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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended June 30, 2007
OR
| o | 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)
| Delaware | 75-1328153 | |
| (State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
| incorporation or organization) | ||
| 3322 West End Ave. Ste. 1000, Nashville, Tennessee | 37203 | |
| (Address of principal executive offices) | (Zip Code) |
(615) 844-2800
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of exchange on which registered | |
| Common Stock, $.01 par value per share | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or 15(d) of the Act. Yes o No þ
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
The aggregate market value of the voting stock held by non-affiliates of the registrant, based
on the closing price of these shares on the New York Stock Exchange on December 31, 2006, was
$183,451,664. For the purposes of this disclosure only, the registrant has assumed that its
directors, executive officers and beneficial owners of 5% or more of the registrant’s common stock
are the affiliates of the registrant.
As of September 7, 2007, there were 47,615,289 shares of the registrant’s common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
All of the information called for by Part III of this report is incorporated by reference to
the Definitive Proxy Statement for our 2007 Annual Meeting of Shareholders, which will be held on
November 7, 2007.
FIRST ACCEPTANCE CORPORATION
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FIRST ACCEPTANCE CORPORATION
PART I
Item 1. Business
General
First Acceptance Corporation (the “Company,” “we” or “us”) is a retailer, servicer and
underwriter of non-standard personal automobile insurance based in Nashville, Tennessee. We
currently write non-standard personal automobile insurance in 12 states and are licensed as an
insurer in 13 additional states. Non-standard personal automobile insurance is made available to
individuals who are categorized as “non-standard” because of their inability or unwillingness to
obtain standard insurance coverage due to various factors, including payment history, payment
preference, failure in the past to maintain continuous insurance coverage, driving record and/or
vehicle type, and in most instances who are required by law to buy a minimum amount of automobile
insurance. As of August 31, 2007, we leased and operated 462 retail locations, staffed by
employee-agents. Our employee-agents exclusively sell insurance products either underwritten or
serviced by us.
Our Business Strategy
We have grown as a provider of non-standard personal automobile insurance by adhering to a
focused business model and disciplined execution of our operating strategy. Our business model
includes the following core strategies:
| • | Integrated Operations. To meet the preference of our customers for convenient, personal service, we have integrated the retail distribution, underwriting and service functions of personal automobile insurance into one system. By doing so, we are able to provide prompt and personal service to meet effectively the insurance needs of our customers, while capturing revenue that would otherwise be shared with several participants under a traditional, non-integrated insurance business model. Our integrated model is supported by both point of sale agency and back office systems. | ||
| • | Extensive Office Network. We emphasize the use of employee-agents as the cornerstone of our customer relationship. We believe our customers value face-to-face contact, speed of service and convenient locations. Consequently, we train our employee-agents to cultivate client relationships and utilize real-time service and information enabled by access to our information systems. As of August 31, 2007, we leased and operated 462 retail sales offices staffed with our employee-agents and strategically located in geographic markets to reach and service our customers. | ||
| • | Favorable Customer Payment Plans. Our customers can initiate insurance coverage with a modest down payment. Any remaining premium is paid in monthly installments over the term of the policy. We believe this modest initial payment and favorable payment plan is a major factor in our success in meeting the market demand for low monthly insurance payments. | ||
| • | Strong Sales and Marketing. We build brand recognition and generate valuable sales leads through extensive use of television advertising, Yellow Pages® advertisements and a broad network of retail sales offices. | ||
| • | Efficient Systems. We have developed systems that enable timely and efficient communication and data sharing among the various segments of our integrated operations. All of our retail sales office computers transmit information directly to our central processing computer where policy information, customer profiles, risk assessment and underwriting criteria are entered and stored in our database. |
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Our Business Model
We believe our operations benefit from our ability to identify and satisfy the needs of our
target customers and eliminate many of the inefficiencies associated with a traditional automobile
insurance model. We have developed our business model by drawing on significant experience in the
auto insurance industry. We are a vertically integrated business that acts as the agency, servicer
and underwriter of non-standard personal automobile insurance. We own three insurance company
subsidiaries: First Acceptance Insurance Company, Inc. (“FAIC”), First Acceptance Insurance
Company of Georgia, Inc. (“FAIC-GA”) and First Acceptance Insurance Company of Tennessee, Inc.
(“FAIC-TN”). Our retail locations are staffed by employee-agents who exclusively sell insurance
products underwritten by us. Our vertical integration, combined with our conveniently located
retail locations, enables us to control the point of sale and to retain significant revenue that
would otherwise be lost in a traditional, non-integrated insurance business model. We generate
additional revenue by fully servicing our book of business, which often allows us to collect
policy, billing and other fees.
Our strategy is to offer customers automobile insurance with low down payments, competitive
equal monthly payments, convenient locations and a high level of personal service. This strategy
makes it easier for our customers to obtain automobile insurance, which is legally mandated in the
states in which we currently operate. In addition, we accept customers for our insurance who have
previously terminated coverage provided by us without imposing any additional requirements on such
customers. Currently, our policy renewal rate (the percentage of policies that are renewed after
completion of the full uninterrupted policy term) is approximately 35%, which, due to the payment
patterns of our customers, is lower than the average renewal rate of standard personal automobile
insurance providers. We are able to accept a low down payment because we process all business
through our systems. Our business model and systems allow us to issue policies efficiently and,
when necessary, cancel them to minimize the potential for credit loss while adhering to regulatory
cancellation notice requirements.
In addition to a low down payment and competitive monthly rates, we offer customers valuable
face-to-face contact and speed of service. Many of our customers prefer not to conduct business via
the internet or over the telephone. Substantially all of our customers make their payments at our
retail locations. For these consumers, our employee-agents are not only the face of our company,
but also the preferred interface for buying insurance.
Our ability to process business quickly and accurately gives us an advantage over more
traditional insurance companies that produce business using independent agents. Our policies are
issued at the point of sale, and applications are processed within two business days, as opposed to
the two or more weeks that is often typical in the auto insurance industry. The traditional
automobile insurance model typically involves interaction and paperwork exchange between the
insurance company, independent agent and premium finance provider. This complicated interaction
presents numerous opportunities for miscommunication, delays or lost information. Accordingly, we
believe that some of our competitors who rely on the traditional model and independent agents
cannot match our efficiency in serving our customer base.
We believe that another distinct advantage of our model over the traditional independent
agency approach is that our employee-agents offer a single non-standard insurance product as
opposed to many products from many insurance companies. The typical independent agent selling
non-standard personal automobile insurance generally has multiple non-standard insurance companies
and premium finance sources from which to quote based on agent commission, price and other factors.
This means that insurance companies using the independent agent model must compete to provide the
most attractive agent commissions and absolute lowest prices to encourage the independent agent to
sell their product. Our employee-agents sell our products exclusively. Therefore, we do not have
to compete for the attention of those distributing our product on the basis of agent commissions,
price or other factors.
Personal Automobile Insurance Market
Personal automobile insurance is the largest line of property and casualty insurance in the
United States. According to A.M. Best, for the year ended December 31, 2006, the total premiums
paid in the non-standard automobile market segment in the United States were approximately $37
billion, representing approximately 22% of the total personal automobile insurance market. Personal
automobile insurance provides drivers with coverage for liability to others for bodily injury and
property damage and for physical damage to the driver’s vehicle from collision and other perils.
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The market for personal automobile insurance is generally divided into three product segments:
non-standard, standard and preferred insurance. Non-standard personal automobile insurance is
designed to be attractive to drivers who prefer to purchase only the minimum amount of coverage
required by law or to minimize the required payment each payment period.
Our Products
Our core business involves issuing automobile insurance policies to individuals who are
categorized as “non-standard,” based primarily on their inability or unwillingness to obtain
coverage from standard carriers due to various factors, including their need for monthly payment
plans, failure to maintain continuous insurance coverage or driving record. We believe that a
majority of our customers seek non-standard insurance due to their failure to maintain continuous
coverage or their need for affordable monthly payments, rather than as a result of poor driving
records. The majority of our customers purchase the minimum amount of coverage required by law.
The average six-month premium on our policies currently in force is $678. We allow most
customers to pay for their insurance with an initial down payment and five equal monthly
installments, which include a billing fee. We believe that our target customers prefer lower down
payments and level monthly payments over the payment options traditionally offered by other
non-standard providers. Because our proprietary technology enables us to control all aspects of
servicing our insurance policies, we can generally cancel the policy of a customer who fails to
make a payment, without incurring a credit loss, while remaining within the regulatory cancellation
guidelines.
We use a single “product template” as the basis for our rates, rules and forms. Product
uniformity simplifies our business and allows speed to market when entering a new state, modifying
an existing program or introducing a new program. In addition, our retail agents, underwriters and
claims adjusters only need to be trained in one basic set of underwriting guidelines and one basic
auto policy. Programming and systems maintenance also is simplified because we have one basic
product.
In addition to non-standard personal automobile insurance, we also offer our customers
optional products and policies that provide ancillary reimbursements and benefits in the event of
an automobile accident. Those products and policies generally provide reimbursements for medical
expenses and hospital stays as a result of injuries sustained in an automobile accident, automobile
towing and rental, bail bond premiums and ambulance services.
Our Growth Strategy
During fiscal 2007 we focused our efforts on developing our emerging states and anticipate
this to continue into fiscal 2008. When appropriate we will, however, explore growth opportunities
primarily through three strategies:
| • | Increase the Number of Customers in Existing Geographic Markets. We intend to work to continue to increase the number of our customers through advertising campaigns and we may open new retail sales offices in some of the states where we currently do business. We believe that the number of our customers will also increase as our recently-added sales offices continue to add new customers. | ||
| • | Expand into New Geographic Markets. We currently operate in 12 states and are licensed as an insurer in 13 additional states. We may expand into additional states through the opening of new sales offices and through selective acquisitions. | ||
| • | Pursue Acquisitions of Local Agencies. We may selectively pursue acquisitions of local agencies who write non-standard automobile insurance for other insurance companies in our existing markets and in new markets. During 2006, we completed the acquisition of a local insurance agency operation in Chicago, Illinois and in 2005 we completed a similar acquisition in Texas. |
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Competition
The non-standard personal automobile insurance business is highly competitive. Based upon data
compiled from A.M. Best, we believe that, as of December 31, 2006, ten insurance groups accounted
for approximately 71% of the approximately $37 billion non-standard personal automobile insurance
market segment. We are not a member of these groups. We believe that our primary competition comes
not only from national companies or their subsidiaries, but also from non-standard insurers and
independent agents that operate in specific regions or states. We compete against other vertically
integrated insurance companies and independent agencies that market insurance on behalf of a number
of insurers. We compete with these other insurers on factors such as initial down payment,
availability of monthly payment plans, price, customer service and claims service. We believe that
our significant competitors are the Allstate insurance group, the Berkshire Hathaway insurance
group (including GEICO), the Bristol West insurance group, the Direct General insurance group, the
Infinity insurance group, the Progressive insurance group, the AIG insurance group, and the State
Farm insurance group.
Marketing and Distribution
Our marketing strategy is based on promoting brand recognition of our product and encouraging
prospective customers to visit one of our retail locations. Our advertising strategy combines
low-cost television advertising with local print media advertising, such as the Yellow Pages®. We
market our business under the name “Acceptance Insurance” in all areas except in the Chicago-area,
where we use the names “Yale” and “Insurance Plus.”
We primarily distribute our products through our retail sales offices. We believe the local
office concept is attractive to most of our customers, as they desire face-to-face assistance they
cannot receive via the internet or over the telephone. Our advertisements promote local phone
numbers that are answered at either the local retail office or one of our regional customer service
centers, which are located in Nashville, Tennessee, Chicago, Illinois and Houston, Texas. We
provide quotes over the telephone highlighting our low down payment and monthly payments, and
direct prospective customers to the nearest local retail office to complete an application. The
entire sales process can be completed at the local retail office where the down payment is
collected and a policy issued. Future payments can be made either at the local office or mailed to
our customer service centers.
During the fiscal year ended June 30, 2007, we generated approximately 97% of our total gross
premiums earned from our retail locations. In select geographic areas in Tennessee, four
independently-owned insurance agencies write non-standard insurance policies through our insurance
company subsidiaries. Although these agencies operate under their own name and transact other
insurance business, they write all of their non-standard automobile business through us using our
information systems.
Underwriting and Pricing
Our underwriting and rating systems are fully automated, including on-line driving records,
where available. We believe that our underwriting and pricing systems provide a competitive
advantage to us because they give us the ability to capture relevant pricing information, improve
efficiencies, increase the accuracy and consistency of underwriting decisions and reduce training
costs. Our systems can be modified easily on a state-by-state basis to reflect new rates and
underwriting guidelines.
We set premium rates based on the specific type of vehicle and the driver’s age, gender,
marital status, driving experience and location. We review loss trends in each of the states in
which we operate to identify changes in the frequency and severity of accidents and to assess the
adequacy of our rates and underwriting standards. We adjust rates periodically, as necessary and as
permitted by applicable regulatory authorities, to maintain or improve underwriting profit margins
in each market.
Claims Handling
Non-standard personal automobile insurance customers generally have a higher frequency of
claims than preferred and standard insurance customers. We focus on controlling the claims process
and costs, thereby limiting losses, by internally managing the entire claims process. We strive to
promptly assess claims, manage against fraud, and identify loss trends and capture information that
is useful in establishing loss reserves and determining premium
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rates. Our claims process is
designed to promote expedient, fair and consistent claims handling, while controlling loss
adjustment expenses.
As of June 30, 2007, our claims operation had a staff of approximately 340 employees,
including adjusters, appraisers, re-inspectors, special investigators and claims administrative
personnel. We conduct our claims operations out of our Nashville office and through regional claims
offices in Tampa, Florida, Chicago, Illinois and Irving, Texas. Our employees handle all claims
from the initial report of the claim until the final settlement. We believe that directly employing
claims personnel, rather than using independent contractors, results in improved customer service,
lower loss payments and lower loss adjustment expenses. In territories where we do not believe a
staff appraiser would be cost-effective, we utilize the services of independent appraisers to
inspect physical damage to automobiles. The work of independent appraisers is supervised by
regional staff appraisal managers.
While we are strongly committed to settling promptly and fairly the meritorious claims of our
customers and claimants, we are equally committed to defending against non-meritorious claims.
Litigated claims and lawsuits are primarily managed by one of our specially trained litigation
adjusters. Suspicious claims are referred to a special investigation unit. When a dispute arises,
we seek to minimize our claims litigation defense costs by attempting to negotiate flat-fee
representation with outside counsel specializing in automobile insurance claim defense. We believe
that our efforts to obtain high quality claims defense litigation services at a fixed or carefully
controlled cost have helped us control claims losses and expenses.
Loss and Loss Adjustment Expense Reserves
Automobile accidents generally result in insurance companies making payments (referred to as
“losses”) to individuals or companies to compensate for physical damage to an automobile or other
property and/or an injury to a person. Months and sometimes years may elapse between the occurrence
of an accident, report of the accident to the insurer and payment of the claim. Insurers record a
liability for estimates of losses that will be paid for accidents reported to them, which are
referred to herein as case reserves. In addition, because accidents are not always reported
promptly, insurers estimate incurred but not reported, or IBNR, reserves to cover these expected
losses. Insurers also incur expenses in connection with the handling and settling of claims that
are referred to as “loss adjustment expenses” and record a liability for the estimated costs to
settle their expected unpaid losses.
We are directly liable for loss and loss adjustment expenses under terms of the insurance
policies underwritten by our insurance company subsidiaries. Each of our insurance company
subsidiaries establishes a reserve for all unpaid losses, both case and IBNR reserves, and
estimates for the cost to settle the claims. We estimate our IBNR reserves by estimating our
ultimate liability for loss and loss adjustment expense reserves first, and then reducing that
amount by the amount of the cumulative paid claims and by the amount of our case reserves. We rely
primarily on historical loss experience in determining reserve levels on the assumption that
historical loss experience provides a good indication of future loss experience. Other factors,
such as inflation, settlement patterns, legislative activity and litigation trends, are also
considered. With the assistance of our internal actuarial staff, we review our loss and loss
adjustment expense reserve estimates on a quarterly basis and adjust those reserves each quarter to
reflect any favorable or unfavorable development as experience develops or new information becomes
known.
We have experienced rapid and significant growth in recent years, primarily as a result of
expansion into new states which has made the process of estimating reserves more difficult relative
to the larger, more mature states. In these new states we initially establish our reserves using
our loss experience from other states that we perceive as being similar. As our historical loss
experience in these new states continues to develop, we revise our estimates accordingly. As a
result, we have experienced volatility in our reported loss and loss adjustment expense that has
directly impacted our results of operations and financial condition.
We periodically review our methods of establishing case and IBNR reserves and update them if
necessary. Our internal actuarial staff, which includes a fully-credentialed actuary, performs
quarterly comprehensive reviews of reserves and loss trends. We also engaged an independent
actuarial firm to assess the reasonableness of our reserve estimates at June 30, 2007. We believe
that the liabilities that we have recorded for unpaid losses and loss adjustment expenses at June
30, 2007 are adequate to cover the final net cost of losses and loss adjustment expenses incurred
through that date.
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The table below sets forth the year-end reserves since the Company began operations as an
insurance company with the 2004 acquisition of USAuto Holdings, Inc. (“USAuto”) and the subsequent
development of these reserves through June 30, 2007. The purpose of the table is to show a
“cumulative deficiency or redundancy” for each year which represents the aggregate amount by which
original estimates of reserves as of that year-end have changed in subsequent years. The top line
of the table presents the net reserves at the balance sheet date for each of the years indicated.
This represents the estimated amounts of losses and loss adjustment expenses for claims arising in
all years that were unpaid at the balance sheet date, including losses that had been incurred but
not yet reported as of the end of each successive year with respect to those claims. The next
portion of the table presents the re-estimated amount of the previously recorded reserves based on
experience as of the end of each succeeding year, including cumulative payments since the end of
the respective year. As more information becomes known about the payments and the frequency and
severity of claims for individual years, the estimate changes accordingly. Favorable loss
development, shown as a cumulative redundancy in the table, exists when the original reserve
estimate is greater than the re-estimated reserves. Adverse loss development, which would be shown
as a cumulative deficiency in the table, exists when the original reserve estimate is less than the
re-estimated reserves. Information with respect to the cumulative development of gross reserves,
without adjustment for the effect of reinsurance, also appears at the bottom portion of the table.
In evaluating the information in the table below, you should note that each amount entered
incorporates the cumulative effect of all changes in amounts entered for prior periods. In
addition, conditions and trends that have affected the development of liability in the past may not
necessarily recur in the future.
| At June 30 (in thousands) | 2004 | 2005 | 2006 | 2007 | ||||||||||||
Net liability for loss and loss
adjustment expense reserves, originally
estimated |
$ | 18,137 | $ | 39,289 | $ | 61,521 | $ | 91,137 | ||||||||
Cumulative amounts paid as of: |
||||||||||||||||
One year later |
13,103 | 28,024 | 51,420 | |||||||||||||
Two years later |
16,579 | 34,754 | ||||||||||||||
Three years later |
17,795 | |||||||||||||||
Liability re-estimated as of: |
||||||||||||||||
One year later |
17,781 | 37,741 | 65,386 | |||||||||||||
Two years later |
17,244 | 38,226 | ||||||||||||||
Three years later |
16,973 | |||||||||||||||
Net cumulative redundancy (deficiency) |
1,164 | 1,063 | (3,865 | ) | ||||||||||||
Gross liability — end of year |
$ | 30,434 | $ | 42,897 | $ | 62,822 | $ | 91,446 | ||||||||
Reinsurance receivables |
12,297 | 3,608 | 1,301 | 309 | ||||||||||||
Net liability — end of year |
$ | 18,137 | $ | 39,289 | $ | 61,521 | $ | 91,137 | ||||||||
Gross re-estimated liability — latest |
$ | 29,233 | $ | 41,524 | $ | 66,458 | ||||||||||
Re-estimated reinsurance receivables —
latest |
12,260 | 3,298 | 1,072 | |||||||||||||
Net re-estimated — latest |
$ | 16,973 | $ | 38,226 | $ | 65,386 | ||||||||||
Gross cumulative redundancy (deficiency) |
$ | 1,201 | $ | 1,373 | $ | (3,636 | ) | |||||||||
At June 30, 2007, we had $91.4 million of loss and loss adjustment expense reserves, which
included $50.1 million in IBNR reserves and $41.3 million in case reserves, all related to our
non-standard personal automobile insurance business. Through September 1, 2004, we maintained
quota-share reinsurance, the run-off of which resulted in a reinsurance receivable of $0.3 million
that is offset against the gross reserves of $91.4 million in
the above table. For a
reconciliation of net loss and loss adjustment expense reserves from the beginning to the end of
the year for the last two fiscal years, see Note 9 to our consolidated financial statements.
As shown above, for the year ended June 30, 2007, we experienced an adverse net reserve
development of $3.9 million. This adverse development increased our loss and loss adjustment
expense reserves for prior accident years and decreased our income before income taxes for the 2007
fiscal year. We believe that this development was attributable to (i) the inherent imprecision in
estimating reserves, (ii) the limited historical loss experience in our new states which requires
more judgment in determining our loss reserve estimates for those states and (iii) an
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increase in
paid frequency in Florida related to the Bodily Injury (“BI”) and Personal Injury Protection
(“PIP”) coverages.
During fiscal 2007, losses for the current accident year were adversely affected by
unanticipated volatility, primarily higher severity, in our newer states. We also experienced
volatility as a result of an unanticipated change in severity from a greater occurrence of large
losses (losses of $10,000 or above) in our mature states. To a lesser extent, we experienced an increase in losses
for the current year as a result of a change in our business mix resulting from premium growth in
our emerging states. As a result of the effect of these
factors on our anticipated development, we experienced an increase in our loss ratio from 67.5% in
fiscal 2006 to 80.4% in fiscal 2007.
For the fiscal year ended June 30, 2007, our loss and loss adjustment expense reserves were
determined by our internal actuary. Loss and loss adjustment expense reserve estimates were
reviewed on a quarterly basis and adjusted each quarter to reflect any favorable or adverse
development. Development assumptions were based upon historical accident quarters. We analyzed our
reserves for each type of coverage, by state and for loss and loss adjustment expense to determine
our loss and loss adjustment expense reserves. To determine the best estimate, we reviewed the
results of five estimation methods, including the incurred development method, the paid development
method, the incurred Bornhuetter-Ferguson method, the paid Bornhuetter-Ferguson method, and the
counts/averages method for each set of data. Each review developed a point estimate for a subset
of our business. We did not prepare separate point estimates for our entire business using each of
the estimation methods. In determining our loss and loss adjustment expense reserves, we selected
different estimation methods as appropriate for the various subsets of our business, and the method
selected varied by coverage and by state, and considerations included the number and value of the
case reserves for open claims, incurred and paid loss relativities, and suspected biases for each
of the procedures. Other factors considered in establishing reserves include assumptions regarding
loss frequency and loss severity. We believe assumptions regarding loss frequency are reliable
because injured parties generally report their claims within a reasonably short period of time
after an accident. Loss severity is more difficult to estimate because severity is affected by
changes in underlying costs, including medical costs, jury verdicts and regulatory changes.
Based upon the foregoing, we calculated a single point estimate of our net loss and loss
adjustment expense reserves as of June 30, 2007. We believe that estimate is our best estimate of
our loss and loss adjustment expense reserves at June 30, 2007. The loss and loss adjustment
expense reserves in our financial statements for the fiscal year ended June 30, 2007 are equal to
the estimate determined by our internal actuary and were determined to be reasonable by an
independent actuarial firm.
We believe the estimate regarding changes in loss severity is the most significant factor
impacting the IBNR estimate. We believe that a one percent (1%) increase or decrease over the
expected change in loss severity is reasonably likely. A one percent (1%) increase over the
expected change in loss severity would result in adverse development of net loss and loss
adjustment expense reserve levels at June 30, 2007 of approximately $6.1 million. Conversely, a
one percent (1%) decrease in the expected change in loss severity would result in favorable
development of net loss and loss adjustment expense reserve levels at June 30, 2007 of
approximately $6.0 million.
Reinsurance
Reinsurance is an arrangement in which a company called a reinsurer agrees in a contract,
often referred to as a treaty, to assume specified risks written by an insurance company, known as
a ceding company, by paying the insurance company all or a portion of the insurance company’s
losses arising under specified classes of insurance policies. Insurance companies like us can use
reinsurance to reduce their exposures, to increase their underwriting capacity and to manage their
capital more efficiently. Through August 31, 2004, our insurance companies relied on quota-share
reinsurance to maintain our exposure to loss at or below a level that was within the capacity of
our capital resources. In quota-share reinsurance, the reinsurer agrees to assume a specified
percentage of the ceding company’s losses arising out of a defined class of business (for example,
50% of all losses arising from non-standard personal automobile insurance written in a particular
state in a particular year) in exchange for a corresponding percentage of premiums, less a ceding
commission as compensation for underwriting costs incurred by the ceding company.
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Historically, our insurance companies ceded a portion of their non-standard personal
automobile insurance premiums and losses to unaffiliated reinsurers in accordance with these
contracts. Through August 2004, we had in place a quota share treaty whereby we ceded approximately
50% of the premiums written by our insurance company subsidiaries. Effective September 2004, as a
result of available liquidity to increase the statutory capital and surplus of our insurance
company subsidiaries, we non-renewed our quota-share reinsurance treaty. In addition, to reduce
exposure for certain catastrophic events, through April 2006, we maintained excess-of-loss
reinsurance coverage that provided us with coverage for losses up to $4 million less our retention
of the first $1 million per event. Effective April 2006, we elected to not renew this reinsurance.
Prior to May 2005, our insurance company subsidiaries were not licensed in the State of
Alabama and therefore, through quota-share reinsurance, we assumed a percentage of the premiums our
managing general agency subsidiary wrote in Alabama on behalf of two other insurance companies. In
May 2005, we obtained an insurance license in Alabama and began writing policies there through one
of our insurance company subsidiaries. Although FAIC is licensed in Texas, some of our business
there is currently written by a managing general agency subsidiary through a county mutual
insurance company and is assumed by us through 100% quota-share reinsurance.
At June 30, 2007, our reinsurance receivables totaled $0.3 million, which reflects the run-off
of the quota-share reinsurance. All reinsurance receivables were unsecured and due from
Transatlantic Reinsurance Company, a member of American International Group, Inc., which is rated
“A+ (Superior)” by A.M. Best.
Technology
The effectiveness of our business model depends in part on the effectiveness of our
internally-developed information technology systems. Our information systems enable timely and
efficient communication and data-sharing among the various segments of our integrated operations,
including our retail sales offices, insurance underwriters and claims processors. We believe that
this sharing capability provides us with a competitive advantage over many of our competitors, who
must communicate with unaffiliated premium finance companies and with a large number of independent
agents, many of whom use different recordkeeping and information systems that may not be fully
compatible with the insurance company’s systems.
Sales Office Automation. We have emphasized standardization and integration of our systems
among our subsidiaries to facilitate the automated capture of information at the earliest point in
the sales cycle. All of our retail sales offices transmit information directly to our central
office where policy information is added to our systems with little additional handling. Our sales
offices also have immediate access to current information on policies through a common network
interface or through a distributed database downloaded from our central office. Our systems enable
our retail sales offices to process new business, renewals and endorsements and issue policies,
declaration pages and identification cards.
Payment Processing. Most of our customers visit our sales offices at least once a month to
make a payment on their policies. System-generated receipts are required for all payments
collected in our sales offices. Our sales offices generate balancing reports at the end of each
day, prepare bank deposit documents and transmit electronically all payment records to our central
office. Bank deposits are also made electronically through the use of check-imaging technology.
Typically, payments are automatically applied to the applicable policies during the night following
their collection in our sales offices. This results in fewer notices of intent to cancel being
generated and fewer policies being cancelled that must be reinstated if a customer’s late payment
is processed after cancellation. We believe that our payment processing methods reduce mailing
costs and limit unwarranted policy cancellations.
Ratings
In December 2006, A.M. Best, which rates insurance companies based on factors of concern to
policyholders, reaffirmed the ratings of our property and casualty insurance company subsidiaries
at “B (Fair).” FAIC-TN did not commence operations until January 2007 and is currently not rated.
The “B (Fair)” rating is the seventh highest rating amongst a scale of 15 ratings, which currently
range from “A++ (Superior)” to “F (In Liquidation).” Publications of A.M. Best indicate that the
“B (Fair)” rating is assigned to those companies that in A.M. Best’s opinion have a fair ability to
meet their ongoing obligations to policyholders, but are financially vulnerable to adverse changes
in underwriting and economic conditions. In evaluating a company’s financial and
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operating
performance, A.M. Best reviews the company’s profitability, leverage and liquidity, as well as its
book of business, the adequacy and soundness of its reinsurance, the quality and estimated market
value of its assets, the adequacy of its loss reserves, the adequacy of its surplus, its capital
structure, the experience and competence of its management and its market presence. A.M. Best’s
ratings reflect its opinion of an insurance company’s financial strength, operating performance and
ability to meet its obligations to policyholders, and are not recommendations to potential or
current investors to buy, sell or hold our common stock.
Financial institutions and reinsurance companies sometimes use the A.M. Best ratings to help
assess the financial strength and quality of insurance companies. The current ratings of our
property and casualty insurance subsidiaries or their failure to maintain such ratings may dissuade
a financial institution or reinsurance company from conducting business with us or increase our
interest or reinsurance costs. We do not believe that the majority of our customers are motivated
to purchase our products and services based on our A.M. Best rating.
Regulatory Environment
Insurance Company Regulation. We and our insurance company subsidiaries are regulated by
governmental agencies in the states in which we conduct business and by various federal statutes
and regulations. These state regulations vary by jurisdiction but, among other matters, usually
involve:
| • | regulating premium rates and forms; | ||
| • | setting minimum solvency standards; | ||
| • | setting capital and surplus requirements; | ||
| • | licensing companies, agents and, in some states, adjusters; | ||
| • | setting requirements for and limiting the types and amounts of investments; | ||
| • | establishing requirements for the filing of annual statements and other financial reports; | ||
| • | conducting periodic statutory examinations of the affairs of insurance companies; | ||
| • | requiring prior approval of changes in control and of certain transactions with affiliates; | ||
| • | limiting the amount of dividends that may be paid without prior regulatory approval; and | ||
| • | setting standards for advertising and other market conduct activities. |
Required Licensing. We operate under licenses issued by various state insurance authorities.
Such licenses may be of perpetual duration or periodically renewable, provided we continue to meet
applicable regulatory requirements. The licenses govern, among other things, the types of insurance
coverages and products that may be offered in the licensing state. Such licenses are typically
issued only after an appropriate application is filed and prescribed criteria are met. All of our
licenses are in good standing. Currently, we hold property and liability insurance licenses in the
following 25 states:
Alabama
|
Missouri | |
Arizona
|
Nevada | |
Arkansas
|
New Mexico | |
Colorado
|
Ohio | |
Florida
|
Oklahoma | |
Georgia
|
Pennsylvania | |
Illinois
|
South Carolina | |
Indiana
|
Tennessee | |
Iowa
|
Texas | |
Kansas
|
Utah |
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Kentucky
|
Virginia | |
Louisiana
|
West Virginia | |
Mississippi |
In addition, as required by our current operations, we hold a managing general agency license
in Texas and motor club licenses in Mississippi and Tennessee. To expand into a new state or offer
a new line of insurance or other new product, we must apply for and obtain the appropriate
licenses.
Insurance Holding Company Regulation. We operate as an insurance holding company system and
are subject to regulation in the jurisdictions in which our insurance company subsidiaries conduct
business. These regulations require that each insurance company in the holding company system
register with the insurance department of its state of domicile and furnish information concerning
the operations of companies within the holding company system which may materially affect the
operations, management or financial condition of the insurers within the holding company domiciled
in that state. We have insurance company subsidiaries that are organized and domiciled under the
insurance statutes of Texas, Georgia and Tennessee. The insurance laws in each of these states
similarly provide that all transactions among members of a holding company system be done at arm’s
length and be shown to be fair and reasonable to the regulated insurer. Transactions between
insurance company subsidiaries and their parents and affiliates typically must be disclosed to the
state regulators, and any material or extraordinary transaction requires prior approval of the
applicable state insurance regulator. In addition, a change of control of a domestic insurer or of
any controlling person requires the prior approval of the state insurance regulator. In general,
any person who acquires 10% or more of the outstanding voting securities of the insurer or its
parent company is presumed to have acquired control of the domestic insurer. To the best of our
knowledge, we are in compliance with the regulations discussed above.
Restrictions on Paying Dividends. In the future, we may need to rely on dividends from our
insurance company subsidiaries to meet corporate cash requirements. State insurance regulatory
authorities require insurance companies to maintain specified levels of statutory capital and
surplus. The amount of an insurer’s capital and surplus following payment of any dividends must be
reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial
needs. Prior approval from state insurance regulatory authorities is generally required in order
for an insurance company to declare and pay extraordinary dividends. The payment of ordinary
dividends is limited by the amount of capital and surplus available to the insurer, as determined
in accordance with state statutory accounting practices and other applicable limitations. State
insurance regulatory authorities that have jurisdiction over the payment of dividends by our
insurance company subsidiaries may in the future adopt statutory provisions more restrictive than
those currently in effect. See Note 19 to our consolidated financial statements for a discussion
of the ability of our insurance company subsidiaries to pay dividends.
Regulation of Rates and Policy Forms. Most states in which our insurance company subsidiaries
operate have insurance laws that require insurance companies to file premium rate schedules and
policy or coverage forms for review and approval. In many cases, such rates and policy forms must
be approved prior to use. State insurance regulators have broad discretion in judging whether an
insurer’s rates are adequate, not excessive and not unfairly discriminatory. Generally, property
and casualty insurers are unable to implement rate increases until they show that the costs
associated with providing such coverage have increased. The speed at which an insurer can change
rates in response to competition or increasing costs depends, in part, on the method by which the
applicable state’s rating laws are administered. There are three basic rate administration systems:
(i) the insurer must file and obtain regulatory approval of the new rate before using it; (ii) the
insurer may begin using the new rate and immediately file it for regulatory review; or (iii) the
insurer may begin using the new rate and file it within a specified period of time for regulatory
review. Under all three rating systems, the state insurance regulators have the authority to
disapprove the rate subsequent to its filing. Thus, insurers who begin using new rates before the
rates are approved may be required to issue premium refunds or credits to policyholders if the new
rates are ultimately deemed excessive and disapproved by the applicable state insurance
authorities. In addition, in some states there has been pressure in the past years to reduce
premium rates for automobile and other personal insurance or to limit how often an insurer may
request increases for such rates. To the best of our knowledge, we are in compliance with all such
applicable rate regulations.
Guaranty Funds. Under state insurance guaranty fund laws, insurers doing business in a state
can be assessed for certain obligations of insolvent insurance companies to policyholders and
claimants. Maximum contributions required by law in any one year vary between 1% and 2% of annual
premiums written in that state. In
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most states guaranty fund assessments are recoverable either
through future policy surcharges or offsets to state premium tax liability. To date, we have not
received any material unrecoverable assessments.
Investment Regulation. Our insurance company subsidiaries are subject to state laws and
regulations that require diversification of their investment portfolios and limitations on the
amount of investments in certain categories. Failure to comply with these laws and regulations
would cause non-conforming investments to be treated as non-admitted assets for purposes of
measuring statutory policyholders’ surplus and, in some instances, would require divestiture. If a
non-conforming asset is treated as a non-admitted asset, it would lower the affected subsidiary’s
policyholders’ surplus and thus, its ability to write additional premiums and pay dividends. To the
best of our knowledge, our insurance company subsidiaries are in compliance with all such
investment regulations.
Restrictions on Cancellation, Non-Renewal or Withdrawal. Many states have laws and
regulations that limit an insurer’s ability to exit a market. For example, certain states limit an
automobile insurer’s ability to cancel or not renew policies. Some states prohibit an insurer from
withdrawing one or more lines of business from the state, except pursuant to a plan approved by the
state insurance department. The state insurance department may disapprove a plan that may lead to
market disruption. Laws and regulations that limit cancellations and non-renewals and that subject
business withdrawals to prior approval requirements may restrict an insurer’s ability to exit
unprofitable markets. To the best of our knowledge, we are in compliance with such laws and
regulations.
Privacy Regulations. In 1999, the United States Congress enacted the Gramm-Leach-Bliley Act,
which protects consumers from the unauthorized dissemination of certain personal information.
Subsequently, the majority of states have implemented additional regulations to address privacy
issues. These laws and regulations apply to all financial institutions, including insurance
companies, and require us to maintain appropriate procedures for managing and protecting certain
personal information of our customers and to fully disclose our privacy practices to our customers.
We may also be exposed to future privacy laws and regulations, which could impose additional costs
and impact our results of operations or financial condition. To the best of our knowledge, we are
in compliance with all current privacy laws and regulations.
Licensing of Our Employee-Agents and Adjusters. All of our employees who sell, solicit or
negotiate insurance are licensed, as required, by the state in which they work, for the applicable
line or lines of insurance they offer. Our employee-agents generally must renew their licenses
annually and complete a certain number of hours of continuing education. In certain states in which
we operate, our insurance claims adjusters are also required to be licensed and are subject to
annual continuing education requirements.
Unfair Claims Practices. Generally, insurance companies, adjusting companies and individual
claims adjusters are prohibited by state statutes from engaging in unfair claims practices which
could indicate a general business practice. Unfair claims practices include, but are not limited
to:
| • | misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue; | ||
| • | failing to acknowledge and act reasonably promptly upon communications regarding claims arising under insurance policies; | ||
| • | failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed; | ||
| • | attempting to settle claims for less than the amount to which a reasonable person would have believed such person was entitled; | ||
| • | attempting to settle claims on the basis of an application that was altered without notice to or knowledge or consent of the insured; | ||
| • | making known to insureds or claimants a policy of appealing from arbitration awards in favor of insureds or claimants for the purpose of compelling them to accept settlements or compromises less than the amount awarded in arbitration; | ||
| • | delaying the investigation or payment of claims by requiring an insured, claimant or the physician of either to submit a preliminary claim report and then requiring the subsequent submission of formal proof of loss forms, both of which submissions contain substantially the same information; |
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| • | failing to settle claims promptly, where liability has become reasonably clear, under one portion of the insurance policy coverage in order to influence settlements under other portions of the insurance policy coverage; and | ||
| • | not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear. |
We set business conduct policies and conduct regular training to make our employee-adjusters
and other claims personnel aware of these prohibitions, and we require them to conduct their
activities in compliance with these statutes. To the best of our knowledge, we have not engaged in
any unfair claims practices.
Quarterly and Annual Financial Reporting. We are required to file quarterly and annual
financial reports with states utilizing statutory accounting practices that are different from
generally accepted accounting principles (“GAAP”), which reflect our insurance subsidiaries on a
going concern basis. The statutory accounting practices used by state regulators, in keeping with
the intent to assure policyholder protection, are generally based on a liquidation concept. For
statutory financial information on our insurance company subsidiaries, see Note 19 to our
consolidated financial statements included in this report.
Periodic Financial and Market Conduct Examinations. The state insurance departments that have
jurisdiction over our insurance company subsidiaries conduct on-site visits and examinations of the
insurers’ affairs, especially as to their financial condition, ability to fulfill their obligations
to policyholders, market conduct, claims practices and compliance with other laws and applicable
regulations. Typically, these examinations are conducted every three to five years. In addition, if
circumstances dictate, regulators are authorized to conduct special or target examinations of
insurers, insurance agencies and insurance adjusting companies to address particular concerns or
issues. The results of these examinations can give rise to regulatory orders requiring remedial,
injunctive or other corrective action on the part of the company that is the subject of the
examination. FAIC has been examined by the Tennessee Department of Commerce and Insurance for
financial condition through December 31, 2001 and for market conduct through December 31, 2003.
FAIC-GA has been examined by the Georgia Department of Insurance for financial condition through
December 31, 2004. FAIC-TN received an organizational examination by the Tennessee Department of
Commerce and Insurance as of December 4, 2006. None of our insurance company subsidiaries has ever
been the subject of a target examination.
Risk-Based Capital. In order to enhance the regulation of insurer solvency, the National
Association of Insurance Commissioners, or “NAIC,” has adopted a formula and model law to implement
risk-based capital, or “RBC,” requirements designed to assess the minimum amount of statutory
capital that an insurance company needs to support its overall business operations and to ensure
that it has an acceptably low expectation of becoming financially impaired. RBC is used to set
capital requirements based on the size and degree of risk taken by the insurer and taking into
account various risk factors such as asset risk, credit risk, underwriting risk, interest rate risk
and other relevant business risks. The NAIC model law provides for increasing levels of regulatory
intervention as the ratio of an insurer’s total adjusted capital decreases relative to its
risk-based capital, culminating with mandatory control of the operations of the insurer by the
domiciliary insurance department at the so-called mandatory control level. This calculation is
performed on a calendar year basis, and at December 31, 2006,
both FAIC and FAIC-GA maintained an RBC
level that was in excess of an amount that would require any
corrective actions on their part. At
December 31, 2006, FAIC-TN had not yet commenced operations.
RBC is a comprehensive financial analysis system affecting nearly all types of licensed
insurers, including our insurance subsidiaries. It is designed to evaluate the relative financial
condition of the insurer by application of a weighting formula to the company’s assets and its
policyholder obligations. The key RBC calculation is to recast total surplus, after application of
the RBC formula, in terms of an authorized control level RBC. Once the authorized control level RBC
is determined, it is contrasted against the company’s total adjusted capital. A high multiple
generally indicates stronger capitalization and financial strength, while a lower multiple reflects
lesser capitalization and strength. Each state’s statutes also create certain RBC multiples at
which either the company or the regulator must take action. For example, there are four defined RBC
levels that trigger different regulatory events. The minimum RBC level is called the company action
level
RBC and is generally defined as the product of 2.0 and the company’s authorized control level
RBC. The authorized control level RBC is a number determined under the risk-based capital formula
in accordance with certain RBC instructions. Next is a regulatory action level RBC, which is
defined as the product of 1.5 and the company’s authorized control level RBC. Below the regulatory
action level
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RBC is the authorized control level RBC. Finally, there is a mandatory control level
RBC, which means the product of 0.70 and the company’s authorized control level RBC.
As long as the company’s total adjusted capital stays above the company action level RBC
(i.e., at greater than 2.0 times the authorized control level RBC), regulators generally will not
take any corrective action. However, if an insurance company’s total adjusted capital falls below
the company action level RBC, but remains above the regulatory action level RBC, the company is
required to submit an RBC plan to the applicable state regulator(s) that identifies the conditions
that contributed to the substandard RBC level and identifies a remediation plan to increase the
company’s total adjusted capital above 2.0 times its authorized control level RBC. If a company’s
total adjusted capital falls below its regulatory action level RBC but remains above its authorized
control level RBC, then the regulator may require the insurer to submit an RBC plan, perform a
financial examination or analysis on the company’s assets and liabilities, and may issue an order
specifying corrective action for the company to take to improve its RBC number. In the event an
insurance company’s total adjusted capital falls below its authorized control level RBC, the state
regulator may require the insurer to submit an RBC plan or may place the insurer under regulatory
supervision. If an insurance company’s total adjusted capital were to fall below its mandatory
control level RBC, the regulator is obligated to place the insurer under regulatory control, which
could ultimately include, among other actions, administrative supervision, rehabilitation or
liquidation.
As of December 31, 2006, FAIC’s total adjusted capital was 2.7 times its authorized control
level RBC, requiring no corrective action on FAIC’s part. As of December 31, 2006, FAIC-GA’s total
adjusted capital was 3.6 times its authorized control level RBC, requiring no corrective action on
FAIC-GA’s part. At December 31, 2006, FAIC-TN had not yet commenced operations.
IRIS Ratios. The NAIC Insurance Regulatory Information System, or IRIS, is part of a
collection of analytical tools designed to provide state insurance regulators with an integrated
approach to screening and analyzing the financial condition of insurance companies operating in
their respective states. IRIS is intended to assist state insurance regulators in targeting
resources to those insurers in greatest need of regulatory attention. IRIS consists of two phases:
statistical and analytical. In the statistical phase, the NAIC database generates key financial
ratio results based on financial information obtained from insurers’ annual statutory statements.
The analytical phase is a review of the annual statements, financial ratios and other automated
solvency tools. The primary goal of the analytical phase is to identify companies that appear to
require immediate regulatory attention. A ratio result falling outside the usual range of IRIS
ratios is not considered a failing result; rather, unusual values are viewed as part of the
regulatory early monitoring system. Furthermore, in some years, it may not be unusual for
financially sound insurance companies to have several ratios with results outside the usual ranges.
As of December 31, 2006, FAIC had four IRIS ratios outside the usual range and FAIC-GA had one
IRIS ratio outside the usual range as follows:
| • | FAIC had a ratio outside the usual range for high investment yield as the calculated yield was above 6.5%. The calculated yield was 18.9% and was inflated as a result of the inclusion of a dividend received during the year from FAIC-GA. Excluding this dividend, the calculated yield would have been 4.0% which is above the low end of the investment yield range of 3%. | ||
| • | FAIC had a ratio outside of the usual IRIS range for the change in net premiums written, which is plus or minus 33%. Net premiums written increased 82% primarily as the result of FAIC’s growth from the development of recently-added retail locations in Florida and Texas and from the acquisition of retail stores in Chicago, Illinois in January 2006. | ||
| • | FAIC had ratios outside of the usual IRIS range for both the gross and net changes in capital and surplus, which are plus or minus 50% and 25%, respectively. FAIC increased its gross and net capital and surplus by 125% and 83%, respectively, primarily through capital contributions to support its premium growth. The net change in capital and surplus excludes amounts that are paid in. FAIC-GA also had a ratio out of the usual IRIS range for the net change in capital and surplus. On a net basis, FAIC-GA reduced its capital and surplus by 26% which was primarily the result of paying a dividend during the year to FAIC. |
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These IRIS results were provided to regulators on February 23, 2007. Since that date, no
regulatory action has been taken, nor is any such action anticipated.
Employees
As of June 30, 2007, we had approximately 1,350 employees. Our employees are not covered by
any collective bargaining agreements.
Available Information
We file reports with the Securities and Exchange Commission, including Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q, and other reports from time to time. The public may read and
copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E.,
Room 1580, NW, Washington D.C. 20549. The public may obtain information about the operation of the
Public Reference Room on-line at www.sec.gov/info/edgar/prrrules.htm or by calling the SEC at
1-800-SEC-0330. We are an electronic filer, and the SEC maintains an Internet site at www.sec.gov
that contains our reports, proxy and information statements, and other information filed
electronically. These website addresses are provided as inactive textual references only, and the
information provided on those websites is not part of this report and is therefore not incorporated
by reference unless such information is otherwise specifically referenced elsewhere in this report.
Internet Website
The Company maintains an internet website at the following address:
www.firstacceptancecorp.com. The information on the Company’s website is not incorporated by
reference in this Annual Report on Form 10-K. We make available on or through our website certain
reports and amendments to those reports that we file with or furnish to the SEC in accordance with
the Securities Exchange Act of 1934, as amended. These include our annual reports on Form 10-K, our
quarterly reports on Form 10-Q and our current reports on Form 8-K. We make this information
available on our website free of charge as soon as reasonably practicable after we electronically
file the information with, or furnish it to, the SEC.
Item 1A. Risk Factors
Our loss and loss adjustment expenses may exceed our reserves, which would adversely impact our
results of operations and financial condition.
We establish reserves for the estimated amount of claims under terms of the insurance policies
underwritten by our insurance company subsidiaries. The amount of the reserve is determined based
on historical claims information, industry statistics and other factors. The establishment of
appropriate reserves is an inherently uncertain process due to a number of factors, including the
difficulty in predicting the frequency and severity of claims, the rate of inflation, the rate and
direction of changes in trends, ongoing interpretation of insurance policy provisions by courts,
inconsistent decisions in lawsuits regarding coverage and broader theories of liability. Any
changes in claims settlement practices can also lead to changes in loss payment patterns, which are
used to estimate reserve levels. Recently, our ability to accurately estimate our loss and loss
adjustment expense reserves has been made more difficult by our rapid growth and entry into new
states. If our reserves prove to be inadequate, we will be required to increase our loss reserves
and the amount of any such increase would reduce our income in the period that the deficiency is
recognized. The historic development of reserves for loss and loss adjustment expenses may not
necessarily reflect future trends in the development of these amounts. Consequently, our actual
losses could materially exceed our loss reserves, which would have a material adverse effect on our
results of operations and financial condition.
Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.
Based on our calculations and in accordance with the rules stated in the Internal Revenue Code
of 1986, as amended (the “Code”), we do not believe that any “ownership change,” as described in
the following paragraph and as defined in Section 382 of the Code, has occurred with respect to our
net operating losses (“NOLs”) and accordingly we believe that there is no existing annual
limitation under Section 382 of the Code on our ability to use
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NOLs to reduce our future taxable
income. We did not obtain, and currently do not plan to obtain, an IRS ruling or opinion of counsel
regarding either of these conclusions.
Generally, an ownership change occurs if certain persons or groups increase their aggregate
ownership of our total capital stock by more than 50 percentage points in any three-year period. If
an ownership change occurs, our ability to use our NOLs to reduce income taxes is limited to an
annual amount (the “Section 382 limitation”) equal to the fair market value of our stock
immediately prior to the ownership change multiplied by the long term tax-exempt interest rate,
which is published monthly by the Internal Revenue Service. In the event of an ownership change,
NOLs that exceed the Section 382 limitation in any year will continue to be allowed as
carryforwards for the remainder of the carryforward period and such excess NOLs can be used to
offset taxable income for years within the carryforward period subject to the Section 382
limitation in each year. Regardless of whether an ownership change occurs, the carryforward period
for NOLs is either 15 or 20 years from the year in which the losses giving rise to the NOLs were
incurred, depending on when those losses were incurred. The earliest losses that gave rise to our
remaining NOLs were incurred in 1993 and will expire in 2008. The most recent losses that gave rise
to our NOLs were incurred in 2003 and will expire in 2023. If the carryforward period for any NOL
were to expire before that NOL had been fully utilized, the use of the unutilized portion of that
NOL would be permanently prohibited. Our use of new NOLs arising after the date of an ownership
change would not be affected by the Section 382 limitation, unless there were another ownership
change after those new NOLs arose.
It is impossible for us to state that an ownership change will not occur in the future. In
addition, limitations imposed by Code Section 382 and the restrictions contained in our certificate
of incorporation may limit our ability to issue additional stock to raise capital or acquire
businesses. To the extent not prohibited by our certificate of incorporation, we may decide in the
future that it is necessary or in our interest to take certain actions that could result in an
ownership change.
Code Section 269 permits the IRS to disallow any deduction, credit or allowance, including the
utilization of NOLs, that otherwise would not be available but for the acquisition of control of a
corporation, including acquisition by merger, for the principal purpose of avoiding federal income
taxes, including avoidance through the use of NOLs. If the IRS were to assert that the principal
purpose of the April 2004 acquisition of USAuto was the avoidance of federal income tax, we would
have the burden of proving that this was not the principal purpose. The determination of the
principal purpose of a transaction is purely a question of fact and requires an analysis of all the
facts and circumstances surrounding the transaction. Courts generally have been reluctant to apply
Code Section 269 where a reasonable business purpose existed for the timing and form of the
transaction, even if the availability of tax benefits was also an acknowledged consideration in the
transaction. We think that Code Section 269 should not apply to the acquisition of USAuto because
we can show that genuine business purposes existed for the USAuto acquisition and that tax
avoidance was not the principal purpose for the merger. Our primary objective of the merger was to
seek long-term growth for our stockholders through an acquisition. To that end, we redeployed a
significant amount of our existing capital and offered our existing stockholders the right to make
a substantial additional investment in the Company to facilitate the acquisition of USAuto. If,
nevertheless, the IRS were to assert that Code Section 269 applied and if such assertion were
sustained, our ability to utilize our existing NOLs would be severely limited or extinguished. Due
to the fact that the application of Code Section 269 is ultimately a question of fact, there can be
no assurance that the IRS would not prevail if it were to assert the application of Code Section
269.
The loss of our President and Chief Executive Officer, Stephen J. Harrison, could negatively affect
our ability to conduct our business efficiently and could lead to loss of customers.
Our success is largely dependent on the skills, experience, effort and performance of our
President and Chief Executive Officer, Stephen J. Harrison. The loss of the services of Mr.
Harrison could have a material adverse effect on us and could hinder our ability to implement our
business strategy successfully. We have an employment agreement with Mr. Harrison that does not
have a fixed term of employment, but may be terminated by us or Mr. Harrison at any time. We also
maintain a “key man” insurance policy for Mr. Harrison.
Our business is highly competitive, which may make it difficult for us to market our core products
effectively and profitably.
The non-standard personal automobile insurance business is highly competitive. We believe that
our primary insurance company competition comes not only from national insurance companies or their
subsidiaries, but
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also from non-standard insurers and independent agents that operate in a specific
region or single state in which we also operate. We believe that our significant competitors are
the Allstate insurance group, the Berkshire Hathaway insurance group (including GEICO), the Bristol
West insurance group, the Direct General insurance group, the Infinity insurance group, the
Progressive insurance group, the AIG insurance group, and the State Farm insurance group. Some of
our competitors have substantially greater financial and other resources than us, and they may
offer a broader range of products or competing products at lower prices. Our revenues,
profitability and financial condition could be materially adversely affected if we are required to
decrease or are unable to increase prices to stay competitive or if we do not successfully retain
our current customers and attract new customers.
Our business may be adversely affected by negative developments in the states in which we operate.
We currently operate in 12 states located primarily in the Southeastern and Midwestern United
States. For the year ended June 30, 2007, approximately 23% and 18% of our gross premiums earned
were generated from non-standard personal automobile insurance policies written in Georgia and
Florida, respectively. Our revenues and profitability are affected by the prevailing regulatory,
economic, demographic, competitive and other conditions in the states in which we operate. Changes
in any of these conditions could make it more costly or difficult for us to conduct business.
Adverse regulatory developments, which could include reductions in the maximum rates permitted to
be charged, restrictions on rate increases or fundamental changes to the design or implementation
of the automobile insurance regulatory framework, could reduce our revenues, increase our expenses
or otherwise have a material adverse effect on our results of operations and financial condition.
In addition, these developments could have a greater effect on us, as compared with more
diversified insurers that also sell other types of automobile insurance products, write other
additional lines of insurance coverages or whose premiums are not as concentrated in a single line
of insurance.
Our business may be adversely affected by negative developments in the non-standard personal
automobile insurance industry.
Substantially all of our gross premiums written are generated from sales of non-standard
personal automobile insurance policies. As a result of our concentration in this line of business,
negative developments in the economic, competitive or regulatory conditions affecting the
non-standard personal automobile insurance industry could reduce our revenues, increase our
expenses or otherwise have a material adverse effect on our results of operations and financial
condition. In addition, these developments could have a greater effect on us compared with more
diversified insurers that also sell other types of automobile insurance products or write other
additional lines of insurance.
Our results may fluctuate as a result of cyclical changes in the personal automobile insurance
industry.
The non-standard personal automobile insurance industry is cyclical in nature. In the past,
the industry has been characterized by periods of price competition and excess capacity followed by
periods of high premium rates and shortages of underwriting capacity. If new competitors enter this
market, existing competitors may attempt to increase market share by lowering rates. Such
conditions could lead to reduced prices, which would negatively impact our revenues and
profitability. We believe that between 2002 and 2005, the underwriting results in the personal
automobile insurance industry improved as a result of favorable pricing and competitive conditions
that allowed for broad increases in rate levels by insurers. However, since then we have witnessed
a stabilization followed by a reduction in premiums and rates across most states. Given the
cyclical nature of the industry, these conditions may negatively impact our revenues and
profitability.
Our investment portfolio may suffer reduced returns or losses, which could reduce our
profitability.
Our results of operations depend, in part, on the performance of our invested assets. As of
June 30, 2007, substantially all of our investment portfolio was invested either directly or
indirectly in debt securities, primarily in liquid state, municipal, corporate and federal
government bonds and collateralized mortgage obligations. Fluctuations in interest rates affect
our returns on, and the fair value of, debt securities. Unrealized gains and losses on debt
securities are recognized in other comprehensive income and increase or decrease our stockholders’
equity. As of June 30, 2007, the amortized cost of our investment portfolio exceeded the fair value
by $2.8 million. We believe the unrealized loss is temporary;
however, an increase in interest
rates could further reduce the fair value of our investments in debt securities. As of June 30,
2007, the impact of an immediate 100 basis point increase in
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market interest rates on our fixed
maturities portfolio would have resulted in an estimated decrease in fair value of 4.5%, or
approximately $7.9 million. In addition, defaults by third parties who fail to pay or perform
obligations could reduce our investment income and could also result in investment losses to our
portfolio.
We rely on our information technology and communication systems, and the failure of these systems
could materially and adversely affect our business.
Our business is highly dependent on the proprietary integrated technology systems that enable
timely and efficient communication and data sharing among the various segments of our integrated
operations. These systems are used in all our operations, including quotation, policy issuance,
customer service, underwriting, claims, accounting, and communications. We have a technical staff
that develops, maintains and supports all elements of our technology infrastructure. However,
disruption of power systems or communication systems could result in deterioration in our ability
to respond to customers’ requests, write and service new business, and process claims in a timely
manner. We believe we have appropriate types and levels of insurance to protect our real property,
systems, and other assets. However, insurance does not provide full reimbursement for all losses,
both direct and indirect, that may result from such an event.
We may have difficulties in managing our expansion into new markets.
Our future growth plans may include expanding into new states by opening new sales offices,
acquiring the business and assets of local agencies and possibly introducing additional insurance
products. In order to grow our business successfully, we must apply for and maintain necessary
licenses, properly design and price our products and identify, hire and train new claims,
underwriting and sales employees. Our expansion will also place significant demands on our
management, operations, systems, accounting, internal controls and financial resources. If we fail
to do any one of these well, we may not be able to expand our business successfully. Even if we
successfully complete an acquisition, we face the risk that we may acquire business in states in
which market and other conditions may not be favorable to us. Any failure by us to manage growth
and to respond to changes in our business could have a material adverse effect on our business,
financial condition and results of operations.
We may not be successful in identifying agency acquisition candidates or integrating their
operations, which could harm our financial results.
In order to grow our business by acquisition, we must identify agency candidates and integrate
the operations of acquired agencies. If we are unable to identify and acquire appropriate agency
acquisition candidates, we may experience slower growth. If we do acquire additional agencies, we
could face increased costs, or, if we are unable to successfully integrate the operations of the
acquired agency into our operations, we could experience disruption of our business and distraction
of our management, which may not be offset by corresponding increases in revenues. The integration
of operations after an acquisition is subject to risks, including, among others, loss of key
personnel of the acquired company, difficulty associated with assimilating the personnel and
operations of the acquired company, potential disruption of ongoing business, maintenance of
uniform standards, controls, procedures and policies and impairment of the acquired company’s
reputation and relationships with its employees and clients. Any of these may result in the loss of
customers. It is also possible that we may not realize, either at all or in a timely manner, any or
all benefits from recent and future acquisitions and may incur significant costs in connection with
these acquisitions. Failure to successfully integrate future acquisitions could materially
adversely affect the results of our operations.
Our insurance company subsidiaries are subject to statutory capital and surplus requirements and
other standards, and their failure to meet these requirements or standards could subject them to
regulatory actions.
Our insurance company subsidiaries are subject to risk-based capital standards, which we refer
to as RBC standards, and other minimum statutory capital and surplus requirements imposed under the
laws of their respective states of domicile. The RBC standards, which are based upon the RBC Model
Act adopted by the NAIC, require our insurance company subsidiaries to annually report their
results of risk-based capital calculations to the state departments of insurance and the NAIC.
Failure to meet applicable risk-based capital requirements or minimum statutory capital and
surplus requirements could subject our insurance company subsidiaries to further examination or
corrective action imposed
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by state regulators, including limitations on their writing of additional
business, state supervision or even liquidation. Any changes in existing RBC requirements or
minimum statutory capital and surplus requirements may require our insurance company subsidiaries
to increase their statutory capital and surplus levels, which they may be unable to do. This
calculation is performed on a calendar year basis, and at
December 31, 2006, both FAIC and FAIC-GA
maintained an RBC level in excess of an amount that would require any
corrective actions on their
part. At December 31, 2006, FAIC-TN had not commenced operations.
State regulators also screen and analyze the financial condition of insurance companies using
the NAIC Insurance Regulatory Information System, or IRIS. As part of IRIS, the NAIC database
generates key financial ratio results obtained from an insurer’s annual statutory statements. A
ratio result falling outside the usual range of IRIS ratios may result in further examination by a
state regulator to determine if corrective action is necessary. As of December 31, 2006, FAIC and
FAIC-GA had IRIS ratios outside the usual ranges that were reported to the appropriate regulatory
authorities, but no regulatory authority has informed the insurance company subsidiaries that it
intends to conduct a further examination of their financial condition. We cannot assure you that
regulatory authorities will not conduct any such examination of the financial condition of our
insurance company subsidiaries, or of the outcome of any such investigation. See “Business —
Regulatory Environment.”
New pricing, claim and coverage issues and class action litigation are continually emerging in the
automobile insurance industry, and these new issues could adversely impact our revenues or our
methods of doing business.
As automobile insurance industry practices and regulatory, judicial and consumer conditions
change, unexpected and unintended issues related to claims, coverages and business practices may
emerge. These issues can have an adverse effect on our business by changing the way we price our
products, extending coverage beyond our underwriting intent, requiring us to obtain additional
licenses or increasing the size of claims. Recent examples of some emerging issues include:
| • | concerns over the use of an applicant’s credit score or zip code as a factor in making risk selections and pricing decisions; | ||
| • | a growing trend of plaintiffs targeting automobile insurers in purported class action litigation relating to claims-handling practices, such as total loss evaluation methodology, the use of aftermarket (non-original equipment manufacturer) parts and the alleged diminution in value to insureds’ vehicles involved in accidents; and | ||
| • | consumer groups lobbying state legislatures to regulate and require separate licenses for individuals and companies engaged in the sale of ancillary products or services. |
The effects of these and other unforeseen emerging issues could negatively affect our revenues
or our methods of doing business.
Due to our largely fixed cost structure, our profitability may decline if our sales volume were to
decline significantly.
Our reliance on leased retail sales offices staffed by employee-agents results in a cost
structure that has a high proportion of fixed costs. In times of increasing sales volume, our
acquisition cost per policy decreases, improving our expense ratio, which we believe is one of the
significant advantages of our business model. However, in times of declining sales volume, the
opposite would occur. A decline in sales volume could decrease our profitability, cause us to close
some of our retail sales offices or lay off some employee-agents to manage our expenses.
Severe weather conditions and other catastrophes may result in an increase in the number and amount
of claims filed against us.
Our business is exposed to the risk of severe weather conditions and other catastrophes.
Catastrophes can be caused by various events, including natural events, such as severe winter
weather, hurricanes, tornados, windstorms, earthquakes, hailstorms, thunderstorms and fires, and
other events, such as explosions, terrorist attacks and riots. The incidence and severity of
catastrophes and severe weather conditions are inherently unpredictable.
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Severe weather conditions
generally result in more automobile accidents, leading to an increase in the number of claims filed
and/or the amount of compensation sought by claimants.
In the event that a severe weather condition or other major catastrophe were to occur
resulting in property losses to us, we would have to cover such losses using additional resources,
which could increase our losses incurred, cause our statutory capital and surplus to fall below
required levels or otherwise have a material adverse effect on our results of operations and
financial condition.
A few of our stockholders have significant control over us, and their interests may differ from
yours.
Three of our stockholders, Gerald J. Ford, our Chairman of the Board; Stephen J. Harrison, our
President and Chief Executive Officer; and Thomas M. Harrison, Jr., our Executive Vice President
and Secretary, in the aggregate, control 62% of our outstanding common stock. If these
stockholders acted or voted together, they would have the power to control the election and removal
of our directors. They would also have significant control over other matters requiring stockholder
approval, including the approval of major corporate transactions and proposed amendments to our
certificate of incorporation. In addition, this concentration of ownership may delay or prevent a
change in control of our company, as well as frustrate attempts to replace or remove current
management, even when a change may be in the best interests of our other stockholders. Furthermore,
the interests of these stockholders may not always coincide with the interests of our company or
other stockholders.
Our insurance company subsidiaries are subject to regulatory restrictions on paying dividends to
us.
State insurance laws limit the ability of our insurance company subsidiaries to pay dividends
and require our insurance company subsidiaries to maintain specified minimum levels of statutory
capital and surplus. These restrictions affect the ability of our insurance company subsidiaries to
pay dividends to us and may require our subsidiaries to obtain the prior approval of regulatory
authorities, which could slow the timing of such payments to us or reduce the amount that can be
paid. To the extent we may need to rely, in part, on receiving dividends from the insurance
company subsidiaries, the limit on the amount of dividends that can be paid by the insurance
company subsidiaries may affect our ability to pay dividends to our stockholders. The
dividend-paying ability of the insurance company subsidiaries is discussed in Note 19 to the
consolidated financial statements.
We and our subsidiaries are subject to comprehensive regulation and supervision that may restrict
our ability to earn profits.
We and our subsidiaries are subject to comprehensive regulation and supervision by the
insurance departments in the states where our subsidiaries are domiciled and where our subsidiaries
sell insurance and ancillary products, issue policies and handle claims. Certain regulatory
restrictions and prior approval requirements may affect our subsidiaries’ ability to operate,
change their operations or obtain necessary rate adjustments in a timely manner or may increase our
costs and reduce profitability.
Among other things, regulation and supervision of us and our subsidiaries extends to:
Required Licensing. We and our subsidiaries operate under licenses issued by various state
insurance authorities. These licenses govern, among other things, the types of insurance coverages,
agency and claims services and motor club products that we and our subsidiaries may offer consumers
in the particular state. Such licenses typically are issued only after the filing of an appropriate
application and the satisfaction of prescribed criteria. In addition, the licensing procedures of
the states in which we and our subsidiaries operate differ somewhat from state-to-state. We and our
subsidiaries must determine which licenses, if any, are required in a particular state and apply
for and obtain the appropriate licenses before we can implement any plan to expand into a new state
or offer a new line of insurance or other new product. If a regulatory authority denies or delays
granting such new license, our ability to enter new markets quickly or offer new products can be
substantially impaired.
Transactions Between Insurance Companies and Their Affiliates. Our insurance company
subsidiaries are organized and domiciled under the insurance statutes of Texas, Georgia and
Tennessee. The insurance laws in these states provide that all transactions among members of an
insurance holding company system must be done at arm’s length and shown to be fair and reasonable
to the regulated insurer. Transactions between our insurance company subsidiaries and other
subsidiaries generally must be disclosed to the state regulators, and prior approval of the
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applicable regulator generally is required before any material or extraordinary transaction may be
consummated. State regulators may refuse to approve or delay approval of such a transaction, which
may impact our ability to innovate or operate efficiently.
Regulation of Rates and Policy Forms. The insurance laws of most states in which our
insurance company subsidiaries operate require insurance companies to file premium rate schedules
and policy forms for review and approval. State insurance regulators have broad discretion in
judging whether our rates are adequate, not excessive and not unfairly discriminatory. The speed at
which we can change our rates in response to market conditions or increasing costs depends, in
part, on the method by which the applicable state’s rating laws are administered. Generally, state
insurance regulators have the authority to disapprove our requested rates. Thus, if as permitted in
some states, we begin using new rates before they are approved, we may be required to issue premium
refunds or credits to our policyholders if the new rates are ultimately deemed excessive or unfair
and disapproved by the applicable state regulator. In addition, in some states, there has been
pressure in past years to reduce premium rates for automobile and other personal insurance or to
limit how often an insurer may request increases for such rates. In states where such pressure is
applied, our ability to respond to market developments or increased costs in that state may be
adversely affected.
Investment Restrictions. Our insurance company subsidiaries are subject to state laws and
regulations that require diversification of their investment portfolios and that limit the amount
of investments in certain categories. Failure to comply with these laws and regulations would cause
non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory
capital and surplus and, in some instances, would require divestiture. If a non-conforming asset is
treated as a non-admitted asset, it would lower the affected subsidiary’s capital and surplus and
thus, its ability to write additional premiums and pay dividends.
Restrictions on Cancellation, Non-Renewal or Withdrawal. Many states have laws and
regulations that limit an insurer’s ability to exit a market. For example, certain states limit an
automobile insurer’s ability to cancel or not renew policies. Some states prohibit an insurer from
withdrawing from one or more lines of business in the state, except pursuant to a plan approved by
the state insurance department. The state insurance department may disapprove a plan that may lead
to market disruption. To date, none of these restrictions has had an impact on our operations or
strategic planning in the states in which we operate. However, these laws and regulations that
limit cancellations and non-renewals and that subject business withdrawals to prior approval
restrictions could limit our ability to exit unprofitable markets or discontinue unprofitable
products in the future.
Provisions in our certificate of incorporation and bylaws may prevent a takeover or a change in
management that you may deem favorable.
Our certificate of incorporation contains prohibitions on the transfer of our common stock to
avoid limitations on the use of the NOL carryforwards and other federal income tax attributes that
we inherited from our predecessor. These restrictions could prevent or inhibit a third party from
acquiring us. Our certificate of incorporation generally prohibits, without the prior approval of
our board of directors, any transfer of common stock, any subsequent issue of voting stock or stock
that participates in our earnings or growth, and certain options with respect to such stock, if the
transfer of such stock or options would (i) cause any group or person to own 4.9% or more, by
aggregate value, of the outstanding shares of our common stock, (ii) increase the ownership
position of any person or group that already owns 4.9% or more, by aggregate value, of the
outstanding shares of our common stock, or (iii) cause any person or group to be treated like the
owner of 4.9% or more, by aggregate value, of our outstanding shares of common stock for tax
purposes.
Our certificate of incorporation and bylaws also contain the following provisions that could
prevent or inhibit a third party from acquiring us:
| • | the requirement that only stockholders owning at least one-third of the outstanding shares of our common stock may call a special stockholders’ meeting; and | ||
| • | the requirement that stockholders owning at least two-thirds of the outstanding shares of our common stock must approve any amendment to our certificate of incorporation provisions concerning the transfer restrictions and the special stockholders’ meetings. |
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In addition, under our certificate of incorporation, we may issue shares of preferred stock on
terms that are unfavorable to the holders of our common stock. The issuance of shares of preferred
stock could also prevent or inhibit a third party from acquiring us. The existence of these
provisions could depress the price of our common stock, could delay or prevent a takeover attempt
or could prevent attempts to replace or remove incumbent management.
Item 1B. Unresolved Staff Comments
None.
Executive Officers of the Registrant
Pursuant to General Instruction G(3) of Form 10-K, the following information regarding our
executive officers is included in Part I of this Annual Report on Form 10-K in lieu of being
included in the Proxy Statement for the Annual Meeting of Stockholders to be held on November 7,
2007.
The following table sets forth certain information concerning our executive officers:
| Name | Age | Position | ||||
Stephen J. Harrison
|
55 | President and Chief Executive Officer | ||||
Thomas M. Harrison, Jr.
|
57 | Executive Vice President and Secretary | ||||
Edward L. Pierce
|
50 | Executive Vice President and Chief Financial Officer | ||||
Kevin P. Cohn
|
38 | Chief Accounting Officer and Corporate Controller | ||||
Michael J. Bodayle
|
51 | Chief Financial Officer — Insurance Company Operations | ||||
William R. Pentecost
|
49 | Chief Information Officer | ||||
Randy L. Reed
|
51 | Senior Vice President — Sales and Marketing | ||||
Stephen J. Harrison has served as President and Chief Executive Officer of the Company since
April 2004. Mr. Harrison co-founded FAIC, USAuto’s predecessor company, in 1995 and served as
President and Chief Executive Officer of USAuto from USAuto’s inception. He has over 30 years
experience in insurance and related industries, including automobile insurance and insurance agency
operations. From 1974 to 1991, he served in various capacities with the Harrison Insurance Agency,
a family-owned multi-line insurance agency. From 1991 to 1993, Mr. Harrison served as President of
Direct Insurance Company, a non-standard automobile insurance company. Mr. Harrison is the brother
of Thomas M. Harrison, Jr., who is Executive Vice President and Secretary of the Company.
Thomas M. Harrison, Jr. has served as Executive Vice President and Secretary of the Company
since April 2004. Mr. Harrison co-founded FAIC, USAuto’s predecessor company, in 1995 and has
served as Vice President and Secretary of USAuto from USAuto’s inception. He has over 30 years
experience in insurance and related industries, including automobile insurance and insurance agency
operations. From 1976 to 1995, Mr. Harrison served in various capacities with the Harrison
Insurance Agency, a family-owned multi-line insurance agency. Mr. Harrison is the brother of
Stephen J. Harrison, who is President and Chief Executive Officer of the Company.
Edward L. Pierce has served as Executive Vice President of the Company since August 2006 and
Chief Financial Officer since October 2006. From May 2001 through February 2006, Mr. Pierce served
as Executive Vice President and Chief Financial Officer and as a director of BindView Development
Corporation, a publicly-traded network security software development company. From November 1994
through January 2001, Mr. Pierce held various financial management positions, including Executive
Vice President and Chief Financial Officer, with Metamor Worldwide Corporation, a publicly-traded
global information technology services company. Previously, Mr. Pierce was Corporate Controller of
American Oil and Gas Corporation and a Senior Audit Manager at Arthur Andersen & Co.
Kevin P. Cohn has served as Chief Accounting Officer and Corporate Controller of the Company
since October 2006. From May 2001 through May 2006, he
served as Vice President,
Chief
Accounting Officer and Corporate Controller of BindView Development Corporation, a publicly-traded
network security software development company. From December 1997 until February 2001, Mr. Cohn was
employed by Metamor Worldwide Inc., a publicly-traded global information technology services
company, where he was Vice President,
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Chief Accounting Officer and Corporate Controller. Before
that, Mr. Cohn was employed with Ernst & Young LLP as an Audit Manager.
Michael J. Bodayle has served as Chief Financial Officer — Insurance Company Operations of
the Company since April 2004. Mr. Bodayle has been Treasurer and Chief Financial Officer of the
Company’s insurance company subsidiaries since March 2004 and had served as USAuto’s Treasurer and
Chief Financial Officer since July 1998. He has over 25 years of experience focused primarily in
the insurance industry, which includes auditing, financial reporting and insurance agency
operations. He has over seven years of public accounting experience and was formerly a Senior Audit
Manager with Peat, Marwick, Main (now known as KPMG) from 1980 to 1985. From 1985 to 1996, Mr.
Bodayle was Treasurer and Chief Financial Officer for Titan Holdings, Inc., a publicly-traded
insurance holding company.
William R. Pentecost has been Chief Information Officer of the Company since April 2004. Mr.
Pentecost was USAuto’s Chief Information Officer from USAuto’s inception in 1995. He has over 15
years experience with insurance company information systems. Mr. Pentecost is also a Chartered
Property Casualty Underwriter.
Randy L. Reed has been Senior Vice President — Sales and Marketing of the Company since April
2004. Mr. Reed was USAuto’s Vice President — Sales and Marketing since February 1997. Prior to
February 1997, Mr. Reed served for over ten years as co-owner and President of Reed Oil Company,
Inc., a wholesaler and retailer involved in the oil jobber business.
Item 2. Properties
We lease office space in Nashville, Tennessee for our executive offices (approximately 21,000
square feet) and for our claims and customer service center (approximately 51,000 square feet). We
also lease office space in Chicago, Illinois, Tampa, Florida and Irving, Texas for our regional
claims offices and in Chicago, Illinois and Houston, Texas for our regional customer service
centers. Our retail locations are all leased and typically are located in storefronts in retail
shopping centers, and each location typically contains less than 1,000 square feet of space.
Item 3. Legal Proceedings
We and our subsidiaries are named from time to time as defendants in various legal actions
that are incidental to our business, including those which arise out of or are related to the
handling of claims made in connection with our insurance policies. The plaintiffs in some of these
lawsuits have alleged bad faith or extracontractual damages, and some have sought punitive damages
or class action status.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters subject to a vote of stockholders during the fourth quarter of the
fiscal year ended June 30, 2007.
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PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock is currently quoted on the New York Stock Exchange under the symbol “FAC”.
The following table sets forth quarterly high and low bid prices for our common stock for the
periods indicated based upon quotations periodically published on the New York Stock Exchange. All
price quotations represent prices between dealers, without accounting for retail mark-ups,
mark-downs or commissions, and may not represent actual transactions.
| Price Range | ||||||||
| High | Low | |||||||
Year Ended June 30, 2006 |
||||||||
First Quarter |
$ | 10.37 | $ | 8.77 | ||||
Second Quarter |
10.66 | 9.59 | ||||||
Third Quarter |
13.34 | 10.06 | ||||||
Fourth Quarter |
13.40 | 10.95 | ||||||
Year Ended June 30, 2007 |
||||||||
First Quarter |
$ | 12.09 | $ | 10.55 | ||||
Second Quarter |
11.74 | 9.61 | ||||||
Third Quarter |
10.69 | 9.91 | ||||||
Fourth Quarter |
10.82 | 9.86 | ||||||
Holders
According to the records of our transfer agent, there were 547 holders of record of our common
stock on September 7, 2007, including record holders such as banks and brokerage firms who hold
shares for beneficial holders, and 47,615,289 shares of our common stock were outstanding.
Dividends
We paid no dividends during the two most recent fiscal years. We do not anticipate paying
cash dividends in the future. Any future determination to pay dividends will be at the discretion
of our Board of Directors and will depend upon, among other factors, our results of operations,
financial condition, capital requirements and contractual restrictions. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital
Resources” and Note 19 to our consolidated financial statements for a discussion of the legal
restrictions on the ability of our insurance company subsidiaries to pay dividends.
Stock Transfer Restrictions
Our certificate of incorporation (the “Charter”) contains prohibitions on the transfer of our
common stock to avoid limitations on the use of the net operating loss carryforwards and other
federal income tax attributes that we inherited from our predecessor. The Charter generally
prohibits, without the prior approval of our Board of Directors, any transfer of common stock, any
subsequent issue of voting stock or stock that participates in our earnings or growth, and certain
options with respect to such stock, if the transfer of such stock would cause any group or person
to own 4.9% or more (by aggregate value) of our outstanding shares or cause any person to be
treated like the owner of 4.9% or more (by aggregate value) of our outstanding shares for tax
purposes. Transfers in violation of this prohibition will be void, unless our Board of Directors
consents to the transfer. If void, upon our demand, the purported transferee must return the
shares to our agent to be sold, or if already sold, the purported transferee must forfeit some, or
possibly all, of the sale proceeds. In addition, in connection with certain changes in the
ownership of the holders of our shares, we may require the holder to dispose of some or all of such
shares. For
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this purpose, “person” is defined broadly to mean any individual, corporation, estate,
debtor, association, company, partnership, joint venture, or similar organization.
Performance Graph
The following graph compares the total cumulative shareholder return for $100 invested in our
common shares against the cumulative total return of the Russell 3000 Index and the S&P Property &
Casualty Insurance Index on June 30, 2002 to the end of the most recently completed fiscal year.
CUMULATIVE VALUE OF $100 INVESTMENT
| June 30, | ||||||||||||||||||||||||||||||||
| 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | |||||||||||||||||||||||||||
First Acceptance Corporation |
100.00 | 139.23 | 179.49 | 242.56 | 302.05 | 260.51 | ||||||||||||||||||||||||||
Russell 3000 |
100.00 | 100.77 | 121.38 | 131.16 | 143.70 | 172.54 | ||||||||||||||||||||||||||
S&P Property & Casualty
Insurance |
100.00 | 95.64 | 113.59 | 129.12 | 136.66 | 156.32 | ||||||||||||||||||||||||||
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Item 6. Selected Financial Data
The following tables provide selected historical consolidated financial and operating data of
the Company as of the dates and for the periods indicated. In conjunction with the data provided
in the following tables and in order to more fully understand our historical consolidated financial
and operating data, you should also read “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and our consolidated financial statements and the accompanying
notes included in this report. We derived our selected historical consolidated financial data as
of June 30, 2007 and 2006 and for the years ended June 30, 2007, 2006 and 2005 from our audited
consolidated financial statements included in this report. We derived our selected historical
consolidated financial data as of June 30, 2005, 2004 and 2003 and for the years ended June 30,
2004 and 2003 from our audited consolidated financial statements not included in this report. The
results for past accounting periods are not necessarily indicative of the results to be expected
for any future accounting period.
The actual results for the year ended June 30, 2004 reflect only the results of USAuto’s
operations since the date of acquisition (April 30, 2004). The unaudited pro forma results for the
years ended June 30, 2004 and 2003 give effect to the USAuto acquisition and related transactions
as if they had been consummated on July 1, 2002.
The unaudited pro forma results should not be considered indicative of actual results that
would have been achieved had the USAuto acquisition and related transactions been consummated on
July 1, 2002 and do not purport to indicate results of operations for any future period.
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| Year Ended June 30, | ||||||||||||||||||||||||||||
| Proforma | Proforma | |||||||||||||||||||||||||||
| Actual | 2004 | Actual | 2003 | |||||||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | (unaudited) | 2003 | (unaudited) | ||||||||||||||||||||||
| (in thousands, except per share data) | ||||||||||||||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||||||||||
Revenues: |
||||||||||||||||||||||||||||
Premiums earned |
$ | 300,661 | $ | 208,771 | $ | 132,677 | $ | 11,728 | $ | 57,716 | $ | — | $ | 38,353 | ||||||||||||||
Commission and fee income |
37,324 | 26,757 | 26,821 | 4,401 | 26,275 | — | 33,462 | |||||||||||||||||||||
Investment income |
8,863 | 5,762 | 3,353 | 958 | 1,431 | 1,098 | 1,289 | |||||||||||||||||||||
Other |
789 | 7,712 | 3,944 | 6,066 | 14,901 | 233 | 7,333 | |||||||||||||||||||||
Total revenues |
347,637 | 249,002 | 166,795 | 23,153 | 100,323 | 1,331 | 80,437 | |||||||||||||||||||||
Expenses: |
||||||||||||||||||||||||||||
Losses and loss adjustment expenses |
241,908 | 140,845 | 87,493 | 7,167 | 36,616 | — | 25,905 | |||||||||||||||||||||
Insurance operating expenses |
97,629 | 75,773 | 49,921 | 7,194 | 41,142 | — | 35,962 | |||||||||||||||||||||
Other operating expenses |
2,623 | 2,494 | 2,775 | 6,235 | 2,278 | 2,637 | 1,648 | |||||||||||||||||||||
Stock-based compensation |
1,063 | 500 | 332 | 7,850 | — | 546 | — | |||||||||||||||||||||
Depreciation and amortization |
1,624 | 1,463 | 1,920 | 648 | 1,366 | 10 | 1,954 | |||||||||||||||||||||
Interest expense |
1,874 | 898 | 351 | 44 | 318 | — | 29 | |||||||||||||||||||||
Total expenses |
346,721 | 221,973 | 142,792 | 29,138 | 81,720 | 3,193 | 65,498 | |||||||||||||||||||||
Income (loss) before income taxes |
916 | 27,029 | 24,003 | (5,985 | ) | 18,603 | (1,862 | ) | 14,939 | |||||||||||||||||||
Provision (benefit) for income taxes (1) |
17,586 | (1,039 | ) | (2,153 | ) | (2,189 | ) | 6,983 | — | 5,844 | ||||||||||||||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | $ | (3,796 | ) | $ | 11,620 | $ | (1,862 | ) | $ | 9,095 | |||||||||||
Per Share Data: |
||||||||||||||||||||||||||||
Income (loss) per share: |
||||||||||||||||||||||||||||
Basic |
$ | (0.35 | ) | $ | 0.59 | $ | 0.56 | $ | (0.15 | ) | $ | 0.25 | $ | (0.09 | ) | $ | 0.20 | |||||||||||
Diluted |
$ | (0.35 | ) | $ | 0.57 | $ | 0.53 | $ | (0.15 | ) | $ | 0.24 | $ | (0.09 | ) | $ | 0.19 | |||||||||||
Weighted average shares outstanding: |
||||||||||||||||||||||||||||
Basic |
47,584 | 47,487 | 47,055 | 24,965 | 46,405 | 20,420 | 46,229 | |||||||||||||||||||||
Diluted |
47,584 | 49,576 | 48,989 | 24,965 | 47,883 | 20,420 | 46,985 | |||||||||||||||||||||
| June 30, | ||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||||||
| (in thousands, except per share data) | ||||||||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Fixed maturities, available-for-sale |
$ | 176,555 | $ | 127,828 | $ | 74,840 | $ | 33,243 | $ | — | ||||||||||
Cash, cash equivalents and other
invested assets |
34,161 | 31,534 | 35,682 | 38,352 | 56,847 | |||||||||||||||
Deferred tax asset |
30,936 | 48,068 | 48,106 | 45,493 | — | |||||||||||||||
Total assets |
498,892 | 435,327 | 331,645 | 286,450 | 59,053 | |||||||||||||||
Total liabilities |
259,408 | 181,904 | 103,316 | 92,224 | 978 | |||||||||||||||
Total stockholders’ equity |
239,484 | 253,423 | 228,329 | 194,226 | 58,075 | |||||||||||||||
Book value per common share |
$ | 5.03 | $ | 5.33 | $ | 4.81 | $ | 4.17 | $ | 2.82 | ||||||||||
| (1) | The provision for income taxes for the year ended June 30, 2007 includes an increase in the valuation allowance for the deferred tax asset of $6.9 million as well as $10.0 million related to the expiration of certain net operating loss carryforwards (“NOLs”) resulting in a charge totaling $16.9 million. The benefit from income taxes for the years ended June 30, 2006 and 2005 include decreases in the valuation allowance for the deferred tax asset of $10.5 million and $10.6 million, respectively. There was no provision (benefit) for income tax expense recorded for the year ended June 30, 2003 because we had NOLs available to offset federal taxable income for which a full valuation allowance had been established. For the year ended June 30, 2003, the benefit resulting from the utilization of NOLs directly offsets federal income taxes that would have otherwise been payable. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial
statements and accompanying notes included in this report. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ materially from
those anticipated in these forward-looking statements as a result of various factors, including
those discussed below and elsewhere in this report, particularly under the caption “Risk Factors.”
General
We are principally a retailer, servicer and underwriter of non-standard personal automobile
insurance, based in Nashville, Tennessee. Non-standard personal automobile insurance is made
available to individuals who are categorized as “non-standard” because of their inability or
unwillingness to obtain standard insurance coverage due to various factors, including payment
history, payment preference, failure in the past to maintain continuous insurance coverage, driving
record and/or vehicle type. Generally, our customers are required by law to buy a minimum amount
of automobile insurance.
Prior to our April 30, 2004 acquisition of USAuto Holdings, Inc., we were engaged in pursuing
opportunities to acquire one or more operating companies. In addition, we marketed for sale a
portfolio of foreclosed real estate. We will continue to market the remaining real estate held,
consisting of two tracts of land in San Antonio, Texas, and will attempt to sell it on a basis that
provides us with the best economic return. We do not anticipate any new investments in real estate.
As of August 31, 2007, we leased and operated 462 retail locations, staffed by
employee-agents. Our employee-agents exclusively sell insurance products either underwritten or
serviced by us. As of August 31, 2007, we wrote non-standard personal automobile insurance in 12
states and were licensed in 13 additional states.
The following table shows the changes in the number of our retail locations for the periods
presented. Retail location counts are based upon the date that a location commenced writing
business.
| Year Ended June 30, | ||||||||
| 2007 | 2006 | |||||||
Retail locations — beginning of period |
460 | 248 | ||||||
Opened |
18 | 149 | ||||||
Acquired |
— | 72 | ||||||
Closed |
(16 | ) | (9 | ) | ||||
Retail locations — end of period |
462 | 460 | ||||||
The following table shows the number of our retail locations by state.
| June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Alabama |
25 | 25 | 25 | |||||||||
Florida |
41 | 39 | 20 | |||||||||
Georgia |
62 | 63 | 62 | |||||||||
Illinois |
81 | 86 | 5 | |||||||||
Indiana |
24 | 26 | 21 | |||||||||
Mississippi |
8 | 8 | 8 | |||||||||
Missouri |
15 | 18 | 14 | |||||||||
Ohio |
30 | 30 | 29 | |||||||||
Pennsylvania |
25 | 25 | 7 | |||||||||
South Carolina |
28 | 21 | — | |||||||||
Tennessee |
20 | 20 | 20 | |||||||||
Texas |
103 | 99 | 37 | |||||||||
Total |
462 | 460 | 248 | |||||||||
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Table of Contents
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.
The following table presents selected financial data for our insurance operations and real
estate and corporate segments for the periods presented:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
| (in thousands) | ||||||||||||
Revenues: |
||||||||||||
Insurance |
$ | 347,431 | $ | 244,557 | $ | 164,974 | ||||||
Real estate and corporate |
206 | 4,445 | 1,821 | |||||||||
Consolidated total |
$ | 347,637 | $ | 249,002 | $ | 166,795 | ||||||
Income (loss) before income taxes: |
||||||||||||
Insurance |
$ | 6,252 | $ | 26,476 | $ | 25,640 | ||||||
Real estate and corporate |
(5,336 | ) | 553 | (1,637 | ) | |||||||
Consolidated total |
$ | 916 | $ | 27,029 | $ | 24,003 | ||||||
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 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 as well as fees for other ancillary services (principally a motor club product); and | ||
| • | investment income earned on the invested assets of the insurance company subsidiaries. |
The following table presents gross premiums earned by state and includes policies written and
assumed by the insurance company subsidiaries and policies issued by our Managing General Agency
(“MGA”) subsidiaries on behalf of other insurance companies that are assumed by one of our
insurance company subsidiaries through quota-share reinsurance. Prior to May 2005, we were not
licensed to write insurance in Alabama and therefore one of our insurance companies assumed a
percentage of the business written in Alabama through an MGA subsidiary. The assumed percentage was
50% from July 1, 2004 through February 1, 2005, and 100% following February 1, 2005. Since May
2005, all new Alabama business has been written by one of our insurance company subsidiaries on a
direct basis. Although we are licensed in Texas, we currently write some business in Texas through
the Texas county mutual insurance company system that is assumed 100% by one of our insurance
company subsidiaries. For the months of July and August of 2004, we ceded 50% of our gross
premiums earned to a reinsurer under a quota-share reinsurance agreement that was non-renewed
effective September 1, 2004. Premiums ceded after September 1, 2004 reflect only the cost of
catastrophic reinsurance. Effective April 14, 2006, we elected to not renew our catastrophic
reinsurance.
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| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
| (in thousands) | ||||||||||||
Gross premiums earned: |
||||||||||||
Georgia |
$ | 70,312 | $ | 68,948 | $ | 69,806 | ||||||
Florida |
55,117 | 26,327 | 1,181 | |||||||||
Texas |
32,480 | 18,596 | 4,899 | |||||||||
Illinois |
31,201 | 7,680 | 112 | |||||||||
Alabama |
30,316 | 28,952 | 26,610 | |||||||||
Tennessee |
23,800 | 24,387 | 26,205 | |||||||||
Ohio |
16,455 | 14,046 | 10,703 | |||||||||
South Carolina |
14,797 | 1,238 | — | |||||||||
Indiana |
8,186 | 6,163 | 2,032 | |||||||||
Pennsylvania |
6,937 | 1,996 | 24 | |||||||||
Missouri |
6,087 | 5,332 | 4,193 | |||||||||
Mississippi |
4,973 | 5,187 | 4,431 | |||||||||
Total gross premiums earned |
300,661 | 208,852 | 150,196 | |||||||||
Premiums ceded |
— | (81 | ) | (8,732 | ) | |||||||
Premiums not assumed |
— | — | (8,787 | ) | ||||||||
Total net premiums earned |
$ | 300,661 | $ | 208,771 | $ | 132,677 | ||||||
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 cancel or expire and are not renewed.
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Policies in force — beginning of period |
200,401 | 119,422 | 91,385 | |||||||||
Acquired |
— | — | 6,473 | |||||||||
Net increase during period |
26,573 | 80,979 | 21,564 | |||||||||
Policies in force — end of period |
226,974 | 200,401 | 119,422 | |||||||||
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, net of
ceded reinsurance.
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. We calculate this ratio on a net basis as a percentage of net
premiums earned. Insurance operating expenses are reduced by fee income from insureds and ceding
commissions received from our quota-share reinsurer as compensation for the costs we incurred in
servicing this business on their behalf. Our expense ratio for fiscal 2005 excludes expenses and
fee income related to incidental MGA operations. For the period from January 1, 2006 through
December 31, 2006, our operating expenses were reduced by 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.
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 our insurance operations
for the periods presented.
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Table of Contents
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Loss and loss adjustment expense |
80.4 | % | 67.5 | % | 65.9 | % | ||||||
Expense |
19.8 | % | 21.5 | % | 17.9 | % | ||||||
Combined |
100.2 | % | 89.0 | % | 83.8 | % | ||||||
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 types of investments enable our
insurance company subsidiaries to obtain premium tax credits. Investment income is composed
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 based upon changes in interest rates and changes in the credit quality of securities held.
The non-standard personal automobile insurance industry is cyclical in nature. In the past,
the industry has been characterized by periods of price competition and excess capacity followed by
periods of high premium rates and shortages of underwriting capacity. If new competitors enter this
market, existing competitors may attempt to increase market share by lowering rates. Such
conditions could lead to reduced prices, which would negatively impact our revenues and
profitability. We believe that between 2002 and 2005, the underwriting results in the personal
automobile insurance industry improved as a result of favorable pricing and competitive conditions
that allowed for broad increases in rate levels by insurers. However, since then we have witnessed
a stabilization followed by a reduction in premiums and rates across most states. Given the
cyclical nature of the industry, these conditions may negatively impact our revenues and
profitability.
Year Ended June 30, 2007 Compared with the Year Ended June 30, 2006
Consolidated Results
Revenues for the year ended June 30, 2007 increased 40% to $347.6 million from $249.0 million
in the prior year. Net loss for the year ended June 30, 2007 was $16.7 million, compared with net
income of $28.1 million for the year ended June 30, 2006. Basic and diluted net income (loss) per
share was $(0.35) for the year ended June 30, 2007, compared with $0.59 and $0.57, respectively,
for the year ended June 30, 2006.
The provision for income taxes for the year ended June 30, 2007 includes an increase in the
valuation allowance for the deferred tax asset of $6.9 million ($0.14 per share on a diluted basis)
as well as $10.0 million ($0.21 per share on a diluted basis) related to the expiration of certain
net operating loss carryforwards resulting in a deferred tax asset charge totaling $16.9 million
($0.35 per share on a diluted basis), while the benefit from income taxes for the year ended June
30, 2006 includes a decrease in the valuation allowance for the deferred tax asset of $10.5 million
($0.21 per share on a diluted basis). The increase in the valuation allowance for the year ended
June 30, 2007 was due to revisions in management’s estimates for our future taxable income based on
the results for the most recent fiscal year, while the charge related to the expiration of net
operating loss carryforwards was due to taxable income for the current fiscal year being less than
management’s prior estimates. The decrease for the year ended June 30, 2006 was the result of
taxable income exceeding the estimates used by management in establishing the valuation allowances
at June 30, 2006 and 2005, respectively, in addition to revisions in management’s estimates for our
future taxable income.
Net income per share for the year ended June 30, 2006 included gains on sales of foreclosed
real estate held for sale of $3.6 million ($0.05 per share on a diluted basis).
Insurance Operations
Revenues from insurance operations were $347.4 million for the year ended June 30, 2007,
compared with $244.6 million for the year ended June 30, 2006. Income before income taxes from
insurance operations for the year ended June 30, 2007 was $6.3 million, compared with $26.5 million
for the year ended June 30, 2006.
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Table of Contents
Premiums Earned
For the year ended June 30, 2007, premiums earned increased by $91.9 million, or 44%, to
$300.7 million from $208.8 million for the year ended June 30, 2006. The increase was due primarily
to the expansion of our business. Approximately 87% of the premium growth was in Florida, Texas and
South Carolina, where we opened 102 locations in fiscal year 2006, and Chicago, where we acquired
72 locations in January 2006. The total number of insured policies in force at June 30, 2007
increased 13% over the same date in 2006 from 200,401 to 226,974. At June 30, 2007, we operated
462 retail locations (or “stores”), compared with 460 stores at June 30, 2006.
Commission and Fee Income
Commissions and fee income increased 39% to $37.3 million for the year ended June 30, 2007,
from $26.8 million for the year ended June 30, 2006. This increase was the result of the growth in
net premiums earned. However, fee income increased at a rate lower than our increase in premiums
earned because we charge lower fees in Florida compared with our other states.
Investment Income
Investment income increased primarily as a result of the increase in the amount of invested
assets. The weighted average investment yields for our fixed maturities portfolio were 5.5% and
5.6% at June 30, 2007 and 2006, respectively, with effective durations of 3.43 years and 3.83 years
at June 30, 2007 and 2006, respectively. The yields for the comparable Lehman Brothers indices were
5.5% at June 30, 2007 and 2006.
Other
Other revenues for the year ended June 30, 2007 included $0.9 million, compared with $4.2
million for the prior year, from a transaction service fee earned through December 2006 in
connection with the Chicago acquisition for servicing the run-off business previously written by
the Chicago agencies whose assets we acquired in January 2006. We will not receive this
transaction service fee in future periods.
Loss and Loss Adjustment Expenses
The loss and loss adjustment expense ratio was 80.4% for the year ended June 30, 2007 compared
with 67.5% for the same period last year. For the year ended June 30, 2007, we experienced a
negative development for losses occurring in prior accident periods of approximately $3.9 million.
For the premiums earned during this fiscal year, the loss and loss adjustment expense ratio was
79.2%. During fiscal 2007, we experienced significant unanticipated increases in (1) the frequency
of PIP losses in Florida, (2) the severity of Bodily Injury (“BI”) losses in Florida and Georgia,
and (3) the severity of Property Damage losses in Georgia and other states. The higher than
anticipated severity in Georgia BI losses was somewhat driven by a higher than anticipated
occurrence of large losses (losses of $10,000 or above). To a lesser extent, the increase in the
loss and loss adjustment expense ratio for the current year was the result of a change in our
business mix resulting from premium growth in our emerging states of Florida and Texas where we
anticipated higher loss ratios.
In January 2007, we hired a new head of product management with significant experience in rate
making for the non-standard automobile insurance sector. We have filed new rates, which are
currently effective in Florida (commenced December 2006), South
Carolina and Georgia (commenced March 2007) and
Pennsylvania (commenced September 1, 2007). We are currently preparing a rate filing for Texas, which we
expect to file on or before September 30, 2007. We expect to file new rates in the emerging states
of Illinois, Missouri, Indiana and Ohio within the next 60 days.
We will file new rates for Bodily Injury, Medical Payments, and Uninsured Motorists Coverage
in Florida, in conjunction with the change in Florida coverage resulting from the October 1, 2007
expiration of Florida’s Motor Vehicle No-Fault Law (Personal
Injury Protection, or PIP). We also
expect to file for new rates for our other Florida coverages (i.e., Property Damage, Comprehensive
and Collision, etc.) within 60 days, which should be approved and made effective prior to December
31, 2007. While the scheduled elimination of the PIP coverage will
result in a decline in premiums earned in Florida, it may improve our overall loss ratio for
Florida. Our loss ratio (exclusive of loss adjustment expenses) for
Florida PIP coverage was 133.1% and
107.6% for the three months and year ended June 30, 2007, respectively, on premiums earned of $4.5
million and $15.5 million for the respective periods.
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Operating Expenses
Insurance operating expenses increased 29% to $97.6 million for the year ended June 30, 2007
from $75.8 million for the year ended June 30, 2006. This increase was primarily due to the
addition in fiscal 2006 of new retail locations (including those acquired in Chicago) and expenses,
such as advertising, employee-agent compensation, rent and premium taxes that vary along with the
increase in net premiums earned.
The expense ratio decreased from 21.5% for the year ended June 30, 2006 to 19.8% for the year
ended June 30, 2007. This decrease is primarily a result of the increase in premiums earned from
new stores without a corresponding increase in fixed operating costs (such as advertising, rent and
base compensation of our employee-agents).
Overall, the combined ratio increased to 100.2% for the year ended June 30, 2007 from 89.0%
for the year ended June 30, 2006 as a result of the higher loss and loss adjustment expense ratio.
Real Estate and Corporate
Loss before income taxes from real estate and corporate for the year ended June 30, 2007 was
$5.3 million versus income before income taxes of $0.6 million for the year ended June 30, 2006.
The year ended June 30, 2006 included gains on sales of foreclosed real estate held for sale of
$3.6 million. There were no gains on sales of foreclosed real estate held for sale during the year
ended June 30, 2007. In addition, during the year ended June 30, 2007, we incurred $1.7 million of
interest expense in connection with borrowings related to the Chicago acquisition compared with
$0.9 million for the year ended June 30, 2006.
Year Ended June 30, 2006 Compared with the Year Ended June 30, 2005
Consolidated Results
Net income for the year ended June 30, 2006 was $28.1 million, compared with $26.2 million for
the year ended June 30, 2005. Net income per share was $0.59 and $0.57 on a basic and diluted
basis, respectively, for the year ended June 30, 2006 and $0.56 and $0.53 on a basic and diluted
basis, respectively, for the year ended June 30, 2005. Total revenues for the year ended June 30,
2006 increased 49% from $166.8 million to $249.0 million over the same period last year.
The benefit from income taxes for the years ended June 30, 2006 and 2005 included decreases in
the valuation allowance for the deferred tax asset of $10.5 million ($0.21 per share on a diluted
basis) and $10.6 million ($0.22 per share on a diluted basis), respectively. Such decreases were
the result of taxable income for these years exceeding the estimates used by management in
establishing the valuation allowances at June 30, 2005 and 2004, respectively, in addition to
revisions in management’s estimates for our future taxable income based on the results for the most
recent fiscal years.
Net income per share for the year ended June 30, 2006 included gains on sales of foreclosed
real estate held for sale of $3.6 million ($0.05 per share on a diluted basis) compared with gains
of $0.8 million ($0.01 per share on a diluted basis) for the year ended June 30, 2005.
Insurance Operations
Revenues from insurance operations were $244.6 million for the year ended June 30, 2006,
compared with $165.0 million for the year ended June 30, 2005. Income before income taxes from
insurance operations was $26.5 million for the year ended June 30, 2006 compared with $25.6 million
for the year ended June 30, 2005.
Premiums Earned
Total gross premiums earned, before the effects of reinsurance, increased by $58.7 million, or
39%, to $208.9 million for the year ended June 30, 2006, from $150.2 million for the year ended
June 30, 2005. This increase was due to the development of new stores in existing states as well
as our expansion into new states. Of
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Table of Contents
this increase, $38.8 million was attributable to the
expansion of our business into Florida and Texas. Overall, the number of insured policies in force
at June 30, 2006 increased 68% over the same date in 2005 from 119,422 to 200,401. At June 30,
2006, the number of operating retail locations (or “stores”) was 460 as compared with 248 stores at
June 30, 2005.
Net premiums earned increased 57% for the year ended June 30, 2006 over the same period in
2005. In addition to the increase in total gross premiums earned, net premiums earned also
increased as a result of two changes involving reinsurance. Net premiums earned increased as a
result of the change in the assumed reinsurance percentage for our Alabama business (written
through other insurance companies) from 50% to 100% effective February 1, 2005. For the year ended
June 30, 2005, $8.8 million in premiums earned in Alabama were not assumed by us. We are now
licensed in Alabama and, starting in May 2005, we began writing all new policies in Alabama on a
direct basis. As a result, in Alabama, we no longer incur the contractual costs associated with
writing business through another insurance company. Net premiums earned for the year ended June 30,
2006 also increased as the result of eliminating our 50% quota-share reinsurance effective
September 1, 2004. This reinsurance was in effect for two months of the year ended June 30, 2005
and resulted in an $8.6 million reduction in net premiums earned, which we ceded to the reinsurer.
Commission and Fee Income
Commission and fee income declined as a percentage of net premiums earned during the year
ended June 30, 2006 compared with the prior year as a result of not renewing the quota-share
reinsurance and increasing the assumed reinsurance percentage for our Alabama business. Ceding
commissions from our reinsurer were eliminated with the non-renewal of the quota-share reinsurance
agreement.
Investment Income
Investment income increased primarily as a result of the increase in invested assets as a
result of our growth and to a lesser extent as we shifted the portfolio from tax-exempt to taxable
investments. The weighted average investment yield for our fixed maturities portfolio was 5.6% at
June 30, 2006 with an effective duration of 3.83 years. The yield for the comparable Lehman
Brothers indices at June 30, 2006 was 5.5%.
Other
Other revenues for the year ended June 30, 2006 included a $4.2 million transaction service
fee earned in connection with the Chicago acquisition for servicing the run-off business previously
written by the Chicago agencies whose assets we acquired in January 2006.
Loss and Loss Adjustment Expenses
The loss and loss adjustment expense ratio increased to 67.5% for the year ended June 30, 2006
from 65.9% for the year ended June 30, 2005. For the year ended June 30, 2006, we experienced a
positive development for losses occurring in prior accident periods of $1.5 million, which we
believe was attributable to the inherent uncertainty in the estimation process and was not the
result of any individual factor. The loss ratio for the year ended June 30, 2006 increased
primarily as a result of higher loss ratios in our expansion states and from an increase in storm
losses.
Operating Expenses
Insurance operating expenses increased 52% to $75.8 million for the year ended June 30, 2006
from $49.9 million for the year ended June 30, 2005. This increase was primarily due to the
addition of new retail locations (including those acquired in Chicago) and expenses, such as
advertising, employee-agent compensation, rent and premium taxes that vary along with the increase
in net premiums earned.
The expense ratio increased from 17.9% for the year ended June 30, 2005 to 21.5% for the year
ended June 30, 2006. The expense ratio for the year ended June 30, 2005 was positively impacted by
an additional ceding commission of $1.0 million, or 0.8%, which was recorded based upon the
favorable loss experience during the last year of the quota-share reinsurance which was non-renewed
effective September 1, 2004. Operating expenses
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incurred for new retail locations also contributed
to the increase in the expense ratio for the year ended June 30, 2006. In addition, the expense
ratio increased as a result of declining fee income from ancillary products (which reduces expenses
in calculating the expense ratio), and the fact that this fee income was spread over a larger base
of net premiums earned as a result of not renewing the quota-share reinsurance.
Overall, the combined ratio increased to 89.0% for the year ended June 30, 2006 from 83.8% for
the year ended June 30, 2005.
Real Estate and Corporate
Income before income taxes from real estate and corporate for the year ended June 30, 2006 was
$0.6 million versus a loss before income taxes of $1.6 million for the year ended June 30, 2005.
The year ended June 30, 2006 included gains on the sales of foreclosed real estate held for sale of
$3.6 million compared with $0.8 million for the year ended June 30, 2005. Investment income
declined from $1.1 million for the year ended June 30, 2005 to $0.8 million for the year ended June
30, 2006 primarily due to a reduction in the amount of invested assets.
Other operating expenses primarily include other general corporate overhead expenses. During
the year ended June 30, 2006, we incurred severance costs of $0.4 million in connection with the
resignation of a former executive officer. In addition, for the year ended June 30, 2006, we
incurred $0.9 million of interest expense in connection with borrowings related to the Chicago
acquisition.
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 year ended
June 30, 2007 provided $36.7 million of cash, compared with $52.9 million provided in the same
period in fiscal 2006. Net cash used by investing activities for the year ended June 30, 2007 was
$75.5 million, compared with $70.8 million in the same period in fiscal 2006. Both periods reflect
net additions to our investment portfolio as a result of the increase in net premiums earned.
During the year ended June 30, 2007, we sold fixed maturity investments of $45.9 million that were
subsequently reinvested. These sales and reinvestments were primarily related to weekly
auction-rate securities that were reinvested longer term and portfolio changes made in order to
help obtain premium tax credits in certain states. In December 2006, we borrowed $5.0 million from
our revolving credit facility and used the proceeds to increase the statutory capital and surplus
of our insurance company subsidiaries. We repaid this amount in July 2007.
During the year ended June 30, 2007, we increased the statutory capital and surplus of the
insurance company subsidiaries by a total of $44.7 million to support additional premium writings.
Of this capital contribution, $2.7 million came from funds our holding company received from our
insurance company subsidiaries through an intercompany tax allocation agreement under which the
holding company was reimbursed for current tax benefits utilized through the recognition of tax net
operating loss carryforwards. The balance of the capital contribution came from $7.0 million of
unrestricted cash, $5.0 million from the borrowing under the revolving credit facility and $30.0
million from the proceeds of trust preferred securities sold by one of our subsidiaries in June
2007. At June 30, 2007, we had $10.4 million available in unrestricted cash and investments
outside of the insurance company subsidiaries. Of these funds, in July 2007, we used $5.0 million
to pay down the revolving credit facility and $2.2 million to pay scheduled quarterly payments of
principal and interest on our debt. Future debt payments will be serviced by the additional
unrestricted cash from the sources described in the next paragraph.
We are part of an insurance holding company system with substantially all of our operations
conducted by our insurance company subsidiaries. Accordingly, the holding company will only
receive cash from operating activities as a result of investment income and the ultimate
liquidation of our foreclosed real estate held for sale. It will also receive dividends from
non-insurance company subsidiaries that sell ancillary products to our insureds. Cash could be made
available through loans from financial institutions, the sale of securities, and dividends from our
insurance company subsidiaries. In addition, as a result of our tax net operating loss
carryforwards, taxable income generated by the insurance company subsidiaries 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 net operating loss carryforwards.
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State insurance laws limit the amount of dividends that may be paid from our 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.
We believe that existing cash and investment balances, when combined with anticipated cash
flows generated from operations and dividends from our insurance company subsidiaries, will be
adequate to meet our expected liquidity needs in both the short term and the reasonably foreseeable
future. Our growth strategy includes possible acquisitions. Any acquisitions or other 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.
Chicago Acquisition
In order to gain a presence in the market, on January 12, 2006, we acquired certain assets
(principally the trade names, customer lists and relationships and the lease rights to 72 retail
locations) of two non-standard automobile insurance agencies under common control in Chicago,
Illinois for $30.0 million in cash. In addition, in accordance with the terms of the acquisition,
$1.0 million of additional consideration was paid in March 2007 based on attainment of certain
financial targets. No further amounts are due from the Company in connection with this
acquisition.
Credit
Facility
In
connection with the Chicago acquisition, we entered into, and borrowed under, a credit agreement
with two banks consisting of a $5.0 million revolving facility and a $25.0 million term loan
facility, both maturing on June 30, 2010. Through September 13,
2007, both facilities bore interest at LIBOR plus 175 basis
points per annum. We entered into an interest rate swap agreement on January 17, 2006 that fixed
the interest rate on the term loan facility at 6.63% through June 30, 2010. At June 30, 2007, the
swap, which qualifies as a cash flow hedge, had a fair value of $0.1 million and is included within
other assets and accumulated other comprehensive loss. Payments/receipts associated with the swap
are reported in the statement of operations as a part of interest expense. The term loan facility
is due in equal quarterly installments through June 30, 2010. Both
facilities are secured by the common stock and certain assets of our non-regulated subsidiaries.
For the year ended June 30, 2007, we incurred $1.7 million of interest expense in connection with
the noted credit agreement. At June 30, 2007, the unpaid balance due under the facilities was $23.1
million.
At
June 30, 2007, we were not in compliance with financial
covenants in the credit agreement regarding a minimum
fixed charge coverage ratio and a maximum combined ratio. Our lenders
waived this non-compliance as of June 30, 2007 and we entered into an amendment to the credit agreement
dated September 13, 2007. The amended terms have less
restrictive financial covenants, increased the interest rate we pay
by 75 basis points and require us to make a prepayment of at least $6.0 million in principal before December 31, 2007. In
addition, the availability under the revolving credit facility was permanently reduced from $5.0
million to $2.0 million.
Trust Preferred Securities
On June 15, 2007, First Acceptance Statutory Trust I (“FAST I”), our newly formed wholly-owned
unconsolidated subsidiary trust entity, completed a private placement whereby FAST I issued
40,000 shares of preferred securities at $1,000 per share to outside
investors and 1,240 shares of common securities to us, also at $1,000 per share. FAST I used the proceeds from the sale
of the preferred securities to purchase $41.2 million of junior subordinated debentures from us.
The debentures will mature on July 30, 2037 and are redeemable by the Company in whole or in part
beginning on July 30, 2012, at which time the preferred securities are callable. The debentures pay
a fixed rate of 9.277% until July 30, 2012, after which the rate becomes variable (LIBOR plus 375
basis points). The obligations of the Company under the junior subordinated debentures represent
full and unconditional guarantees by the Company of FAST I’s obligations for the preferred
securities. Dividends on the preferred securities are cumulative, payable quarterly in arrears and
are deferrable at the Company’s option for up to
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five years. The dividends on these securities are
the same as the interest on the debentures. The Company cannot pay dividends on its common stock
during such deferments. FAST I does not meet the requirements for consolidation of Financial
Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest
Entities — An Interpretation of ARB No. 51.
Off-Balance Sheet Arrangements
We use off-balance sheet arrangements (e.g., operating leases) where the economics and sound
business principles warrant their use. Refer to “Trust Preferred Securities” section above
regarding a new off-balance sheet arrangement.
Contractual Obligations
The following table summarizes all of our contractual obligations by period as of June 30,
2007:
| Payments Due By Period | ||||||||||||||||||||
| More than 5 | ||||||||||||||||||||
| Total | Less than 1 year | 1-3 Years | 3-5 Years | years | ||||||||||||||||
Loss and loss adjustment expense
reserves (1) |
$ | 91,446 | $ | 54,991 | $ | 33,265 | $ | 2,734 | $ | 456 | ||||||||||
Notes payable (2) (6) |
19,725 | 6,481 | 13,244 | — | — | |||||||||||||||
Revolving credit agreement (3) (6) |
5,000 | — | 5,000 | — | — | |||||||||||||||
Debentures payable (4) |
154,299 | 3,826 | 7,652 | 7,652 | 135,169 | |||||||||||||||
Capitalized lease obligations |
462 | 231 | 231 | — | — | |||||||||||||||
Operating leases (5) |
28,965 | 9,573 | 13,461 | 4,348 | 1,583 | |||||||||||||||
Employment agreements |
1,707 | 965 | 742 | — | — | |||||||||||||||
Severance agreement obligation |
501 | 264 | 237 | — | — | |||||||||||||||
Advisory services agreement |
208 | 208 | — | — | — | |||||||||||||||
Total contractual cash obligations |
$ | 302,313 | $ | 76,539 | $ | 73,832 | $ | 14,734 | $ | 137,208 | ||||||||||
| (1) | Loss and loss adjustment expense reserves do not have contractual maturity dates; however, based on historical payment patterns, the amount presented is our estimate of the expected timing of these payments. The timing of these payments is subject to significant uncertainty. We maintain a portfolio of marketable investments with varying maturities and a substantial amount of cash and cash equivalents intended to provide adequate cash flows for such payments. The noted payments due by period of $91,446 include $309 related to reinsurance receivables. | |
| (2) | Noted payments due by period assume a fixed interest rate on notes payable of 6.63% consistent with interest rate swap agreement effective through term loan facility maturity date of June 30, 2010. | |
| (3) | Noted payments due on revolving credit agreement of $5,000 was repaid in July 2007. | |
| (4) | Noted payments due by period assume a contractual fixed interest rate of 9.277% until July 30, 2012, after which the rate becomes variable (LIBOR plus 375 basis points, or 9.11% as of June 30, 2007). | |
| (5) | Consists primarily of rental obligations under real estate leases related to our retail locations and corporate offices. | |
| (6) | At June 30, 2007, we were not in compliance with financial covenants in the credit agreement regarding a minimum fixed charge coverage ratio and a maximum combined ratio. Our lenders waived this non-compliance as of June 30, 2007 and we entered into an amendment to the credit agreement dated September 13, 2007. The amended terms have less restrictive financial covenants, increased the interest rate we pay by 75 basis points and require us to make a prepayment of at least $6.0 million in principal before December 31, 2007. In addition, the availability under the revolving credit facility was permanently reduced from $5.0 million to $2.0 million. |
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Critical Accounting Policies
The preparation of consolidated financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that affect amounts
reported in the consolidated financial statements. As more information becomes known, these
estimates and assumptions could change, thus having an impact on the amounts reported in the
future. The following are considered to be our critical accounting policies:
Losses and loss adjustment expense reserves. Loss and loss adjustment expense reserves
represent our best estimate of our ultimate liability for losses and loss adjustment expenses
relating to events that occurred prior to the end of any given accounting period, but have not been
paid. Months and sometimes years may elapse between the occurrence of an automobile accident
covered by one of our insurance policies, the reporting of the accident and the payment of the
claim. We record a liability for estimates of losses that will be paid for accidents that have been
reported, which is referred to as case reserves. In addition, since accidents are not always
reported when they occur, we estimate liabilities for accidents that have occurred but have not
been reported, which are referred to herein as incurred but not reported, or IBNR, reserves.
We are directly liable for loss and loss adjustment expenses under the terms of the insurance
policies that our insurance company subsidiaries underwrite. Each of the insurance company
subsidiaries establishes a reserve for all of its unpaid losses and loss adjustment expenses,
including case and IBNR reserves, and estimates for the cost to settle the claims. We
estimate our IBNR reserves by estimating our ultimate unpaid liability for loss and loss adjustment
expense reserves first, and then reducing that amount by the amount of cumulative paid claims and
by the amount of our case reserves. We rely primarily on historical loss experience in determining
reserve levels, on the assumption that historical loss experience provides a good indication of
future loss experience. We also consider various other factors, such as inflation, claims
settlement patterns, legislative activity and litigation trends. Our internal actuarial staff
continually monitors these estimates on a state and coverage level. We utilized our internal
actuarial staff to determine appropriate reserve levels. As experience develops or new information
becomes known, we increase or decrease the level of our reserves in the period in which changes to
the estimates are determined. Accordingly, the actual losses and loss adjustment expenses may
differ materially from the estimates we have recorded. See “Business — Loss and Loss Adjustment
Expense Reserves” for additional information.
Revenue Recognition. Insurance premiums earned are recognized on a pro-rata basis over the
respective terms of the policies. Written premiums are recorded as of the effective date of the
policies for the full policy premium although most policyholders elect to pay on a monthly
installment basis. Policy and renewal fees are included in premiums earned and are recognized on a
pro-rata basis over the respective terms of the policies. Premiums are generally collected in
advance of providing risk coverage, minimizing our exposure to credit risk. Premiums receivable are
recorded net of an estimated allowance for uncollectible amounts.
Commission income and related policy fees, written for affiliated and unaffiliated insurance
companies, are recognized at the date the customer is initially billed or as of the effective date
of the insurance policy, whichever is later. Commissions on premium endorsements are recognized
when premiums are processed. Motor club fees written by an affiliate are earned on a pro-rata
basis over the respective terms of the contracts and included within commission and fee income.
Fees are paid monthly by motor club members and are generally collected in advance of providing
coverage, minimizing our exposure to credit risk.
Fee income includes agency and installment fees to compensate us for the costs of providing
installment payment plans, as well as late payment, policy cancellation, policy rewrite and
reinstatement fees. We recognize these fees on a collected basis. Installment billing fees paid by
policyholders are recognized as revenue when each installment is billed.
Valuation of deferred tax asset. Income taxes are maintained 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.
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Based on business activity prior to the USAuto acquisition, management believed it was more
likely than not that we would not realize the benefits of the loss carryforwards. Therefore, a full
valuation allowance had been established. Based upon our estimates of our future taxable income
after the USAuto acquisition, we reduced our deferred tax valuation allowance by $41.3 million.
Further, based upon our revised estimates after considering the actual results for the year ended
June 30, 2007, the allowance was increased by $6.9 million, while the years ended June 30, 2006 and
2005 included reductions in the allowance of $10.5 million and $10.6 million, respectively. In
addition, during the year ended June 30, 2007, the provision for income taxes included a $10.0
million charge related to the expiration of certain net operating loss carryforwards due to taxable
income for the current fiscal year being less than management’s prior estimates. At June 30, 2007,
our total gross deferred tax asset is $58.0 million, and we had net operating loss carryforwards
for federal income tax purposes of approximately $133.0 million. On a net basis, the deferred tax
asset is $30.9 million after an allowance of $27.1 million. Realization of this deferred tax asset
is dependent upon our generation of sufficient taxable income in the future. If future taxable
income is not sufficient to recover the deferred tax asset, the maximum charge to the provision for
income taxes will be $30.9 million. If we generate sufficient future taxable income to fully
utilize the deferred tax asset as of June 30, 2007, the maximum additional benefit for income taxes
will be $27.1 million.
Goodwill and identifiable intangible assets. Our acquisitions have resulted in goodwill of
$138.1 million. Goodwill represents the excess of the purchase price over the fair value of the net
assets acquired. The acquisitions also resulted in other identifiable intangible assets with a
current book value of $6.4 million. As required by SFAS No. 142, Goodwill and Other Intangible
Assets, we perform an annual impairment test of goodwill and identifiable intangible assets. If
impairment indicators exist between the annual testing periods, management will perform an interim
impairment test. Should either an annual or interim impairment test determine that the fair value
is below the carrying value, a write-down of these assets will be required. At June 30, 2007,
impairment tests were performed and in management’s opinion, no impairment exists.
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 management’s 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 the “Risk
Factors” section, as well as other sections, of this report.
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.
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Item 7A. 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
collateralized mortgage obligations that have been rated “A” or better by Standard & Poors. At June
30, 2007, 89.8% of our investment portfolio was invested in securities rated “AA” or better by
Standard & Poors and 97.9% in securities rated “A” or better by Standard & Poors. At June 30,
2007, our exposure with regards to sub-prime mortgage securities was limited to $2.0 million in
fixed maturities that were all rated “A” or better by Standard & Poors. We have not recognized any
other-than-temporary losses on our investment portfolio. We also utilize the services of a
professional fixed income investment manager.
As of June 30, 2007, 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 4.5%, or approximately $7.9 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 4.3%, or approximately $7.6 million.
In connection with the January 12, 2006 Chicago acquisition, we entered into a new $30.0
million credit facility that includes a $25.0 million term loan facility and a $5.0 million
revolving facility. We amended the credit facility 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
June 30, 2007, $5.0 million was borrowed under the revolving facility. In July 2007, we repaid the
$5.0 million outstanding under the revolving credit facility.
On June 15, 2007, we used the proceeds from the sale of preferred securities by our newly
formed wholly-owned unconsolidated trust entity, FAST I, 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). The dividends on these securities are the
same as the interest on the debentures.
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Item 8.
Financial Statements and Supplementary Data
| Page | ||||
| 41 | ||||
| 44 | ||||
| 45 | ||||
| 46 | ||||
| 47 | ||||
| 48 | ||||
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Acceptance Corporation
First Acceptance Corporation
We have audited the accompanying consolidated balance sheets of First Acceptance Corporation and
subsidiaries (the “Company”) as of June 30, 2007 and 2006, and the related consolidated statements
of operations, stockholders’ equity, and cash flows for the years then ended. Our audits also
included the financial statement schedules listed in the index at Item 15(a). These financial
statements and schedules are the responsibility of the Company’s management. Our responsibility is
to express an opinion on these consolidated financial statements and schedules based on our audits.
The consolidated financial statements of the Company for the year ended June 30, 2005 were audited
by other auditors whose report dated September 9, 2005 expressed an unqualified opinion on those
statements.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the 2007 and 2006 financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First Acceptance Corporation and
subsidiaries as of June 30, 2007 and 2006 and the results of its operations and its cash flows for
the years then ended, in conformity with U.S. generally accepted accounting principles. Also in our
opinion, the related financial statement schedules, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material respects, the information
set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of First Acceptance Corporation and subsidiaries’ internal
control over financial reporting as of June 30, 2007, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated September 13, 2007 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
Nashville, Tennessee
September 13, 2007
September 13, 2007
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Acceptance Corporation
First Acceptance Corporation
We have audited First Acceptance Corporation and subsidiaries (the “Company”) internal control over
financial reporting as of June 30, 2007, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). The Company’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management’s Annual Report on
Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material risk exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
In our opinion, First Acceptance Corporation maintained, in all material respects, effective
internal control over financial reporting as of June 30, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of the Company as of June 30, 2007 and 2006,
and the related consolidated statements of operations, stockholders’ equity, and cash flows for the
years then ended, and our report dated September 13, 2007 expressed an unqualified opinion thereon.
ERNST & YOUNG LLP
Nashville, Tennessee
September 13, 2007
September 13, 2007
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Acceptance Corporation:
First Acceptance Corporation:
We have audited the accompanying consolidated statements of operations, stockholders’ equity, and
cash flows of First Acceptance Corporation and subsidiaries (the “Company”) for the year ended June
30, 2005. These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated financial statements
based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the results of operations and the cash flows of First Acceptance Corporation and
subsidiaries for the year ended June 30, 2005, in conformity with U.S. generally accepted
accounting principles.
KPMG LLP
Dallas, Texas
September 9, 2005
September 9, 2005
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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
| June 30, | ||||||||
| 2007 | 2006 | |||||||
ASSETS |
||||||||
Fixed maturities, available-for-sale at fair value (amortized
cost $179,328 and $131,291, respectively) |
$ | 176,555 | $ | 127,828 | ||||
Cash and cash equivalents |
34,161 | 31,534 | ||||||
Premiums and fees receivable, net of allowance of $606 and $668 |
71,771 | 65,095 | ||||||
Reinsurance receivables |
326 | 1,344 | ||||||
Receivable for securities |
19,973 | 999 | ||||||
Deferred tax asset |
30,936 | 48,068 | ||||||
Other assets |
11,396 | 7,883 | ||||||
Property and equipment, net |
4,116 | 3,376 | ||||||
Deferred acquisition costs |
5,166 | 5,330 | ||||||
Goodwill |
138,082 | 137,045 | ||||||
Identifiable intangible assets |
6,410 | 6,825 | ||||||
TOTAL ASSETS |
$ | 498,892 | $ | 435,327 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Loss and loss adjustment expense reserves |
$ | 91,446 | $ | 62,822 | ||||
Unearned premiums and fees |
88,831 | 78,331 | ||||||
Notes payable and capitalized lease obligations |
23,490 | 24,026 | ||||||
Debentures payable |
41,240 | — | ||||||
Payable for securities |
999 | 4,914 | ||||||
Other liabilities |
13,402 | 11,811 | ||||||
Total liabilities |
259,408 | 181,904 | ||||||
Stockholders’ equity: |
||||||||
Preferred stock, $.01 par value, 10,000 shares authorized |
— | — | ||||||
Common stock, $.01 par value, 75,000 shares authorized;
47,615 and 47,535 shares issued and outstanding,
respectively |
476 | 475 | ||||||
Additional paid-in capital |
460,968 | 459,049 | ||||||
Accumulated other comprehensive loss |
(2,652 | ) | (3,463 | ) | ||||
Accumulated deficit |
(219,308 | ) | (202,638 | ) | ||||
Total stockholders’ equity |
239,484 | 253,423 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
$ | 498,892 | $ | 435,327 | ||||
See notes to consolidated financial statements.
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Table of Contents
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Revenues: |
||||||||||||
Premiums earned |
$ | 300,661 | $ | 208,771 | $ | 132,677 | ||||||
Commissions and fee income |
37,324 | 26,757 | 26,821 | |||||||||
Investment income |
8,863 | 5,762 | 3,353 | |||||||||
Other |
789 | 7,712 | 3,944 | |||||||||
| 347,637 | 249,002 | 166,795 | ||||||||||
Costs and expenses: |
||||||||||||
Losses and loss adjustment expenses |
241,908 | 140,845 | 87,493 | |||||||||
Insurance operating expenses |
97,629 | 75,773 | 49,921 | |||||||||
Other operating expenses |
2,623 | 2,494 | 2,775 | |||||||||
Stock-based compensation |
1,063 | 500 | 332 | |||||||||
Depreciation and amortization |
1,624 | 1,463 | 1,920 | |||||||||
Interest expense |
1,874 | 898 | 351 | |||||||||
| 346,721 | 221,973 | 142,792 | ||||||||||
Income before income taxes |
916 | 27,029 | 24,003 | |||||||||
Provision (benefit) for income taxes |
17,586 | (1,039 | ) | (2,153 | ) | |||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
Net income (loss) per share: |
||||||||||||
Basic |
$ | (0.35 | ) | $ | 0.59 | $ | 0.56 | |||||
Diluted |
$ | (0.35 | ) | $ | 0.57 | $ | 0.53 | |||||
Number of shares used to calculate net income
(loss) per share: |
||||||||||||
Basic |
47,584 | 47,487 | 47,055 | |||||||||
Diluted |
47,584 | 49,576 | 48,989 | |||||||||
Reconciliation of net income (loss) to
comprehensive income (loss): |
||||||||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
Net unrealized change on investments |
690 | (4,118 | ) | 690 | ||||||||
Unrealized gain on interest rate swap agreement |
121 | — | — | |||||||||
Comprehensive income (loss) |
$ | (15,859 | ) | $ | 23,950 | $ | 26,846 | |||||
See notes to consolidated financial statements.
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Table of Contents
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| Accumulated | ||||||||||||||||||||||||||||
| Additional | other | Total | ||||||||||||||||||||||||||
| Common Stock | paid-in | comprehensive | Accumulated | Treasury | stockholders’ | |||||||||||||||||||||||
| Shares | Amount | capital | income (loss) | deficit | stock | equity | ||||||||||||||||||||||
Balances at July 1, 2004 |
46,535 | $ | 465 | $ | 450,658 | $ | (35 | ) | $ | (256,862 | ) | $ | — | $ | 194,226 | |||||||||||||
Net income |
— | — | — | — | 26,156 | — | 26,156 | |||||||||||||||||||||
Net unrealized change on investments (net of tax of $373) |
— | — | — | 690 | — | — | 690 | |||||||||||||||||||||
Issuance of contingent
shares related to
acquisition |
750 | 8 | 6,712 | — | — | — | 6,720 | |||||||||||||||||||||
Stock-based compensation |
3 | — | 332 | — | — | — | 332 | |||||||||||||||||||||
Issuance of shares under
Employee Stock Purchase
Plan |
11 | 1 | 103 | — | — | — | 104 | |||||||||||||||||||||
Purchase of treasury
stock, at cost |
— | — | — | — | — | (639 | ) | (639 | ) | |||||||||||||||||||
Retirement of treasury
stock, at cost |
(90 | ) | (1 | ) | (638 | ) | — | — | 639 | — | ||||||||||||||||||
Exercise of stock options |
246 | 2 | 738 | — | — | — | 740 | |||||||||||||||||||||
Balances at June 30, 2005 |
47,455 | 475 | 457,905 | 655 | (230,706 | ) | — | 228,329 | ||||||||||||||||||||
Net income |
— | — | — | — | 28,068 | — | 28,068 | |||||||||||||||||||||
Net unrealized change on
investments (net of tax
of $353) |
— | — | — | (4,118 | ) | — | — | (4,118 | ) | |||||||||||||||||||
Stock-based compensation |
3 | — | 500 | — | — | — | 500 | |||||||||||||||||||||
Issuance of shares under
Employee Stock Purchase
Plan |
22 | — | 223 | — | — | — | 223 | |||||||||||||||||||||
Exercise of stock options |
55 | — | 421 | — | — | — | 421 | |||||||||||||||||||||
Balances at June 30, 2006 |
47,535 | 475 | 459,049 | (3,463 | ) | (202,638 | ) | — | 253,423 | |||||||||||||||||||
Net loss |
— | — | — | — | (16,670 | ) | — | (16,670 | ) | |||||||||||||||||||
Net unrealized change on
investments (net of tax
of $0) |
— | — | — | 690 | — | — | 690 | |||||||||||||||||||||
Change in unrealized
gain on interest rate
swap agreement |
— | — | — | 121 | — | — | 121 | |||||||||||||||||||||
Sale of common stock |
50 | 1 | 590 | — | — | — | 591 | |||||||||||||||||||||
Stock-based compensation |
5 | — | 1,063 | — | — | — | 1,063 | |||||||||||||||||||||
Issuance of shares under
Employee Stock Purchase
Plan |
25 | — | 266 | — | — | — | 266 | |||||||||||||||||||||
Balances at June 30, 2007 |
47,615 | $ | 476 | $ | 460,968 | $ | (2,652 | ) | $ | (219,308 | ) | $ | — | $ | 239,484 | |||||||||||||
See notes to consolidated financial statements.
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Table of Contents
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
Adjustments to reconcile net income (loss) to cash provided by
operating activities: |
||||||||||||
Depreciation and amortization |
1,624 | 1,463 | 1,920 | |||||||||
Stock-based compensation |
1,063 | 500 | 332 | |||||||||
Amortization of premium on fixed maturities |
217 | 460 | 357 | |||||||||
Deferred income taxes |
17,132 | (1,533 | ) | (2,986 | ) | |||||||
Gains on sales of foreclosed real estate |
— | (3,638 | ) | (755 | ) | |||||||
Other |
38 | 76 | (214 | ) | ||||||||
Change in: |
||||||||||||
Premiums and fees receivable |
(6,676 | ) | (21,264 | ) | (10,972 | ) | ||||||
Reinsurance receivables |
1,018 | 3,146 | 7,807 | |||||||||
Prepaid reinsurance premiums |
— | — | 12,384 | |||||||||
Deferred acquisition costs |
164 | (2,059 | ) | (3,571 | ) | |||||||
Loss and loss adjustment expense reserves |
28,624 | 19,925 | 12,463 | |||||||||
Unearned premiums and fees |
10,500 | 28,307 | 14,001 | |||||||||
Amounts due to reinsurers |
— | — | (11,899 | ) | ||||||||
Other |
(307 | ) | (582 | ) | 425 | |||||||
Net cash provided by operating activities |
36,727 | 52,869 | 45,448 | |||||||||
Cash flows from investing activities: |
||||||||||||
Purchases of fixed maturities, available-for-sale |
(101,295 | ) | (82,144 | ) | (48,493 | ) | ||||||
Maturities and paydowns of fixed maturities, available-for-sale |
7,048 | 8,748 | 3,502 | |||||||||
Sales of fixed maturities, available-for-sale |
45,932 | 15,400 | 4,153 | |||||||||
Sales (purchases) of investment in mutual fund |
— | 10,920 | (10,920 | ) | ||||||||
Net change in receivable/payable for securities |
(22,889 | ) | 3,915 | — | ||||||||
Purchase of common stock in trust |
(1,240 | ) | — | — | ||||||||
Acquisitions of property and equipment |
(1,769 | ) | (2,265 | ) | (1,053 | ) | ||||||
Proceeds from sale of property and equipment |
— | — | 666 | |||||||||
Improvements to foreclosed real estate |
(254 | ) | — | (300 | ) | |||||||
Proceeds from sales of foreclosed real estate |
— | 4,512 | 1,202 | |||||||||
Cash paid for acquisitions, net of cash acquired |
(1,037 | ) | (29,853 | ) | (4,000 | ) | ||||||
Net cash used in investing activities |
(75,504 | ) | (70,767 | ) | (55,243 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Proceeds from borrowings |
5,000 | 30,431 | — | |||||||||
Payments on borrowings |
(5,693 | ) | (6,405 | ) | (4,000 | ) | ||||||
Proceeds from issuance of debentures |
41,240 | — | — | |||||||||
Net proceeds from issuance of common stock |
857 | 223 | 104 | |||||||||
Exercise of stock options |
— | 421 | 740 | |||||||||
Purchase of treasury stock |
— | — | (639 | ) | ||||||||
Net cash provided by (used in) financing activities |
41,404 | 24,670 | (3,795 | ) | ||||||||
Net increase (decrease) in cash and cash equivalents |
2,627 | 6,772 | (13,590 | ) | ||||||||
Cash and cash equivalents, beginning of year |
31,534 | 24,762 | 38,352 | |||||||||
Cash and cash equivalents, end of year |
$ | 34,161 | $ | 31,534 | $ | 24,762 | ||||||
See notes to consolidated financial statements.
47
Table of Contents
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
1. Summary of Significant Accounting Policies
General
First Acceptance Corporation (the “Company”) is a holding company based in Nashville,
Tennessee with operating subsidiaries whose primary operations include the selling, servicing and
underwriting of non-standard personal automobile insurance. The Company writes non-standard
personal automobile insurance in 12 states and is licensed as an insurer in 13 additional states.
Business is written through three wholly-owned subsidiaries, First Acceptance Insurance Company,
Inc., First Acceptance Insurance Company of Georgia, Inc. and First Acceptance Insurance Company of
Tennessee, Inc. (the “Insurance Companies”). The Company has limited activities related to its
attempts to market and dispose of remaining foreclosed real estate held for sale.
Basis of Consolidation and Reporting
The accompanying consolidated financial statements include the accounts of the Company and its
subsidiaries which are all wholly owned. These financial statements have been prepared in
conformity with accounting principles generally accepted in the United States. All intercompany
accounts and transactions have been eliminated in consolidation.
Reclassifications
Certain reclassifications have been made to the prior year’s consolidated financial statements
to conform with the current year presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles (“GAAP”) requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. It also requires disclosure of
contingent assets and liabilities at the date of the consolidated financial statements and the
reported amounts of revenue and expenses during the period. Actual results could differ from those
estimates.
Investments
Fixed maturities, available-for-sale, include bonds with fixed principal payment schedules and
loan-backed securities which are amortized using the retrospective method. These securities are
carried at market value with the corresponding unrealized appreciation or depreciation, net of
deferred income taxes, reported in other comprehensive income or loss. Market values are obtained
from a recognized pricing service.
Investment securities are exposed to various risks such as interest rate, market and credit
risk. Market values of securities fluctuate based on the magnitude of changing market conditions;
significant changes in market conditions could materially affect portfolio value in the near term.
Management reviews investments for impairment on a quarterly basis. Any 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. The impairment would
be charged to net income and a new cost basis for the security would be established.
Realized gains and losses on sales of securities are computed based on specific identification
and are included within other revenues.
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Table of Contents
Cash and Cash Equivalents
Cash and cash equivalents consist of bank demand deposits and highly-liquid investments. All
investments with original maturities of three months or less are considered cash equivalents.
Revenue Recognition
Insurance premiums earned are recognized on a pro-rata basis over the respective terms of the
policies. Written premiums are recorded as of the effective date of the policies for the full
policy premium although most policyholders elect to pay on a monthly installment basis. Policy and
renewal fees are included in premiums earned and are recognized on a pro-rata basis over the
respective terms of the policies. Premiums are generally collected in advance of providing risk
coverage, minimizing the Company’s exposure to credit risk. Premiums receivable are recorded net of
an estimated allowance for uncollectible amounts.
Commission income and related policy fees, written for affiliated and unaffiliated insurance
companies, are recognized at the date the customer is initially billed or as of the effective date
of the insurance policy, whichever is later. Commissions on premium endorsements are recognized
when premiums are processed. Motor club fees written by an affiliate are earned on a pro-rata
basis over the respective terms of the contracts and included within commission and fee income.
Fees are paid monthly by motor club members and are generally collected in advance of providing
coverage, minimizing the Company’s exposure to credit risk.
Fee income includes agency and installment fees to compensate the Company for the costs of
providing installment payment plans, as well as late payment, policy cancellation, policy rewrite
and reinstatement fees. The Company recognizes these fees on a collected basis. Installment billing
fees paid by policyholders are recognized as revenue when each installment is billed.
Reinsurance
Reinsurance premiums, losses and loss adjustment expenses are accounted for on bases
consistent with those used in accounting for the original policies issued and the terms of the
reinsurance contracts. Ceding commission income with retrospective adjustment features is
calculated based upon the related estimated incurred losses and loss expenses including a provision
for unreported losses. Ceding commission income, as included within other revenues, for the years
ended June 30, 2007, 2006 and 2005 was $0, $0 and $2,975, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date.
A valuation allowance for the deferred tax asset is established based upon management’s
estimate of whether it is more likely than not that the Company would not realize tax benefits in
future periods to the full extent available. Changes in the valuation allowance are recognized in
income during the period in which the circumstances that cause such a change in management’s
estimate occur.
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Table of Contents
Advertising Costs
Advertising costs are expensed when incurred. Advertising expense for the years ended June
30, 2007, 2006 and 2005 was $11,739, $9,384 and $6,692, respectively. At June 30, 2007 and 2006,
prepaid advertising costs, which are included in other assets within the accompanying consolidated
balance sheet, were $2,959 and $2,808.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided over the estimated
useful lives of the assets (generally ranging from three to seven years) using the straight-line
method. Leasehold improvements are amortized over the shorter of the lives of the respective leases
or the service lives of the improvements. Repairs and maintenance are charged to expense as
incurred. Equipment under capitalized lease obligations is stated at the present value of the
minimum lease payments at the beginning of the lease term.
Foreclosed Real Estate Held for Sale
Foreclosed real estate held for sale is recorded at the lower of cost or fair value less
estimated costs to sell. The Company periodically reviews its portfolio of foreclosed real estate
held for sale using current information including (i) independent appraisals, (ii) general economic
factors affecting the area where the property is located, (iii) recent sales activity and asking
prices for comparable properties and (iv) costs to sell and/or develop that would serve to lower
the expected proceeds from the disposal of the real estate. Gains (losses) realized on liquidation
are recorded directly to operations and included within other revenues. Foreclosed real estate
held for sale assets at June 30, 2007 and 2006 of $341 and $87, respectively, are included within
other assets.
Deferred Acquisition Costs / Deferred Ceding Commissions
Deferred acquisition costs include premium taxes and other variable underwriting and direct
sales costs incurred in connection with writing business. These costs are deferred and amortized,
net of deferred ceding commission income from our reinsurer, over the policy period in which the
related premiums are earned, to the extent that such costs are deemed recoverable from future
unearned premiums and anticipated investment income. Amortization expense for the years ended June
30, 2007, 2006 and 2005 was $20,366, $15,226 and $3,967, respectively.
Goodwill and Other Identifiable Intangible Assets
Goodwill and other identifiable intangible assets are attributable to our insurance
operations. Goodwill and indefinite-life intangible assets are not amortized for financial
statement purposes, but are instead tested annually for impairment. The Company uses June 30 of
each year as its annual impairment testing date for goodwill and other intangible assets. As of
June 30, 2007, the Company tested goodwill and other identifiable intangible assets and as a result
has recorded no impairment. Included in unamortized other identifiable intangible assets is an
amount related to the value of customer lists and relationships which is being amortized through
June 2008 in proportion to anticipated policy expirations.
Loss and Loss Adjustment Expense Reserves
Loss and loss adjustment expense reserves are undiscounted and represent case-basis estimates
of reported losses and estimates based on certain actuarial assumptions regarding the past
experience of reported losses, including an estimate of losses incurred but not reported (“IBNR”).
Management believes that the losses and loss adjustment reserves are adequate to cover the ultimate
liability. However, such estimate may be more or less than the amount ultimately paid when the
claims are finally settled.
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Table of Contents
Stock-Based Compensation
Effective July 1, 2005, the Company adopted Statement of Financial Accounting Standards No.
123 (Revised), Share Based Payment (“SFAS No. 123(R)”). SFAS No. 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values. Prior to July 1, 2003, the Company followed the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(“APB No. 25”), to account for its stock option activity in the financial statements. Effective
July 1, 2003, the Company adopted the prospective method provisions of SFAS No. 148, Accounting for
Stock-Based Compensation — Transition and Disclosure, and uses the fair value method for expensing
stock-based compensation on a straight-line basis over the vesting period. Regarding the adoption
of SFAS No. 123(R), there was no effect on net income and net income per share for the years ended
June 30, 2007, 2006 and 2005 since all stock options issued under APB No. 25 were fully vested
prior to July 1, 2004.
Recent Accounting Pronouncements
In July 2006, Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting
for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (“FIN 48”), was
issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements 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. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company is currently evaluating the impact that the adoption of FIN 48 will
have on future consolidated financial statements.
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. The Company has not evaluated the requirements of
SFAS 157 and has not yet determined if SFAS 157 will have a material impact on future consolidated
financial statements.
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 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 FASB’s 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, with early
adoption permitted for an entity that has also elected to apply the provisions of SFAS 157, Fair
Value Measurements. An entity is prohibited from retrospectively applying SFAS 159, unless it
chooses early adoption. SFAS 159 also applies to eligible items existing at November 15, 2007 (or
early adoption). The Company has not evaluated the requirements of SFAS 159 and has not yet
determined if SFAS 159 will have a material impact on future consolidated financial statements.
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Table of Contents
Supplemental Cash Flow Information
During the years ended June 30, 2007, 2006 and 2005, the Company paid $807, $927 and $1,775,
respectively, in income taxes and $1,663, $586 and $233, respectively, in interest.
Basic and Diluted Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) available to
common shareholders by the weighted average number of common shares, while diluted net income
(loss) per share is computed by dividing net income (loss) available to common shareholders by the
weighted average number of such common shares and dilutive share equivalents. Dilutive share
equivalents result from the assumed conversion of employee stock options and are calculated using
the treasury stock method.
2. Business Combinations
USAuto Holdings
On April 30, 2004, the Company consummated an agreement dated December 15, 2003 to acquire
100% of the outstanding common stock of USAuto Holdings, Inc. (“USAuto”), a non-standard automobile
insurance agency based in Nashville, Tennessee. The consideration consisted of $76,000 in cash, 13,250 shares
of our common stock issued at closing and 750 shares issued in 2005 upon the attainment of certain
financial targets. The aggregate purchase price of $166,800 was allocated to the tangible and
intangible assets acquired and the liabilities assumed based upon their respective fair values as
of the date of the acquisition. Total goodwill and identifiable intangible assets recorded from the
acquisition were $110,024, which was net of a $41,277 reduction in the deferred tax allowance based
upon projections of USAuto’s future taxable income. Acquired identifiable intangible assets
included $4,800 assigned to state insurance licenses and trademark and trade names, which are not
subject to amortization.
Texas Insurance Agency
Effective January 1, 2005, the Company acquired the assets (principally the book of business
and 15 retail locations) of a non-standard automobile insurance agency in Texas for $4,000 in cash.
Goodwill and identifiable intangible assets from this acquisition are deductible for tax purposes.
As a result of this acquisition, the Company is now writing business through company-operated
retail locations in Texas. Of the total purchase price, $3,813 has been recorded as goodwill and
$187 has been assigned to an identifiable intangible asset related to the value of policy renewals,
which was amortized over a 7-month period in proportion to anticipated policy expirations.
Pro forma financial information has not been presented for this acquisition since the nature
of the revenue-producing activity of this business has changed from a managing general agency to
the underwriting results of an insurance company. The results of operations of the business
acquired are included in the Company’s statements of operations beginning on January 1, 2005, the
date of acquisition.
Chicago Insurance Agencies
Effective January 12, 2006, the Company acquired certain assets (principally the trade names,
customer lists and relationships and the lease rights to 72 retail locations) of two non-standard
automobile insurance agencies under common control in Chicago, Illinois for $30,000 in cash plus
$183 in acquisition expenses. Goodwill and identifiable intangible assets from this acquisition are
deductible for tax purposes. The purchase price was financed through a newly executed credit
agreement (see Note 10). In accordance with the terms of the acquisition, $1,037 of additional
consideration was paid in March 2007 based on attainment of certain financial targets. As a result
of this acquisition, the Company is now writing business from these locations. The Company also
received a monthly fee from the seller through December 31, 2006 totaling $5,000 as compensation
for servicing the run-off of business previously written by the agencies through other insurance
companies. Fees of $850 and $4,150 were recognized and included within other revenues during the
years ended June 30, 2007 and 2006, respectively.
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Table of Contents
The following table summarizes the estimated fair values of the assets acquired at the date of
acquisition.
Net tangible assets |
$ | 330 | ||
Identifiable intangible assets |
2,570 | |||
Goodwill |
28,320 | |||
Total assets acquired |
$ | 31,220 | ||
Of the $2,570 in acquired identifiable intangible assets, $1,560 was assigned to trademark and
trade names, which are not subject to amortization. The remaining $1,010 of acquired identifiable
intangible assets relates to the value of customer lists and relationships and is being amortized
over a 30-month period in proportion to anticipated policy expirations. The Company estimated the
fair value of the customer lists and relationships acquired by discounting to present value the
estimated future earnings available from future conversions and renewals of insurance policies
existing as of the closing date.
Pro forma financial information has not been presented for this acquisition since the nature
of the revenue-producing activity of this business has changed from a retail insurance agency to
the underwriting results of an insurance company. The results of the operations of the business
acquired are included in the Company’s statements of operations beginning on January 12, 2006, the
date of acquisition.
For the years ended June 30, 2007, 2006 and 2005, amortization related to all identifiable
intangible assets was $415, $612 and $930, respectively. At June 30, 2007, the remaining
identifiable intangible assets subject to amortization were all related to the Chicago acquisition.
Amortization expense for the year ended June 30, 2008 will be $50, which represents the remaining
balance subject to amortization.
3. Investments
Restrictions
At June 30, 2007, fixed maturities and cash equivalents with a market value of $6,328
(amortized cost of $6,425) were on deposit with various insurance departments as a requirement of
doing business in those states. In addition, cash equivalents of $3,189 were on deposit with
another insurance company as collateral for an assumed reinsurance contract (see Note 4).
Investment Income and Net Realized Gains and Losses
The major categories of investment income follow:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Fixed maturities, available-for-sale |
$ | 7,770 | $ | 4,411 | $ | 2,419 | ||||||
Investment in mutual fund |
— | 674 | 920 | |||||||||
Cash and cash equivalents |
1,525 | 983 | 198 | |||||||||
Investment expenses |
(432 | ) | (306 | ) | (184 | ) | ||||||
| $ | 8,863 | $ | 5,762 | $ | 3,353 | |||||||
Net realized capital gains (losses) on investments, which are included in other revenues
within the consolidated statements of operations, from fixed maturities available-for-sale follow:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Gains |
$ | 90 | $ | 88 | $ | 72 | ||||||
Losses |
(151 | ) | (164 | ) | (19 | ) | ||||||
| $ | (61 | ) | $ | (76 | ) | $ | 53 | |||||
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Fixed Maturities, Available-for-sale
The composition of the portfolio follows:
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| June 30, 2007 | Cost | Gains | Losses | Value | ||||||||||||
U.S. Government |
$ | 15,014 | $ | 13 | $ | (320 | ) | $ | 14,707 | |||||||
State |
7,445 | 46 | (131 | ) | 7,360 | |||||||||||
Political subdivisions |
4,389 | 7 | (65 | ) | 4,331 | |||||||||||
Revenue and assessment |
26,876 | 57 | (463 | ) | 26,470 | |||||||||||
Corporate bonds |
32,696 | 17 | (626 | ) | 32,087 | |||||||||||
Collateralized mortgage |
92,908 | 59 | (1,367 | ) | 91,600 | |||||||||||
| $ | 179,328 | $ | 199 | $ | (2,972 | ) | $ | 176,555 | ||||||||
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| June 30, 2006 | Cost | Gains | Losses | Value | ||||||||||||
U.S. Government |
$ | 14,808 | $ | 6 | $ | (466 | ) | $ | 14,348 | |||||||
State |
7,706 | 1 | (196 | ) | 7,511 | |||||||||||
Political subdivisions |
6,630 | — | (140 | ) | 6,490 | |||||||||||
Revenue and assessment |
25,597 | 4 | (684 | ) | 24,917 | |||||||||||
Corporate bonds |
22,006 | — | (599 | ) | 21,407 | |||||||||||
Collateralized mortgage |
54,544 | 25 | (1,414 | ) | 53,155 | |||||||||||
| $ | 131,291 | $ | 36 | $ | (3,499 | ) | $ | 127,828 | ||||||||
The composition of maturities of the portfolio at June 30, 2007 follows:
| Amortized | Fair | |||||||
| Cost | Value | |||||||
One year or less |
$ | 4,780 | $ | 4,740 | ||||
One to five years |
33,664 | 33,248 | ||||||
Five to ten years |
37,510 | 36,902 | ||||||
Greater than ten years |
10,466 | 10,065 | ||||||
No single maturity date |
92,908 | 91,600 | ||||||
| $ | 179,328 | $ | 176,555 | |||||
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The fair value and gross unrealized losses of fixed maturities, available-for-sale, by length
of time that individual securities have been in a continuous unrealized loss position follows:
| Less than 12 months | 12 months or longer | |||||||||||||||||||
| Total | ||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Unrealized | ||||||||||||||||
| June 30, 2007 | Value | Losses | Value | Losses | Losses | |||||||||||||||
U.S. Government |
$ | 6,155 | $ | (71 | ) | $ | 7,546 | $ | (249 | ) | $ | (320 | ) | |||||||
State |
2,469 | (68 | ) | 1,833 | (63 | ) | (131 | ) | ||||||||||||
Political subdivisions |
912 | (9 | ) | 2,296 | (56 | ) | (65 | ) | ||||||||||||
Revenue and assessment |
13,400 | (303 | ) | 6,655 | (160 | ) | (463 | ) | ||||||||||||
Corporate bonds |
17,761 | (488 | ) | 9,215 | (138 | ) | (626 | ) | ||||||||||||
Collateralized mortgage |
54,225 | (834 | ) | 14,268 | (533 | ) | (1,367 | ) | ||||||||||||
| $ | 94,922 | $ | (1,773 | ) | $ | 41,813 | $ | (1,199 | ) | $ | (2,972 | ) | ||||||||
| Less than 12 months | 12 months or longer | |||||||||||||||||||
| Total | ||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Unrealized | ||||||||||||||||
| June 30, 2006 | Value | Losses | Value | Losses | Losses | |||||||||||||||
U.S. Government |
$ | 13,349 | $ | (466 | ) | $ | — | $ | — | $ | (466 | ) | ||||||||
State |
6,372 | (129 | ) | 1,138 | (67 | ) | (196 | ) | ||||||||||||
Political subdivisions |
5,289 | (118 | ) | 1,027 | (22 | ) | (140 | ) | ||||||||||||
Revenue and assessment |
18,236 | (472 | ) | 4,610 | (212 | ) | (684 | ) | ||||||||||||
Corporate bonds |
15,492 | (406 | ) | 5,915 | (193 | ) | (599 | ) | ||||||||||||
Collateralized mortgage |
41,269 | (934 | ) | 8,986 | (480 | ) | (1,414 | ) | ||||||||||||
| $ | 100,007 | $ | (2,525 | ) | $ | 21,676 | $ | (974 | ) | $ | (3,499 | ) | ||||||||
As of June 30, 2007, there were 68 securities with gross unrealized losses for more than 12
months and 142 securities with gross unrealized losses for less than 12 months. As of June 30,
2007 and 2006, the Company has determined that all of the unrealized losses in the tables above
were temporary and were the result of changes in interest rates. There were no fundamental issues
with any of these securities and the Company has the ability and intent to hold the securities
until there is a recovery in fair value. There were no securities with unrealized losses of
greater than 10% of book value.
4. Reinsurance
Prior to September 1, 2004, the Company reinsured risks on a quota-share basis with another
insurance organization to provide it with additional underwriting capacity and minimize its risk.
Such reinsurance was not renewed as of that date on a cut-off basis whereby the reinsurer is not
liable for any losses occurring after such date. Subsequent to this date through April 14, 2006,
the Company utilized only excess-of-loss basis reinsurance for catastrophic auto physical damage
exposures. Effective April 14, 2006, the Company elected to not renew its catastrophic
reinsurance. Although the reinsurance agreements contractually obligate the reinsurers to
reimburse the Company for their share of losses, they do not discharge the primary liability of the
Company, which remains contingently liable in the event the reinsurers are unable to meet their
contractual obligations.
At June 30, 2007 and 2006, the Insurance Companies had unsecured aggregate reinsurance
receivables of $326 and $1,344, respectively, from a single reinsurance entity. At June 30, 2007,
such amount included $309 related to unpaid losses (including $(32) in IBNR), and $17 related to
paid losses recoverable. At June 30, 2006, such amount included $1,301 related to unpaid losses
(including $769 in IBNR), and $43 related to paid losses recoverable.
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Ceded premiums earned and reinsurance recoveries on losses and loss adjustment expenses were
as follows:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Ceded premiums earned |
$ | — | $ | 81 | $ | 8,732 | ||||||
Reinsurance recoveries on losses and loss adjustment expenses |
437 | 188 | 5,867 | |||||||||
The Company also has assumed private-passenger non-standard automobile insurance premiums from
other insurance companies produced by the managing general agency subsidiaries in Alabama and
Texas.
Net premiums written and earned are summarized as follows:
| Year Ended June 30, | ||||||||||||||||||||||||
| 2007 | 2006 | 2005 | ||||||||||||||||||||||
| Written | Earned | Written | Earned | Written | Earned | |||||||||||||||||||
Direct |
$ | 290,784 | $ | 280,946 | $ | 216,131 | $ | 186,833 | $ | 128,543 | $ | 117,706 | ||||||||||||
Assumed |
19,872 | 19,715 | 21,581 | 22,019 | 25,855 | 23,703 | ||||||||||||||||||
Ceded |
— | — | (81 | ) | (81 | ) | 6,051 | (8,732 | ) | |||||||||||||||
Net |
$ | 310,656 | $ | 300,661 | $ | 237,631 | $ | 208,771 | $ | 160,449 | $ | 132,677 | ||||||||||||
The percentages of premiums assumed to net premiums written for the years ended June 30, 2007,
2006 and 2005 were 6%, 9% and 16%, respectively.
5. Stock-Based Compensation Plans
Employee Stock-Based Incentive Plan
The Company has issued stock options to employees under its 2002 Long Term Incentive Plan (the
“Plan”). At June 30, 2007, there were 3,337 shares remaining available for issuance under the
Plan. Option awards are generally granted with an exercise price equal to the market price of the
Company’s stock at the date of grant. The options expire over ten years and generally vest equally
in annual installments over four or five years. Certain option awards provide for accelerated
vesting if there is a change in control (as defined in the Plan).
Compensation expense related to stock options is calculated under the fair value method and is
recorded on a straight-line basis over the vesting period. Fair value of the options was estimated
at the grant dates using the Black-Scholes option pricing model based on the following assumptions:
| Year Ended June 30, | ||||||||
| 2007 | 2006 | 2005 | ||||||
Expected option term |
10 years | 10 years | 10 years | |||||
Annualized volatility rate |
32 to 33% | 32 to 38% | 36 to 38% | |||||
Risk-free rate of return |
4.74 to 4.77% | 4.02 to 5.25% | 4.11% | |||||
Dividend yield |
0% | 0% | 0% | |||||
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A summary of the status of the Plan as of June 30, 2007, 2006 and 2005 and changes during the
years then ended is presented below:
| Weighted | ||||||||||||||||
| Average | Aggregate | |||||||||||||||
| Exercise | Exercise | Intrinsic | ||||||||||||||
| Options | Price | Price | Value | |||||||||||||
Options outstanding at July 1, 2004 |
4,182 | $3.00-$6.64 | $ | 3.17 | ||||||||||||
Granted |
200 | $8.13 | $ | 8.13 | ||||||||||||
Exercised |
(246 | ) | $3.00 | $ | 3.00 | |||||||||||
Forfeited |
— | — | $ | — | ||||||||||||
Options outstanding at June 30, 2005 |
4,136 | $3.00-$8.13 | $ | 3.42 | ||||||||||||
Granted |
— | — | $ | — | ||||||||||||
Exercised |
(55 | ) | $3.00-$8.13 | $ | 7.66 | |||||||||||
Forfeited |
— | — | $ | — | ||||||||||||
Options outstanding at June 30, 2006 |
4,081 | $3.00-$8.13 | $ | 3.37 | ||||||||||||
Granted |
635 | $10.12-$11.81 | $ | 11.61 | ||||||||||||
Exercised |
— | — | $ | — | ||||||||||||
Forfeited |
— | — | $ | — | ||||||||||||
Options outstanding at June 30, 2007 |
4,716 | $3.00-$11.81 | $ | 4.48 | $ | 27,722 | ||||||||||
Options exercisable/vested at June 30, 2007 |
3,917 | $3.00-$8.13 | $ | 3.20 | $ | 27,279 | ||||||||||
The weighted average estimated fair value of stock options granted during the years ended June
30, 2007 and 2005 was $6.27 and $4.74, respectively. There were no options granted during the year
ended June 30, 2006. As of June 30, 2007, the weighted average remaining contractual life of
options outstanding and exercisable/vested is approximately 6.2 years and 5.7 years, respectively.
Employee Stock Purchase Plan
During the year ended June 30, 2005, the Company’s Board of Directors adopted the First
Acceptance Corporation Employee Stock Purchase Plan (“ESPP”) whereby eligible employees may
purchase shares of the Company’s common stock at a price equal to the lower of the closing market
price on the first or last trading day of a six-month period. ESPP participants can authorize
payroll deductions, administered through an independent plan custodian, of up to 15% of their
salary to purchase semi-annually (June 30 and December 31) up to $25 of the Company’s common stock
during each calendar year. The Company has reserved 100 shares of common stock for issuance under
the ESPP. Employees purchased 25, 22 and 11 shares during the years ended June 30, 2007, 2006 and
2005, respectively. Compensation expense attributable to subscriptions to purchase shares under
the ESPP was $25, $22 and $11 for the years ended June 30, 2007, 2006 and 2005. At June 30, 2007,
41 shares remain available for issuance under the ESPP.
6. Employee Benefit Plan
The Company sponsors a defined contribution retirement plan (“401k Plan”) under Section 401(k)
of the Internal Revenue Code. The 401k Plan covers substantially all employees who meet specified
service requirements. Under the 401k Plan, the Company may, at its discretion, match 100% of the
first 3% of an employee’s salary plus 50% of the next 2% up to
the maximum allowed by the Internal
Revenue Code. The Company’s contributions to the 401k Plan for the years ended June 30, 2007, 2006
and 2005 were $654, $396 and $282, respectively.
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7. Property and Equipment
The components of property and equipment are as follows:
| June 30, | ||||||||
| 2007 | 2006 | |||||||
Furniture and equipment |
$ | 6,456 | $ | 4,943 | ||||
Leasehold improvements |
1,999 | 1,740 | ||||||
Capitalized lease obligations |
588 | 431 | ||||||
Aircraft |
190 | 190 | ||||||
| 9,233 | 7,304 | |||||||
Less: accumulated depreciation |
(5,117 | ) | (3,928 | ) | ||||
Total property and equipment, net |
$ | 4,116 | $ | 3,376 | ||||
Depreciation and amortization expense related to property and equipment was $1,209, $851, and
$990 for the years ended June 30, 2007, 2006 and 2005, respectively.
8. Lease Commitments
The Company is committed under various lease agreements for office space and equipment.
Certain lease agreements contain renewal options and rent escalation clauses. Rental expense for
2007, 2006 and 2005 was $11,555, $8,077 and $3,196, respectively. Future minimum lease payments
under these agreements follow:
| Year Ended June 30, | Amount | |||
2008 |
$ | 9,573 | ||
2009 |
7,530 | |||
2010 |
5,931 | |||
2011 |
3,037 | |||
2012 |
1,311 | |||
Thereafter |
1,583 | |||
Total |
$ | 28,965 | ||
Effective with the USAuto acquisition and in accordance with the terms of the severance
agreement of the Company’s former President and Chief Executive Officer and current director, the
Company has assigned and transferred to a new entity all of the Company’s rights, title and
interest in its lease for office space in Chicago, Illinois. Such entity has assumed all
obligations under the lease and such obligations will be reimbursed to the entity by the Company
during the term of the lease. The total future cost of this obligation was $1,086 and such amount
was accrued as of the acquisition date in the consolidated financial statements by the Company as
part of the severance cost. At June 30, 2007, $501 remained to be paid under this obligation
through August 2009.
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9. Losses and Loss Adjustment Expenses Incurred and Paid
Information regarding the reserve for unpaid losses and loss adjustment expenses (“LAE”) is as
follows:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Liability for unpaid losses and LAE at beginning of year, gross |
$ | 62,822 | $ | 42,897 | $ | 30,434 | ||||||
Reinsurance balances receivable |
(1,301 | ) | (3,608 | ) | (12,297 | ) | ||||||
Liability for unpaid losses and LAE at beginning of year, net |
61,521 | 39,289 | 18,137 | |||||||||
Add: Provision for losses and LAE: |
||||||||||||
Current year |
238,043 | 142,436 | 88,068 | |||||||||
Prior years |
3,865 | (1,548 | ) | (356 | ) | |||||||
Accretion of net risk margin/discounting as of the date of acquisition |
— | (43 | ) | (219 | ) | |||||||
Net losses and LAE incurred |
241,908 | 140,845 | 87,493 | |||||||||
Less: Losses and LAE paid: |
||||||||||||
Current year |
160,872 | 90,589 | 53,238 | |||||||||
Prior years |
51,420 | 28,024 | 13,103 | |||||||||
Net losses and LAE paid |
212,292 | 118,613 | 66,341 | |||||||||
Liability for unpaid losses and LAE at end of year, net |
91,137 | 61,521 | 39,289 | |||||||||
Reinsurance balances receivable |
309 | 1,301 | 3,608 | |||||||||
Liability for unpaid losses and LAE at end of year, gross |
$ | 91,446 | $ | 62,822 | $ | 42,897 | ||||||
The unfavorable change in the estimate of unpaid loss and loss adjustment expenses of $3,865
for the year ended June 30, 2007 was primarily a result of the fact that the Company had limited
historical loss experience in our new states for use in determining its loss reserve estimates.
Such unfavorable change was primarily related to the Bodily Injury and Personal Injury Protection
coverages in Florida.
Management believes that the favorable changes in the estimates of unpaid loss and loss
adjustment expenses of $1,548 and $356 recognized for the years ended June 30, 2006 and 2005,
respectively, were attributable to the inherent uncertainty in the estimation process and were not
the result of any individual factor.
10. Notes Payable and Capitalized Lease Obligations
In connection with the acquisition of the Chicago, Illinois non-standard automobile insurance
agencies, on January 12, 2006, the Company entered into, and borrowed under, a credit agreement
with two banks consisting of a $5,000 revolving facility and a $25,000 term loan facility, both
maturing on June 30, 2010. Through September 13, 2007,
outstanding borrowings under the term loan facility bore interest at
LIBOR plus 175 basis points per annum (7.11% at June 30, 2007). At June 30, 2007, the Company had
$5,000 of outstanding borrowings under the revolving facility. The Company entered into an interest
rate swap agreement on January 17, 2006 that fixed the interest rate on the term loan facility at
6.63% through June 30, 2010. The term loan facility is due in
equal quarterly installments through June 30, 2010. Both facilities are secured by the common stock and
certain assets of selected subsidiaries. The credit agreement contains certain financial covenants
regarding (1) a minimum fixed charge coverage ratio, (2) a minimum consolidated tangible net worth,
(3) a maximum net premiums written to surplus ratio, (4) a
maximum combined ratio, (5) a minimum
RBC and (6) a minimum net income requirement.
At June 30, 2007,
we were not in compliance with financial covenants in the credit
agreement regarding a minimum
fixed charge coverage ratio and a maximum combined ratio. Our lenders
waived this non-compliance as of June 30, 2007 and we entered into an amendment to the credit agreement
dated September 13, 2007. The amended terms have less
restrictive financial covenants, increased the interest rate we pay by
75 basis points and require us to make a prepayment of at least $6,000 in principal before December 31, 2007. In
addition, the availability under the revolving credit facility was permanently reduced from $5,000
to $2,000.
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The maturities of the notes payable and capitalized lease obligations secured by equipment as
of June 30, 2007 are as follows:
| Capitalized | ||||||||||||
| Lease | ||||||||||||
| Year Ended June 30, | Obligations | Notes Payable | Total | |||||||||
2008 |
$ | 231 | $ | 5,552 | $ | 5,783 | ||||||
2009 |
230 | 5,552 | 5,782 | |||||||||
2010 |
1 | 11,956 | 11,957 | |||||||||
| $ | 462 | $ | 23,060 | $ | 23,522 | |||||||
Less: Amount representing executory costs |
(30 | ) | ||||||||||
Net minimum lease payments |
432 | |||||||||||
Less: Amount representing interest |
(16 | ) | ||||||||||
Present value of net minimum lease
payments |
$ | 416 | ||||||||||
11. Debentures Payable
In June 2007, First Acceptance Statutory Trust I (“FAST I”), a wholly-owned unconsolidated
subsidiary trust of the Company, issued 40 shares of preferred securities at $1,000 per share
to outside investors and 1.24 shares of common securities to the Company, also at $1,000 per
share. The sole assets of FAST I are $41,240 of junior subordinated debentures issued by the
Company. The debentures will mature on July 30, 2037 and are redeemable by the Company in whole or
in part beginning on July 30, 2012, at which time the preferred securities are callable. The
debentures pay a fixed rate of 9.277% until July 30, 2012, after which the rate becomes variable
(LIBOR plus 375 basis points).
The obligations of the Company under the junior subordinated debentures represent full and
unconditional guarantees by the Company of FAST I’s obligations for the preferred securities.
Dividends on the preferred securities are cumulative, payable quarterly in arrears and are
deferrable at the Company’s option for up to five years. The dividends on these securities are the
same as the interest on the debentures. The Company cannot pay dividends on its common stock during
such deferments.
The debentures are classified as debentures payable on the Company’s consolidated balance
sheets and the interest paid on these debentures is classified as interest expense in the
consolidated statements of operations.
12. Income Taxes
The provision (benefit) for income taxes consisted of the following:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Federal: |
||||||||||||
Current |
$ | 75 | $ | 161 | $ | 515 | ||||||
Deferred |
17,132 | (1,533 | ) | (2,986 | ) | |||||||
State income taxes |
379 | 333 | 318 | |||||||||
| $ | 17,586 | $ | (1,039 | ) | $ | (2,153 | ) | |||||
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The federal provision (benefit) for income taxes differs from the amounts computed by applying
the U.S. Federal corporate tax rate of 35% to income before income taxes as follows:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Provision for income taxes at statutory rate |
$ | 321 | $ | 9,460 | $ | 8,401 | ||||||
Tax effect of: |
||||||||||||
Tax-exempt investment income |
(78 | ) | (221 | ) | (261 | ) | ||||||
Change in the beginning of the year balance of
the valuation allowance for deferred tax asset
allocated to income taxes |
6,882 | (10,540 | ) | (10,594 | ) | |||||||
Net operating loss carryforward expirations |
9,990 | 302 | — | |||||||||
Other |
92 | (373 | ) | (17 | ) | |||||||
| $ | 17,207 | $ | (1,372 | ) | $ | (2,471 | ) | |||||
The tax effects of temporary differences that give rise to the net deferred tax asset at June
30, 2007 and 2006 are presented below:
| 2007 | 2006 | |||||||
Deferred tax assets: |
||||||||
Net operating loss carryforwards |
$ | 46,549 | $ | 57,847 | ||||
Stock option compensation |
3,063 | 2,718 | ||||||
Unearned premiums and loss and loss adjustment
expense reserves |
8,254 | 6,812 | ||||||
Net unrealized change on investments |
929 | 1,212 | ||||||
Alternative minimum tax (“AMT”) credit carryforwards |
1,232 | 1,154 | ||||||
Other |
1,070 | 846 | ||||||
| 61,097 | 70,589 | |||||||
Deferred tax liabilities: |
||||||||
Deferred acquisition costs |
(1,808 | ) | (1,865 | ) | ||||
Goodwill |
(1,320 | ) | (222 | ) | ||||
| (3,128 | ) | (2,087 | ) | |||||
Total net deferred tax assets |
57,969 | 68,502 | ||||||
Less: Valuation allowance |
(27,033 | ) | (20,434 | ) | ||||
Net deferred tax assets |
$ | 30,936 | $ | 48,068 | ||||
The net change in the valuation allowance for the year ended June 30, 2007 was an increase of
$6,599 while the years ended June 30, 2006 and 2005 included decreases of $9,328 and $10,594,
respectively. In addition, during the year ended June 30, 2007, the provision for income taxes
included a $9,990 charge related to the expiration of certain net operating loss (“NOL”)
carryforwards due to taxable income for the current fiscal year being less than management’s most
recent estimates of current fiscal year taxable income. Prior to the acquisition of USAuto, a full
valuation allowance had been established, as management believed that it was more likely than not
that the Company would not realize the benefits of the loss carryforwards. However, as result of
the acquisition, management reduced the valuation allowance based upon internally-prepared
projected operating results. Subsequently, such projections were revised after considering the
actual results for the years ended June 30, 2007, 2006 and 2005, and the allowance was further
revised.
At June 30, 2007 and 2006, $929 and $1,212, respectively, of the valuation allowance was
related to the net unrealized change on investments as management believes that it is more likely
than not that this tax benefit will not be realized. For the years ended June 30, 2007 and 2006,
the change in the valuation allowance of $283 and $1,212, respectively, is included as part of
other comprehensive loss.
At June 30, 2007, the Company had NOL carryforwards for federal income tax purposes of
$132,998, which are available to offset future federal taxable income. In addition, at June 30,
2007, the Company had AMT
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credit carryforwards of $1,232 that have no expiration date. The NOL carryforwards will
expire in 2008 through 2023, as shown in the following table:
| Expiration Year Ended June 30, | Amount | |||
2008 |
$ | 36,188 | ||
2009 |
84,791 | |||
2010 |
7,095 | |||
2011 |
2,099 | |||
Thereafter |
2,825 | |||
Total NOL carryforwards |
$ | 132,998 | ||
13. Net Income (Loss) Per Share
SFAS No. 128, Earnings Per Share, specifies the computation, presentation and disclosure
requirements for earnings per share (“EPS”). Basic EPS are computed using the weighted average
number of shares outstanding. Diluted EPS are computed using the weighted average number of shares
outstanding adjusted for the incremental shares attributed to outstanding securities with a right
to purchase or convert into common stock.
The following table sets forth the computation of basic and diluted net income (loss) per
share:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
Weighted average common basic shares |
47,584 | 47,487 | 47,055 | |||||||||
Effect of dilutive securities — options |
— | 2,089 | 1,934 | |||||||||
Weighted average common dilutive shares |
47,584 | 49,576 | 48,989 | |||||||||
Basic net income (loss) per share |
$ | (0.35 | ) | $ | 0.59 | $ | 0.56 | |||||
Diluted net income (loss) per share |
$ | (0.35 | ) | $ | 0.57 | $ | 0.53 | |||||
Options to purchase 2,083 shares of common stock for the year ended June 30, 2007 were
outstanding, but were not included in the computation of diluted loss per share as their inclusion
would have been anti-dilutive.
14. Concentrations of Credit Risk
At June 30, 2007, the Company had certain concentrations of credit risk with several financial
institutions in the form of cash and cash equivalents, which amounted to $34,161. For purposes of
evaluating credit risk, the stability of financial institutions conducting business with the
Company is periodically reviewed. If the financial institutions failed to completely perform under
the terms of the financial instruments, the exposure for credit loss would be the amount of the
financial instruments less amounts covered by regulatory insurance.
The Company primarily transacts business either directly with its policyholders or through
four independently-owned insurance agencies in Tennessee who exclusively write insurance policies
on behalf of the Company. Direct policyholders make payments directly to the Company. Balances
due from policyholders are generally secured by the related unearned premium. The Company requires
a down payment at the time the policy is originated and subsequent scheduled payments are monitored
in order to prevent the Company from providing coverage beyond the date for which payment has been
received. If subsequent payments are not made timely, the policy is generally cancelled at no loss
to the Company. Policyholders whose premiums are written through the independent agencies make
their payments to these agencies who in turn remit these payments to the Company. Balances due to
the Company resulting from premium payments made to these agencies are unsecured.
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15. Related Party Transactions
Certain of the Company’s executives are covered by employment agreements covering, among other
things, base compensation, incentive-bonus determinations and payments in the event of termination,
or a change in control of the Company.
Effective May 1, 2004, the Company entered into an advisory services agreement with an entity
controlled by a current director of the Company to render advisory services in connection with
financings, mergers and acquisitions and other related matters involving the Company. In
consideration for the advisory services to be provided, the Company will pay to the advisor a
quarterly fee of $62.5 for a four-year period. The advisory agreement may be terminated by the
Company if the advisor fails or refuses to perform its services pursuant to the agreement, does any
act, or fails to do any act, which results in an indictment for or conviction of a felony or other
similarly serious offense or upon the written agreement of the advisor. The advisor may terminate
the agreement upon written consent of the Company or if the Company is in material breach of its
obligations thereunder. See Note 8 to our consolidated financial statements regarding the terms of
a related severance agreement and future obligations.
On September 13, 2006, the Company sold 50 shares of common stock to an executive officer for
an aggregate purchase price of $591, or $11.81 per share, which was the closing price of the common
stock on New York Stock Exchange on the date of sale.
16. 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. Management believes that the ultimate resolution of these matters
will not materially affect the consolidated financial statements.
17. Fair Value of Financial Instruments
The fair value of financial instruments has been estimated by the Company using available
market information as of June 30, 2007 and 2006, and valuation methodologies considered appropriate
to the circumstances:
Investments in fixed maturities are carried at market values which are obtained from a
recognized pricing service.
The fair values of cash and cash equivalents, premiums and fees receivable and reinsurance
receivables approximate their carrying amounts based upon their short maturities.
The fair value of the notes payable approximates their carrying amount based upon their
variable interest rates and comparability to rates currently being offered for similar
notes.
The fair value of the debentures payable issued on June 15, 2007 was estimated using
projected cash flows, discounted at rates currently being offered for similar financial
instruments and approximates their carrying value.
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18. Segment Information
The Company operates in two business segments with its primary focus being the selling,
servicing and underwriting of non-standard personal automobile insurance. The real estate and
corporate segment consists of the 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:
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Revenues: |
||||||||||||
Insurance |
$ | 347,431 | $ | 244,557 | $ | 164,974 | ||||||
Real estate and corporate |
206 | 4,445 | 1,821 | |||||||||
Consolidated total |
$ | 347,637 | $ | 249,002 | $ | 166,795 | ||||||
Income (loss) before income taxes: |
||||||||||||
Insurance |
$ | 6,252 | $ | 26,476 | $ | 25,640 | ||||||
Real estate and corporate |
(5,336 | ) | 553 | (1,637 | ) | |||||||
Consolidated total |
$ | 916 | $ | 27,029 | $ | 24,003 | ||||||
| June 30, | ||||||||||||
| 2007 | 2006 | |||||||||||
Total assets: |
||||||||||||
Insurance |
$ | 460,356 | $ | 384,358 | ||||||||
Real estate and corporate |
38,536 | 50,969 | ||||||||||
Consolidated total |
$ | 498,892 | $ | 435,327 | ||||||||
19. Statutory Financial Information and Accounting Policies
The statutory-basis financial statements of the Insurance Companies are prepared in accordance
with accounting practices prescribed or permitted by the Department of Insurance in each respective
state of domicile. Each state of domicile requires that insurance companies domiciled in those
states prepare their statutory-basis financial statements in accordance with the National
Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures Manual subject
to any deviations prescribed or permitted by the insurance commissioner in each state of domicile.
In addition, the Insurance Companies are required to report their risk-based capital (“RBC”) each
December 31. Failure to maintain an adequate RBC could subject the Insurance Companies to
regulatory action and maintaining an adequate RBC could restrict the payment of dividends. As of
December 31, 2006, the RBC levels of the Insurance Companies did not subject them to any regulatory
action.
At June 30, 2007 and 2006, on an unaudited consolidated statutory basis, capital and surplus
as calculated was $120,201 and $74,586, respectively. For the twelve months ended June 30, 2007,
2006 and 2005, unaudited consolidated statutory net income (loss) as filed was $(1,891), $10,616
and $7,328, respectively. The only material accounting method prescribed or permitted by state
insurance departments for the Insurance Companies that differs from NAIC statutory accounting
practices relates to a reduction in the statutory capital and surplus of FAIC at June 30, 2006 of
$1,237 for investments on deposit with various insurance departments, in states where the company
is licensed, but is not yet transacting business.
The maximum amount of dividends which can be paid by FAIC to the Company, without the prior
approval of the Texas insurance commissioner, is limited to the greater of 10% of statutory capital
and surplus as of December 31 of the next preceding year or net income for the year. Accordingly,
as of December 31, 2006, the maximum amount of dividends available to be paid to the Company from
FAIC without prior approval within any
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preceding twelve-month period is $15,395. The amount of the dividend is further limited by the
amount of FAIC’s “earned surplus” which at June 30, 2007 was $15,110.
FAIC-GA and FAIC-TN are wholly-owned subsidiaries of FAIC and the maximum amount of dividends
which they can pay to FAIC, without the prior approval of the respective insurance commissioner, is
limited to the greater of 10% of their statutory capital and surplus as of December 31 of the next
preceding year or net income (not including realized capital gains) for the year.
20. Selected Quarterly Financial Data (unaudited)
Interim results are not necessarily indicative of fiscal year performance because of the
impact of seasonal and short-term variations. Selected quarterly financial data for the years
ended June 30, 2007 and 2006 is summarized as follows:
| Quarters Ended | ||||||||||||||||
| September 30, | December 31, | March 31, | June 30, | |||||||||||||
Year Ended June 30, 2007: |
||||||||||||||||
Total revenues |
$ | 79,102 | $ | 84,321 | $ | 91,983 | $ | 92,231 | ||||||||
Net income (loss) before income
taxes |
$ | 2,336 | $ | 4,241 | $ | 4,833 | $ | (10,494 | ) | |||||||
Net income (loss) |
$ | 1,493 | $ | 2,701 | $ | 3,066 | $ | (23,930 | ) | |||||||
Basic net income (loss) per share |
$ | 0.03 | $ | 0.06 | $ | 0.06 | $ | (0.50 | ) | |||||||
Diluted net income (loss) per share |
$ | 0.03 | $ | 0.05 | $ | 0.06 | $ | (0.50 | ) | |||||||
Year Ended June 30, 2006: |
||||||||||||||||
Total revenues |
$ | 50,258 | $ | 53,481 | $ | 70,068 | $ | 75,195 | ||||||||
Net income before income taxes |
$ | 5,633 | $ | 5,448 | $ | 9,031 | $ | 6,917 | ||||||||
Net income |
$ | 3,713 | $ | 3,800 | $ | 5,864 | $ | 14,691 | ||||||||
Basic net income per share |
$ | 0.08 | $ | 0.08 | $ | 0.12 | $ | 0.31 | ||||||||
Diluted net income per share |
$ | 0.08 | $ | 0.08 | $ | 0.12 | $ | 0.30 | ||||||||
Net income (loss) for the fourth quarters of the years ended June 30, 2007 and 2006 reflect
the impact of changes in the loss and loss adjustment expense reserves and the valuation allowance
for the deferred tax asset including the effect of the expiration of certain net operating loss
carryforwards.
The year ended June 30, 2007 includes an increase in the valuation allowance of $6,882
resulting from revisions in management’s estimates for the Company’s future taxable income based on
the results for the then most recent fiscal year and an increase in the provision for income taxes
of $9,990 due to the expiration of certain net operating loss carryforwards due to taxable income
for the current fiscal year being less than management’s most recent estimates of current fiscal
year taxable income. In addition, during the fourth quarter of the year ended June 30, 2007, an
unfavorable change in the estimate of unpaid loss and loss adjustment expenses resulted in a
current period charge of $15,589. Of this amount, $12,589 related to prior accident quarters and
$3,000 related to an unanticipated increase in the loss and loss adjustment expense ratio for the
current quarter.
The year ended June 30, 2006 includes a decrease in the valuation allowance of $10,540
resulting from taxable income for the 2006 fiscal year exceeding the estimates used by management
in establishing the valuation allowances at June 30, 2005, in addition to revisions in management’s
estimates for the Company’s future taxable income based on the results for the then most recent
fiscal years.
Net loss per share recognized during the quarter ended June 30, 2007 was decreased by $0.35
on a basic and diluted basis as a result of the combined change in the valuation allowance and net
operating loss carryforwards. Net income per share recognized during the quarter ended June 30,
2006 was increased by $0.22 and $0.21 on a basic and diluted basis, respectively, as a result of
the change in valuation allowance.
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management team, including our
chief executive officer and chief financial officer, we conducted an evaluation of our 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 the Exchange Act) as of June 30, 2007. Based on that evaluation, our chief
executive officer (principal executive officer) and chief financial officer (principal financial
officer) concluded that our disclosure controls and procedures were effective as of June 30, 2007
to ensure that information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining effective internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our
internal control over financial reporting is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our chief
executive officer and chief financial officer, we conducted an assessment of the effectiveness of
our internal control over financial reporting based on the framework in Internal Control —
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). Based on our assessment under the framework in Internal Control — Integrated
Framework, our management concluded that our internal control over financial reporting was
effective as of June 30, 2007.
Our independent registered public accounting firm, Ernst & Young, LLP has issued an
attestation report on our internal control over financial reporting, which report appears on page
42 of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
During the fourth fiscal quarter of the period covered by this report, there has been no
change in our internal control over financial reporting that has materially affected or is
reasonably likely to materially affect our internal control over financial reporting.
Item 9B. Other Information
None.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information with respect to our directors, set forth in our Definitive Proxy Statement for the
Annual Meeting of Stockholders to be held November 7, 2007, under the caption “Election of
Directors,” is incorporated herein by reference. Pursuant to General Instruction G(3), information
concerning our executive officers is included in Part I of this Annual Report on Form 10-K under
the caption “Executive Officers of the Registrant.”
Information with respect to compliance with Section 16(a) of the Securities Exchange Act of
1934, set forth in our Definitive Proxy Statement for the Annual Meeting of Stockholders to be held
November 7, 2007, under the caption “Section 16(a) Beneficial Ownership Reporting Compliance,” is
incorporated herein by reference.
Information with respect to our code of business conduct and ethics, set forth in our
Definitive Proxy Statement for the Annual Meeting of Stockholders to be held November 7, 2007,
under the caption “Code of Business Conduct and Ethics,” is incorporated herein by reference.
Information
with respect to our corporate governance disclosures, set forth in our Definitive Proxy
Statement for the Annual Meeting of Stockholders to be held November 7, 2007, under the caption
“What Committees Has the Board Established?” is incorporated herein by reference.
On December 11, 2006, the Company filed with the New York Stock Exchange (“NYSE”) the Annual
CEO Certification regarding the Company’s compliance with the NYSE’s Corporate Governance listing
standards as required by Section 303A.12(a) of the NYSE Listed Company Manual. The Company has
filed as exhibits to this Annual Report on Form 10-K and to the Annual Report on Form 10-K for the
year ended June 30, 2006, the applicable certifications of its Chief Executive Officer and Chief
Financial Officer required under Section 302 of the Sarbanes-Oxley Act of 2002 regarding the
quality of the Company’s public disclosures.
Item 11. Executive Compensation
Information with respect to our executive officers, set forth in our Definitive Proxy
Statement for the Annual Meeting of Stockholders to be held November 7, 2007, under the caption
“Executive Compensation,” is incorporated herein by reference.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Information with respect to security ownership of certain beneficial owners and management and
related stockholder matters, set forth in our Definitive Proxy Statement for the Annual Meeting of
Stockholders to be held November 7, 2007, under the captions “Stock Ownership” and “Equity
Compensation Plan Information,” is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information with respect to certain relationships and related transactions, and director
independence, set forth in our Definitive Proxy Statement for the Annual Meeting of Stockholders to
be held November 7, 2007, under the caption “Certain Relationships and Related Transactions, and
Director Independence,” is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Information with respect to the fees paid to and services provided by our principal
accountants, set forth in our Definitive Proxy Statement for the Annual Meeting of Stockholders to
be held November 7, 2007, under the caption “Fees Billed to Us by Ernst & Young LLP During 2007 and
2006,” is incorporated herein by reference.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) Financial Statements, Financial Statement Schedules and Exhibits
| (1) | Consolidated Financial Statements: See Index to Consolidated Financial Statements on Page 40. | ||
| (2) | Financial Statement Schedules: | ||
| Schedule I — Financial Information of Registrant (Parent Company) | |||
| (3) | Exhibits: See the exhibit listing set forth below. |
| Exhibit | ||
| Number | ||
| 2.1 | Plan of Reorganization, dated as of April 1, 1996, between the Trust and the Company (incorporated by reference to Exhibit 2.1 of Registration Statement No. 333-07439 on Form S-4, filed July 2, 1996 (the “Registration Statement”)). |
| 2.2 | Stock Purchase Agreement, dated as of January 16, 1996, between Liberté Investors Trust and Hunter’s Glen/Ford, Ltd. (the “Purchaser”) (incorporated by reference to Exhibit 4.1 of Liberté Investors Trust’s Current Report on Form 8-K filed with the Commission on January 24, 1996), as amended by the Amendment to the Stock Purchase Agreement, dated as of February 27, 1996, and the Second Amendment to the Stock Purchase Agreement, dated as of March 28, 1996 (incorporated by reference to Exhibit 2.1 of Liberté Investors Trust’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1996). |
| 2.3 | Agreement and Plan of Merger by and among the Company, USAH Merger Sub, Inc., USAuto Holdings, Inc. and the Stockholders of USAuto Holdings, Inc., dated as of December 15, 2003 (incorporated by reference to Exhibit 2.1 of Registration Statement No. 333-111161 on Form S-1, filed December 15, 2003). |
| 3.1 | Restated Certificate of Incorporation of First Acceptance Corporation (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K dated May 3, 2004). |
| 3.2 | Amended and Restated Bylaws of First Acceptance Corporation (incorporated by reference to Exhibit 3.2 of the Company’s Annual Report on Form 10-K dated September 28, 2004). |
| 4.1 | Form of Registration Rights Agreement, dated August 16, 1996, between the Company and the Purchaser (incorporated by reference to Exhibit 4.1 of the Registration Statement). |
| 4.2 | Form of Agreement Clarifying Registration Rights, dated August 16, 1996, between the Company, the Purchaser, the Enloe Descendants’ Trust, and Robert Ted Enloe, III (incorporated by reference to Exhibit 4.3 of the Registration Statement). |
| 4.3 | Registration Rights Agreement, dated as of July 1, 2002, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K dated July 11, 2002). |
| 4.4 | Form of certificate representing shares of common stock, par value $0.01 per share (incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-8 filed December 26, 2002). |
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| Exhibit | ||
| Number | ||
| 10.1 | Form of Indemnification Agreement for the Company’s directors and officers and schedule of substantially identical documents (incorporated by reference to Exhibit 10.2 of the Registration Statement). |
| 10.2 | Employment Agreement, dated as of July 1, 2002, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated July 11, 2002).* |
| 10.3 | First Acceptance Corporation 2002 Long Term Incentive Plan, as amended (incorporated by reference to Exhibit 4.4 of the Company’s Registration Statement on Form S-8 filed May 18, 2004).* |
| 10.4 | Nonqualified Stock Option Agreement, dated as of July 9, 2002, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K dated July 11, 2002).* |
| 10.5 | Indemnification Agreement, dated as of July 1, 2002, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K dated July 11, 2002). |
| 10.6 | Stock Purchase Agreement, dated as of July 9, 2002, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 10.3 of the Company’s Registration Statement on Form S-8 dated December 26, 2002).* |
| 10.7 | Stock Purchase Agreement, dated as of June 30, 2003, by and between the Company and Donald J. Edwards (incorporated by reference to Exhibit 10.8 of the Company’s Annual Report on Form 10-K dated September 26, 2003).* |
| 10.8 | Advisory Services Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Edwards Capital LLC (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.9 | Separation Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Donald J. Edwards (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.10 | Employment Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Stephen J. Harrison (incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.11 | Employment Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.12 | Nonqualified Stock Option Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Stephen J. Harrison (incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.13 | Nonqualified Stock Option Agreement, dated as of April 30, 2004, by and between First Acceptance Corporation and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K dated May 3, 2004).* |
| 10.14 | Registration Rights Agreement, dated as of April 30, 2004, by and among First Acceptance Corporation, Stephen J. Harrison and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10.7 of the Company’s Current Report on Form 8-K dated May 3, 2004). |
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| Exhibit | ||
| Number | ||
| 10.15 | Severance Compensation Agreement, dated as of August 24, 2004, by and between First Acceptance Corporation and Charles David Hamilton (incorporated by reference to Exhibit 10.15 of the Company’s Annual Report on Form 10-K dated September 28, 2004).* |
| 10.16 | Form of Restricted Stock Award Agreement under the Company’s 2002 Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated November 3, 2004).* |
| 10.17 | Form of Nonqualified Stock Option Agreement under the Company’s 2002 Long Term Incentive Plan (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated November 3, 2004).* |
| 10.18 | First Acceptance Corporation Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.1 of the Registration Statement No. 333-121551 on Form S-8, filed December 22, 2004). |
| 10.19 | Summary of Compensation for Non-Employee Directors and Named Executive Officers |
| 10.20 | Asset Purchase Agreement, dated as of January 12, 2006, by and among First Acceptance Corporation, Acceptance Insurance Agency of Illinois, Inc., Insurance Plus Agency II, Inc., Yale International Insurance Agency, Inc. and Constantine Danos (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated January 18, 2006). |
| 10.21 | Credit Agreement, dated as of January 12, 2006, by and among First Acceptance Corporation, SunTrust Bank, in its capacity as a lender and as administrative agent for the lenders, and First Bank (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated January 18, 2006). |
| 10.22 | Employment Agreement, dated as of September 13, 2006, by and between First Acceptance Corporation and Edward Pierce (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated September 19, 2006).* |
| 10.23 | Stock Purchase Agreement, dated as of September 13, 2006, by and between First Acceptance Corporation and Edward Pierce (incorporated by reference to Exhibit 99.2 of the Company’s Current Report on Form 8-K dated September 19, 2006).* |
| 10.24 | Nonqualified Stock Option Agreement, dated as of September 13, 2006, by and between First Acceptance Corporation and Edward Pierce (incorporated by reference to Exhibit 99.3 of the Company’s Current Report on Form 8-K dated September 19, 2006).* |
| 10.25 | Amendment to Employment Agreement, dated as of September 13, 2006, by and between First Acceptance Corporation and Stephen J. Harrison (incorporated by reference to Exhibit 99.4 of the Company’s Current Report on Form 8-K dated September 19, 2006).* |
| 10.26 | Amendment to Employment Agreement, dated as of September 13, 2006, by and between First Acceptance Corporation and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 99.5 of the Company’s Current Report on Form 8-K dated September 19, 2006).* |
| 10.27 | Employment Agreement, dated as of October 9, 2006, by and between First Acceptance Corporation and Kevin P. Cohn (incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated October 12, 2006).* |
| 10.28 | Nonqualified Stock Option Agreement, dated as of October 9, 2006, by and between First Acceptance Corporation and Kevin P. Cohn (incorporated by reference to Exhibit 99.2 of the Company’s Current Report on Form 8-K dated October 12, 2006).* |
| 10.29 | Second Amendment to the First Acceptance Corporation 2002 Long Term Incentive Plan (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 10-Q dated May 10, 2007).* |
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| Exhibit | ||
| Number | ||
| 10.30 | Form of Restricted Stock Award Agreement of Outside Directors under the Company’s 2002 Long Term Incentive Plan (incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 10-Q dated May 10, 2007).* |
| 10.31 | Form of Indemnification Agreement between the Company and each of the Company’s directors and executive officers (incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 10-Q dated May 10, 2007).* |
| 10.32 | Junior Subordinated Indenture, dated June 15, 2007, between First Acceptance Corporation and Wilmington Trust Company (incorporated by reference to Exhibit 99.2 of the Company’s Current Report on Form 8-K dated June 18, 2007). |
| 10.33 | Guarantee Agreement, dated June 15, 2007, between First Acceptance Corporation and Wilmington Trust Company (incorporated by reference to Exhibit 99.3 of the Company’s Current Report on Form 8-K dated June 18, 2007). |
| 10.34 | Amended and Restated Trust Agreement, dated June 15, 2007, among First Acceptance Corporation, Wilmington Trust Company and the Administrative Trustees Named Therein (incorporated by reference to Exhibit 99.4 of the Company’s Current Report on Form 8-K dated June 18, 2007). |
| 14 | First Acceptance Corporation Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14 of the Company’s Annual Report on Form 10-K dated September 28, 2004). |
| 21 | Subsidiaries of First Acceptance Corporation. |
| 23.1 | Consent of Ernst & Young, LLP. |
| 23.2 | Consent of KPMG LLP. |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a). |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a). |
| 32.1 | Chief Executive Officer’s Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 | Chief Financial Officer’s Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| * | Management contract or compensatory plan or arrangement. |
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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.
| FIRST ACCEPTANCE CORPORATION |
||||
| Date: September 13, 2007 | By /s/ Stephen J. Harrison | |||
| Stephen J. Harrison | ||||
| President and Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
| Signature | Title | Date | ||
| /s/ Stephen J. Harrison
|
President, Chief Executive Officer and Director (Principal Executive Officer) | September 13, 2007 | ||
| /s/ Edward L. Pierce
|
Executive Vice President and Chief Financial Officer (Principal Financial Officer) | September 13, 2007 | ||
| /s/ Kevin P. Cohn
|
Vice President, Chief Accounting Officer and Corporate Controller (Principal Accounting Officer) | September 13, 2007 | ||
| /s/ Gerald J. Ford
|
Chairman of the Board of Directors | September 13, 2007 | ||
| /s/ Thomas M. Harrison, Jr.
|
Executive Vice President, Secretary and Director | September 13, 2007 | ||
| /s/ Rhodes R. Bobbitt
|
Director | September 13, 2007 | ||
| /s/ Harvey B. Cash
|
Director | September 13, 2007 | ||
| /s/ Donald J. Edwards
|
Director | September 13, 2007 | ||
| /s/ Tom C. Nichols
|
Director | September 13, 2007 | ||
| /s/ Lyndon L. Olson
|
Director | September 13, 2007 | ||
| /s/ William A. Shipp, Jr.
|
Director | September 13, 2007 |
72
Table of Contents
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
SCHEDULE I. FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
(in thousands)
SCHEDULE I. FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)
(in thousands)
| June 30, | ||||||||
| Balance Sheets | 2007 | 2006 | ||||||
Assets: |
||||||||
Investment in subsidiaries, at equity in net assets |
$ | 155,010 | $ | 111,246 | ||||
Cash and cash equivalents |
10,350 | 7,554 | ||||||
Deferred tax asset |
24,674 | 42,711 | ||||||
Other assets |
3,395 | 790 | ||||||
Foreclosed real estate held for sale |
341 | 87 | ||||||
Goodwill and identifiable intangible assets |
114,562 | 114,562 | ||||||
Amounts due (to) from subsidiaries |
(3,136 | ) | 1,544 | |||||
| $ | 305,196 | $ | 278,494 | |||||
Liabilities: |
||||||||
Notes payable |
$ | 23,060 | $ | 23,612 | ||||
Debentures payable |
41,240 | — | ||||||
Other liabilities |
1,412 | 1,459 | ||||||
Stockholders’ equity |
239,484 | 253,423 | ||||||
| $ | 305,196 | $ | 278,494 | |||||
| Year Ended June 30, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
Statements of Operations |
||||||||||||
Gains on sales of foreclosed real estate |
$ | — | $ | 3,638 | $ | 755 | ||||||
Investment income |
206 | 807 | 1,066 | |||||||||
Equity in income of subsidiaries, net of tax |
3,743 | 17,377 | 17,197 | |||||||||
Expenses |
(5,608 | ) | (3,987 | ) | (4,036 | ) | ||||||
Income (loss) before income taxes |
(1,659 | ) | 17,835 | 14,982 | ||||||||
Provision (benefit) for income taxes |
15,011 | (10,233 | ) | (11,174 | ) | |||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
| Year Ended June 30, | ||||||||||||
| Statements of Cash Flows | 2007 | 2006 | 2005 | |||||||||
Cash flows from operating activities: |
||||||||||||
Net income (loss) |
$ | (16,670 | ) | $ | 28,068 | $ | 26,156 | |||||
Equity in income of subsidiaries, net of tax |
(3,743 | ) | (17,377 | ) | (17,197 | ) | ||||||
Depreciation and amortization |
66 | 97 | 928 | |||||||||
Stock-based compensation |
1,063 | 500 | 332 | |||||||||
Deferred income taxes |
18,037 | 514 | (1,589 | ) | ||||||||
Gains on sales of foreclosed real estate |
— | (3,638 | ) | (755 | ) | |||||||
Change in assets and liabilities |
3,322 | 5,725 | (3,389 | ) | ||||||||
Net cash provided by operating activities |
2,075 | 13,889 | 4,486 | |||||||||
Cash flows from investing activities: |
||||||||||||
Sales (purchases) of investment in mutual fund |
— | 10,920 | (10,920 | ) | ||||||||
Investment in subsidiary |
(45,765 | ) | (47,026 | ) | (10,950 | ) | ||||||
Dividend from subsidiary |
6,435 | 750 | — | |||||||||
Improvements to foreclosed real estate |
(254 | ) | — | (300 | ) | |||||||
Purchase of common stock in trust |
(1,240 | ) | — | — | ||||||||
Proceeds from sales of foreclosed real estate |
— | 4,512 | 1,202 | |||||||||
Cash paid for acquisitions, net of cash acquired |
— | — | (4,000 | ) | ||||||||
Net cash used in investing activities |
(40,824 | ) | (30,844 | ) | (24,968 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Proceeds from borrowings |
5,000 | 30,000 | — | |||||||||
Payments on borrowings |
(5,552 | ) | (6,388 | ) | — | |||||||
Proceeds from issuance of debentures |
41,240 | — | — | |||||||||
Net proceeds from issuance of common stock |
857 | 223 | 104 | |||||||||
Exercise of stock options |
— | 421 | 740 | |||||||||
Purchase of treasury stock |
— | — | (639 | ) | ||||||||
Net cash provided by financing activities |
41,545 | 24,256 | 205 | |||||||||
Net increase (decrease) in cash and cash equivalents |
2,796 | 7,301 | (20,277 | ) | ||||||||
Cash and cash equivalents, beginning of year |
7,554 | 253 | 20,530 | |||||||||
Cash and cash equivalents, end of year |
$ | 10,350 | $ | 7,554 | $ | 253 | ||||||
73