss and loss adjustment expense
reserves for bad faith claims and in other liabilities for other lawsuits. Amounts incurred are
recorded within the Companys consolidated statement of operations in losses and loss adjustment
expenses for bad faith claims and in insurance operating expenses for other lawsuits.
Certain claims and legal actions have been brought against the Company for which no loss has
been accrued, and for which an estimate of a possible range of loss cannot be made under SFAS 5. At
March 31, 2008, the Company was a party to litigation in Alabama and Georgia in which allegations
are made with respect to sales practices related to ancillary products currently or formerly sold
by the Company in those states. Keisha Milbry Monday, et al. v. First Acceptance Corp.,
et al. was
filed on February 13, 2007, in the Circuit Court of Bullock County, Alabama. Solomon and Catherine
Warren, et al. v. First Acceptance Corp., et al. was filed on November 9, 2007,
in the Circuit Court
of Barbour County, Alabama. Margaret Franklin v. Vesta Insurance Corp., et al. was filed on July 14,
2006, as a putative class action in the Circuit Court of Bullock County, Alabama. Carrie Jackson v.
Alabama Acceptance Insurance Agency, Inc. was filed on July 24, 2007, as a putative class action in
the Circuit Court of Bullock County, Alabama. Annette Rush v. Village Auto Insurance Company, Inc.
(now known as First Acceptance Insurance Company of Georgia, Inc.) was filed on October 26, 2005,
as a putative class action in the Superior Court of Fulton County, Georgia. Each of the suits
alleges that the Company implemented a program to convince its consumers who purchased automobile
insurance policies to also purchase automobile club memberships, and seeks unspecified damages and
attorneys fees. The court has not certified classes of plaintiffs in the two Alabama putative class
actions. The Georgia Superior Court certified the class in the Georgia lawsuit in December 2006.
The Georgia Court of Appeals affirmed the class certification decision and the Georgia Supreme
Court denied our Petition for Certiorari in January 2008. The Company recently began class related
discovery in these matters. The Company believes it has meritorious defenses in all of these
actions and has vigorously defended against these claims. The Company has met with counsel for the
plaintiffs to attempt to mediate these disputes and continues to pursue discussions to resolve all
related litigation. An estimate of the ultimate outcome of these claims or lawsuits cannot be made
at this time. Losses incurred as a result of these cases may have a material adverse impact on the
Companys results of operations and financial position.
11. Recent Accounting Pronouncements
Effective July 1, 2007, the Company adopted the provisions of Financial Accounting Standards
Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes An
Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements in accordance with
FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold
and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return, as well as providing guidance on de-recognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
In accordance with FIN 48, a tax position is a position in a previously filed tax return or a
position expected to be taken in a future tax filing that is reflected in measuring current or
deferred income tax assets and liabilities. Tax positions shall be recognized only when it is more
likely than not (likelihood of greater than 50%), based on technical merits, that the position will
be sustained upon examination. Tax positions that meet the more likely than not threshold should be
measured using a probability weighted approach as the largest amount of tax benefit that is greater
than 50% likely of being realized upon settlement. The Company recognized no additional liability
or reduction in deferred tax asset for unrecognized tax benefits and the Company had no FIN 48 tax
liabilities at the time of
7
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
11. Recent Accounting Pronouncements (continued)
adoption or as of March 31, 2008. Any interest and penalties incurred in connection with income
taxes are recorded as a component of tax expense. The Company is no longer subject to U.S. federal,
state, local or non-U.S. income tax examinations by tax authorities for taxable years prior to June
30, 2003.
In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (SFAS 157),
which defines fair value, establishes a framework for measuring fair value in GAAP and expands
disclosures about fair value measurements. This statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having previously concluded
in those accounting pronouncements that fair value is the relevant measurement attribute.
Accordingly, this statement does not require any new fair value measurements. SFAS 157 is effective
for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. Earlier application is encouraged, provided that the reporting
entity has not yet issued financial statements for the fiscal year, including financial statements
for an interim period within that fiscal year. Based on the current use of fair value measurements,
the Company does not expect SFAS 157 to have a material impact on the results of operations or
financial position of the Company.
In February 2007, the FASB issued Statement No. 159, Establishing the Fair Value Option for
Financial Assets and Liabilities (SFAS 159), which includes an amendment to FASB Statement
No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115). SFAS 159
permits entities to choose to measure many financial instruments and certain other items at fair
value. The objective is to improve financial reporting by providing entities with the opportunity
to mitigate volatility in reported earnings caused by measuring related assets and liabilities
differently without having to apply complex hedge accounting provisions. This statement is expected
to expand the use of fair value measurement, which is consistent with the FASBs long-term
measurement objectives for accounting for financial instruments. This statement applies to all
entities and most of the provisions of this statement apply only to entities that elect the fair
value option. However, the amendment to SFAS 115 applies to all entities with available-for-sale
and trading securities. SFAS 159 is effective for fiscal years beginning after November 15, 2007.
The Company does not expect SFAS 159 to have a material impact on the results of operations or
financial position of the Company.
In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and
Hedging Activities (SFAS 161), which includes an amendment to FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities (SFAS 133). SFAS 161 applies to all derivative
instruments and related hedged items accounted for under SFAS 133. SFAS 161 requires entities to
provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS 133 and its related
interpretations, and (c) how derivative instruments and related hedged items affect an entitys
financial position, results of operations, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November 15, 2008. Earlier
adoption is encouraged. The Company has not evaluated the requirements of SFAS 161 and has not yet
determined if SFAS 161 will have a material impact on its future consolidated financial statements.
8
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements which involve risks and uncertainties. Our actual results may differ
significantly from the results discussed in the forward-looking statements. Factors that might
cause such a difference include those discussed in Item 1A. Risk Factors in our Annual Report on
Form 10-K for the fiscal year ended June 30, 2007. The following discussion should be read in
conjunction with our consolidated financial statements included with this report and our
consolidated financial statements and related Managements Discussion and Analysis of Financial
Condition and Results of Operations for the fiscal year ended June 30, 2007 included in our Annual
Report on Form 10-K.
General
As of March 31, 2008, we leased and operated 432 retail locations (or stores), staffed by
employee-agents. Our employee-agents exclusively sell insurance products either underwritten or
serviced by us. As of March 31, 2008, we wrote non-standard personal automobile insurance in 12
states and were licensed in 13 additional states. See the discussion in Item 1. Business -
General in our Annual Report on Form 10-K for the fiscal year ended June 30, 2007 for additional
information with respect to our business.
The following table shows the change in the number of our retail locations for the periods
presented. Retail location counts are based upon the date that a location commenced or ceased
writing business.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
March 31, |
|
March 31, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Retail locations beginning of period |
|
|
440 |
|
|
|
467 |
|
|
|
462 |
|
|
|
460 |
|
Opened |
|
|
|
|
|
|
5 |
|
|
|
2 |
|
|
|
18 |
|
Closed |
|
|
(8 |
) |
|
|
(4 |
) |
|
|
(32 |
) |
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail locations end of period |
|
|
432 |
|
|
|
468 |
|
|
|
432 |
|
|
|
468 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following tables show the number of our retail locations by state.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
June 30, |
|
|
2008 |
|
2007 |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
Alabama |
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
|
|
25 |
|
Florida |
|
|
40 |
|
|
|
42 |
|
|
|
40 |
|
|
|
41 |
|
|
|
41 |
|
|
|
39 |
|
Georgia |
|
|
61 |
|
|
|
63 |
|
|
|
61 |
|
|
|
63 |
|
|
|
62 |
|
|
|
63 |
|
Illinois |
|
|
80 |
|
|
|
82 |
|
|
|
80 |
|
|
|
85 |
|
|
|
81 |
|
|
|
86 |
|
Indiana |
|
|
19 |
|
|
|
27 |
|
|
|
22 |
|
|
|
26 |
|
|
|
24 |
|
|
|
26 |
|
Mississippi |
|
|
8 |
|
|
|
8 |
|
|
|
8 |
|
|
|
8 |
|
|
|
8 |
|
|
|
8 |
|
Missouri |
|
|
15 |
|
|
|
15 |
|
|
|
16 |
|
|
|
15 |
|
|
|
15 |
|
|
|
18 |
|
Ohio |
|
|
29 |
|
|
|
30 |
|
|
|
29 |
|
|
|
30 |
|
|
|
30 |
|
|
|
30 |
|
Pennsylvania |
|
|
19 |
|
|
|
25 |
|
|
|
19 |
|
|
|
26 |
|
|
|
25 |
|
|
|
25 |
|
South Carolina |
|
|
28 |
|
|
|
28 |
|
|
|
28 |
|
|
|
26 |
|
|
|
28 |
|
|
|
21 |
|
Tennessee |
|
|
20 |
|
|
|
20 |
|
|
|
20 |
|
|
|
20 |
|
|
|
20 |
|
|
|
20 |
|
Texas |
|
|
88 |
|
|
|
103 |
|
|
|
92 |
|
|
|
102 |
|
|
|
103 |
|
|
|
99 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
432 |
|
|
|
468 |
|
|
|
440 |
|
|
|
467 |
|
|
|
462 |
|
|
|
460 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
Consolidated Results of Operations
Overview
Our primary focus is the selling, servicing and underwriting of non-standard personal
automobile insurance. Our real estate and corporate segment consists of activities related to the
disposition of foreclosed real estate held for sale, interest expense associated with debt, and
other general corporate overhead expenses. Our insurance operations generate revenues from
selling, servicing and underwriting non-standard personal automobile insurance policies in 12
states. We conduct our underwriting operations through three insurance company subsidiaries, First
Acceptance Insurance Company, Inc., First Acceptance Insurance Company of Georgia, Inc. and First
Acceptance Insurance Company of Tennessee, Inc. Our insurance revenues are primarily generated
from:
|
|
|
premiums earned, including policy and renewal fees, from sales of policies
written and assumed by our insurance company subsidiaries; |
|
|
|
|
fee income, including installment billing fees on policies written, agency fees
and fees for other ancillary services (principally motor club and bond card
products); and |
|
|
|
|
investment income earned on the invested assets of the insurance company
subsidiaries. |
The following table presents premiums earned by state.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
March 31, |
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Georgia |
|
$ |
15,237 |
|
|
$ |
18,087 |
|
|
$ |
46,475 |
|
|
$ |
52,863 |
|
Florida |
|
|
10,762 |
|
|
|
14,993 |
|
|
|
33,943 |
|
|
|
40,833 |
|
Texas |
|
|
8,781 |
|
|
|
8,658 |
|
|
|
25,524 |
|
|
|
23,555 |
|
Illinois |
|
|
8,016 |
|
|
|
8,410 |
|
|
|
24,116 |
|
|
|
22,681 |
|
Alabama |
|
|
7,209 |
|
|
|
7,845 |
|
|
|
21,747 |
|
|
|
22,417 |
|
South Carolina |
|
|
6,195 |
|
|
|
4,520 |
|
|
|
17,485 |
|
|
|
9,361 |
|
Tennessee |
|
|
5,179 |
|
|
|
6,082 |
|
|
|
15,869 |
|
|
|
17,865 |
|
Ohio |
|
|
3,846 |
|
|
|
4,289 |
|
|
|
11,660 |
|
|
|
12,132 |
|
Pennsylvania |
|
|
2,606 |
|
|
|
1,961 |
|
|
|
7,267 |
|
|
|
4,717 |
|
Indiana |
|
|
1,736 |
|
|
|
2,110 |
|
|
|
5,510 |
|
|
|
6,040 |
|
Missouri |
|
|
1,435 |
|
|
|
1,600 |
|
|
|
4,287 |
|
|
|
4,487 |
|
Mississippi |
|
|
1,207 |
|
|
|
1,287 |
|
|
|
3,613 |
|
|
|
3,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums earned |
|
$ |
72,209 |
|
|
$ |
79,842 |
|
|
$ |
217,496 |
|
|
$ |
220,630 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table presents the change in the total number of policies in force for the
insurance operations for the periods presented. Policies in force increase as a result of new
policies issued and decrease as a result of policies that are canceled or expire and are not
renewed.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
March 31, |
|
March 31, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Policies in force beginning of period |
|
|
203,008 |
|
|
|
217,560 |
|
|
|
226,974 |
|
|
|
200,401 |
|
Net increase (decrease) during period |
|
|
12,849 |
|
|
|
29,474 |
|
|
|
(11,117 |
) |
|
|
46,633 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Policies in force end of period |
|
|
215,857 |
|
|
|
247,034 |
|
|
|
215,857 |
|
|
|
247,034 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance companies present a combined ratio as a measure of their overall underwriting
profitability. The components of the combined ratio are as follows:
Loss Ratio Loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment
expenses incurred to premiums earned and is a basic element of underwriting profitability. We
calculate this ratio based on all direct and assumed premiums earned.
Expense Ratio Expense ratio is the ratio (expressed as a percentage) of operating expenses
to premiums earned. This is a measurement that illustrates relative management efficiency in
administering our operations. Insurance operating expenses are reduced by fee income from insureds
and, for the period from January 1, 2006
10
through December 31, 2006, a transaction service fee we received for servicing the run-off
business previously written by the Chicago agencies whose business we acquired in January 2006
(Chicago acquisition).
Combined Ratio Combined ratio is the sum of the loss ratio and the expense ratio. If the
combined ratio is at or above 100%, an insurance company cannot be profitable without sufficient
investment income. The following table presents the combined ratios for the insurance operations
for the periods presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
March 31, |
|
March 31, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Loss and loss adjustment expense |
|
|
76.6 |
% |
|
|
75.4 |
% |
|
|
76.9 |
% |
|
|
75.9 |
% |
Expense |
|
|
21.6 |
% |
|
|
19.3 |
% |
|
|
21.4 |
% |
|
|
19.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined |
|
|
98.2 |
% |
|
|
94.7 |
% |
|
|
98.3 |
% |
|
|
95.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The invested assets of the insurance operations are generally highly liquid and consist
substantially of readily marketable, investment grade, municipal and corporate bonds and
collateralized mortgage obligations. We invest in certain securities issued by political
subdivisions in the states of Georgia and Tennessee, as these investments enable our insurance
company subsidiaries to obtain premium tax credits. Investment income is comprised primarily of
interest earned on these securities, net of related investment expenses. Realized gains and losses
on our investment portfolio may occur from time to time as changes are made to our holdings to
enable premium tax credits or based upon changes in interest rates and changes in the credit
quality of securities held.
Three and Nine Months Ended March 31, 2008 Compared with the Three and Nine Months Ended March 31,
2007
Consolidated Results
Revenues for the three months ended March 31, 2008 decreased 9% to $84.0 million from $92.0
million in the same period last year. Net income for the three months ended March 31, 2008 was
$0.8 million, compared with net income of $3.1 million for the three months ended March 31, 2007.
Basic and diluted net income per share was $0.02 for the three months ended March 31, 2008,
compared with basic and diluted net income per share of $0.06 for the three months ended March 31,
2007.
Revenues for the nine months ended March 31, 2008 decreased 1% to $253.5 million from $255.4
million in the same period last year. Net loss for the nine months ended March 31, 2008 was $9.1
million, compared with net income of $7.3 million for the nine months ended March 31, 2007. Basic
and diluted net loss per share was $(0.19) for the nine months ended March 31, 2008, compared with
basic and diluted net income per share of $0.15 for the nine months ended March 31, 2007.
Insurance Operations
Revenues from insurance operations were $84.0 million for the three months ended March 31,
2008, compared with $92.0 million for the three months ended March 31, 2007. For the nine months
ended March 31, 2008, revenues from insurance operations were $253.3 million, compared with $255.2
million for the nine months ended March 31, 2007.
Income before income taxes from insurance operations for the three months ended March 31, 2008
was $3.2 million, compared with $6.1 million for the three months ended March 31, 2007. Income
before income taxes for the nine months ended March 31, 2008 was $10.7 million, compared with $15.4
million for the nine months ended March 31, 2007.
Premiums Earned
Premiums earned decreased by $7.6 million, or 10%, to $72.2 million for the three months ended
March 31, 2008 from $79.8 million for the three months ended March 31, 2007. The decrease in
premiums earned was due to declines in new policies written during the quarter caused by (1)
continued soft economic conditions in our markets coupled with a competitive pricing environment
and (2) the closure of 44 underperforming stores since January 2007. These declines were partially
offset by premium growth in our South Carolina, Pennsylvania and Texas markets. The total number
of insured policies in force at March 31, 2008 decreased 13% over the same date
11
in 2007 from 247,034 to 215,857, primarily due to the factors noted above. At March 31, 2008,
we operated 432 stores, compared with 468 stores at March 31, 2007.
For the nine months ended March 31, 2008, premiums earned decreased by $3.1 million, or 1%, to
$217.5 million from $220.6 million for the nine months ended March 31, 2007. This decrease was
also a result of the decrease in policies in force.
Fee Income
Fee income decreased 5% to $9.3 million for the three months ended March 31, 2008 from $9.9
million for the three months ended March 31, 2007. The decrease in fee income was a result of the
decrease in policies in force partially offset by higher fee income in Illinois and Florida.
For the nine months ended March 31, 2008, fee income decreased slightly to $27.6 million from
$27.7 million for the nine months ended March 31, 2007. This decrease was the result of factors
discussed above for the three months ended March 31, 2008.
Investment Income
Investment income increased during the three and nine months ended March 31, 2008 as a result
of the increase in invested assets. Invested assets increased during the three and nine months
ended March 31, 2008 as a result of cash provided by operating activities and the proceeds received
from the sale of debentures in June 2007. At March 31, 2008 and 2007, the tax-equivalent book
yields for our fixed maturities portfolio were 5.1% and 5.2%, respectively, with effective
durations of 3.44 years for both periods. The yields for the comparable Lehman Brothers indices
were 4.2% and 5.0% at March 31, 2008 and 2007, respectively.
Other
Included in other revenues during the three months ended March 31, 2008 is $0.3 million of
charges related to the other-than-temporary impairment of certain non-agency mortgage-backed
securities. Managements assessment of whether an impairment is other-than-temporary includes an
evaluation of factors such as the credit quality of the investment, the duration of the impairment,
our ability and intent to hold the investment until recovery or maturity and overall economic
conditions. If it is determined that the value of any investment is other-than-temporarily
impaired, the impairment would be charged against earnings and a new cost basis for the security
would be established. Due to the deterioration in liquidity in the credit markets during the first
calendar quarter of 2008, yields on certain non-agency mortgage-backed securities declined below
projected book yield requiring the $0.3 million impairment of these securities under the guidance
set forth in Emerging Issues Task Force Issue No. 99-20 Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a
Transferor in Securitized Financial Assets (EITF 99-20).
Other revenues for the nine months ended March 31, 2007 are primarily comprised of $0.9
million in transaction service fees earned for servicing the run-off business previously written by
the Chicago agencies whose assets we acquired in January 2006. We received the transaction service
fee from the effective date of the acquisition in January 2006 through December 31, 2006.
Losses and Loss Adjustment Expenses
The loss and loss adjustment expense ratio was 76.6% for the three months ended March 31, 2008
and 75.4% for the three months ended March 31, 2007. The loss and loss adjustment expense ratio was
76.9% for the nine months ended March 31, 2008 and 75.9% for the nine months ended March 31, 2007.
The increase for the three months ended March 31, 2008 was primarily the result of increased
frequency attributable to weather-related claims. The increase for the nine months ended March 31,
2008 was further impacted by increased severity attributable to bodily injury and property damage
losses in several states.
For the three and nine months ended March 31, 2008, we did not experience any significant
adverse development for prior accident periods. We had previously reported that the three months
ended September 30, 2006 included approximately $3.7 million (1.7% of the ratio for the nine months
ended March 31, 2007) of adverse development related primarily to the estimation of the severity of
losses in Florida and Texas, where we had
12
significant growth during 2006, and Georgia, where we reduced our physical damage premium
rates effective January 2006.
Effective January 1, 2008, we increased our rates in Florida for bodily injury, medical
payments, and uninsured motorists coverage in conjunction with the change in coverage resulting
from the reinstatement of Personal Injury Protection (PIP) coverage. During the first quarter of
2008, we also increased rates in Illinois, Indiana and Texas.
Operating Expenses
Insurance operating expenses decreased 1% to $24.9 million for the three months ended March
31, 2008 from $25.2 million for the three months ended March 31, 2007. This decrease was primarily
a result of the cost savings associated with the closure of underperforming stores offset by an
increased investment in our product, actuarial and information technology functions. For the nine
months ended March 31, 2008, operating expenses increased 4% to $74.1 million from $71.1 million
for the nine months ended March 31, 2007. This increase was primarily related to the investments
discussed above as well as non-recurring costs of $0.3 million associated with the closure of
underperforming stores and severance and related benefits charges of $0.7 million incurred in
connection with a separation agreement with an executive officer.
The expense ratio increased from 19.3% for the three months ended March 31, 2007 to 21.6% for
the same period in the current fiscal year. The expense ratio increased from 19.3% for the nine
months ended March 31, 2007 to 21.4% for the same period in the current fiscal year. These
increases were primarily due to the factors discussed above and the positive impact on the expense
ratio during the nine months ended March 31, 2007 from the transaction service fee of $0.9 million,
or 0.6%, earned through December 31, 2006 in connection with our Chicago acquisition.
Overall, the combined ratio increased to 98.2% for the three months ended March 31, 2008 from
94.7% for the three months ended March 31, 2007. For the nine months ended March 31, 2008, the
combined ratio increased to 98.3% from 95.2% for the nine months ended March 31, 2007.
Real Estate and Corporate
Loss before income taxes for the three months ended March 31, 2008 was $2.0 million, compared
with a loss of $1.3 million for the three months ended March 31, 2007. For the nine months ended
March 31, 2008, loss before income taxes was $6.4 million, compared with a loss of $4.0 million for
the nine months ended March 31, 2007.
During the three and nine months ended March 31, 2008, we incurred $0.1 million and $0.7
million, respectively, of interest expense in connection with borrowings related to the Chicago
acquisition compared with $0.4 million and $1.3 million for the three and nine months ended March
31, 2007, respectively. In addition, we incurred $1.0 million and $3.0 million of interest expense
during the three and nine months ended March 31, 2008 related to the debentures issued in June
2007. The nine months ended March 31, 2008 also includes a non-cash severance charge of $0.1
million related to the vesting of unvested stock options resulting from the separation of an
executive officer.
Provision for Income Taxes
The provision for income taxes for the nine months ended March 31, 2008 includes an increase
in the valuation allowance for the deferred tax asset of $11.6 million, or $0.24 per share on a
diluted basis, at December 31, 2007. After considering the recent declines in premiums written,
premiums earned and policies in force, we assessed the realization of our net operating loss
(NOL) carryforwards, which comprises the majority of our deferred tax asset. We concluded at
December 31, 2007 that it was appropriate to increase our valuation allowance for the deferred tax
asset related to the NOL carryforwards that expire in fiscal years 2008 and 2009 by $11.6 million.
As in our prior assessments, we considered our historical and expected taxable income to determine
the sufficiency of our valuation allowance. We remain optimistic about the Companys future outlook
and expect to generate taxable income sufficient to realize our remaining net deferred tax asset.
However, our evaluation includes multiple assumptions and estimates that may change over time. If
future taxable income is less than current projections, an additional valuation allowance may
become necessary that could have a materially adverse impact on
13
our results of operations and financial position. Our updated evaluation at March 31, 2008
resulted in no adjustment to the valuation allowance. At March 31, 2008, the total gross deferred
tax asset was $54.7 million, and the valuation allowance was $37.7 million.
Liquidity and Capital Resources
Our primary sources of funds are premiums, fee income and investment income. Our primary uses
of funds are the payment of claims and operating expenses. Operating activities for the nine
months ended March 31, 2008 provided $13.9 million of cash, compared with $34.7 million provided in
the same period in fiscal 2007. The decrease in cash provided by operating activities was the
result of an increase in paid loss and loss adjustment expenses and a decrease in cash collected on
premiums written. Net cash provided by investing activities for the nine months ended March 31,
2008 was $10.2 million, compared with net cash used in investing activities of $38.2 million in the
same period in fiscal 2007. Both periods reflect net additions to our investment portfolio, while
the nine months ended March 31, 2008 includes the settlement of a $20.0 million receivable for
securities in July 2007. Financing activities for the nine months ended March 31, 2008 included the
repayment of $5.0 million related to our revolving credit facility, the required principal
prepayment of $6.0 million on our term loan facility made in accordance with the amendment to the
credit agreement in September 2007, and the additional principal prepayment of $5.0 million on our
term loan facility in January 2008. The nine months ended March 31, 2008 and 2007 included
scheduled quarterly principal payments on our term loan facility of $2.7 million and $4.2 million,
respectively.
In October 2007, the holding company received a $6.5 million ordinary dividend from the
insurance company subsidiaries. We used $6.0 million of these funds to make the required principal
prepayment noted above. In addition, in December 2007, the holding company received a $5.5 million
ordinary dividend from the insurance company subsidiaries. We used these funds in January 2008 to
make the additional principal prepayment of $5.0 million noted above. Future debt payments will be
serviced by the unrestricted cash from the sources described below. At March 31, 2008, we had $0.9
million available in unrestricted cash outside of the insurance company subsidiaries.
We are part of an insurance holding company system with substantially all of our operations
conducted by our insurance company subsidiaries. Accordingly, the holding companys primary
sources of cash are dividends from our insurance company subsidiaries and from our non-insurance
company subsidiaries that sell ancillary products to our insureds. The holding company will also
receive cash from operating activities as a result of investment income and the ultimate
liquidation of our foreclosed real estate held for sale. However, in accordance with the terms of
our credit agreement, any proceeds from the sale of our foreclosed real estate must be applied
against our outstanding term loan. In addition, as a result of our NOL carryforwards, taxable
income generated by the insurance company subsidiaries through June 30, 2009 will provide cash to
the holding company through an intercompany tax allocation agreement through which the insurance
company subsidiaries reimburse the holding company for current tax benefits utilized through
recognition of the NOL carryforwards. Cash could also be made available through the issuance of
securities and loans from financial institutions, although our current credit facility prohibits
the incurrence of additional indebtedness.
State insurance laws limit the amount of dividends that may be paid from the insurance company
subsidiaries. These limitations relate to statutory capital and surplus and net income. In
addition, the National Association of Insurance Commissioners Model Act for risk-based capital
(RBC) provides formulas to determine the amount of statutory capital and surplus that an
insurance company needs to ensure that it has an acceptable expectation of not becoming financially
impaired. A low RBC ratio would prevent an insurance company from paying dividends. Statutory
guidelines suggest that the insurance company subsidiaries should not exceed a ratio of net
premiums written to statutory capital and surplus of 3-to-1. We believe that our insurance company
subsidiaries have sufficient financial resources available to support their net premium writings in
both the short-term and the reasonably foreseeable future.
Based on our December 31, 2007 statutory capital and surplus, our ordinary dividend capacity
for calendar 2008 is approximately $11 million. Such amount is limited however to the amount of
earned surplus, which at March 31, 2008 was approximately $3 million. The timing of dividend
payments during calendar 2008 is affected by the amount of dividend payments made in the preceding
twelve-month period. Therefore, subject to the sufficiency of earned surplus, we are permitted to
pay an ordinary dividend of $6.5 million in October 2008 and an additional $4.5 million in December
2008.
14
We believe that existing cash and investment balances, when combined with anticipated cash
flows as noted above, will be adequate to meet our expected liquidity needs in both the short-term
and the reasonably foreseeable future. Our growth strategy may include possible acquisitions. Any
acquisitions or other unexpected growth opportunities may require external financing, and we may
from time to time seek to obtain external financing. We cannot assure you that additional sources
of financing will be available to us on favorable terms, or at all, or that any such financing
would not negatively impact our results of operations.
Credit Facility
In January 2008, we made a principal prepayment of $5.0 million on our credit facility. The
unpaid balance under our credit agreement as of March 31, 2008 was $4.3 million. We entered into an
amendment to our credit agreement, dated February 6, 2008, that contains less restrictive financial
covenants for future periods. At March 31, 2008, we were in compliance with our financial
covenants.
Critical Accounting Policies
There have been no significant changes, other than those discussed below, to our critical
accounting policies and estimates during the nine months ended March 31, 2008 compared with those
disclosed in Item 7. Managements Discussion and Analysis of Financial Condition and Results of
Operations Critical Accounting Policies included in our Annual Report on Form 10-K for the
fiscal year ended June 30, 2007.
Valuation of deferred tax asset. We maintain income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, whereby deferred
income tax assets and liabilities result from temporary differences. Temporary differences are
differences between the tax basis of assets and liabilities and operating loss and tax credit
carryforwards and their reported amounts in the consolidated financial statements that will result
in taxable or deductible amounts in future years. Valuation of the deferred tax asset is considered
a critical accounting policy because the determination of our ability to utilize the asset involves
a number of management assumptions relating to future operations that could materially affect the
determination of the ultimate value and, therefore, the carrying amount of our deferred tax asset.
After considering the recent declines in premiums written, premiums earned and policies in
force, we assessed the realization of our NOL carryforwards, which comprises the majority of our
deferred tax asset. We concluded at December 31, 2007 that it was appropriate to increase our
valuation allowance for the deferred tax asset related to the NOL carryforwards that expire in
fiscal years 2008 and 2009 by $11.6 million. As in our prior assessments, we considered our
historical and expected taxable income to determine the sufficiency of our valuation allowance. We
remain optimistic about the Companys future outlook and expect to generate taxable income
sufficient to realize our remaining net deferred tax asset. However, our evaluation includes
multiple assumptions and estimates that may change over time. If future taxable income is less than
current projections, an additional valuation allowance may become necessary that could have a
materially adverse impact on our results of operations and financial position. Our updated
evaluation at March 31, 2008 resulted in no adjustment to the valuation allowance. At March 31,
2008, the total gross deferred tax asset was $54.7 million, and the valuation allowance was $37.7
million.
Goodwill and identifiable intangible assets. After considering the recent declines in
premiums written, premiums earned and policies in force, we conducted an interim impairment test in
accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142).
In the event that facts and circumstances indicate that goodwill and other identifiable intangible
assets may be impaired, SFAS 142 requires an evaluation of the recoverability of such assets. The
estimated future discounted cash flows associated with these assets are compared with their
carrying amounts to determine if a write down to market value or discounted cash flow value is
necessary. We evaluated the recent trends in our historical results and expected future discounted
cash flows and concluded that goodwill and other identifiable intangible assets are fully
realizable as of March 31, 2008. However, our evaluation includes multiple assumptions, including
estimated discounted cash flows and estimates that may change over time. If future discounted cash
flows become less than those projected, an impairment charge may become necessary that could have a
materially adverse impact on our results of operations and financial position.
Investments. Our investments are recorded at market value, which is typically based on
publicly available quoted prices. From time to time, the carrying value of our investments may be
temporarily impaired because of the inherent volatility of publicly-traded investments. Management
reviews investments for impairment on a quarterly
15
basis. A decline in the market value of any available-for-sale security below cost that is
deemed to be other-than-temporary would result in a reduction in the carrying amount of the
security to market value. Managements assessment of whether an impairment is other-than-temporary
includes an evaluation of factors such as the credit quality of the investment, the duration of the
impairment, our ability and intent to hold the investment until recovery or maturity and overall
economic conditions. If we determine that the value of an investment is other-than-temporarily
impaired, the impairment would be charged against earnings and a new cost basis for the security
would be established. Our evaluation as of March 31, 2008 resulted in an other-than-temporary
impairment charge of $0.3 million related to certain non-agency mortgage-backed securities in our
investment portfolio. Due to the deterioration in liquidity in the credit markets during the first
calendar quarter of 2008, yields on certain non-agency mortgage-backed securities declined below
projected book yield requiring the $0.3 million impairment under the guidance set forth in EITF
99-20.
Off-Balance Sheet Arrangements
There have been no new off-balance sheet arrangements since June 30, 2007. Refer to Item 7.
Managements Discussion and Analysis of Financial Condition and Results of Operations -
Off-Balance Sheet Arrangements included in our Annual Report on Form 10-K for the fiscal year
ended June 30, 2007.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements made in the report, other than statements of historical fact, are
forward-looking statements. You can identify these statements from our use of the words may,
should, could, potential, continue, plan, forecast, estimate, project, believe,
intent, anticipate, expect, target, is likely, will, or the negative of these terms,
and similar expressions. These statements are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. These forward-looking statements may include,
among other things:
|
|
|
statements and assumptions relating to future growth, income, income per share and
other financial performance measures, as well as managements short-term and long-term
performance goals; |
|
|
|
|
statements relating to the anticipated effects on results of operations or financial
condition from recent and expected developments or events; |
|
|
|
|
statements relating to our business and growth strategies; and |
|
|
|
|
any other statements or assumptions that are not historical facts. |
We believe that our expectations are based on reasonable assumptions. However, these
forward-looking statements involve known and unknown risks, uncertainties and other important
factors that could cause our actual results, performance or achievements, or industry results to
differ materially from our expectations of future results, performance or achievements expressed or
implied by these forward-looking statements. In addition, our past results of operations do not
necessarily indicate our future results. We discuss these and other uncertainties in Item 1A.
Risk Factors of our Annual Report on Form 10-K for the fiscal year ended June 30, 2007.
You should not place undue reliance on any forward-looking statements. These statements speak
only as of the date of this report. Except as otherwise required by applicable laws, we undertake
no obligation to publicly update or revise any forward-looking statements or the risk factors
described in this report, whether as a result of new information, future events, changed
circumstances or any other reason after the date of this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have an exposure to interest rate risk relating to fixed maturity investments. Changes in
market interest rates directly impact the market value of the fixed maturity securities. Some fixed
income securities have call or prepayment options. This subjects us to reinvestment risk as issuers
may call their securities, which could result in us reinvesting the proceeds at lower interest
rates. We manage exposure to interest rate risks by adhering to specific guidelines in connection
with our investment portfolio. We invest primarily in municipal and corporate bonds and
16
collateralized mortgage obligations that have been rated A or better by Standard & Poors. At
March 31, 2008, 79.9% of our investment portfolio was invested in securities rated AA or better
by Standard & Poors and 95.1% in securities rated A or better by Standard & Poors. At March 31,
2008, our exposure with regard to sub-prime mortgage securities was limited to $2.0 million in
fixed maturities that were all rated A or better by Standard & Poors. However, due to the
deterioration in liquidity in the credit markets during the first calendar quarter of 2008, yields
on certain non-agency mortgage-backed securities declined below projected book yield requiring a
$0.3 million other-than-temporary impairment charge during the three months ended March 31, 2008
under the guidance set forth in EITF 99-20. We utilize the services of a professional fixed income
investment manager.
As of March 31, 2008, the impact of an immediate 100 basis point increase in market interest
rates on our fixed maturities portfolio would have resulted in an estimated decrease in fair value
of 4.0%, or approximately $7.6 million. As of the same date, the impact of an immediate 100 basis
point decrease in market interest rates on our portfolio would have resulted in an estimated
increase in fair value of 3.8%, or approximately $7.3 million.
In connection with the Chicago acquisition, we entered into a new $30.0 million credit
facility that included a $25.0 million term loan facility and a $5.0 million revolving facility.
The credit facility was amended in September 2007 to, among other things, reduce the availability
under the revolving facility to $2.0 million. Although we have fixed the interest rate of the term
loan facility through an interest rate swap agreement, we have interest rate risk with respect to
any borrowings under the revolving facility, which bears interest at a floating rate of LIBOR plus
250 basis points. At March 31, 2008, there were no outstanding borrowings under the revolving
facility.
On June 15, 2007, our newly formed wholly-owned unconsolidated trust entity, First Acceptance
Statutory Trust I, used the proceeds from its sale of trust preferred securities to purchase $41.2
million of junior subordinated debentures. The debentures pay a fixed rate of 9.277% until July 30,
2012, after which the rate becomes variable (LIBOR plus 375 basis points).
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Companys chief executive officer and chief financial officer have reviewed and evaluated
the effectiveness of the Companys disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, or Exchange Act) as of
March 31, 2008. Based on that evaluation, the Companys chief executive officer and chief
financial officer have concluded that the Companys disclosure controls and procedures effectively
ensure that information required to be disclosed by the Company in the reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms.
Changes in Internal Control Over Financial Reporting
During the period covered by this report, there has been no change in the Companys internal
control over financial reporting that has materially affected or is reasonably likely to materially
affect the Companys internal control over financial reporting.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to litigation in Alabama and Georgia concerning the Companys sales
practices related to ancillary products currently or formerly sold by the Company in those states.
Keisha Milbry Monday, et al. v. First Acceptance Corp., et al. was filed on February 13, 2007, in
the Circuit Court of Bullock County, Alabama. Solomon and Catherine Warren, et al. v. First
Acceptance Corp., et al. was filed on November 9, 2007, in the Circuit Court of Barbour County,
Alabama. Margaret Franklin v. Vesta Insurance Corp., et al. was filed on July 14, 2006, as a
putative class action in the Circuit Court of Bullock County, Alabama. Carrie Jackson v. Alabama
Acceptance Insurance Agency, Inc. was filed on July 24, 2007, as a putative class action in the
Circuit Court of Bullock County, Alabama. Annette Rush v. Village Auto Insurance Company, Inc.
(now known as First Acceptance Insurance Company of Georgia, Inc.) was filed on October 26, 2005,
as a putative class action in the Superior Court of Fulton County, Georgia. Each of the suits
alleges that the Company implemented a program to convince its consumers who purchased automobile
insurance policies to also purchase automobile club memberships, and seeks unspecified damages and
attorneys fees. The court has not certified classes of plaintiffs in the two Alabama putative class
actions. The Georgia Superior Court certified the class in the Georgia lawsuit in December 2006.
The Georgia Court of Appeals affirmed the class certification decision and the Georgia Supreme
Court denied our Petition for Certiorari in January 2008. The Company recently began class related
discovery in these matters. The Company believes it has meritorious defenses in all of these
actions and has vigorously defended against these claims. The Company has met with counsel for the
plaintiffs to attempt to mediate these disputes and continues to pursue discussions to resolve all
related litigation. An estimate of the ultimate outcome of these claims or lawsuits cannot be made
at this time. Losses incurred as a result of these cases may have a material adverse impact on the
Companys results of operations and financial position.
Item 6. Exhibits
The following exhibits are attached to this report:
31.1 |
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Certification of Chief Executive Officer pursuant to Rule 13a-14(a). |
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31.2 |
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Certification of Chief Financial Officer pursuant to Rule 13a-14(a). |
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32.1 |
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Chief Executive Officers Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 |
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Chief Financial Officers Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements 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.
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FIRST ACCEPTANCE CORPORATION
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May 12, 2008 |
By: |
/s/ Kevin P. Cohn |
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Kevin P. Cohn |
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Senior Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting
Officer) |
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