UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2009
Commission File Number: 001-12117
FIRST ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 75-1328153 (I.R.S. Employer Identification No.) | |
3813 Green Hills Village Drive Nashville, Tennessee (Address of principal executive offices) | 37215 (Zip Code) |
(615) 844-2800
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
3322 West End Ave, Suite 1000
Nashville, Tennessee 37203
(Former name, former address and former fiscal year, if changed since last report)
Nashville, Tennessee 37203
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yeso Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filero | Accelerated filero | Non-accelerated filero(Do not check if a smaller reporting company) | Smaller Reporting Companyþ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
At February 8, 2010, there were 48,489,717 shares outstanding of the registrant’s common stock, par value $0.01 per share.
FIRST ACCEPTANCE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2009
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2009
INDEX
1 | ||||
1 | ||||
17 | ||||
26 | ||||
29 | ||||
30 | ||||
30 | ||||
30 | ||||
31 |
i
PART I – FINANCIAL INFORMATION
Item 1. | Financial Statements |
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
December 31, | June 30, | |||||||
2009 | 2009 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
Fixed maturities, available-for-sale at fair value (amortized cost of $183,318 and $140,849, respectively) | $ | 186,328 | $ | 140,311 | ||||
Cash and cash equivalents | 29,227 | 77,201 | ||||||
Premiums and fees receivable, net of allowance of $531 and $419 | 39,212 | 45,309 | ||||||
Other assets | 9,543 | 11,866 | ||||||
Property and equipment, net | 3,546 | 3,921 | ||||||
Deferred acquisition costs | 3,641 | 3,896 | ||||||
Goodwill | 70,092 | 70,092 | ||||||
Identifiable intangible assets | 6,360 | 6,360 | ||||||
TOTAL ASSETS | $ | 347,949 | $ | 358,956 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Loss and loss adjustment expense reserves | $ | 77,546 | $ | 83,973 | ||||
Unearned premiums and fees | 50,160 | 57,350 | ||||||
Debentures payable | 41,240 | 41,240 | ||||||
Other liabilities | 10,676 | 16,537 | ||||||
Total liabilities | 179,622 | 199,100 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $.01 par value, 10,000 shares authorized | — | — | ||||||
Common stock, $.01 par value, 75,000 shares authorized; 48,490 and 48,312 shares issued and outstanding, respectively | 485 | 483 | ||||||
Additional paid-in capital | 465,406 | 464,720 | ||||||
Accumulated other comprehensive income (loss) | 3,010 | (538 | ) | |||||
Accumulated deficit | (300,574 | ) | (304,809 | ) | ||||
Total stockholders’ equity | 168,327 | 159,856 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 347,949 | $ | 358,956 | ||||
See notes to consolidated financial statements.
1
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: | ||||||||||||||||
Premiums earned | $ | 45,199 | $ | 54,823 | $ | 93,666 | $ | 116,661 | ||||||||
Commission and fee income | 6,966 | 7,675 | 13,920 | 15,918 | ||||||||||||
Investment income | 2,033 | 2,608 | 3,946 | 5,331 | ||||||||||||
Net realized losses on fixed maturities, available-for-sale | (423 | ) | (26 | ) | (445 | ) | (1,241 | ) | ||||||||
53,775 | 65,080 | 111,087 | 136,669 | |||||||||||||
Costs and expenses: | ||||||||||||||||
Losses and loss adjustment expenses | 29,871 | 37,553 | 63,024 | 81,285 | ||||||||||||
Insurance operating expenses | 19,711 | 21,510 | 39,281 | 42,956 | ||||||||||||
Other operating expenses | 750 | 314 | 1,023 | 706 | ||||||||||||
Litigation settlement | 102 | 5,089 | (279 | ) | 5,234 | |||||||||||
Stock-based compensation | 272 | 514 | 655 | 1,009 | ||||||||||||
Depreciation and amortization | 500 | 455 | 964 | 924 | ||||||||||||
Interest expense | 992 | 1,033 | 1,981 | 2,190 | ||||||||||||
52,198 | 66,468 | 106,649 | 134,304 | |||||||||||||
Income (loss) before income taxes | 1,577 | (1,388 | ) | 4,438 | 2,365 | |||||||||||
Provision (benefit) for income taxes | 102 | (385 | ) | 203 | 1,527 | |||||||||||
Net income (loss) | $ | 1,475 | $ | (1,003 | ) | $ | 4,235 | $ | 838 | |||||||
Net income (loss) per share: | ||||||||||||||||
Basic and diluted | $ | 0.03 | $ | (0.02 | ) | $ | 0.09 | $ | 0.02 | |||||||
Number of shares used to calculate net income (loss) per share: | ||||||||||||||||
Basic | 47,960 | 47,658 | 47,919 | 47,656 | ||||||||||||
Diluted | 48,551 | 47,658 | 48,720 | 49,088 | ||||||||||||
Reconciliation of net income (loss) to comprehensive income (loss): | ||||||||||||||||
Net income (loss) | $ | 1,475 | $ | (1,003 | ) | $ | 4,235 | $ | 838 | |||||||
Net unrealized change in investments | (627 | ) | 1,790 | 3,548 | (1,673 | ) | ||||||||||
Comprehensive income (loss) | $ | 848 | $ | 787 | $ | 7,783 | $ | (835 | ) | |||||||
Detail of net realized losses on fixed maturities, available-for-sale: | ||||||||||||||||
Net realized gains (losses) on sales | $ | 15 | $ | (26 | ) | $ | 314 | $ | 24 | |||||||
Unrealized losses on fixed maturities with other-than-temporary impairment charges | (1,128 | ) | — | (1,449 | ) | (1,265 | ) | |||||||||
Non-credit portion included in comprehensive income (loss) | (690 | ) | — | (690 | ) | — | ||||||||||
Other-than-temporary impairment charges recognized in income (loss) | (438 | ) | — | (759 | ) | (1,265 | ) | |||||||||
Net realized losses on fixed maturities, available-for-sale | $ | (423 | ) | $ | (26 | ) | $ | (445 | ) | $ | (1,241 | ) | ||||
See notes to consolidated financial statements.
2
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
Six Months Ended | ||||||||
December 31, | ||||||||
2009 | 2008 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 4,235 | $ | 838 | ||||
Adjustments to reconcile net income to cash used in operating activities: | ||||||||
Depreciation and amortization | 964 | 924 | ||||||
Stock-based compensation | 655 | 1,009 | ||||||
Deferred income taxes | — | 1,346 | ||||||
Other-than-temporary impairment on investment securities | 759 | 1,265 | ||||||
Net realized gains on sales of investments | (314 | ) | (24 | ) | ||||
Other | 789 | 82 | ||||||
Change in: | ||||||||
Premiums and fees receivable | 5,566 | 14,655 | ||||||
Loss and loss adjustment expense reserves | (6,427 | ) | (7,604 | ) | ||||
Unearned premiums and fees | (7,190 | ) | (16,870 | ) | ||||
Litigation settlement | 669 | 880 | ||||||
Other | (3,903 | ) | (2,671 | ) | ||||
Net cash used in operating activities | (4,197 | ) | (6,170 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchases of fixed maturities, available-for-sale | (61,439 | ) | (14,225 | ) | ||||
Maturities and paydowns of fixed maturities, available-for-sale | 6,704 | 6,476 | ||||||
Sales of fixed maturities, available-for-sale | 11,566 | 4,425 | ||||||
Net change in receivable/payable for securities | — | (1,045 | ) | |||||
Capital expenditures | (592 | ) | (463 | ) | ||||
Other | (21 | ) | (99 | ) | ||||
Net cash used in investing activities | (43,782 | ) | (4,931 | ) | ||||
Cash flows from financing activities: | ||||||||
Payments on borrowings | (28 | ) | (4,026 | ) | ||||
Net proceeds from issuance of common stock | 33 | 37 | ||||||
Net cash provided by (used in) financing activities | 5 | (3,989 | ) | |||||
Net decrease in cash and cash equivalents | (47,974 | ) | (15,090 | ) | ||||
Cash and cash equivalents, beginning of period | 77,201 | 38,646 | ||||||
Cash and cash equivalents, end of period | $ | 29,227 | $ | 23,556 | ||||
See notes to consolidated financial statements.
3
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
The consolidated financial statements of First Acceptance Corporation (the “Company”) included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted. In the opinion of management, the consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the interim periods. Certain reclassifications have been made to the prior year’s consolidated financial statements to conform with the current year presentation.
In connection with the preparation of these consolidated interim financial statements, the Company has evaluated subsequent events through February 8, 2010, which is the date the financial statements were issued. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
2. Investments
Fair Value
Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company holds available-for-sale fixed maturity investments, which are carried at fair value.
Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs are based on market data from independent sources, while unobservable inputs reflect the Company’s view of market assumptions in the absence of observable market information. All assets and liabilities that are carried at fair value are classified and disclosed in one of the following categories:
Level 1 - | Quoted prices in active markets for identical assets or liabilities. | |||
Level 2 - | Quoted market prices for similar assets or liabilities in active markets; quoted prices by independent pricing services for identical or similar assets or liabilities in markets that are not active; and valuations, using models or other valuation techniques, that use observable market data. All significant inputs are observable, or derived from observable information in the marketplace, or are supported by observable levels at which transactions are executed in the market place. | |||
Level 3 - | Instruments that use non-binding broker quotes or model driven valuations that do not have observable market data. |
4
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table presents the fair-value measurements for each major category of assets that are measured on a recurring basis at December 31, 2009 (in thousands).
Fair Value Measurements Using | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | |||||||||||||||
Markets for | Other | Significant | ||||||||||||||
Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
Description | Total | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Fixed maturities, available-for-sale: | ||||||||||||||||
U.S. government and agencies | $ | 29,903 | $ | 29,903 | $ | — | $ | — | ||||||||
State | 8,255 | — | 8,255 | — | ||||||||||||
Political subdivisions | 1,832 | — | 1,832 | — | ||||||||||||
Revenue and assessment | 26,092 | — | 26,092 | — | ||||||||||||
Corporate bonds | 76,784 | — | 72,810 | 3,974 | ||||||||||||
Collateralized mortgage obligations: | — | |||||||||||||||
Agency backed | 30,283 | — | 30,283 | — | ||||||||||||
Non-agency backed — residential | 6,362 | — | 3,762 | 2,600 | ||||||||||||
Non-agency backed — commercial | 6,817 | — | 6,817 | — | ||||||||||||
Total fixed maturities, available-for-sale | 186,328 | 29,903 | 149,851 | 6,574 | ||||||||||||
Cash and cash equivalents | 29,227 | 29,227 | — | — | ||||||||||||
Total | $ | 215,555 | $ | 59,130 | $ | 149,851 | $ | 6,574 | ||||||||
The fair values of the Company’s fixed maturities are determined by management after taking into consideration available sources of data. All of the portfolio valuations classified as Level 1 or Level 2 in the above table are priced exclusively by utilizing the services of independent pricing sources using observable market data. The Level 2 classified security valuations are obtained from a single independent pricing service. The Level 3 classified securities in the table above consist of three collateralized mortgage obligations (“CMOs”) and one corporate bond that are priced from non-binding broker quotes obtained from a single dealer familiar with each particular security or model driven valuations that do not have observable market data. Based on the nature of these securities and the lack of similar securities trading to obtain observable market data, the Company believes that these Level 3 valuations are more subjective in nature. The Company has not made any adjustments to the prices obtained from the independent pricing sources and dealers.
The Company has reviewed the pricing techniques and methodologies of the independent pricing sources and dealers and believes that their policies adequately consider market activity, either based on specific transactions for the security valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. The Company monitored security-specific valuation trends and discussed material changes or the absence of expected changes with the pricing sources to understand the underlying factors and inputs and to validate the reasonableness of the pricing.
5
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Based on the above categorization, the following tables represent the quantitative disclosure for those assets included in category Level 3 at December 31, 2009 (in thousands).
Fair Value Measurements Using | ||||||||||||||||
Significant Unobservable Inputs (Level 3) | ||||||||||||||||
Collateralized mortgage obligations | ||||||||||||||||
Non-agency | Non-agency | |||||||||||||||
Corporate | backed – | backed – | ||||||||||||||
Three Months Ended December 31, 2009: | bonds | residential | commercial | Total | ||||||||||||
Balance at October 1, 2009 | $ | — | $ | 3,294 | $ | — | $ | 3,294 | ||||||||
Total gains or losses (realized or unrealized): | ||||||||||||||||
Included in net income (loss) | — | (97 | ) | — | (97 | ) | ||||||||||
Included in other comprehensive income (loss) | 71 | 221 | — | 292 | ||||||||||||
Purchases, sales, issuances and settlements | 3,903 | — | — | 3,903 | ||||||||||||
Transfers in to Level 3 | — | 870 | — | 870 | ||||||||||||
Transfers out of Level 3 | — | (1,688 | ) | — | (1,688 | ) | ||||||||||
Balance at December 31, 2009 | $ | 3,974 | $ | 2,600 | $ | — | $ | 6,574 | ||||||||
Fair Value Measurements Using | ||||||||||||||||
Significant Unobservable Inputs (Level 3) | ||||||||||||||||
Collateralized mortgage obligations | ||||||||||||||||
Non-agency | Non-agency | |||||||||||||||
Corporate | backed – | backed – | ||||||||||||||
Six Months Ended December 31, 2009: | bonds | residential | commercial | Total | ||||||||||||
Balance at July 1, 2009 | $ | — | $ | 1,930 | $ | 707 | $ | 2,637 | ||||||||
Total gains or losses (realized or unrealized): | ||||||||||||||||
Included in net income (loss) | — | (97 | ) | — | (97 | ) | ||||||||||
Included in other comprehensive income (loss) | 71 | 424 | 91 | 586 | ||||||||||||
Purchases, sales, issuances and settlements | 3,903 | — | — | 3,903 | ||||||||||||
Transfers in to Level 3 | — | 880 | — | 880 | ||||||||||||
Transfers out of Level 3 | — | (537 | ) | (798 | ) | (1,335 | ) | |||||||||
Balance at December 31, 2009 | $ | 3,974 | $ | 2,600 | $ | — | $ | 6,574 | ||||||||
Investment Income and Net Realized Gains and Losses
The major categories of investment income follow (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Fixed maturities, available-for-sale | $ | 2,164 | $ | 2,582 | $ | 4,193 | $ | 5,213 | ||||||||
Cash and cash equivalents | 4 | 107 | 23 | 286 | ||||||||||||
Other | 29 | 29 | 59 | 58 | ||||||||||||
Investment expenses | (164 | ) | (110 | ) | (329 | ) | (226 | ) | ||||||||
$ | 2,033 | $ | 2,608 | $ | 3,946 | $ | 5,331 | |||||||||
6
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The components of net realized losses on fixed maturities, available-for-sale are as follows (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Gains | $ | 16 | $ | 3 | $ | 319 | $ | 62 | ||||||||
Losses | (1 | ) | (29 | ) | (5 | ) | (38 | ) | ||||||||
Other-than-temporary impairment | (438 | ) | — | (759 | ) | (1,265 | ) | |||||||||
$ | (423 | ) | $ | (26 | ) | $ | (445 | ) | $ | (1,241 | ) | |||||
Realized gains and losses on sales of securities are computed based on specific identification. The non-credit related portion of other-than-temporary impairment (“OTTI”) charges are included in other comprehensive income (loss). The amounts of such charges taken for securities still owned were $1.3 million for non-agency backed residential CMOs and $0.6 million for non-agency backed commercial CMOs at December 31, 2009 and $0.6 million for non-agency backed residential CMOs and $0.6 million for non-agency backed commercial CMOs at June 30, 2009.
Fixed Maturities, Available-for-Sale
The following tables summarize the Company’s fixed maturity securities (in thousands).
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
December 31, 2009 | Cost | Gains | Losses | Value | ||||||||||||
U.S. government and agencies | $ | 29,505 | $ | 434 | $ | (36 | ) | $ | 29,903 | |||||||
State | 7,962 | 299 | (6 | ) | 8,255 | |||||||||||
Political subdivisions | 1,826 | 51 | (45 | ) | 1,832 | |||||||||||
Revenue and assessment | 25,546 | 739 | (193 | ) | 26,092 | |||||||||||
Corporate bonds | 74,674 | 2,608 | (498 | ) | 76,784 | |||||||||||
Collateralized mortgage obligations: | ||||||||||||||||
Agency backed | 28,874 | 1,409 | — | 30,283 | ||||||||||||
Non-agency backed — residential | 7,316 | 20 | (974 | ) | 6,362 | |||||||||||
Non-agency backed — commercial | 7,615 | 57 | (855 | ) | 6,817 | |||||||||||
$ | 183,318 | $ | 5,617 | $ | (2,607 | ) | $ | 186,328 | ||||||||
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
June 30, 2009 | Cost | Gains | Losses | Value | ||||||||||||
U.S. government and agencies | $ | 10,744 | $ | 473 | $ | (37 | ) | $ | 11,180 | |||||||
State | 8,238 | 344 | (19 | ) | 8,563 | |||||||||||
Political subdivisions | 1,834 | 52 | (32 | ) | 1,854 | |||||||||||
Revenue and assessment | 27,816 | 831 | (166 | ) | 28,481 | |||||||||||
Corporate bonds | 45,737 | 1,654 | (665 | ) | 46,726 | |||||||||||
Collateralized mortgage obligations: | ||||||||||||||||
Agency backed | 30,656 | 1,270 | — | 31,926 | ||||||||||||
Non-agency backed — residential | 8,178 | 1 | (2,561 | ) | 5,618 | |||||||||||
Non-agency backed — commercial | 7,646 | — | (1,683 | ) | 5,963 | |||||||||||
$ | 140,849 | $ | 4,625 | $ | (5,163 | ) | $ | 140,311 | ||||||||
7
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table sets forth the scheduled maturities of our fixed maturity securities at December 31, 2009 based on their fair values (in thousands). Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
Securities | ||||||||||||||||
with No | ||||||||||||||||
Securities | Securities | Gross | ||||||||||||||
with Gross | with Gross | Unrealized | All | |||||||||||||
Unrealized | Unrealized | Gains or | Fixed Maturity | |||||||||||||
Gains | Losses | Losses | Securities | |||||||||||||
One year or less | $ | — | $ | — | $ | — | $ | — | ||||||||
After one through five years | 81,536 | 9,047 | — | 90,583 | ||||||||||||
After five through ten years | 27,865 | 13,055 | — | 40,920 | ||||||||||||
After ten years | 3,183 | 8,180 | — | 11,363 | ||||||||||||
No single maturity date | 34,084 | 9,378 | — | 43,462 | ||||||||||||
$ | 146,668 | $ | 39,660 | $ | — | $ | 186,328 | |||||||||
The following table reflects the number of securities with gross unrealized gains and losses. Gross unrealized losses are further segregated by the length of time that individual securities have been in a continuous unrealized loss position.
Gross Unrealized Losses | ||||||||||||
Less than | Greater | Gross | ||||||||||
or equal to | than 12 | Unrealized | ||||||||||
At: | 12 months | months | Gains | |||||||||
December 31, 2009 | 13 | 24 | 144 | |||||||||
June 30, 2009 | 3 | 37 | 133 |
The following tables reflect the fair value and gross unrealized losses of those securities in a continuous unrealized loss position for greater than 12 months. Gross unrealized losses are further segregated by the percentage of amortized cost (in thousands, except number of securities).
Number | Gross | |||||||||||
Gross Unrealized Losses | of | Fair | Unrealized | |||||||||
at December 31, 2009: | Securities | Value | Losses | |||||||||
Less than 10% | 11 | $ | 7,925 | $ | (407 | ) | ||||||
Greater than 10% | 13 | 6,634 | (1,904 | ) | ||||||||
24 | $ | 14,559 | $ | (2,311 | ) | |||||||
Number | Gross | |||||||||||
Gross Unrealized Losses | of | Fair | Unrealized | |||||||||
at June 30, 2009: | Securities | Value | Losses | |||||||||
Less than 10% | 17 | $ | 15,368 | $ | (766 | ) | ||||||
Greater than 10% | 20 | 8,970 | (4,348 | ) | ||||||||
37 | $ | 24,338 | $ | (5,114 | ) | |||||||
8
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following tables set forth the amount of gross unrealized losses by current severity (as compared to amortized cost) and length of time that individual securities have been in a continuous unrealized loss position (in thousands).
Fair Value of | ||||||||||||||||||||
Securities with | Severity of Gross Unrealized Losses | |||||||||||||||||||
Length of | Gross | Gross | Greater | |||||||||||||||||
Gross Unrealized Losses | Unrealized | Unrealized | Less | 5% to | than | |||||||||||||||
at December 31, 2009: | Losses | Losses | than 5% | 10% | 10% | |||||||||||||||
Less than or equal to: | ||||||||||||||||||||
Three months | $ | 24,521 | $ | (281 | ) | $ | (281 | ) | $ | — | $ | — | ||||||||
Six months | 543 | (14 | ) | (14 | ) | — | — | |||||||||||||
Nine months | — | — | — | — | — | |||||||||||||||
Twelve months | 37 | (1 | ) | (1 | ) | — | — | |||||||||||||
Greater than twelve months | 14,559 | (2,311 | ) | (71 | ) | (336 | ) | (1,904 | ) | |||||||||||
Total | $ | 39,660 | $ | (2,607 | ) | $ | (367 | ) | $ | (336 | ) | $ | (1,904 | ) | ||||||
Fair Value of | ||||||||||||||||||||
Securities with | Severity of Gross Unrealized Losses | |||||||||||||||||||
Length of | Gross | Gross | Greater | |||||||||||||||||
Gross Unrealized Losses | Unrealized | Unrealized | Less | 5% to | than | |||||||||||||||
at June 30, 2009: | Losses | Losses | than 5% | 10% | 10% | |||||||||||||||
Less than or equal to: | ||||||||||||||||||||
Three months | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Six months | 1,011 | (38 | ) | (38 | ) | — | — | |||||||||||||
Nine months | — | — | — | — | — | |||||||||||||||
Twelve months | 533 | (11 | ) | (11 | ) | — | — | |||||||||||||
Greater than twelve months | 24,338 | (5,114 | ) | (249 | ) | (517 | ) | (4,348 | ) | |||||||||||
Total | $ | 25,882 | $ | (5,163 | ) | $ | (298 | ) | $ | (517 | ) | $ | (4,348 | ) | ||||||
Other-Than-Temporary Impairment
Effective April 1, 2009, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320-10-65,Recognition and Presentation of Other-Than-Temporary Impairments(Prior authoritative literature:FASB Staff Position No. FAS 115-2) (“FASB ASC 320-10-65”). Under this guidance, the Company separates OTTI into the following two components: (i) the amount related to credit losses, which is recognized in the consolidated statement of operations, and (ii) the amount related to all other factors, which is recorded in other comprehensive income (loss). The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield at the date of acquisition.
The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. The Company routinely monitors its fixed maturity portfolio for changes in fair value that might indicate potential impairments and performs detailed reviews on such securities. Changes in fair value are evaluated to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer or (ii) market-related factors such as interest rates or sector declines.
Securities with declines attributable to issuer-specific fundamentals are reviewed to identify all available evidence to estimate the potential for impairment. Resources used include historical financial data included in filings with the Securities and Exchange Commission for corporate bonds and performance data regarding the underlying loans for CMOs. Securities with declines attributable solely to market or sector declines where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before the full recovery of its amortized cost basis are not deemed to be other-than-temporary.
9
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The issuer-specific factors considered in reaching the conclusion that securities with declines are not other-than-temporary include (i) the extent and duration of the decline in fair value, including the duration of any significant decline in value, (ii) whether the security is current as to payments of principal and interest, (iii) a valuation of any underlying collateral, (iv) current and future conditions and trends for both the business and its industry, (v) changes in cash flow assumptions for CMOs and (vi) rating agency actions. Based on these factors, the Company makes a determination as to the probability of recovering principal and interest on the security.
The number and amount of securities for which the Company has recorded OTTI are presented in the following tables (in thousands, except for the number of securities).
Three Months Ended December 31, | ||||||||||||||||
2009 | 2008 | |||||||||||||||
Number | Number | |||||||||||||||
of | of | |||||||||||||||
Securities | OTTI | Securities | OTTI | |||||||||||||
Corporate bonds | — | $ | — | — | $ | — | ||||||||||
Collateralized mortgage obligations: | ||||||||||||||||
Non-agency backed — residential | 7 | (438 | ) | — | — | |||||||||||
Non-agency backed — commercial | — | — | — | — | ||||||||||||
7 | $ | (438 | ) | — | $ | — | ||||||||||
Six Months Ended December 31, | ||||||||||||||||
2009 | 2008 | |||||||||||||||
Number | Number | |||||||||||||||
of | of | |||||||||||||||
Securities | OTTI | Securities | OTTI | |||||||||||||
Corporate bonds | — | $ | — | 2 | $ | (721 | ) | |||||||||
Collateralized mortgage obligations: | ||||||||||||||||
Non-agency backed — residential | 8 | (759 | ) | 3 | (283 | ) | ||||||||||
Non-agency backed — commercial | — | — | 3 | (261 | ) | |||||||||||
8 | $ | (759 | ) | 8 | $ | (1,265 | ) | |||||||||
Since the adoption of FASB ASC 320-10-65, the following is a progression of the credit-related portion of OTTI on fixed maturity securities owned at December 31, 2009 (in thousands).
Three Months Ended | Six Months Ended | |||||||
December 31, 2009 | December 31, 2009 | |||||||
Beginning balance | $ | (2,639 | ) | $ | (2,870 | ) | ||
Additional credit impairments on: | ||||||||
Previously impaired securities | (221 | ) | (270 | ) | ||||
Securities without previous impairments | (217 | ) | (489 | ) | ||||
(438 | ) | (759 | ) | |||||
Reductions for securities sold | — | 552 | ||||||
Balance at December 31, 2009 | $ | (3,077 | ) | $ | (3,077 | ) | ||
On a quarterly basis, the Company reviews cash flow estimates for certain non-agency backed CMOs of lesser credit quality following the guidance of FASB ASC 325-40-65,Amendments to the Impairment Guidance of EITF Issue No. 99-20(Prior authoritative literature:FSP EITF 99-20-1) (“FASB ASC 325-40-65”). Accordingly, when changes in estimated cash flows from the cash flows previously estimated occur due to actual or estimated prepayment or credit loss experience, and the present value of the revised cash flows is less than the present value previously estimated, OTTI is deemed to have occurred. For non-agency backed CMOs not subject to FASB ASC 325-40-65, the Company prepares quarterly projected cash flow analyses and recognizes OTTI when it determines that a loss is probable. The Company has recognized OTTI related to certain non-agency backed CMOs as the underlying cash flows have been adversely impacted due to a reduction in prepayments from mortgage refinancing and an increase in actual and projected delinquencies in the underlying mortgages.
10
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The Company’s review of non-agency backed CMOs included an analysis of available information such as collateral quality, anticipated cash flows, credit enhancements, default rates, loss severities, the securities’ relative position in their respective capital structures, and credit ratings from statistical rating agencies. The Company reviews quarterly projected cash flow analyses for each security utilizing current assumptions regarding (i) actual and anticipated delinquencies, (ii) delinquency transition-to-default rates, and (iii) loss severities. Based on its quarterly reviews, the Company determined that there had not been an adverse change in projected cash flows, except in the case of those securities for which OTTI charges have been recorded. The Company believes that the unrealized losses on these securities are not necessarily predictive of the ultimate performance of the underlying collateral. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before the recovery of their amortized cost basis.
The OTTI charges on corporate bonds for the six months ended December 31, 2008 were recorded as these bonds were considered to be impaired based on the extent and duration of the declines in their fair values and issuer-specific fundamentals relating to (i) poor operating results and weakened financial conditions, (ii) negative industry trends further impacted by the recent economic decline, and (iii) a series of downgrades to their credit ratings. Based on the factors that existed at the time of impairment, the Company did not believe that these bonds would recover their unrealized losses in the near future.
The Company believes that the remaining securities having unrealized losses at December 31, 2009 were not other-than-temporarily impaired. The Company also does not intend to sell any of these securities and it is more likely than not that the Company will not be required to sell any of these securities before the recovery of their amortized cost basis.
3. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share data).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net income (loss) | $ | 1,475 | $ | (1,003 | ) | $ | 4,235 | $ | 838 | |||||||
Weighted average common basic shares | 47,960 | 47,658 | 47,919 | 47,656 | ||||||||||||
Weighted average effect of dilutive securities | 591 | — | 801 | 1,432 | ||||||||||||
Weighted average common dilutive shares | 48,551 | 47,658 | 48,720 | 49,088 | ||||||||||||
Basic and diluted net income (loss) per share | $ | 0.03 | $ | (0.02 | ) | $ | 0.09 | $ | 0.02 | |||||||
For the three months ended December 31, 2009, options to purchase approximately 4.6 million shares of common stock, a dilutive effect of approximately 0.2 million shares, and 0.5 million shares of unvested restricted common stock were included in the computation of diluted income per share. For the three months ended December 31, 2008, options to purchase approximately 5.3 million shares of common stock, a dilutive effect of approximately 0.8 million shares, and 0.4 million shares of unvested restricted common stock were not included in the computation of diluted loss per share as their inclusion would have been anti-dilutive.
For the six months ended December 31, 2009, options to purchase approximately 4.6 million shares of common stock, a dilutive effect of approximately 0.4 million shares, and 0.5 million shares of unvested restricted common stock were included in the computation of diluted income per share. For the six months ended December 31, 2008, options to purchase approximately 5.3 million shares of common stock, a dilutive effect of approximately 1.0 million shares, and 0.4 million shares of unvested restricted common stock were included in the computation of diluted income per share.
11
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
4. Income Taxes
The provision (benefit) for income taxes consisted of the following (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Federal: | ||||||||||||||||
Current | $ | — | $ | (72 | ) | $ | — | $ | (28 | ) | ||||||
Deferred | — | (535 | ) | — | 1,152 | |||||||||||
— | (607 | ) | — | 1,124 | ||||||||||||
State: | ||||||||||||||||
Current | 102 | 42 | 203 | 209 | ||||||||||||
Deferred | — | 180 | — | 194 | ||||||||||||
102 | 222 | 203 | 403 | |||||||||||||
$ | 102 | $ | (385 | ) | $ | 203 | $ | 1,527 | ||||||||
The provision (benefit) for income taxes differs from the amounts computed by applying the statutory federal corporate tax rate of 35% to income (loss) before income taxes as a result of the following (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Provision (benefit) for income taxes at statutory rate | $ | 552 | $ | (486 | ) | $ | 1,553 | $ | 828 | |||||||
Tax effect of: | ||||||||||||||||
Tax-exempt investment income | (4 | ) | (1 | ) | (8 | ) | (7 | ) | ||||||||
Change in the beginning of the period balance of the valuation allowance for deferred tax assets allocated to income taxes | (516 | ) | (252 | ) | (1,471 | ) | — | |||||||||
State income taxes, net of federal income tax benefit | 65 | 208 | 120 | 330 | ||||||||||||
Other | 5 | 146 | 9 | 376 | ||||||||||||
$ | 102 | $ | (385 | ) | $ | 203 | $ | 1,527 | ||||||||
The Company had a valuation allowance of $22.2 million and $24.9 million at December 31, 2009 and June 30, 2009, respectively, to reduce net deferred tax assets to the amount that is more likely than not to be realized, which included all net deferred tax assets at December 31, 2009 and June 30, 2009. For the six months ended December 31, 2009, the change in the valuation allowance included the unrealized change on investments of $1.2 million included in other comprehensive income (loss).
In assessing the realization of deferred tax assets, management considered whether it was more likely than not that some portion or all of the deferred tax assets will not be realized. The Company is required to assess whether a valuation allowance should be established against the Company’s deferred tax assets based on the consideration of all available evidence using a more likely than not standard. In making such judgments, significant weight is given to evidence that can be objectively verified. In assessing the Company’s ability to support the realizability of its deferred tax assets, management considered both positive and negative evidence. The Company placed greater weight on historical results than the Company’s outlook for future profitability and established a valuation allowance against all net deferred tax assets at December 31, 2009 and June 30, 2009. The deferred tax valuation allowance may be adjusted in future periods if management considers that it is more likely than not that some portion or all of the deferred tax assets will be realized. In the event the deferred tax valuation allowance is adjusted, the Company would record an income tax benefit for the adjustment.
12
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
5. Goodwill and Identifiable Intangible Assets
Goodwill and other identifiable intangible assets are attributable to the Company’s insurance operations and were initially recorded at their estimated fair values at the date of acquisition. Goodwill and other intangible assets having an indefinite useful life are not amortized for financial statement purposes. The Company performs required annual impairment tests of its goodwill and intangible assets as of the last day of the fourth quarter of each fiscal year. In the event that facts and circumstances indicate that the goodwill and other identifiable intangible assets may be impaired, an interim impairment test would be required. Intangible assets with finite lives have been fully amortized over their useful lives.
The goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit based on valuation techniques, including a discounted cash flow model using revenue and profit forecasts, and comparing those estimated fair values with the carrying values of those assets and liabilities, which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment, if any, by determining an “implied fair value” of goodwill. The determination of the “implied fair value” of goodwill of a reporting unit requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.
As a result of the adverse impact of difficult economic conditions on the Company’s customers and business and the resulting decline in its share price during the fourth quarter of fiscal year 2009, the Company estimated that a goodwill impairment was probable. Accordingly, the Company recognized an estimated non-cash, pre-tax goodwill impairment charge of $68.0 million in the fourth quarter of fiscal year 2009. Due to the complexity of the fair value calculations involved, the analysis of the goodwill impairment charge recognized during the fourth quarter of fiscal year 2009 was finalized during the first quarter of fiscal year 2010 and the amount of the impairment did not differ from the initial estimate.
The Company’s evaluation includes multiple assumptions, including estimated discounted cash flows and other estimates that may change over time. If future discounted cash flows become less than those projected by the Company, further impairment charges may become necessary that could have a materially adverse impact on the Company’s results of operations and financial condition. As quoted market prices in active stock markets are relevant evidence of fair value, a significant decline in the Company’s common stock trading price may indicate an impairment of goodwill.
6. Litigation
The Company is named as a defendant in various lawsuits, arising in the ordinary course of business, generally relating to its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves. The Company also faces lawsuits that seek damages beyond policy limits, commonly known as bad faith claims, as well as class action and individual lawsuits that involve issues arising in the course of the Company’s business. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB ASC 450-20,Loss Contingencies(Prior authoritative literature:FASB Statement No. 5) (“FASB ASC 450-20”). Pursuant to FASB ASC 450-20, reserves for a loss may only be recognized if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will disclose, if it can be estimated, a possible range of loss or state that an estimate cannot be made. Management evaluates each legal action and records reserves for losses as warranted by establishing a reserve in its consolidated balance sheets in loss and loss adjustment expense reserves for bad faith claims and in other liabilities for other lawsuits. Amounts incurred are recorded in the Company’s consolidated statements of operations in losses and loss adjustment expenses for bad faith claims and in insurance operating expenses for other lawsuits unless otherwise disclosed.
13
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The Company has established an accrual for losses related to the litigation settlements entered into during fiscal year 2009 related to litigation brought against the Company in Alabama and Georgia with respect to its sales practices, primarily the sale of ancillary motor club memberships currently or formerly sold in those states. Pursuant to the terms of the settlements, eligible class members are entitled to certain premium credits towards a future automobile insurance policy with the Company or a reimbursement certificate for future rental or towing expenses. Benefits to the Georgia and Alabama class members commenced January 1, 2009 and March 7, 2009, respectively. Any premium credits issued to class members as described above will be prorated over a twelve-month term not to extend beyond August 2011, and the class member will be entitled to the prorated premium credit only so long as their insurance premiums remain current during the twelve-month term.
At December 31, 2008, the Company accrued $5.2 million for premium credits available to class members who were actively insured by the Company. The following is a progression of the activity associated with the estimated premium credit liability (in thousands).
Balance at December 31, 2008 | $ | 5,227 | ||
Credits utilized | (1,338 | ) | ||
Credits forfeited | (904 | ) | ||
Balance at June 30, 2009 | 2,985 | |||
Credits utilized | (1,939 | ) | ||
Credits forfeited | (234 | ) | ||
Balance at December 31, 2009 | $ | 812 | ||
The Company has not established an accrual for $0.3 million in potential premium credits available to class members who were not actively insured by the Company upon commencement of the settlement due to the uncertainty associated with this group having to purchase a new automobile insurance policy. Based on experience to date, the Company does not expect any significant costs associated with the reimbursement certificates. The final costs of the settlements will depend on, among other factors, the rate of redemption and forfeiture of the premium credits and reimbursement certificates.
The litigation settlement costs are classified in the litigation settlement expenses line item in the Company’s consolidated statements of operations. The litigation settlement accrual for those currently estimable costs associated with the utilization of premium credits is classified in other liabilities in the Company’s consolidated balance sheet. Management intends to adjust the estimated accrual as necessary during future periods to account for the impact of the actual rate of redemption and forfeiture of the premium credits and reimbursement certificates.
The Company received $2.95 million in July 2009 from its insurance carrier regarding coverage for the costs and expenses incurred by the Company relating to the settlement of the Georgia and Alabama litigation. The insurance recovery was accrued in fiscal year 2009 and is included in other assets in the Company’s consolidated balance sheet at June 30, 2009.
14
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
7. Fair Value of Financial Instruments
The carrying values and fair values of certain of the Company’s financial instruments were as follows (in thousands).
December 31, 2009 | June 30, 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Value | Value | Value | Value | |||||||||||||
Assets: | ||||||||||||||||
Fixed maturities, available-for-sale | $ | 186,328 | $ | 186,328 | $ | 140,311 | $ | 140,311 | ||||||||
Cash and cash equivalents | 29,227 | 29,227 | 77,201 | 77,201 | ||||||||||||
Premiums and fees receivable, net | 39,212 | 39,212 | 45,309 | 45,309 | ||||||||||||
Liabilities: | ||||||||||||||||
Capitalized lease obligations | 196 | 196 | 224 | 224 | ||||||||||||
Debentures payable | 41,240 | 19,176 | 41,240 | 15,568 |
The fair values as presented represent the Company’s best estimates and may not be substantiated by comparisons to independent markets. The fair value of the debentures payable was based on current market rates offered for debt with similar risks and maturities. Certain financial instruments and all non-financial instruments are not required to be disclosed. Therefore, the aggregate fair values presented in the table do not purport to represent the Company’s underlying value.
8. 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 debt and other general corporate overhead expenses.
The following table presents selected financial data by business segment (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues: | ||||||||||||||||
Insurance | $ | 53,745 | $ | 65,046 | $ | 111,028 | $ | 136,603 | ||||||||
Real estate and corporate | 30 | 34 | 59 | 66 | ||||||||||||
Consolidated total | $ | 53,775 | $ | 65,080 | $ | 111,087 | $ | 136,669 | ||||||||
Income (loss) before income taxes: | ||||||||||||||||
Insurance | $ | 3,560 | $ | 438 | $ | 8,035 | $ | 6,200 | ||||||||
Real estate and corporate | (1,983 | ) | (1,826 | ) | (3,597 | ) | (3,835 | ) | ||||||||
Consolidated total | $ | 1,577 | $ | (1,388 | ) | $ | 4,438 | $ | 2,365 | |||||||
December 31, | June 30, | |||||||||||||||
2009 | 2009 | |||||||||||||||
Total assets: | ||||||||||||||||
Insurance | $ | 336,700 | $ | 348,801 | ||||||||||||
Real estate and corporate | 11,249 | 10,155 | ||||||||||||||
Consolidated total | $ | 347,949 | $ | 358,956 | ||||||||||||
15
FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
9. Recent Accounting Pronouncements
In June 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-01,Generally Accepted Accounting Principles (Topic 105)(“FASB ASU No. 2009-01”), which establishes the FASB Accounting Standards Codification as the single source of authoritative accounting principles recognized by the FASB. This codification does not create new accounting and reporting standards but organizes their structure and requires the Company to update all existing U.S. generally accepted accounting principles references to the new codification references for all future filings. The Company adopted the provisions of FASB ASU No. 2009-01 in the quarter ended September 30, 2009.
In August 2009, the FASB issued ASU No. 2009-05,Measuring Liabilities at Fair Value (Topic 820) (“FASB ASU No. 2009-05”), which amends FASB ASC 820,Fair Value Measurements and Disclosures (Prior authoritative literature:FASB SFAS No. 157), by clarifying that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses either the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets. The Company adopted the provisions of FASB ASU No. 2009-05 upon issuance. The adoption did not have an impact on the Company’s results of operations or financial condition.
16
FIRST ACCEPTANCE CORPORATION 10-Q
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include those discussed in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009. The following discussion should be read in conjunction with our consolidated financial statements included in this report and our consolidated financial statements and related Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended June 30, 2009 included in our Annual Report on Form 10-K.
General
At December 31, 2009, we leased and operated 409 retail locations (or “stores”) staffed by employee-agents. Our employee-agents exclusively sell non-standard automobile insurance products underwritten by us. At December 31, 2009, we wrote non-standard personal automobile insurance in 12 states and were licensed in 13 additional states. See the discussion in Item 1. “Business - General” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009 for additional information with respect to our business.
The following table shows the change in the number of our retail locations for the periods presented. Retail location counts are based upon the date that a location commenced or ceased writing business.
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Retail locations — beginning of period | 415 | 429 | 418 | 431 | ||||||||||||
Opened | — | — | — | 1 | ||||||||||||
Closed | (6 | ) | (5 | ) | (9 | ) | (8 | ) | ||||||||
Retail locations — end of period | 409 | 424 | 409 | 424 | ||||||||||||
The following table shows the number of our retail locations by state.
December 31, | September 30, | June 30, | ||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||
Alabama | 25 | 25 | 25 | 25 | 25 | 25 | ||||||||||||||||||
Florida | 34 | 39 | 36 | 39 | 39 | 40 | ||||||||||||||||||
Georgia | 61 | 61 | 61 | 61 | 61 | 61 | ||||||||||||||||||
Illinois | 76 | 81 | 78 | 81 | 78 | 80 | ||||||||||||||||||
Indiana | 18 | 18 | 18 | 19 | 18 | 19 | ||||||||||||||||||
Mississippi | 8 | 8 | 8 | 8 | 8 | 8 | ||||||||||||||||||
Missouri | 12 | 12 | 12 | 13 | 12 | 14 | ||||||||||||||||||
Ohio | 27 | 28 | 27 | 29 | 27 | 29 | ||||||||||||||||||
Pennsylvania | 17 | 18 | 17 | 18 | 17 | 19 | ||||||||||||||||||
South Carolina | 27 | 27 | 27 | 28 | 27 | 28 | ||||||||||||||||||
Tennessee | 19 | 20 | 20 | 20 | 20 | 20 | ||||||||||||||||||
Texas | 85 | 87 | 86 | 88 | 86 | 88 | ||||||||||||||||||
Total | 409 | 424 | 415 | 429 | 418 | 431 | ||||||||||||||||||
17
FIRST ACCEPTANCE CORPORATION 10-Q
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 real estate held for sale, interest expense associated with debt, and other general corporate overhead expenses. Our insurance operations generate revenues from selling, servicing and underwriting non-standard personal automobile insurance policies in 12 states. We conduct our underwriting operations through three insurance company subsidiaries: First Acceptance Insurance Company, Inc., First Acceptance Insurance Company of Georgia, Inc. and First Acceptance Insurance Company of Tennessee, Inc. Our insurance revenues are primarily generated from:
• | premiums earned, including policy and renewal fees, from sales of policies written and assumed by our insurance company subsidiaries; | ||
• | commission and fee income, including installment billing fees on policies written, agency fees and commissions and fees for other ancillary products and services; and | ||
• | investment income earned on the invested assets of the insurance company subsidiaries. |
The following table presents premiums earned by state (in thousands).
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Premiums earned: | ||||||||||||||||
Georgia | $ | 9,960 | $ | 12,344 | $ | 20,861 | $ | 25,772 | ||||||||
Illinois | 6,075 | 6,826 | 12,406 | 14,188 | ||||||||||||
Texas | 5,714 | 6,133 | 11,626 | 13,134 | ||||||||||||
Florida | 4,933 | 6,196 | 10,194 | 13,812 | ||||||||||||
Alabama | 4,709 | 5,888 | 9,918 | 12,460 | ||||||||||||
Ohio | 2,909 | 3,182 | 5,862 | 6,633 | ||||||||||||
Tennessee | 2,855 | 3,800 | 5,958 | 8,215 | ||||||||||||
South Carolina | 2,727 | 4,491 | 5,866 | 9,941 | ||||||||||||
Pennsylvania | 2,610 | 2,786 | 5,429 | 5,572 | ||||||||||||
Indiana | 1,211 | 1,298 | 2,433 | 2,861 | ||||||||||||
Missouri | 782 | 956 | 1,609 | 2,085 | ||||||||||||
Mississippi | 714 | 923 | 1,504 | 1,988 | ||||||||||||
Total premiums earned | $ | 45,199 | $ | 54,823 | $ | 93,666 | $ | 116,661 | ||||||||
The following table presents the change in the total number of policies in force for the insurance operations. Policies in force increase as a result of new policies issued and decrease as a result of policies that are canceled or expire and are not renewed.
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Policies in force — beginning of period | 152,866 | 170,555 | 158,222 | 194,079 | ||||||||||||
Net decrease during period | (5,776 | ) | (10,998 | ) | (11,132 | ) | (34,522 | ) | ||||||||
Policies in force — end of period | 147,090 | 159,557 | 147,090 | 159,557 | ||||||||||||
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.
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FIRST ACCEPTANCE CORPORATION 10-Q
Expense Ratio —Expense ratio is the ratio (expressed as a percentage) of insurance operating expenses to premiums earned. Insurance operating expenses are reduced by commission and fee income from insureds. This is a measurement that illustrates relative management efficiency in administering our operations.
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 loss, expense and combined ratios for our insurance operations.
Three Months Ended | Six Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Loss and loss adjustment expense | 66.1 | % | 68.5 | % | 67.3 | % | 69.7 | % | ||||||||
Expense | 28.2 | % | 25.2 | % | 27.1 | % | 23.2 | % | ||||||||
Combined | 94.3 | % | 93.7 | % | 94.4 | % | 92.9 | % | ||||||||
The non-standard personal automobile insurance industry is cyclical in nature. Likewise, adverse economic conditions impact our customers and many will choose to reduce their coverage or go uninsured during a weak economy. 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.
Investments
We use the services of an independent investment manager to manage our fixed maturities investment portfolio. The investment manager conducts, in accordance with our investment policy, all of the investment purchases and sales for our insurance company subsidiaries. Our investment policy has been established by the Investment Committee of our Board of Directors and specifically addresses overall investment goals and objectives, authorized investments, prohibited securities, restrictions on sales by the investment manager and guidelines as to asset allocation, duration and credit quality. This policy currently does not allow investments in equity securities. Management and the Investment Committee meet regularly with our investment manager to review the performance of the portfolio and compliance with our investment guidelines.
The invested assets of the insurance company subsidiaries consist substantially of marketable, investment grade, U.S. government securities, municipal bonds, corporate bonds and collateralized mortgage obligations (“CMOs”). We also invest a portion of the portfolio in certain securities issued by political subdivisions, which enable our insurance company subsidiaries to obtain premium tax credits. Investment income is comprised primarily of interest earned on these securities, net of related investment expenses. Realized gains and losses may occur from time to time as changes are made to our holdings or based upon changes in interest rates or the credit quality of specific securities.
The value of our consolidated investment portfolio was $186.3 million at December 31, 2009 and consisted of fixed maturity securities, all carried at fair value with unrealized gains and losses reported as a separate component of stockholders’ equity on an after-tax basis. At December 31, 2009, we had gross unrealized gains of $5.6 million and gross unrealized losses of $2.6 million.
At December 31, 2009, 96.1% of the fair value of our investment portfolio was rated “investment grade” (a credit rating of AAA to BBB) by nationally recognized rating organizations. The average credit rating of our fixed maturity portfolio was AA at December 31, 2009. Investment grade securities generally bear lower yields and have lower degrees of risk than those that are unrated or non-investment grade. We believe that a high quality investment portfolio is more likely to generate a stable and predictable investment return.
Investments in CMOs had a fair value of $43.5 million at December 31, 2009 and represented 23% of our fixed maturity portfolio. At December 31, 2009, 96% of our CMOs were considered investment grade by the nationally recognized rating agencies. In addition, 84% of our CMOs were rated AAA and 70% of our CMOs were backed by agencies of the United States government. Of the non-agency backed CMOs, 48% were rated AAA.
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FIRST ACCEPTANCE CORPORATION 10-Q
The following table summarizes our fixed maturity securities at December 31, 2009 (in thousands).
Gross | Gross | |||||||||||||||
Amortized | Unrealized | Unrealized | Fair | |||||||||||||
Cost | Gains | Losses | Value | |||||||||||||
U.S. government and agencies | $ | 29,505 | $ | 434 | $ | (36 | ) | $ | 29,903 | |||||||
State | 7,962 | 299 | (6 | ) | 8,255 | |||||||||||
Political subdivisions | 1,826 | 51 | (45 | ) | 1,832 | |||||||||||
Revenue and assessment | 25,546 | 739 | (193 | ) | 26,092 | |||||||||||
Corporate bonds | 74,674 | 2,608 | (498 | ) | 76,784 | |||||||||||
Collateralized mortgage obligations: | ||||||||||||||||
Agency backed | 28,874 | 1,409 | — | 30,283 | ||||||||||||
Non-agency backed — residential | 7,316 | 20 | (974 | ) | 6,362 | |||||||||||
Non-agency backed — commercial | 7,615 | 57 | (855 | ) | 6,817 | |||||||||||
$ | 183,318 | $ | 5,617 | $ | (2,607 | ) | $ | 186,328 | ||||||||
The following table sets forth the scheduled maturities of our fixed maturity securities at December 31, 2009 based on their fair values (in thousands). Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
Securities | ||||||||||||||||
with No | ||||||||||||||||
Securities | Securities | Gross | All | |||||||||||||
with Gross | with Gross | Unrealized | Fixed | |||||||||||||
Unrealized | Unrealized | Gains or | Maturity | |||||||||||||
Gains | Losses | Losses | Securities | |||||||||||||
One year or less | $ | — | $ | — | $ | — | $ | — | ||||||||
After one through five years | 81,536 | 9,047 | — | 90,583 | ||||||||||||
After five through ten years | 27,865 | 13,055 | — | 40,920 | ||||||||||||
After ten years | 3,183 | 8,180 | — | 11,363 | ||||||||||||
No single maturity date | 34,084 | 9,378 | — | 43,462 | ||||||||||||
$ | 146,668 | $ | 39,660 | $ | — | $ | 186,328 | |||||||||
Other-Than-Temporary Impairment
Effective April 1, 2009, we adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320-10-65,Recognition and Presentation of Other-Than-Temporary Impairments(Prior authoritative literature:FASB Staff Position No. FAS 115-2). Under this guidance, we separate other-than-temporary impairment (“OTTI”) into the following two components: (i) the amount related to credit losses, which is recognized in the consolidated statement of operations, and (ii) the amount related to all other factors, which is recorded in other comprehensive income (loss). The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield at the date of acquisition.
The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. We routinely monitor our fixed maturity portfolio for changes in fair value that might indicate potential impairments and perform detailed reviews on such securities. Changes in fair value are evaluated to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer or (ii) market-related factors such as interest rates or sector declines.
Securities with declines attributable to issuer-specific fundamentals are reviewed to identify all available evidence to estimate the potential for impairment. Resources used include historical financial data included in filings with the Securities and Exchange Commission for corporate bonds and performance data regarding the underlying loans for CMOs. Securities with declines attributable solely to market or sector declines where we do not intend to sell the security and it is more likely than not that we will not be required to sell the security before the full recovery of its amortized cost basis are not deemed to be other-than-temporary.
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FIRST ACCEPTANCE CORPORATION 10-Q
The issuer-specific factors considered in reaching the conclusion that securities with declines are not other-than-temporary include (i) the extent and duration of the decline in fair value, including the duration of any significant decline in value, (ii) whether the security is current as to payments of principal and interest, (iii) a valuation of any underlying collateral, (iv) current and future conditions and trends for both the business and its industry, (v) changes in cash flow assumptions for CMOs and (vi) rating agency actions. Based on these factors, we make a determination as to the probability of recovering principal and interest on the security.
On a quarterly basis, we review cash flow estimates for certain non-agency backed CMOs of lesser credit quality following the guidance of FASB ASC 325-40-65,Amendments to the Impairment Guidance of EITF Issue No. 99-20(Prior authoritative literature:FSP EITF 99-20-1) (“FASB ASC 325-40-65”). Accordingly, when changes in estimated cash flows from the cash flows previously estimated occur due to actual or estimated prepayment or credit loss experience, and the present value of the revised cash flows is less than the present value previously estimated, OTTI is deemed to have occurred. For non-agency backed CMOs not subject to FASB ASC 325-40-65, we prepare quarterly projected cash flow analyses and recognize OTTI when it is determined that a loss is probable. We have recognized OTTI related to certain non-agency backed CMOs as the underlying cash flows have been adversely impacted due to a reduction in prepayments from mortgage refinancing and an increase in actual and projected delinquencies in the underlying mortgages.
Our review of non-agency backed CMOs included an analysis of available information such as collateral quality, anticipated cash flows, credit enhancements, default rates, loss severities, the securities’ relative position in their respective capital structures, and credit ratings from statistical rating agencies. We review quarterly projected cash flow analyses for each security utilizing current assumptions regarding (i) actual and anticipated delinquencies, (ii) delinquency transition-to-default rates, and (iii) loss severities. Based on our quarterly reviews, we determined that there had not been adverse changes in projected cash flows, except in the case of those securities previously discussed in Note 2 to our consolidated financial statements which incurred OTTI charges of $0.8 million for the six months ended December 31, 2009. We believe that the unrealized losses on these securities are not necessarily predictive of the ultimate performance of the underlying collateral. We do not intend to sell these securities and it is more likely than not that we will not be required to sell these securities before the recovery of their amortized cost basis.
The OTTI charges on corporate bonds for the six months ended December 31, 2008 were recorded as these bonds were considered to be impaired based on the extent and duration of the declines in their fair values and issuer-specific fundamentals relating to (i) poor operating results and weakened financial conditions, (ii) negative industry trends further impacted by the recent economic decline, and (iii) a series of downgrades to their credit ratings. Based on the factors that existed at the time of impairment, we did not believe that these bonds would recover their unrealized losses in the near future.
We believe that the remaining securities having unrealized losses at December 31, 2009 were not other-than-temporarily impaired. We also do not intend to sell any of these securities and it is more likely than not that we will not be required to sell any of these securities before the recovery of their amortized cost basis.
Three and Six Months Ended December 31, 2009 Compared with the Three and Six Months Ended December 31, 2008
Consolidated Results
Revenues for the three months ended December 31, 2009 decreased 17% to $53.8 million from $65.1 million in the same period in the prior year. Income before income taxes for the three months ended December 31, 2009 was $1.6 million, compared with a loss before income taxes of $1.4 million for the three months ended December 31, 2008. Net income for the three months ended December 31, 2009 was $1.5 million, compared with a net loss of $1.0 million for the three months ended December 31, 2008. Basic and diluted net income per share was $0.03 for the three months ended December 31, 2009, compared with basic and diluted net loss per share of $0.02 for the three months ended December 31, 2008.
Revenues for the six months ended December 31, 2009 decreased 19% to $111.1 million from $136.7 million in the same period in the prior year. Income before income taxes for the six months ended December 31, 2009 was $4.4 million, compared with $2.4 million for the six months ended December 31, 2008. Net income for the six months ended December 31, 2009 was $4.2 million, compared with $0.8 million for the six months ended
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FIRST ACCEPTANCE CORPORATION 10-Q
December 31, 2008. Basic and diluted net income per share was $0.09 for the six months ended December 31, 2009, compared with $0.02 for the six months ended December 31, 2008.
Insurance Operations
Revenues from insurance operations were $53.7 million for the three months ended December 31, 2009, compared with $65.0 million for the three months ended December 31, 2008. For the six months ended December 31, 2009, revenues from insurance operations were $111.0 million, compared with $136.6 million for the six months ended December 31, 2008.
Income before income taxes from insurance operations for the three months ended December 31, 2009 was $3.6 million, compared with income before income taxes from insurance operations of $0.4 million for the three months ended December 31, 2008. Income before income taxes from insurance operations for the six months ended December 31, 2009 was $8.0 million, compared with income before income taxes from insurance operations of $6.2 million for the six months ended December 31, 2008.
Premiums Earned
Premiums earned decreased by $9.6 million, or 18%, to $45.2 million for the three months ended December 31, 2009, from $54.8 million for the three months ended December 31, 2008. For the six months ended December 31, 2009, premiums earned decreased by $23.0 million, or 20%, to $93.7 million from $116.7 million for the six months ended December 31, 2008. The decreases in premiums earned were primarily due to the weak economic conditions, which have caused both a decline in the number of policies written, as well as an increase in the percentage of our customers purchasing liability only coverage. Rate actions taken in a number of states to improve underwriting profitability and the closure of underperforming stores also contributed to the decrease in policies written and premiums earned. Approximately 56% of the $9.6 million decline in premiums earned for the three months ended December 31, 2009 and 55% of the $23.0 million decline in premiums earned for the six months ended December 31, 2009 were in our Florida, Georgia and South Carolina markets.
The number of policies in force at December 31, 2009 decreased 8% over the same date in 2008 from 159,557 to 147,090, due to the factors noted above. At December 31, 2009, we operated 409 stores, compared with 424 stores at December 31, 2008.
Commission and Fee Income
Commission and fee income decreased 9% to $7.0 million for the three months ended December 31, 2009, from $7.7 million for the three months ended December 31, 2008. For the six months ended December 31, 2009, commission and fee income decreased 13% to $13.9 million from $15.9 million for the six months ended December 31, 2008. The decreases in commission and fee income were a result of the decrease in the number of policies in force, partially offset by higher fee income related to commissionable ancillary products sold through our retail locations.
Investment Income
Investment income decreased to $2.0 million during the three months ended December 31, 2009 from $2.6 million during the three months ended December 31, 2008. For the six months ended December 31, 2009, investment income decreased to $3.9 million from $5.3 million during the six months ended December 31, 2008. These decreases were primarily as a result of the sale of fixed maturity investments in fiscal year 2009 to generate taxable income to utilize expiring net operating losses and the reduced yields obtained on reinvestment. At December 31, 2009 and 2008, the tax-equivalent book yield for our portfolio was 4.3% and 5.0%, respectively, with effective durations of 3.35 and 3.56 years, respectively.
Net realized losses on fixed maturities, available-for-sale
Net realized losses on fixed maturities, available-for-sale during the three months ended December 31, 2009 consisted of $0.4 million of charges related to OTTI on certain non-agency backed CMOs. The three months ended December 31, 2008 included only net realized losses on sales of securities.
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FIRST ACCEPTANCE CORPORATION 10-Q
For the six months ended December 31, 2009, net realized losses on fixed maturities, available-for-sale included $0.3 million in net realized gains on sales of securities and $0.8 million of charges related to OTTI on certain non-agency backed CMOs. The six months ended December 31, 2008 included $1.3 million of charges related to OTTI.
Loss and Loss Adjustment Expenses
The loss and loss adjustment expense ratio was 66.1% for the three months ended December 31, 2009, compared with 68.5% for the three months ended December 31, 2008. The loss and loss adjustment expense ratio was 67.3% for the six months ended December 31, 2009, compared with 69.7% for the six months ended December 31, 2008. For the three months ended December 31, 2009, we experienced favorable development on losses related to prior periods of approximately $2.4 million, compared with unfavorable development of $0.1 million for the three months ended December 31, 2008. For the six months ended December 31, 2009, we experienced favorable development of approximately $6.1 million, compared with $4.2 million for the six months ended December 31, 2008.
Excluding development, the loss and loss adjustment expense ratios for the three months ended December 31, 2009 and 2008 were 71.4% and 68.3%, respectively. Excluding favorable development, the loss and loss adjustment expense ratios for the six months ended December 31, 2009 and 2008 were 73.8% and 73.3%, respectively. The favorable development for the six months ended December 31, 2009 and 2008 was due to lower than anticipated severity and frequency of accidents.
Operating Expenses
Insurance operating expenses decreased 8% to $19.7 million for the three months ended December 31, 2009 from $21.5 million for the three months ended December 31, 2008. For the six months ended December 31, 2009, insurance operating expenses decreased 9% to $39.3 million from $43.0 million for the six months ended December 31, 2008. The decreases were primarily a result of a reduction in costs (such as employee-agent commissions and premium taxes) that varied along with the decrease in premiums earned as well as savings realized from the closure of underperforming stores.
The expense ratio increased from 25.2% for the three months ended December 31, 2008 to 28.2% for the same period in the current fiscal year. The expense ratio increased from 23.2% for the six months ended December 31, 2008 to 27.1% for the same period in the current fiscal year. The year-over-year increase in the expense ratio was due to the decrease in premiums earned, which resulted in a higher percentage of fixed expenses in our retail operations (such as rent and base salary).
Overall, the combined ratio was 94.3% for the three months ended December 31, 2009, compared with 93.7% for the three months ended December 31, 2008. For the six months ended December 31, 2009, the combined ratio was 94.4%, compared with 92.9% for the six months ended December 31, 2008.
Litigation Settlement
Litigation settlement costs for the three months ended December 31, 2009 were $0.1 million, compared with $5.1 million for the same period in the prior fiscal year. For the six months ended December 31, 2009, litigation settlement costs were $(0.3) million, compared with $5.2 million for the same period in the prior fiscal year. The expense during the three months ended December 31, 2009 related to revisions in estimated costs associated with remaining available premium credits. The reduction in expense during the six months ended December 31, 2009 related to the forfeiture of premium credits by Georgia and Alabama class members partially offset by the revisions in estimated costs previously discussed. The costs during the three and six months ended December 31, 2008 were incurred in connection with our settlement and defense of the litigation as described further in Note 6 to our consolidated financial statements.
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FIRST ACCEPTANCE CORPORATION 10-Q
Pursuant to the terms of the settlements, eligible class members are entitled to certain premium credits towards a future automobile insurance policy with the Company or a reimbursement certificate for future rental or towing expenses. Benefits to the Georgia and Alabama class members commenced January 1, 2009 and March 7, 2009, respectively. Any premium credits issued to class members as described above will be prorated over a twelve-month term not to extend beyond August 2011, and the class member will be entitled to the prorated premium credit only so long as their insurance premiums remain current during the twelve-month term.
At December 31, 2008, we accrued $5.2 million for premium credits available to class members who were actively insured by the Company. The following is a progression of the activity associated with the estimated premium credit liability (in thousands).
Balance at December 31, 2008 | $ | 5,227 | ||
Credits utilized | (1,338 | ) | ||
Credits forfeited | (904 | ) | ||
Balance at June 30, 2009 | 2,985 | |||
Credits utilized | (1,939 | ) | ||
Credits forfeited | (234 | ) | ||
Balance at December 31, 2009 | $ | 812 | ||
We have not established an accrual for $0.3 million in potential premium credits available to class members who were not actively insured by the Company upon commencement of the settlement due to the uncertainty associated with this group having to purchase a new automobile insurance policy. Based on experience to date, we do not expect any significant costs associated with the reimbursement certificates. The final costs of the settlements will depend on, among other factors, the rate of redemption and forfeiture of the premium credits and reimbursement certificates.
The litigation settlement costs are classified in the litigation settlement expenses line item in our consolidated statements of operations. The litigation settlement accrual for those currently estimable costs associated with the utilization of premium credits is classified in other liabilities in our consolidated balance sheet. We intend to adjust the estimated accrual as necessary during future periods to account for the impact of actual rate of redemption and forfeiture of the premium credits and reimbursement certificates. For additional information with respect to the litigation settlements, see Note 6 to our consolidated financial statements.
Provision (Benefit) for Income Taxes
The provision for income taxes for the three months ended December 31, 2009 was $0.1 million, compared with a benefit of $0.4 million for the same period in the prior fiscal year. For the six months ended December 31, 2009, the provision for income taxes was $0.2 million, compared with $1.5 million for the same period in the prior fiscal year. The provision for income taxes for the three and six months ended December 31, 2009 related to current state income taxes for certain subsidiaries with taxable income. At December 31, 2009 and June 30, 2009, we established a full valuation allowance against all net deferred tax assets. In assessing our ability to support the realizability of our deferred tax assets, we considered both positive and negative evidence. We placed greater weight on historical results than on our outlook for future profitability. The deferred tax valuation allowance may be adjusted in future periods if we consider that it is more likely than not that some portion or all of the deferred tax assets will be realized. In the event the deferred tax valuation allowance is adjusted, we would record an income tax benefit for the adjustment.
Real Estate and Corporate
Loss before income taxes from real estate and corporate operations for the three months ended December 31, 2009 was $2.0 million, compared with a loss before income taxes from real estate and corporate operations of $1.8 million for the three months ended December 31, 2008. Loss before income taxes from real estate and corporate operations for the six months ended December 31, 2009 was $3.6 million, compared with a loss before income taxes from real estate and corporate operations of $3.8 million for the six months ended December 31, 2008. Segment losses consist of other operating expenses not directly related to our insurance operations, interest expense and stock-based compensation offset by investment income on corporate invested assets.
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FIRST ACCEPTANCE CORPORATION 10-Q
We incurred $1.0 million and $2.0 million, respectively, of interest expense during both the three and six months ended December 31, 2009 and 2008 related to the debentures issued in June 2007. During the six months ended December 31, 2008, we incurred $0.2 million of interest expense in connection with borrowings under our former credit facility. The credit facility was repaid in full and terminated on October 31, 2008.
Liquidity and Capital Resources
Our primary sources of funds are premiums, fees and investment income from our insurance company subsidiaries and commissions and fee income from our non-insurance company subsidiaries. Our primary uses of funds are the payment of claims and operating expenses. Net cash used in operating activities for the six months ended December 31, 2009 and 2008 was $4.2 million and $6.2 million, respectively. Net cash used in operating activities in both periods was primarily the result of a decrease in cash collected from premiums written. Net cash used in investing activities for the six months ended December 31, 2009 was $43.8 million, compared with $4.9 million for the same period in the prior fiscal year. The six months ended December 31, 2009 included net additions in our investment portfolio of $43.2 million, while the same period in the prior fiscal year included net additions to our investment portfolio of $3.3 million. The net additions in the current fiscal year were primarily the result of the sale of fixed maturity investments in fiscal year 2009 to generate taxable income to utilize expiring net operating losses and the reinvestment of the sale proceeds in fiscal year 2010. Financing activities for the six months ended December 31, 2008 included principal prepayments made on our former credit facility of $3.9 million.
Our holding company requires cash for general corporate overhead expenses and for debt service related to our debentures payable. The holding company’s primary sources of unrestricted cash to meet its obligations are dividends from our insurance company subsidiaries and the sale of ancillary products to our insureds. The holding company also receives cash from operating activities as a result of investment income. Through an intercompany tax allocation arrangement, taxable losses of the holding company provide cash to the holding company to the extent that taxable income is generated by the insurance company subsidiaries. At December 31, 2009, we had $8.4 million available in unrestricted cash and investments outside of the insurance company subsidiaries. These funds and the additional unrestricted cash from the sources noted above will be used to pay our future cash requirements outside of the insurance company subsidiaries.
The holding company has debt service requirements related to the debentures payable. The debentures are interest-only and mature in full in July 2037. Interest is fixed annually through July 2012 at $3.9 million. The debentures pay a fixed rate of 9.277% until July 30, 2012, after which time the rate becomes variable (LIBOR plus 375 basis points).
State insurance laws limit the amount of dividends that may be paid from our insurance company subsidiaries. Based on our statutory capital and surplus, we believe our ordinary dividend capacity for the next twelve months will be approximately $11 million.
The National Association of Insurance Commissioners Model Act for risk-based capital 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. There are statutory guidelines that suggest that on an annual calendar year basis, the insurance company subsidiaries should not exceed a ratio of net premiums written to statutory capital and surplus of 3-to-1. Based on our current forecast of statutory capital and surplus and net premiums written, we anticipate our ratio will be approximately 2-to-1 for the reasonably foreseeable future.
We believe that existing cash and investment balances, when combined with anticipated cash flows as noted above, will be adequate to meet our expected liquidity needs, for both the holding company and our insurance company subsidiaries, in both the short-term and the reasonably foreseeable future. Any future growth strategy may require external financing, and we may from time to time seek to obtain external financing. We cannot assure 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.
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FIRST ACCEPTANCE CORPORATION 10-Q
Critical Accounting Estimates
There have been no significant changes to our critical accounting estimates during the six months ended December 31, 2009 compared with those disclosed in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates” included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
Off-Balance Sheet Arrangements
We have not entered into any new off-balance sheet arrangements since June 30, 2009. For information with respect to our off-balance sheet arrangements at June 30, 2009, see Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Off-Balance Sheet Arrangements” included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
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 (the “Exchange Act”). All statements made in this 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 Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2009.
You should not place undue reliance on any forward-looking statements. These statements speak only as of the date of this report. Except as otherwise required by applicable laws, we undertake no obligation to publicly update or revise any forward-looking statements or the risk factors described in this report, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. Our exposures to market risk relate primarily to our investment portfolio, which is exposed primarily to interest rate risk and credit risk. The fair value of our fixed maturity portfolio is directly impacted by changes in market interest rates; generally, the fair value of fixed-income investments moves inversely with movements in market interest rates. Our fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. This portfolio composition allows flexibility in reacting to fluctuations of interest rates. The portfolios of our insurance company subsidiaries are managed to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations.
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FIRST ACCEPTANCE CORPORATION 10-Q
Interest Rate Risk
The fair values of our fixed maturity investments fluctuate in response to changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into decreases and increases, respectively, in the fair values of those instruments. Additionally, the fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.
The following table summarizes the estimated effects of hypothetical increases and decreases in interest rates resulting from parallel shifts in market yield curves on our fixed maturity portfolio (in thousands). It is assumed that the effects are realized immediately upon the change in interest rates. The hypothetical changes in market interest rates do not reflect what could be deemed best or worst case scenarios. Variations in market interest rates could produce significant changes in the timing of repayments due to prepayment options available. For these reasons, actual results might differ from those reflected in the table.
Sensitivity to Instantaneous Interest Rate Changes (basis points) | ||||||||||||||||||||||||
(100) | (50) | 0 | 50 | 100 | 200 | |||||||||||||||||||
Fair value of fixed maturity portfolio | $ | 193,452 | $ | 189,898 | $ | 186,328 | $ | 182,796 | $ | 179,325 | $ | 172,626 | ||||||||||||
The following table provides information about our fixed maturity investments at December 31, 2009 which are sensitive to interest rate risk. The table shows expected principal cash flows (at par value, which differs from amortized cost as a result of discounts at the time of purchase and OTTI) by expected maturity date for each of the five fiscal years and collectively for all fiscal years thereafter (in thousands). Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. CMOs and sinking fund issues are included based on maturity year adjusted for expected payment patterns. Actual cash flows may differ from those expected.
Securities | ||||||||||||||||
with No | ||||||||||||||||
Securities | Securities | Gross | ||||||||||||||
with Gross | with Gross | Unrealized | ||||||||||||||
Unrealized | Unrealized | Gains or | ||||||||||||||
Year Ended June 30, | Gains | Losses | Losses | Amount | ||||||||||||
2010 | $ | 2,963 | $ | 581 | $ | — | $ | 3,544 | ||||||||
2011 | 11,048 | 2,855 | — | 13,903 | ||||||||||||
2012 | 22,427 | 271 | — | 22,698 | ||||||||||||
2013 | 20,424 | 7,053 | — | 27,477 | ||||||||||||
2014 | 21,805 | 1,339 | — | 23,144 | ||||||||||||
Thereafter | 59,913 | 30,034 | — | 89,947 | ||||||||||||
Total | $ | 138,580 | $ | 42,133 | $ | — | $ | 180,713 | ||||||||
Fair value | $ | 146,668 | $ | 39,660 | $ | — | $ | 186,328 | ||||||||
On June 15, 2007, our wholly-owned unconsolidated trust entity, First Acceptance Statutory Trust I, used the proceeds from its sale of trust preferred securities to purchase $41.2 million of junior subordinated debentures. The debentures pay a fixed rate of 9.277% until July 30, 2012, after which the rate becomes variable (LIBOR plus 375 basis points).
Credit Risk
Credit risk is managed by diversifying the portfolio to avoid concentrations in any single industry group or issuer and by limiting investments in securities with lower credit ratings. The largest investment in any one fixed maturity security, excluding U.S. government and agency securities, is $5.1 million, or 3% of the fixed maturity portfolio. The top five investments make up 14% of the fixed maturity portfolio. The average credit quality rating for our fixed maturity portfolio was AA at December 31, 2009. There are no fixed maturities in the portfolio that have not produced investment income during the previous twelve months.
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FIRST ACCEPTANCE CORPORATION 10-Q
The following table presents the underlying ratings of our fixed maturity portfolio by nationally recognized securities rating organizations at December 31, 2009 (in thousands).
% of | % of | |||||||||||||||
Amortized | Amortized | Fair | Fair | |||||||||||||
Comparable Rating | Cost | Cost | Value | Value | ||||||||||||
AAA | $ | 78,224 | 42.7 | % | $ | 80,205 | 43.1 | % | ||||||||
AA+, AA, AA- | 37,285 | 20.3 | % | 38,004 | 20.4 | % | ||||||||||
A+, A, A- | 49,823 | 27.2 | % | 50,756 | 27.2 | % | ||||||||||
BBB+, BBB, BBB- | 10,170 | 5.5 | % | 10,112 | 5.4 | % | ||||||||||
Total investment grade | 175,502 | 95.7 | % | 179,077 | 96.1 | % | ||||||||||
Not rated | 4,079 | 2.2 | % | 3,974 | 2.1 | % | ||||||||||
BB+, BB, BB- | 1,911 | 1.1 | % | 1,797 | 1.0 | % | ||||||||||
B+, B, B- | 804 | 0.4 | % | 745 | 0.4 | % | ||||||||||
CCC+, CCC, CCC- | 842 | 0.5 | % | 617 | 0.3 | % | ||||||||||
CC+, CC, CC- | 180 | 0.1 | % | 118 | 0.1 | % | ||||||||||
Total non-investment grade | 3,737 | 2.1 | % | 3,277 | 1.8 | % | ||||||||||
Total | $ | 183,318 | 100.0 | % | $ | 186,328 | 100.0 | % | ||||||||
The mortgage industry has experienced a rise in mortgage delinquencies and foreclosures, particularly among lower quality exposures (“sub-prime” and “Alt-A”). As a result of these increasing delinquencies and foreclosures, many CMOs with underlying sub-prime and Alt-A mortgages as collateral experienced significant declines in fair value. We have only modest exposure to sub-prime investments and no exposure to Alt-A investments. At December 31, 2009, our fixed maturity portfolio included three CMOs having sub-prime exposure with a fair value of $0.8 million.
Our investment portfolio consists of $36.2 million of municipal bonds, of which $24.4 million are insured. Of the insured bonds, 68% are insured with MBIA, 14% with AMBAC and 18% with XL Capital. These securities are paying their principal and periodic interest timely.
The following table presents the underlying ratings as of December 31, 2009, represented by the lower of either Standard and Poor’s, Fitch’s, or Moody’s ratings, of the municipal bond portfolio (in thousands).
Insured | Uninsured | Total | ||||||||||||||||||||||
% of | % of | % of | ||||||||||||||||||||||
Fair | Fair | Fair | Fair | Fair | Fair | |||||||||||||||||||
Value | Value | Value | Value | Value | Value | |||||||||||||||||||
AAA | $ | — | — | $ | 4,775 | 40 | % | $ | 4,775 | 13 | % | |||||||||||||
AA+, AA, AA- | 11,694 | 48 | % | 5,960 | 51 | % | 17,654 | 49 | % | |||||||||||||||
A+, A, A- | 11,160 | 46 | % | 1,036 | 9 | % | 12,196 | 34 | % | |||||||||||||||
BBB+, BBB, BBB- | 1,554 | 6 | % | — | — | 1,554 | 4 | % | ||||||||||||||||
Total | $ | 24,408 | 100 | % | $ | 11,771 | 100 | % | $ | 36,179 | 100 | % | ||||||||||||
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FIRST ACCEPTANCE CORPORATION 10-Q
Item 4T. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our chief executive officer and chief financial officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of December 31, 2009. Based on that evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures effectively 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 Securities and Exchange Commission’s rules and forms.
Changes in Internal Control Over Financial Reporting
During 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.
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FIRST ACCEPTANCE CORPORATION 10-Q
PART II — OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
At the Company’s Annual Meeting of Stockholders held on November 17, 2009 (the “Annual Meeting”), the following persons were elected to the Company’s Board of Directors for a one-year term:
Votes For | Votes Withheld | |||||||
Rhodes R. Bobbitt | 45,449,810 | 1,223,877 | ||||||
Harvey B. Cash | 39,407,008 | 7,266,679 | ||||||
Donald J. Edwards | 44,959,606 | 1,714,081 | ||||||
Gerald J. Ford | 45,360,661 | 1,313,026 | ||||||
Stephen J. Harrison | 45,851,721 | 821,966 | ||||||
Thomas M. Harrison, Jr. | 45,852,623 | 821,064 | ||||||
Tom C. Nichols | 44,955,607 | 1,718,080 | ||||||
Lyndon L. Olson, Jr. | 39,405,397 | 7,268,290 | ||||||
William A. Shipp, Jr. | 45,707,354 | 966,333 |
The following proposals were also considered and approved at the Annual Meeting by the vote set forth below:
Votes Withheld | ||||||||||||
and Broker | ||||||||||||
Votes For | Votes Against | Non-Votes | ||||||||||
Approval of the Amended and Restated First Acceptance Corporation 2002 Long Term Incentive Plan | 35,372,976 | 7,276,925 | 43,119 | |||||||||
Approval of value-for-value option exchange whereby certain outstanding stock options would be exchanged for shares of restricted common stock | 35,209,908 | 7,419,478 | 63,634 | |||||||||
Ratification of the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending June 30, 2010 | 46,632,365 | 17,380 | 23,992 |
Item 6. Exhibits
The following exhibits are attached to this report:
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. |
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FIRST ACCEPTANCE CORPORATION 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FIRST ACCEPTANCE CORPORATION | ||||
February 8, 2010 | By: | /s/ Kevin P. Cohn | ||
Kevin P. Cohn | ||||
Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | ||||
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