##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Fiscal Year Ended June 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to.
 Commission file number 001-12117
 FIRST ACCEPTANCE CORPORATION
 (Exact name of registrant as specified in its charter)
 Delaware
    
    75-1328153(State or other jurisdiction of
incorporation or organization)
    
    (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)  Securities registered pursuant to Section 12(b) of the Act:
 Title of Each Class
    
    Name of exchange on which registeredCommon Stock, $.01 par value per share
    
    New York Stock Exchange
 Securities registered pursuant to Section 12(g) of the Act:
 þ o
 o
 þ o
 o o
   DOCUMENTS INCORPORATED BY REFERENCE




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FIRST ACCEPTANCE CORPORATION
 Table of Contents
  
 PagePART I
    
    
    1Item 1. Business
    
    
    1Item 2. Properties
    
    
    21Item 3. Legal Proceedings
    
    
    21Item 4. Submission of Matters to a Vote of Security Holders
    
    
    21PART II
    
    
    22Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
    
    
    22Item 6. Selected Financial Data
    
    
    23Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 8. Financial Statements and Supplementary Data
    
    
    38Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    67Item 9A. Controls and Procedures
    
    
    67Item 9B. Other Information
    
    
    67PART III
    
    
    68Item 10. Directors and Executive Officers of the Registrant
    
    
    68Item 11. Executive Compensation
    
    
    68Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
    
    
    68Item 13. Certain Relationships and Related Transactions
    
    
    68Item 14. Principal Accountant Fees and Services
    
    
    68PART IV
    
    
    68Item 15. Exhibits and Financial Statement Schedules
    
    
    68SIGNATURES
    
    
    72EX-10.20  SUMMARY OF COMPENSATIONEX-21  SUBSIDIARIES OF FIRST ACCEPTANCE CORPORATIONEX-23  CONSENT OF KPMG LLPEX-31.1  SECTION 302 CERTIFICATION OF THE CEOEX-31.2  SECTION 302 CERTIFICATION OF THE CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEOEX-32.2  SECTION 906 CERTIFICATION OF THE CFO
  i




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FIRST ACCEPTANCE CORPORATION
 
 PART I
 
 Item 1. Business
 General
  Acquisition of USAuto
   Our Business Strategy
  
    
    Integrated Operations. To meet the preference of our customers for convenient, personal
service, we have integrated the retail distribution, underwriting and service functions of
personal automobile insurance into one system. By doing so, we are able to provide prompt
and personal service to meet effectively the insurance needs of our customers while
capturing revenue that would otherwise be shared with several participants under a
traditional, non-integrated insurance business model. Our integrated model is supported by
both a point of sale agency and back office control systems.
    
    Extensive Office Network. We emphasize the use of employee-agents as the cornerstone of
our customer relationship. We believe our customers value face-to-face contact, speed of
service and convenient locations. Consequently, we train our employee-agents to cultivate
client relationships and utilize real-time
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service and information enabled by access to our
intranet system. As of September 1, 2005, we leased 334 retail sales offices staffed with
our employee-agents and strategically located in geographic markets to reach and service
our customers.
    
    Favorable Customer Payment Plans. We enable customers to initiate insurance coverage
with a modest down payment that is equal to one months premium payment. The remaining
premium is paid in monthly installments over the term of the policy. We believe this
modest initial payment and favorable payment plan is a major factor in our success in
meeting the market demand for low monthly insurance payments.
    
    Strong Sales and Marketing. We build brand recognition and generate valuable sales
leads through extensive use of television advertising, Yellow Pages® and a broad network of
retail sales offices.
    
    Efficient Technology Systems. We have developed technology systems that enable timely
and efficient communication and data sharing among the various segments of our integrated
operations. All of our retail sales office computers transmit information directly to our
central processing computer where policy information, customer profiles, risk assessment
and underwriting criteria are entered into our database.
 Our Business Model
      2




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Personal Automobile Insurance Market
   Our Products
      3




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Our Growth Strategy
  
    
    Increase the Number of Customers in Existing Geographic Markets. We intend to work to
continue to increase the number of our customers through expanded advertising campaigns and
opening new retail sales offices in the states where we currently do business.
    
    Expand into New Geographic Markets. We currently operate in eleven states and are
licensed as an insurer in 13 additional states. We intend to expand into additional states
through the opening of new sales offices and through selective acquisitions. During the
fiscal year ended June 30, 2005, we began operating in four new states: Florida, Illinois,
Pennsylvania and Texas.
    
    Pursue Acquisitions of Local Agencies.We intend to selectively pursue acquisitions of
local agencies who write non-standard automobile insurance for other insurance companies in
our existing markets and in new markets. During 2005, we completed the acquisition of a
local insurance agency in the State of Texas.
   Competition
  Marketing and Distribution
    4




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Underwriting and Pricing
   Claims Handling
     Loss and Loss Adjustment Expense Reserves
  5




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At June 30 (in thousands)
    
    2004
    
    
    2005Net liability for loss and loss
adjustment expense reserves, originally
estimated
    
    $
    18,137
    
    
    $
    39,289Cumulative amounts paid as of:One year later
    
    
    13,103Liability reestimated as of:One year later
    
    
    17,781Cumulative redundancy (deficiency)
    
    
    356Gross liability  end of year
    
    $
    30,434
    
    
    $
    42,897Reinsurance recoverables
    
    
    12,297
    
    
    
    3,608Net liability  end of year
    
    $
    18,137
    
    
    $
    39,289Gross reestimated liability  latest
    
    $
    29,697Reestimated reinsurance recoverables  latest
    
    
    11,916Net reestimated  latest
    
    $
    17,781Gross cumulative redundancy (deficiency)
    
    $
    737
 Reinsurance
   6




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Technology
  Sales Office Automation
 Payment Processing
 Ratings
   7




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Regulatory Environment
 Insurance Company Regulation
 
    
    regulating premium rates and forms;
    
    setting minimum solvency standards;
    
    setting capital and surplus requirements;
    
    licensing companies, agents and, in some states, adjusters;
    
    setting requirements for and limiting the types and amounts of investments;
    
    establishing requirements for the filing of annual statements and other financial reports;
    
    conducting periodic statutory examinations of the affairs of insurance companies;
    
    requiring prior approval of changes in control and of certain transactions with affiliates;
    
    limiting the amount of dividends that may be paid without prior regulatory approval; and
    
    setting standards for advertising and other market conduct activities.
 Required Licensing.
  Insurance Holding Company Regulation
 8




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Restrictions on Paying Dividends
 Regulation of Rates and Policy Forms
 Guaranty Funds
 Investment Regulation
 Restrictions on Cancellation, Non-Renewal or Withdrawal
 9




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Privacy Regulations
 Licensing of Our Employee-Agents and Adjusters.
 Unfair Claims Practices
 
    
    misrepresenting pertinent facts or insurance policy provisions relating to coverages at
issue;
    
    failing to acknowledge and act reasonably promptly upon communications regarding claims
arising under insurance policies;
    
    failing to affirm or deny coverage of claims within a reasonable time after proof of
loss statements have been completed;
    
    attempting to settle claims for less than the amount to which a reasonable person would
have believed such person was entitled;
    
    attempting to settle claims on the basis of an application that was altered without
notice to or knowledge or consent of the insured;
    
    making known to insureds or claimants a policy of appealing from arbitration awards in
favor of insureds or claimants for the purpose of compelling them to accept settlements or
compromises less than the amount awarded in arbitration;
    
    delaying the investigation or payment of claims by requiring an insured, claimant or the
physician of either to submit a preliminary claim report and then requiring the subsequent
submission of formal proof of loss forms, both of which submissions contain substantially
the same information;
    
    failing to settle claims promptly, where liability has become reasonably clear, under
one portion of the insurance policy coverage in order to influence settlements under other
portions of the insurance policy coverage; and
    
    not attempting in good faith to effectuate prompt, fair and equitable settlements of
claims in which liability has become reasonably clear.
  Quarterly and Annual Financial Reporting.
 10




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Periodic Financial and Market Conduct Examinations
 Risk-Based Capital
   11




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IRIS Ratios
  
    
    Both had ratios outside the usual range for low investment yields as their
calculated yields were below 4.5%. The calculated yields for both were 2.4%. The
yields are based upon simple annual averages and do not take into account any weighting
for the fact that the companies increased their invested assets significantly during
the year. In addition, the 4.5% yield is not reflective of current market rates for
the fixed maturities investments which the companies recently have purchased as their
invested assets have grown through increased premium writings and additional capital
and surplus.
    
    Both had ratio results outside of the usual IRIS range for changes in net premiums
written, which is plus or minus 33%. Net premiums written increased 101% and 120% for
USAuto Insurance Company and Village Auto Insurance Company, respectively. In addition
to the growth attributable to increased business, gross premium writings for USAuto
Insurance Company increased as a result of increasing the percentage of reinsurance
assumed in Alabama from 15% to 50% effective February 1, 2004. Likewise, gross premium
writings for Village Insurance Company increased because we wrote more of our Georgia
business during 2004 through our insurance company subsidiaries. On a net premiums
written basis, both companies experienced increases as a result of the non-renewal of
their quota-share reinsurance effective September 1, 2004.
    
    Village Auto Insurance Company had a ratio outside of the usual IRIS range for
changes in capital and surplus, which is plus or minus 50%. Village Auto Insurance
Company increased its capital and surplus by 105% primarily through capital
contributions to support its premium growth.
  Employees
  12




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Available Information
  Risk Factors
 Our ability to use net operating loss carryforwards to reduce future tax payments may be limited .
     13




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Our losses and loss adjustment expenses may exceed our reserves, which would adversely impact our
results of operations and financial condition .
  The loss of our President and Chief Executive Officer, Stephen J. Harrison, could negatively affect
our ability to conduct our business efficiently and could lead to loss of customers and proprietary
information .
  Our business is highly competitive, which may make it difficult for us to market our core products
effectively and profitably .
  Our business may be adversely affected by negative developments in Georgia, Alabama, and Tennessee .
  14




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Our business may be adversely affected by negative developments in the non-standard personal
automobile insurance industry .
  Our results may fluctuate as a result of cyclical changes in the personal automobile insurance
industry.
  Our investment portfolio may suffer reduced returns or losses, which could reduce our
profitability.
  15




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We rely on our information technology and communication systems, and the failure of these systems
could materially and adversely affect our business.
  We may have difficulties in managing our expansion into new markets .
  We may not be successful in identifying agency acquisition candidates or integrating their
operations, which could harm our financial results .
  Our insurance company subsidiaries are subject to statutory capital and surplus requirements and
other standards, and their failure to meet these requirements or standards could subject them to
regulatory actions .
   16




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New pricing, claim and coverage issues and class action litigation are continually emerging in the
automobile insurance industry, and these new issues could adversely impact our revenues or our
methods of doing business .
  
    
    concerns over the use of an applicants credit score or zip code as a factor in making
risk selections and pricing decisions;
    
    a growing trend of plaintiffs targeting automobile insurers in purported class action
litigation relating to claims-handling practices, such as total loss evaluation
methodology, the use of aftermarket (non-original equipment manufacturer) parts and the
alleged diminution in value to insureds vehicles involved in accidents; and
    
    consumer groups lobbying state legislatures to regulate and require separate licenses
for individuals and companies engaged in the sale of ancillary products or services.
  Due to our largely fixed cost structure, our profitability may decline if our sales volume were to
decline significantly .
  Severe weather conditions and other catastrophes may result in an increase in the number and amount
of claims filed against us .
  17




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A few of our stockholders have significant control over us, and their interests may differ from
yours
  Our insurance company subsidiaries are subject to regulatory restrictions on paying dividends to
us .
 .
 We and our subsidiaries are subject to comprehensive regulation and supervision that may restrict
our ability to earn profits.
   Required Licensing
 Transactions Between Insurance Companies and Their Affiliates
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Regulation of Rates and Policy Forms
 Investment Restrictions
 Restrictions on Cancellation, Non-Renewal or Withdrawal
 Provisions in our certificate of incorporation and bylaws may prevent a takeover or a change in
management that you may deem favorable.
   
    
    the requirement that only stockholders owning at least one-third of the outstanding
shares of our common stock may call a special stockholders meeting; and
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
    
    the requirement that stockholders owning at least two-thirds of the outstanding shares
of our common stock must approve any amendment to our certificate of incorporation
provisions concerning the transfer restrictions and the special stockholders meetings.
  Executive Officers of the Registrant
   Name
    
    Age
    
    PositionStephen J. Harrison
    
    
    53
    
    
    President and Chief Executive OfficerThomas M. Harrison, Jr.
    
    
    55
    
    
    Executive Vice President and
SecretaryCharles D. Hamilton
    
    
    49
    
    
    Senior Vice President, Chief
Financial Officer and TreasurerMichael J. Bodayle
    
    
    49
    
    
    Chief Financial Officer 
Insurance Company OperationsWilliam R. Pentecost
    
    
    47
    
    
    Chief Information OfficerRandy L. Reed
    
    
    49
    
    
    Senior Vice President  Sales and MarketingJames R. Dickson
    
    
    39
    
    
    Senior Vice President  Claims
 Stephen J. Harrison
 Thomas M. Harrison, Jr.
 Charles D. Hamilton
 Michael J. Bodayle
 20




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William R. Pentecost
 Randy L. Reed
 James R. Dickson
 
 Item 2. Properties
  
 Item 3. Legal Proceedings
  
 Item 4. Submission of Matters to a Vote of Security Holders
  21




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PART II
 
 Item 5.

    Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
 Trading Prices
  Price RangeHigh
    
    
    LowYear Ended June 30, 2004First Quarter
    
    $
    5.75
    
    
    $
    5.09Second Quarter
    
    
    7.45
    
    
    
    5.25Third Quarter
    
    
    9.35
    
    
    
    7.10Fourth Quarter
    
    
    8.05
    
    
    
    6.53Year Ended June 30, 2005First Quarter
    
    $
    7.45
    
    
    $
    5.83Second Quarter
    
    
    9.08
    
    
    
    7.01Third Quarter
    
    
    10.95
    
    
    
    8.60Fourth Quarter
    
    
    10.85
    
    
    
    8.23
  Dividend Policy
  Stock Transfer Restrictions
  22




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Item 6. Selected Financial Data
    23




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Year Ended June 30,Pro forma
    
    
    
    
    
    
    Pro formaActual
    
    
    2004
    
    
    Actual
    
    
    20032005
    
    
    2004
    
    
    (unaudited)
    
    
    2003
    
    
    (unaudited)
    
    
    2002
    
    
    2001(in thousands, except per share data)Statement of Operations Data:Revenues:Premiums earned
    
    $
    132,347
    
    
    $
    11,728
    
    
    $
    57,716
    
    
    $
    
    
    
    $
    38,353
    
    
    $
    
    
    
    $
    Commissions and fees
    
    
    27,151
    
    
    
    4,401
    
    
    
    26,275
    
    
    
    
    
    
    
    33,462
    
    
    
    
    
    
    
    Ceding commissions from reinsurer
    
    
    2,975
    
    
    
    1,925
    
    
    
    10,674
    
    
    
    
    
    
    
    6,952
    
    
    
    
    
    
    
    Gains on sales of foreclosed real estate
    
    
    755
    
    
    
    4,147
    
    
    
    4,147
    
    
    
    233
    
    
    
    233
    
    
    
    139
    
    
    
    378Investment income
    
    
    3,353
    
    
    
    958
    
    
    
    1,431
    
    
    
    1,098
    
    
    
    1,289
    
    
    
    1,335
    
    
    
    2,922Other
    
    
    214
    
    
    
    (6
    )
    
    
    80
    
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    21Total revenues
    
    
    166,795
    
    
    
    23,153
    
    
    
    100,323
    
    
    
    1,331
    
    
    
    80,437
    
    
    
    1,474
    
    
    
    3,321Expenses:Losses and loss adjustment expenses
    
    
    87,493
    
    
    
    7,167
    
    
    
    36,616
    
    
    
    
    
    
    
    25,905
    
    
    
    
    
    
    
    Insurance operating expenses
    
    
    49,921
    
    
    
    7,194
    
    
    
    41,142
    
    
    
    
    
    
    
    35,962
    
    
    
    
    
    
    
    Other operating expenses
    
    
    2,775
    
    
    
    6,235
    
    
    
    2,278
    
    
    
    2,637
    
    
    
    1,648
    
    
    
    988
    
    
    
    797Stock-based compensation
    
    
    332
    
    
    
    7,850
    
    
    
    
    
    
    
    546
    
    
    
    
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    1,920
    
    
    
    648
    
    
    
    1,366
    
    
    
    10
    
    
    
    1,954
    
    
    
    6
    
    
    
    8Interest expense
    
    
    351
    
    
    
    44
    
    
    
    318
    
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    Total expenses
    
    
    142,792
    
    
    
    29,138
    
    
    
    81,720
    
    
    
    3,193
    
    
    
    65,498
    
    
    
    994
    
    
    
    805Income (loss) before income taxes
    
    
    24,003
    
    
    
    (5,985
    )
    
    
    18,603
    
    
    
    (1,862
    )
    
    
    14,939
    
    
    
    480
    
    
    
    2,516Income tax expense (benefit) (1).
    
    
    (2,153
    )
    
    
    (2,189
    )
    
    
    6,983
    
    
    
    
    
    
    
    5,844
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    26,156
    
    
    $
    (3,796
    )
    
    $
    11,620
    
    
    $
    (1,862
    )
    
    $
    9,095
    
    
    $
    480
    
    
    $
    2,516Basic net income (loss) per share
    
    $
    0.56
    
    
    $
    (0.15
    )
    
    $
    0.25
    
    
    $
    (0.09
    )
    
    $
    0.20
    
    
    $
    0.02
    
    
    $
    0.12Diluted net income (loss) per share
    
    $
    0.53
    
    
    $
    (0.15
    )
    
    $
    0.24
    
    
    $
    (0.09
    )
    
    $
    0.19
    
    
    $
    0.02
    
    
    $
    0.12Weighted average basic shares
    
    
    47,055
    
    
    
    24,965
    
    
    
    46,405
    
    
    
    20,420
    
    
    
    46,229
    
    
    
    20,256
    
    
    
    20,256Weighted average diluted shares
    
    
    48,989
    
    
    
    24,965
    
    
    
    47,883
    
    
    
    20,420
    
    
    
    46,985
    
    
    
    20,256
    
    
    
    20,256Cash dividend declared per share of common
stock
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    0.006
    
    
    $
    0.125
 June 30,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001(in thousands, except per share data)Balance Sheet Data:Fixed maturities, available for sale
    
    $
    74,840
    
    
    $
    33,243
    
    
    $
    
    
    
    $
    
    
    
    $
    Cash, cash equivalents and other invested
assets
    
    
    35,682
    
    
    
    38,352
    
    
    
    56,847
    
    
    
    56,510
    
    
    
    56,103Foreclosed real estate held for sale
    
    
    961
    
    
    
    1,108
    
    
    
    1,594
    
    
    
    2,175
    
    
    
    2,359Deferred tax asset
    
    
    48,106
    
    
    
    45,493
    
    
    
    
    
    
    
    
    
    
    
    Goodwill and identifiable intangible assets
    
    
    112,704
    
    
    
    102,914
    
    
    
    
    
    
    
    
    
    
    
    Total assets
    
    
    330,722
    
    
    
    285,667
    
    
    
    59,053
    
    
    
    58,919
    
    
    
    58,564Loss and loss adjustment expense reserves
    
    
    42,897
    
    
    
    30,434
    
    
    
    
    
    
    
    
    
    
    
    Unearned premiums
    
    
    47,752
    
    
    
    33,433
    
    
    
    
    
    
    
    
    
    
    
    Note payable to financial institution
    
    
    
    
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    Total liabilities
    
    
    102,393
    
    
    
    91,441
    
    
    
    978
    
    
    
    528
    
    
    
    531Total stockholders equity
    
    
    228,329
    
    
    
    194,226
    
    
    
    58,075
    
    
    
    58,391
    
    
    
    58,033Book value per share
    
    $
    4.81
    
    
    $
    4.17
    
    
    $
    2.82
    
    
    $
    2.88
    
    
    $
    2.86
 
 (1)
    
    The income tax expense (benefit) for the year ended June 30, 2005 includes a $10,594
decrease in the valuation allowance for the deferred tax asset. There was no income tax
expense (benefit) recorded for the years presented prior to the year ended June 30, 2004
because we had NOLs available to offset federal taxable income for which a full valuation
allowance had been established. For these years, the benefit resulting from the utilization
of NOLs directly offsets federal income taxes that would have otherwise been payable. 24




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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion should be read in conjunction with our consolidated financial
statements and accompanying notes included in this report. This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results could differ materially from
those anticipated in these forward-looking statements as a result of various factors, including
those discussed below and elsewhere in this report, particularly under the caption Business  Risk
Factors.
 General
     Year Ended June 30,Actual
    
    
    Pro forma2005
    
    
    2004Retail locations:Beginning of period
    
    
    138
    
    
    
    108Opened
    
    
    157
    
    
    
    30Acquired
    
    
    15
    
    
    
    Closed
    
    
    (1
    )
    
    
    End of period
    
    
    309
    
    
    
    138
  Increase in LocationsAs of June 30,
    
    
    Year Ended June 30,Actual
    
    
    Actual
    
    
    Pro forma
    
    
    Actual
    
    
    Pro forma2005
    
    
    2004
    
    
    2003
    
    
    2005
    
    
    2004Alabama
    
    
    25
    
    
    
    21
    
    
    
    19
    
    
    
    4
    
    
    
    2Florida
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    Georgia
    
    
    63
    
    
    
    55
    
    
    
    52
    
    
    
    8
    
    
    
    3Illinois
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    Indiana
    
    
    22
    
    
    
    4
    
    
    
    
    
    
    
    18
    
    
    
    4Ohio
    
    
    30
    
    
    
    25
    
    
    
    12
    
    
    
    5
    
    
    
    13Mississippi
    
    
    9
    
    
    
    6
    
    
    
    6
    
    
    
    3
    
    
    
    Missouri
    
    
    18
    
    
    
    11
    
    
    
    5
    
    
    
    7
    
    
    
    6Pennsylvania
    
    
    14
    
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    Tennessee
    
    
    20
    
    
    
    16
    
    
    
    14
    
    
    
    4
    
    
    
    2Texas
    
    
    72
    
    
    
    
    
    
    
    
    
    
    
    72
    
    
    
    Total
    
    
    309
    
    
    
    138
    
    
    
    108
    
    
    
    171
    
    
    
    30
 25




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##### Table of Contents



Consolidated Results of Operations
 Overview
  26




---



##### Table of Contents



Pro formaActual
    
    
    (unaudited)Year Ended June 30,
    
    
    Year Ended June 30,2005
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003(in thousands)Insurance OperationsRevenues:Premiums earned
    
    $
    132,347
    
    
    $
    11,728
    
    
    $
    
    
    
    $
    57,716
    
    
    $
    38,353Commissions and fees
    
    
    27,151
    
    
    
    4,401
    
    
    
    
    
    
    
    26,275
    
    
    
    33,462Ceding commissions from reinsurer
    
    
    2,975
    
    
    
    1,925
    
    
    
    
    
    
    
    10,674
    
    
    
    6,952Investment income
    
    
    2,287
    
    
    
    180
    
    
    
    
    
    
    
    1,007
    
    
    
    545Other
    
    
    214
    
    
    
    (6
    )
    
    
    
    
    
    
    80
    
    
    
    148Total revenues
    
    
    164,974
    
    
    
    18,228
    
    
    
    
    
    
    
    95,752
    
    
    
    79,460Expenses:Losses and loss adjustment expenses
    
    
    87,493
    
    
    
    7,167
    
    
    
    
    
    
    
    36,616
    
    
    
    25,905Operating expenses
    
    
    49,921
    
    
    
    7,194
    
    
    
    
    
    
    
    41,142
    
    
    
    35,962Depreciation and amortization
    
    
    1,920
    
    
    
    608
    
    
    
    
    
    
    
    1,366
    
    
    
    1,954Total expenses
    
    
    139,334
    
    
    
    14,969
    
    
    
    
    
    
    
    79,124
    
    
    
    63,821Income before income taxes
    
    $
    25,640
    
    
    $
    3,259
    
    
    $
    
    
    
    $
    16,628
    
    
    $
    15,639
 Pro formaActual
    
    
    (unaudited)Year Ended June 30,
    
    
    Year Ended June 30,2005
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003(in thousands)Real Estate and CorporateRevenues:Gains on sales of foreclosed real estate
    
    $
    755
    
    
    $
    4,147
    
    
    $
    233
    
    
    $
    4,147
    
    
    $
    233Investment income
    
    
    1,066
    
    
    
    778
    
    
    
    1,098
    
    
    
    424
    
    
    
    744Total revenues
    
    
    1,821
    
    
    
    4,925
    
    
    
    1,331
    
    
    
    4,571
    
    
    
    977Expenses:Operating expenses
    
    
    2,775
    
    
    
    6,235
    
    
    
    2,637
    
    
    
    2,278
    
    
    
    1,648Stock-based compensation
    
    
    332
    
    
    
    7,850
    
    
    
    546
    
    
    
    
    
    
    
    Depreciation
    
    
    
    
    
    
    40
    
    
    
    10
    
    
    
    
    
    
    
    Interest expense
    
    
    351
    
    
    
    44
    
    
    
    
    
    
    
    318
    
    
    
    29Total expenses
    
    
    3,458
    
    
    
    14,169
    
    
    
    3,193
    
    
    
    2,596
    
    
    
    1,677(Loss) income before income taxes
    
    $
    (1,637
    )
    
    $
    (9,244
    )
    
    $
    (1,862
    )
    
    $
    1,975
    
    
    $
    (700
    )
  
    
    premiums earned (which includes policy and renewal fees) from
(i) sales of policies
issued by our insurance company subsidiaries, net of the portion of those premiums
that have been ceded to reinsurers, and (ii) the sales of policies issued by our
managing general agency subsidiaries and assumed by our insurance company
subsidiaries through quota-share reinsurance;
    
    fee income, which includes installment billing fees on policies written as well
as fees for other ancillary services (principally a motor club product);
    
    commission income paid by our reinsurer to us for ceded premiums (through the
September 1, 2004 non-renewal of our quota share reinsurance); and
    
    investment income earned on the invested assets of the insurance company
subsidiaries.
  27




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##### Table of Contents



Pro formaActual
    
    
    (unaudited)Year Ended June 30,
    
    
    Year Ended June 30,2005
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003(in thousands)Insurance company subsidiaries:Georgia
    
    $
    67,442
    
    
    $
    10,582
    
    
    $
    
    
    
    $
    53,878
    
    
    $
    34,898Tennessee
    
    
    26,205
    
    
    
    4,460
    
    
    
    
    
    
    
    25,387
    
    
    
    22,672Ohio
    
    
    10,703
    
    
    
    1,250
    
    
    
    
    
    
    
    5,789
    
    
    
    1,694Mississippi
    
    
    4,431
    
    
    
    680
    
    
    
    
    
    
    
    3,822
    
    
    
    3,323Missouri
    
    
    4,193
    
    
    
    587
    
    
    
    
    
    
    
    3,125
    
    
    
    1,794Indiana
    
    
    2,032
    
    
    
    23
    
    
    
    
    
    
    
    25
    
    
    
    Alabama
    
    
    1,383
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Florida
    
    
    1,181
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Illinois
    
    
    112
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Pennsylvania
    
    
    24
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    117,706
    
    
    
    17,582
    
    
    
    
    
    
    
    92,026
    
    
    
    64,381MGA subsidiaries:Alabama
    
    
    25,227
    
    
    
    4,331
    
    
    
    
    
    
    
    24,219
    
    
    
    19,832Texas
    
    
    4,569
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Georgia
    
    
    2,364
    
    
    
    837
    
    
    
    
    
    
    
    11,618
    
    
    
    28,853Tennessee
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2532,160
    
    
    
    5,168
    
    
    
    
    
    
    
    35,837
    
    
    
    48,710Total gross premiums earned
    
    $
    149,866
    
    
    $
    22,750
    
    
    $
    
    
    
    $
    127,863
    
    
    $
    113,091
  Year Ended June 30,Actual
    
    
    Pro forma2005
    
    
    2004Insurance company subsidiaries:Policies in force  beginning of year
    
    
    69,061
    
    
    
    59,186Net increase during year
    
    
    31,081
    
    
    
    9,875Policies in force  end of year
    
    
    100,142
    
    
    
    69,061MGA subsidiaries:Policies in force  beginning of year
    
    
    22,324
    
    
    
    27,828Acquired
    
    
    6,473
    
    
    
    Net decrease during year
    
    
    (9,517
    )
    
    
    (5,504
    )Policies in force  end of year
    
    
    19,280
    
    
    
    22,324Total policies in force  end of year
    
    
    119,422
    
    
    
    91,385
  28




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##### Table of Contents



Pro formaActual
    
    
    (unaudited)Year Ended June 30,
    
    
    Year Ended June 30,2005
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003(in thousands)Georgia
    
    $
    63,281
    
    
    $
    5,828
    
    
    $
    
    
    
    $
    29,802
    
    
    $
    20,184Tennessee
    
    
    24,145
    
    
    
    2,300
    
    
    
    
    
    
    
    13,115
    
    
    
    11,613Alabama
    
    
    18,862
    
    
    
    2,247
    
    
    
    
    
    
    
    8,057
    
    
    
    2,919Ohio
    
    
    10,076
    
    
    
    650
    
    
    
    
    
    
    
    3,013
    
    
    
    862Texas
    
    
    4,566
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Mississippi
    
    
    4,151
    
    
    
    371
    
    
    
    
    
    
    
    2,083
    
    
    
    1,780Missouri
    
    
    3,918
    
    
    
    309
    
    
    
    
    
    
    
    1,620
    
    
    
    995Indiana
    
    
    2,030
    
    
    
    23
    
    
    
    
    
    
    
    26
    
    
    
    Florida
    
    
    1,185
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Illinois
    
    
    112
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Pennsylvania
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total net premiums earned
    
    $
    132,347
    
    
    $
    11,728
    
    
    $
    
    
    
    $
    57,716
    
    
    $
    38,353
  Loss Ratio 
 Expense Ratio 
 Combined Ratio 
 Pro formaActual
    
    (unaudited)Year Ended June 30,
    
    Year Ended June 30,2005
    
    2004
    
    2003
    
    2004
    
    2003Loss and loss adjustment expense
    
    
    66.1
    %
    
    
    61.1
    %
    
    
    
    
    
    
    63.4
    %
    
    
    67.5
    %Expense
    
    
    17.7
    %
    
    
    13.7
    %
    
    
    
    
    
    
    15.8
    %
    
    
    13.1
    %83.8
    %
    
    
    74.8
    %
    
    
    
    
    
    
    79.2
    %
    
    
    80.6
    %
   29




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##### Table of Contents



Fiscal Year Ended June 30, 2005 Compared With Fiscal Year Ended June 30, 2004
 Actual Consolidated Results
    Pro forma Consolidated Results
  Actual Results  Insurance Operations
  Pro forma Results  Insurance Operations
    30




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31




---



##### Table of Contents



Actual Results  Real Estate and Corporate
    Pro forma Results  Real Estate and Corporate
  Fiscal Year Ended June 30, 2004 Compared With Fiscal Year Ended June 30, 2003
 Actual Consolidated Results
   Pro forma Consolidated Results
  Actual Results  Real Estate and Corporate
   32




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##### Table of Contents



Pro forma Results  Real Estate and Corporate
  Actual Results  Insurance Operations
  Pro forma Results  Insurance Operations
       33




---



##### Table of Contents



Liquidity and Capital Resources
           34




---



##### Table of Contents



Off-Balance Sheet Arrangements
  Contractual Obligations
  Payments Due By PeriodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    1 year
    
    
    1-3 Years
    
    
    3-5 Years
    
    
    5 years(in thousands)Loss and loss adjustment expenses
    
    $
    42,897
    
    
    $
    22,473
    
    
    $
    17,326
    
    
    $
    2,700
    
    
    $
    398Operating leases
    
    
    16,542
    
    
    
    5,044
    
    
    
    7,259
    
    
    
    3,374
    
    
    
    865Employment agreements
    
    
    3,067
    
    
    
    800
    
    
    
    1,600
    
    
    
    667
    
    
    
    Advisory services agreement
    
    
    708
    
    
    
    250
    
    
    
    458
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    63,214
    
    
    $
    28,567
    
    
    $
    26,643
    
    
    $
    6,741
    
    
    $
    1,263
  Critical Accounting Policies
  Valuation of deferred tax asset.
  35




---



##### Table of Contents



Losses and loss adjustment expense reserves.
  Goodwill and identifiable intangible assets.
 Recent Accounting Pronouncements
   Forward-Looking Statements
  36




---



##### Table of Contents




    
    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.
   
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
   37




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##### Table of Contents



Item 8.Financial Statements and Supplementary Data
 PageReports of Independent Registered Public Accounting Firm
    
    
    40Consolidated Balance Sheets as of June 30, 2005 and 2004
    
    
    42Consolidated Statements of Operations for the Years Ended June 30, 2005, 2004 and 2003
    
    
    43Consolidated Statements of Stockholders Equity for the Years Ended June 30, 2005, 2004 and 2003
    
    
    44Consolidated Statements of Cash Flows for the Years Ended June 30, 2005, 2004 and 2003
    
    
    45Notes to Consolidated Financial Statements
    
    
    46
 38




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
      
 39




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##### Table of Contents



Report of Independent Registered Public Accounting Firm
 
        
 40




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
 June 30, 2005 and 2004
 2005
    
    
    2004ASSETSFixed maturities, available-for-sale at market value
(amortized cost: $73,832 and $33,298, respectively)
    
    $
    74,840
    
    
    $
    33,243Investment in mutual fund, at market value
    
    
    10,920
    
    
    
    Cash and cash equivalents
    
    
    24,762
    
    
    
    38,352Fiduciary funds  restricted
    
    
    935
    
    
    
    1,851Premiums and fees receivable from policyholders and agents
    
    
    42,908
    
    
    
    32,076Reinsurance recoverables
    
    
    4,490
    
    
    
    12,297Prepaid reinsurance premiums
    
    
    
    
    
    
    12,384Deferred tax asset
    
    
    48,106
    
    
    
    45,493Other assets
    
    
    4,863
    
    
    
    3,545Property and equipment, net
    
    
    1,962
    
    
    
    2,404Foreclosed real estate held for sale
    
    
    961
    
    
    
    1,108Deferred acquisition costs
    
    
    3,271
    
    
    
    Goodwill
    
    
    107,837
    
    
    
    97,304Identifiable intangible assets
    
    
    4,867
    
    
    
    5,610TOTAL
    
    $
    330,722
    
    
    $
    285,667LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    42,897
    
    
    $
    30,434Unearned premiums
    
    
    47,752
    
    
    
    33,433Deferred fee income
    
    
    2,272
    
    
    
    2,590Amounts due to reinsurers
    
    
    
    
    
    
    11,899Amounts due to insurance companies
    
    
    935
    
    
    
    1,851Note payable to financial institution
    
    
    
    
    
    
    4,000Deferred ceding commissions, net
    
    
    
    
    
    
    300Federal income taxes payable
    
    
    361
    
    
    
    1,032Other liabilities
    
    
    8,176
    
    
    
    5,902Total liabilities
    
    
    102,393
    
    
    
    91,441Commitments and contingencies (notes 4, 5, 7, 14, 16 and 19)Stockholders equity:Common stock, $.01 par value, 75,000 shares authorized;
47,455 and 46,535 shares issued and outstanding,
respectively
    
    
    475
    
    
    
    465Preferred stock, $.01 par value, 10,000 shares authorized
    
    
    
    
    
    
    Additional paid-in capital
    
    
    457,905
    
    
    
    450,658Accumulated other comprehensive income (loss):Net unrealized appreciation (depreciation) on investments
    
    
    655
    
    
    
    (35
    )Accumulated deficit
    
    
    (230,706
    )
    
    
    (256,862
    )Total stockholders equity
    
    
    228,329
    
    
    
    194,226TOTAL
    
    $
    330,722
    
    
    $
    285,667
  41




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 Years Ended June 30, 2005, 2004 and 2003
 2005
    
    
    2004
    
    
    2003Revenues:Premiums earned
    
    $
    132,347
    
    
    $
    11,728
    
    
    $
    Commissions and fees
    
    
    27,151
    
    
    
    4,401
    
    
    
    Ceding commissions from reinsurer
    
    
    2,975
    
    
    
    1,925
    
    
    
    Gains on sales of foreclosed real estate
    
    
    755
    
    
    
    4,147
    
    
    
    233Investment income
    
    
    3,353
    
    
    
    958
    
    
    
    1,098Gains (losses) on sales of assets
    
    
    214
    
    
    
    (6
    )
    
    
    Total revenues
    
    
    166,795
    
    
    
    23,153
    
    
    
    1,331Expenses:Losses and loss adjustment expenses
    
    
    87,493
    
    
    
    7,167
    
    
    
    Insurance operating expenses
    
    
    49,921
    
    
    
    7,194
    
    
    
    Other operating expenses
    
    
    2,775
    
    
    
    6,235
    
    
    
    2,637Stock-based compensation
    
    
    332
    
    
    
    7,850
    
    
    
    546Depreciation
    
    
    990
    
    
    
    258
    
    
    
    10Amortization of identifiable intangible assets
    
    
    930
    
    
    
    390
    
    
    
    Interest expense
    
    
    351
    
    
    
    44
    
    
    
    Total expenses
    
    
    142,792
    
    
    
    29,138
    
    
    
    3,193Income (loss) before income taxes
    
    
    24,003
    
    
    
    (5,985
    )
    
    
    (1,862
    )Income tax benefit
    
    
    (2,153
    )
    
    
    (2,189
    )
    
    
    Net income (loss)
    
    $
    26,156
    
    
    $
    (3,796
    )
    
    $
    (1,862
    )Basic net income (loss) per share
    
    $
    0.56
    
    
    $
    (0.15
    )
    
    $
    (0.09
    )Diluted net income (loss) per share
    
    $
    0.53
    
    
    $
    (0.15
    )
    
    $
    (0.09
    )Weighted average basic shares
    
    
    47,055
    
    
    
    24,965
    
    
    
    20,420Weighted average diluted shares
    
    
    48,989
    
    
    
    24,965
    
    
    
    20,420
  42




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands)   Years Ended June 30, 2005, 2004 and 2003
 AccumulatedAdditional
    
    
    Deferred
    
    
    other
    
    
    
    
    
    
    
    
    
    
    TotalCommon Stock
    
    
    paid-in
    
    
    compensation
    
    
    comprehensive
    
    
    Accumulated
    
    
    Treasury
    
    
    stockholdersShares
    
    
    Amount
    
    
    capital
    
    
    expense
    
    
    income (loss)
    
    
    deficit
    
    
    Stock
    
    
    equityBalances at July 1, 2003
    
    
    20,256
    
    
    $
    203
    
    
    $
    309,392
    
    
    $
    
    
    
    $
    
    
    
    $
    (251,204
    )
    
    $
    
    
    
    $
    58,391Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,862
    )
    
    
    
    
    
    
    (1,862
    )Stock issued to officer
    
    
    333
    
    
    
    3
    
    
    
    1,197
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,200Issuance of stock options
    
    
    
    
    
    
    
    
    
    
    1,862
    
    
    
    (1,862
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred
compensation expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    346
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    346Balances at June 30, 2003
    
    
    20,589
    
    
    
    206
    
    
    
    312,451
    
    
    
    (1,516
    )
    
    
    
    
    
    
    (253,066
    )
    
    
    
    
    
    
    58,075Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,796
    )
    
    
    
    
    
    
    (3,796
    )Other comprehensive
losschange in unrealized
depreciation on
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35
    )
    
    
    
    
    
    
    
    
    
    
    (35
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,831
    )Issuance of stock options
    
    
    
    
    
    
    
    
    
    
    6,334
    
    
    
    (92
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,242Stock rights offering
    
    
    12,560
    
    
    
    126
    
    
    
    49,238
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49,364Stock issued in acquisition
    
    
    13,250
    
    
    
    132
    
    
    
    82,230
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82,362Exercise of stock options
    
    
    136
    
    
    
    1
    
    
    
    405
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    406Amortization of deferred
compensation expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,608
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,608Balances at June 30, 2004
    
    
    46,535
    
    
    
    465
    
    
    
    450,658
    
    
    
    
    
    
    
    (35
    )
    
    
    (256,862
    )
    
    
    
    
    
    
    194,226Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,156
    
    
    
    
    
    
    
    26,156Other comprehensive
incomechange in
unrealized appreciation
(depreciation) on
Investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    690
    
    
    
    
    
    
    
    
    
    
    
    690Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,846Issuance of contingent
shares related to
acquisition
    
    
    750
    
    
    
    8
    
    
    
    6,712
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,720Stock-based compensation
    
    
    3
    
    
    
    
    
    
    
    332
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    332Issuance of shares under
Employee Stock Purchase
Plan
    
    
    11
    
    
    
    1
    
    
    
    103
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104Purchase of treasury
stock, at cost
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (639
    )
    
    
    (639
    )Retirement of treasury
stock, at cost
    
    
    (90
    )
    
    
    (1
    )
    
    
    (638
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    639
    
    
    
    Exercise of stock options
    
    
    246
    
    
    
    2
    
    
    
    738
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    740Balances at June 30, 2005
    
    
    47,455
    
    
    $
    475
    
    
    $
    457,905
    
    
    $
    
    
    
    $
    655
    
    
    $
    (230,706
    )
    
    $
    
    
    
    $
    228,329
  43




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Years Ended June 30, 2005, 2004 and 2003
 2005
    
    
    2004
    
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    26,156
    
    
    $
    (3,796
    )
    
    $
    (1,862
    )Adjustments to reconcile net income (loss) to cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    1,920
    
    
    
    648
    
    
    
    10Stock-based compensation
    
    
    332
    
    
    
    7,850
    
    
    
    546Amortization of premium on fixed maturities
    
    
    357
    
    
    
    65
    
    
    
    Deferred income taxes
    
    
    (2,986
    )
    
    
    (2,283
    )
    
    
    Gains on sales of foreclosed real estate
    
    
    (755
    )
    
    
    (4,147
    )
    
    
    (233
    )Loss on write-down of foreclosed real estate
    
    
    
    
    
    
    
    
    
    
    142(Gains) losses on sales of assets
    
    
    (214
    )
    
    
    6
    
    
    
    Change in:Fiduciary funds  restricted
    
    
    916
    
    
    
    125
    
    
    
    Premiums and fees receivable from policyholders and agents
    
    
    (10,832
    )
    
    
    2,518
    
    
    
    Reinsurance recoverables
    
    
    7,807
    
    
    
    (1,015
    )
    
    
    Prepaid reinsurance premiums
    
    
    12,384
    
    
    
    (215
    )
    
    
    Other assets
    
    
    (1,318
    )
    
    
    (9
    )
    
    
    (192
    )Deferred acquisition costs, net
    
    
    (3,571
    )
    
    
    300
    
    
    
    Loss and loss adjustment expense reserves
    
    
    12,463
    
    
    
    2,440
    
    
    
    Unearned premiums
    
    
    14,319
    
    
    
    (1,535
    )
    
    
    Deferred fee income
    
    
    (318
    )
    
    
    (168
    )
    
    
    Amounts due to reinsurers
    
    
    (11,899
    )
    
    
    (949
    )
    
    
    Amounts due to insurance companies
    
    
    (916
    )
    
    
    (125
    )
    
    
    Federal income taxes payable
    
    
    (671
    )
    
    
    (525
    )
    
    
    Other liabilities
    
    
    2,274
    
    
    
    330
    
    
    
    449Net cash provided by (used in) operating activities
    
    
    45,448
    
    
    
    (485
    )
    
    
    (1,140
    )Cash flows from investing activities:Proceeds from sales of foreclosed real estate
    
    
    1,202
    
    
    
    4,634
    
    
    
    672Addition to foreclosed real estate
    
    
    (300
    )
    
    
    
    
    
    
    Proceeds from sale of property and equipment
    
    
    666
    
    
    
    
    
    
    
    Acquisitions of property and equipment
    
    
    (1,053
    )
    
    
    (68
    )
    
    
    (195
    )Sales of fixed maturities, available-for-sale
    
    
    4,153
    
    
    
    10,673
    
    
    
    Maturities and paydowns of fixed maturities, available-for-sale
    
    
    3,502
    
    
    
    
    
    
    
    Purchases of investment in mutual fund
    
    
    (10,920
    )
    
    
    
    
    
    
    Purchases of fixed maturities, available-for-sale
    
    
    (48,493
    )
    
    
    (10,371
    )
    
    
    Business acquired through asset purchase
    
    
    (4,000
    )
    
    
    
    
    
    
    Acquisition, net of cash received
    
    
    
    
    
    
    (72,398
    )
    
    
    Net cash (used in) provided by investing activities
    
    
    (55,243
    )
    
    
    (67,530
    )
    
    
    477Cash flows from financing activities:Net proceeds from issuance of common stock
    
    
    104
    
    
    
    49,364
    
    
    
    1,000Purchase of treasury stock
    
    
    (639
    )
    
    
    
    
    
    
    Exercise of stock options
    
    
    740
    
    
    
    406
    
    
    
    Payments on borrowings
    
    
    (4,000
    )
    
    
    (250
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (3,795
    )
    
    
    49,520
    
    
    
    1,000Net (decrease) increase in cash and cash equivalents
    
    
    (13,590
    )
    
    
    (18,495
    )
    
    
    337Cash and cash equivalents, beginning of year
    
    
    38,352
    
    
    
    56,847
    
    
    
    56,510Cash and cash equivalents, end of year
    
    $
    24,762
    
    
    $
    38,352
    
    
    $
    56,847
  44




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 1. Summary of Significant Accounting Policies
 A. General
     B. Basis of Consolidation and Reporting
  C. Use of Estimates
  45




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 D. Investments
    E. Fiduciary Funds-Restricted
  F. Property and Equipment
  G. Insurance Revenue Recognition
  H. Reinsurance
  I. Deferred Acquisition Costs / Deferred Ceding Commissions
  46




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 J. Loss and Loss Adjustment Expense Reserves
   K. Other Fee Income
  L. Foreclosed Real Estate Held for Sale
  M. Goodwill and Other Identifiable Intangible Assets
  47




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 N. Income Taxes
   O. New Accounting Standards
   P. Supplemental Cash Flow Information
   Q. Basic and Diluted Net Income (Loss) Per Share
  48




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  R.

    Stock-Based Compensation
   Years Ended June 30,2004
    
    
    2003Net loss before income taxes, as reported
    
    $
    (5,985
    )
    
    $
    (1,862
    )Add: Stock-based employee compensation
expense included in reported net loss
    
    
    7,850
    
    
    
    546Deduct: Stock-based employee compensation
expense determined under fair value-based
method for all awards
    
    
    (11,598
    )
    
    
    (1,443
    )Net loss before income taxes, pro forma
    
    
    (9,733
    )
    
    
    (2,759
    )Income tax benefit, pro forma
    
    
    3,501
    
    
    
    Net loss, pro forma
    
    $
    (6,232
    )
    
    $
    (2,759
    )Net loss per share:Basic and diluted  as reported
    
    $
    (0.15
    )
    
    $
    (0.09
    )Basic and diluted  pro forma
    
    $
    (0.25
    )
    
    $
    (0.14
    )
  2.
    
    Business Combinations
 A.
    
    Acquisition of USAuto and Stock Rights Offering
   49




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
   Cash and cash equivalents
    
    $
    8,225Net tangible assets
    
    
    7,274Identifiable intangible assets
    
    
    6,000Goodwill
    
    
    97,304Change in deferred tax asset valuation allowance
    
    
    41,277Total assets acquired
    
    $
    160,080
    B.
    
    Texas Insurance Agency
  3.
    
    Investments
 A.
    
    Restriction
  50




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 B.
    
    Investment Income and Net Realized Gains and Losses
  Years Ended June 30,2005
    
    
    2004
    
    
    2003Fixed maturities, available for sale
    
    $
    2,419
    
    
    $
    200
    
    
    $
    Investment in mutual fund
    
    
    920
    
    
    
    
    
    
    
    Cash and cash equivalents
    
    
    198
    
    
    
    778
    
    
    
    1,098Investment expenses
    
    
    (184
    )
    
    
    (20
    )
    
    
    $
    3,353
    
    
    $
    958
    
    
    $
    1,098
  Years Ended June 30,2005
    
    
    2004Gains
    
    $
    72
    
    
    $
    41Losses
    
    
    (19
    )
    
    
    (47
    )$
    53
    
    
    $
    (6
    )
 C.
    
    Fixed Maturities, Available for Sale
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Market2005
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueU.S. Government
    
    $
    6,115
    
    
    $
    107
    
    
    $
    
    
    
    $
    6,222State
    
    
    5,416
    
    
    
    60
    
    
    
    
    
    
    
    5,476Political subdivisions
    
    
    6,616
    
    
    
    92
    
    
    
    (19
    )
    
    
    6,689Revenue and assessment
    
    
    24,130
    
    
    
    557
    
    
    
    (23
    )
    
    
    24,664Corporate bonds
    
    
    11,110
    
    
    
    58
    
    
    
    (18
    )
    
    
    11,150Collateralized mortgage
    
    
    20,445
    
    
    
    210
    
    
    
    (16
    )
    
    
    20,639$
    73,832
    
    
    $
    1,084
    
    
    $
    (76
    )
    
    $
    74,840
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Market2004
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueU.S. Government
    
    $
    295
    
    
    $
    9
    
    
    $
    
    
    
    $
    304State
    
    
    3,839
    
    
    
    15
    
    
    
    (18
    )
    
    
    3,836Political subdivisions
    
    
    7,103
    
    
    
    17
    
    
    
    (63
    )
    
    
    7,057Revenue and assessment
    
    
    22,061
    
    
    
    136
    
    
    
    (151
    )
    
    
    22,046$
    33,298
    
    
    $
    177
    
    
    $
    (232
    )
    
    $
    33,243
 51




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  Amortized
    
    
    MarketCost
    
    
    ValueOne year or less
    
    $
    4,167
    
    
    $
    4,176One to five years
    
    
    16,686
    
    
    
    16,760Five to ten years
    
    
    22,458
    
    
    
    22,801Greater than ten years
    
    
    10,076
    
    
    
    10,464No single maturity date
    
    
    20,445
    
    
    
    20,639$
    73,832
    
    
    $
    74,840
  4.
    
    Reinsurance
     Years Ended June 30,2005
    
    
    2004Ceded premiums earned
    
    $
    8,732
    
    
    $
    8,459Reinsurance recoveries on losses and loss adjustment expenses
    
    $
    5,867
    
    
    $
    5,846
  52




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  Years Ended June 30,2005
    
    
    2004Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    128,543
    
    
    $
    117,706
    
    
    $
    15,553
    
    
    $
    17,582Assumed
    
    
    25,343
    
    
    
    23,373
    
    
    
    2,303
    
    
    
    2,605Ceded
    
    
    6,051
    
    
    
    (8,732
    )
    
    
    (7,435
    )
    
    
    (8,459
    )Net
    
    $
    159,937
    
    
    $
    132,347
    
    
    $
    10,421
    
    
    $
    11,728
  5.
    
    Federal Income Taxes
  Years Ended June 30,2005
    
    
    2004Federal income taxes-current
    
    $
    515
    
    
    $
    Federal income taxes-deferred
    
    
    (2,986
    )
    
    
    (2,283
    )State income taxes
    
    
    318
    
    
    
    94$
    (2,153
    )
    
    $
    (2,189
    )
   Years Ended June 30,2005
    
    
    2004
    
    
    2003Computed expected income tax expense
(benefit)
    
    $
    8,401
    
    
    $
    (2,095
    )
    
    $
    (633
    )Increase (decrease) in taxes resulting from:Tax-exempt investment income
    
    
    (261
    )
    
    
    (45
    )
    
    
    Other
    
    
    (17
    )
    
    
    (143
    )
    
    
    1Change in the beginning of the year balance
of the valuation allowance for deferred tax
assets allocated to income taxes
    
    
    (10,594
    )
    
    
    
    
    
    
    632$
    (2,471
    )
    
    $
    (2,283
    )
    
    $
    
 53




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  2005
    
    
    2004Deferred tax asset:Net operating loss carryforwards
    
    $
    68,724
    
    
    $
    77,736Stock option compensation
    
    
    2,634
    
    
    
    2,590Unearned premiums and loss and loss
adjustment expense reserves
    
    
    4,280
    
    
    
    1,920Basis differences of foreclosed real estate
    
    
    606
    
    
    
    1,250Other
    
    
    1,624
    
    
    
    2,353Total gross deferred tax asset
    
    
    77,868
    
    
    
    85,849Less: Valuation allowance
    
    
    (29,762
    )
    
    
    (40,356
    )Net deferred tax asset
    
    $
    48,106
    
    
    $
    45,493
   Expiration Year
    
    Amount2006
    
    $
    31,0772007
    
    
    32,5842008
    
    
    36,1882009
    
    
    84,7912010
    
    
    7,095Thereafter
    
    
    4,619Total NOL carryforwards
    
    $
    196,354
 6.
    
    Net Income Per Share
  54




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  2005Net income
    
    $
    26,156Weighted average basic shares
    
    
    47,055Effect of dilutive securities  options
    
    
    1,934Weighted average dilutive shares
    
    
    48,989Basic net income per share
    
    $
    0.56Diluted net income per share
    
    $
    0.53
  7.
    
    Stock-Based Compensation
    55




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
     Number
    
    
    
    
    
    
    Number ofof
    
    
    Exercise
    
    
    OptionsOptions
    
    
    Price
    
    
    ExercisableBalance/price at July 1, 2003
    
    
    
    
    
    
    Granted
    
    
    2,824
    
    
    $
    3.00Exercised
    
    
    
    
    
    
    N/AForfeited
    
    
    
    
    
    
    N/ABalance/price at June 30, 2003
    
    
    2,824
    
    
    $
    3.00
    
    
    
    544Granted
    
    
    1,494
    
    
    $
    3.00-$6.64Exercised
    
    
    (136
    )
    
    $
    3.00Forfeited
    
    
    
    
    
    
    N/ABalance/price at June 30, 2004
    
    
    4,182
    
    
    $
    3.00-$6.64
    
    
    
    3,982Granted
    
    
    200
    
    
    $
    8.13Exercised
    
    
    (246
    )
    
    $
    3.00Forfeited
    
    
    
    
    
    
    N/ABalance/price at June 30, 2005
    
    
    4,136
    
    
    $
    3.00-$8.13
    
    
    
    3,829
 8.
    
    Employee Stock Purchase Plan
  56




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##### Table of Contents



FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
   9.
    
    Statutory Financial Information and Accounting Policies
     57




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 10.
    
    Parent Company Financial Information
  June 30,2005
    
    
    2004Balance SheetsAssets:Investment in subsidiaries, at equity in net assets
    
    $
    51,713
    
    
    $
    22,874Investment in mutual fund
    
    
    10,920
    
    
    
    Cash and cash equivalents
    
    
    253
    
    
    
    20,530Deferred tax asset
    
    
    45,150
    
    
    
    43,561Other assets
    
    
    177
    
    
    
    681Foreclosed real estate held for sale
    
    
    961
    
    
    
    1,108Goodwill and identifiable intangible assets
    
    
    112,704
    
    
    
    102,914Amounts due from subsidiaries
    
    
    7,806
    
    
    
    4,661$
    229,684
    
    
    $
    196,329Liabilities:Other liabilities
    
    $
    1,355
    
    
    $
    2,103Stockholders equity
    
    
    228,329
    
    
    
    194,226$
    229,684
    
    
    $
    196,329
 Years Ended June 30,2005
    
    
    2004Statements of OperationsGains on sales of foreclosed real estate
    
    $
    755
    
    
    $
    4,147Investment income
    
    
    1,066
    
    
    
    778Equity in income of subsidiaries, net of tax
    
    
    17,197
    
    
    
    2,411Expenses
    
    
    (4,036
    )
    
    
    (14,515
    )Income (loss) before income taxes
    
    
    14,982
    
    
    
    (7,179
    )Income tax benefit
    
    
    (11,174
    )
    
    
    (3,383
    )Net income (loss)
    
    $
    26,156
    
    
    $
    (3,796
    )
 Year s Ended June 30,2005
    
    
    2004Statements of Cash FlowsOperating activities:Net income (loss)
    
    $
    26,156
    
    
    $
    (3,796
    )Equity in income of subsidiaries, net of tax
    
    
    (17,197
    )
    
    
    (2,411
    )Depreciation and amortization
    
    
    928
    
    
    
    430Stock-based compensation
    
    
    332
    
    
    
    7,850Deferred income taxes
    
    
    (1,589
    )
    
    
    (3,383
    )Gains on sales of foreclosed real estate
    
    
    (755
    )
    
    
    (4,147
    )Change in assets and liabilities
    
    
    (3,389
    )
    
    
    (2,546
    )Net cash provided by (used in) operating activities
    
    
    4,486
    
    
    
    (8,003
    )Investing activities:Proceeds from sales of foreclosed real estate
    
    
    1,202
    
    
    
    4,634Addition to foreclosed real estate
    
    
    (300
    )
    
    
    Purchases of investment in mutual fund
    
    
    (10,920
    )
    
    
    Investment in subsidiary
    
    
    (10,950
    )
    
    
    (5,000
    )Acquisition
    
    
    (4,000
    )
    
    
    (77,718
    )Net cash used in investing activities
    
    
    (24,968
    )
    
    
    (78,084
    )Financing activities:Proceeds from issuance of common stock
    
    
    104
    
    
    
    49,364Purchase of treasury stock
    
    
    (639
    )
    
    
    Exercise of stock options
    
    
    740
    
    
    
    406Net cash provided by financing activities
    
    
    205
    
    
    
    49,770Net decrease in cash and cash equivalents
    
    $
    (20,277
    )
    
    $
    (36,317
    )
 58




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 11.
    
    Losses and Loss Adjustment Expenses Incurred and Paid
  Years Ended June 30,2005
    
    
    2004Liability for unpaid loss and loss adjustment expenses at beginning of
year/date of acquisition, gross
    
    $
    30,434
    
    
    $
    27,993Reinsurance balances recoverable
    
    
    (12,297
    )
    
    
    (11,281
    )Liability for unpaid loss and loss adjustment expenses at beginning of
year/date of acquisition, net
    
    
    18,137
    
    
    
    16,712Add: Provision for losses and loss adjustment expenses:Current year
    
    
    88,068
    
    
    
    7,381Prior years
    
    
    (356
    )
    
    
    Accretion of net risk margin/discounting as of the date of acquisition
    
    
    (219
    )
    
    
    (214
    )Net loss and loss adjustment expenses incurred
    
    
    87,493
    
    
    
    7,167Less: Loss and loss adjustment expense payments:Current year
    
    
    53,238
    
    
    
    5,742Prior years
    
    
    13,103
    
    
    
    Net loss and loss adjustment expense payments
    
    
    66,341
    
    
    
    5,742Liability for unpaid loss and loss adjustment expenses at end of year, gross
    
    
    42,897
    
    
    
    30,434Reinsurance balances recoverable
    
    
    (3,608
    )
    
    
    (12,297
    )Liability for unpaid loss and loss adjustment expenses at end of year, net
    
    $
    39,289
    
    
    $
    18,137
  12.
    
    Deferred Acquisition Costs / Deferred Ceding Commissions
  13.
    
    Note Payable to Financial Institution
  59




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 14.
    
    Lease Commitments
  Years Ending June 30,
    
    Amount2006
    
    $
    5,0442007
    
    
    4,2132008
    
    
    3,0462009
    
    
    1,8482010
    
    
    1,526Thereafter
    
    
    865Total
    
    $
    16,542
  15.
    
    Property and Equipment
  June 30,2005
    
    
    2004Leasehold improvements
    
    $
    1,452
    
    
    $
    1,529Vehicles
    
    
    
    
    
    
    79Aircraft
    
    
    190
    
    
    
    985Furniture and equipment
    
    
    3,397
    
    
    
    2,564Total property and equipment at cost
    
    
    5,039
    
    
    
    5,157Less: Accumulated depreciation
    
    
    (3,077
    )
    
    
    (2,753
    )Total property and equipment, net
    
    $
    1,962
    
    
    $
    2,404
 16.
    
    Concentrations of Credit Risk
   60




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
   17. Employee Benefit Plan
  18. Related Party Transactions
     19. Litigation
  61




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 20. Fair Value of Financial Instruments
     21. Segment Information
   62




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
  Real Estateand
    
    
    ConsolidatedYear Ended June 30, 2005
    
    Insurance
    
    
    Corporate
    
    
    TotalRevenues:Premiums earned
    
    $
    132,347
    
    
    $
    
    
    
    $
    132,347Commissions and fees
    
    
    27,151
    
    
    
    
    
    
    
    27,151Ceding commissions from reinsurer
    
    
    2,975
    
    
    
    
    
    
    
    2,975Gains on sales of foreclosed real estate
    
    
    
    
    
    
    755
    
    
    
    755Investment income
    
    
    2,287
    
    
    
    1,066
    
    
    
    3,353Other
    
    
    214
    
    
    
    
    
    
    
    214Total revenues
    
    
    164,974
    
    
    
    1,821
    
    
    
    166,795Expenses:Losses and loss adjustment expenses
    
    
    87,493
    
    
    
    
    
    
    
    87,493Operating expenses
    
    
    49,921
    
    
    
    2,775
    
    
    
    52,696Stock-based compensation
    
    
    
    
    
    
    332
    
    
    
    332Depreciation and amortization
    
    
    1,920
    
    
    
    
    
    
    
    1,920Interest expense
    
    
    
    
    
    
    351
    
    
    
    351Total expenses
    
    
    139,334
    
    
    
    3,458
    
    
    
    142,792Income (loss) before income taxes
    
    $
    25,640
    
    
    $
    (1,637
    )
    
    $
    24,003Total assets at June 30, 2005
    
    $
    164,677
    
    
    $
    166,045
    
    
    $
    330,722
 Real Estateand
    
    
    ConsolidatedYear Ended June 30, 2004
    
    Insurance
    
    
    Corporate
    
    
    TotalRevenues:Premiums earned
    
    $
    11,728
    
    
    $
    
    
    
    $
    11,728Commissions and fees
    
    
    4,401
    
    
    
    
    
    
    
    4,401Ceding commissions from reinsurer
    
    
    1,925
    
    
    
    
    
    
    
    1,925Gains on sales of foreclosed real estate
    
    
    
    
    
    
    4,147
    
    
    
    4,147Investment income
    
    
    180
    
    
    
    778
    
    
    
    958Other
    
    
    (6
    )
    
    
    
    
    
    
    (6
    )Total revenues
    
    
    18,228
    
    
    
    4,925
    
    
    
    23,153Expenses:Losses and loss adjustment expenses
    
    
    7,167
    
    
    
    
    
    
    
    7,167Operating expenses
    
    
    7,194
    
    
    
    6,235
    
    
    
    13,429Stock-based compensation
    
    
    
    
    
    
    7,850
    
    
    
    7,850Depreciation and amortization
    
    
    608
    
    
    
    40
    
    
    
    648Interest expense
    
    
    
    
    
    
    44
    
    
    
    44Total expenses
    
    
    14,969
    
    
    
    14,169
    
    
    
    29,138Income (loss) before income taxes
    
    $
    3,259
    
    
    $
    (9,244
    )
    
    $
    (5,985
    )Total assets at June 30, 2004
    
    $
    117,823
    
    
    $
    167,844
    
    
    $
    285,667
 63




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 22. Business Combination (unaudited)
  USAutoHistoricalTen Months Ended
    
    
    Pro forma
    
    
    CompanyPro forma Statement of Income
    
    Company
    
    
    April 30, 2004
    
    
    Adjustments
    
    
    Pro formaYear Ended June 30, 2004
    
    Historical
    
    
    (unaudited)
    
    
    (unaudited)
    
    
    (unaudited)Revenues:Premiums earned
    
    $
    11,728
    
    
    $
    45,988
    
    
    $
    
    
    
    $
    57,716Commissions and fees
    
    
    4,401
    
    
    
    21,874
    
    
    
    
    
    
    
    26,275Ceding commissions from reinsurer
    
    
    1,925
    
    
    
    8,749
    
    
    
    
    
    
    
    10,674Gains on sales of foreclosed real estate
    
    
    4,147
    
    
    
    
    
    
    
    
    
    
    
    4,147Investment income
    
    
    958
    
    
    
    827
    
    
    
    (354
    )(a)
    
    
    1,431Gains (losses) on sales of assets
    
    
    (6
    )
    
    
    86
    
    
    
    
    
    
    
    80Total revenues
    
    
    23,153
    
    
    
    77,524
    
    
    
    (354
    )
    
    
    100,323Expenses:Losses and loss adjustment expenses
    
    
    7,167
    
    
    
    29,465
    
    
    
    (16
    )(b)
    
    
    36,616Insurance operating expenses
    
    
    7,194
    
    
    
    34,015
    
    
    
    (67
    )(c)
    
    
    41,142Operating expenses
    
    
    6,235
    
    
    
    
    
    
    
    (3,957
    )(d)
    
    
    2,278Stock-based compensation
    
    
    7,850
    
    
    
    
    
    
    
    (7,850
    )(e)
    
    
    Depreciation and amortization
    
    
    648
    
    
    
    536
    
    
    
    182
    (f)
    
    
    1,366Interest
    
    
    44
    
    
    
    274
    
    
    
    
    
    
    
    318Total expenses
    
    
    29,138
    
    
    
    64,290
    
    
    
    (11,708
    )
    
    
    81,720Income (loss) before income taxes
    
    
    (5,985
    )
    
    
    13,234
    
    
    
    11,354
    
    
    
    18,603Income tax (benefit) expense
    
    
    (2,189
    )
    
    
    2,373
    
    
    
    6,799
    (g)
    
    
    6,983Net (loss) income
    
    $
    (3,796
    )
    
    $
    10,861
    
    
    $
    4,555
    
    
    $
    11,620Basic net (loss) income per share
    
    $
    (0.15
    )
    
    
    
    
    
    
    
    
    
    $
    0.25Diluted net (loss) income per share
    
    $
    (0.15
    )
    
    
    
    
    
    
    
    
    
    $
    0.24Weighted average basic shares
    
    
    24,965
    
    
    
    
    
    
    
    
    
    
    
    46,405
    (h)Weighted average diluted shares
    
    
    24,965
    
    
    
    
    
    
    
    
    
    
    
    47,883
    (h)
 64




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 USAutoHistoricalYear Ended
    
    
    Pro forma
    
    
    CompanyPro forma Statement of Income
    
    Company
    
    
    June 30, 2003
    
    
    Adjustments
    
    
    Pro formaYear Ended June 30, 2003
    
    Historical
    
    
    (unaudited)
    
    
    (unaudited)
    
    
    (unaudited)Revenues:Premiums earned
    
    $
    
    
    
    $
    38,353
    
    
    $
    
    
    
    $
    38,353Commissions and fees
    
    
    
    
    
    
    33,462
    
    
    
    
    
    
    
    33,462Ceding commissions from reinsurer
    
    
    
    
    
    
    6,952
    
    
    
    
    
    
    
    6,952Gains on sales of foreclosed real estate
    
    
    233
    
    
    
    
    
    
    
    
    
    
    
    233Investment income
    
    
    1,098
    
    
    
    545
    
    
    
    (354
    )(a)
    
    
    1,289Gains on sales of assets
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    148Total revenues
    
    
    1,331
    
    
    
    79,460
    
    
    
    (354
    )
    
    
    80,437Expenses:Losses and loss adjustment expenses
    
    
    
    
    
    
    26,034
    
    
    
    (129
    )(b)
    
    
    25,905Insurance operating expenses
    
    
    
    
    
    
    36,362
    
    
    
    (400
    )(c)
    
    
    35,962Operating expenses
    
    
    2,637
    
    
    
    
    
    
    
    (989
    )(d)
    
    
    1,648Stock-based compensation
    
    
    546
    
    
    
    
    
    
    
    (546
    )(e)
    
    
    Depreciation and amortization
    
    
    10
    
    
    
    736
    
    
    
    1,208
    (f)
    
    
    1,954Interest
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    29Total expenses
    
    
    3,193
    
    
    
    63,161
    
    
    
    (856
    )
    
    
    65,498(Loss) income before income taxes
    
    
    (1,862
    )
    
    
    16,299
    
    
    
    502
    
    
    
    14,939Income tax expense
    
    
    
    
    
    
    1,904
    
    
    
    3,940
    (g)
    
    
    5,844Net (loss) income
    
    $
    (1,862
    )
    
    $
    14,395
    
    
    $
    (3,438
    )
    
    $
    9,095Basic net (loss) income per share
    
    $
    (0.09
    )
    
    
    
    
    
    
    
    
    
    $
    0.20Diluted net (loss) income per share
    
    $
    (0.09
    )
    
    
    
    
    
    
    
    
    
    $
    0.19Weighted average basic shares
    
    
    20,420
    
    
    
    
    
    
    
    
    
    
    
    46,229
    (h)Weighted average diluted shares
    
    
    20,420
    
    
    
    
    
    
    
    
    
    
    
    46,985
    (h)
  
 (a)
    
    To eliminate investment income that would not have been earned if the
acquisition had been completed on July 1, 2002.(b)
    
    To record accretion of fair value adjustment to loss and loss adjustment
expense reserves.(c)
    
    To record net increase in salary expense reflecting new employment agreements
with USAuto executives effective with the acquisition and eliminate loan guarantee fees
that are no longer required following the acquisition.(d)
    
    To eliminate compensation expense of Company employees terminated pursuant to
the terms of the acquisition agreement effective upon closing of acquisition and to
include the expense of a new advisory agreement (see notes 14 and 18).(e)
    
    To eliminate stock-based compensation expense of Company employees terminated
pursuant to the terms of the acquisition agreement effective upon closing of the
acquisition.(f)
    
    To amortize identifiable intangible assets resulting from the acquisition and
also eliminate depreciation on assets disposed of as part of Company employee severance
cost as result of the acquisition.(g)
    
    To record the additional income tax expense as result of (1) the change in tax
status of certain USAuto subsidiary companies from S corporation to C corporation, (2)
expected utilization of available NOL carryforwards and (3) the tax-effect of
deductible pro forma adjustments.(h)
    
    Includes the dilutive effect of stock options issued to Company employees as
result of the acquisition as if such options had been issued on July 1, 2002. 65




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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except per share data)
Years Ended June 30, 2005, 2004 and 2003
 23. Selected Quarterly Financial Data (unaudited)
  QuartersFirst
    
    Second
    
    Third
    
    FourthFiscal Year 2003Operating revenues
    
    $
    525
    
    
    $
    280
    
    
    $
    265
    
    
    $
    261Net loss
    
    $
    (341
    )
    
    $
    (279
    )
    
    $
    (447
    )
    
    $
    (795
    )Basic and diluted net loss per share:
    
    $
    (0.02
    )
    
    $
    (0.01
    )
    
    $
    (0.02
    )
    
    $
    (0.04
    )Fiscal Year 2004Operating revenues
    
    $
    1,549
    
    
    $
    301
    
    
    $
    2,917
    
    
    $
    18,386Net income (loss) before income taxes
    
    $
    880
    
    
    $
    (754
    )
    
    $
    2,194
    
    
    $
    (8,305
    )Net income (loss)
    
    $
    880
    
    
    $
    (754
    )
    
    $
    2,194
    
    
    $
    (6,116
    )Basic and diluted net income (loss) per share:
    
    $
    0.04
    
    
    $
    (0.04
    )
    
    $
    0.10
    
    
    $
    (0.16
    )Fiscal Year 2005Operating revenues
    
    $
    30,903
    
    
    $
    40,725
    
    
    $
    45,395
    
    
    $
    49,772Net income before income taxes
    
    $
    5,898
    
    
    $
    7,328
    
    
    $
    6,779
    
    
    $
    3,998Net income
    
    $
    3,864
    
    
    $
    4,687
    
    
    $
    4,405
    
    
    $
    13,200Basic net income per share
    
    $
    0.08
    
    
    $
    0.10
    
    
    $
    0.09
    
    
    $
    0.28Diluted net income per share
    
    $
    0.08
    
    
    $
    0.10
    
    
    $
    0.09
    
    
    $
    0.27
 66




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##### Table of Contents



Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
  
 Item 9A. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
  Internal Control over Financial Reporting
 Managements Annual Report on Internal Control Over Financial Reporting
     Changes in Internal Control over Financial Reporting
  
 Item 9B. Other Information
  67




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PART III
 
 Item 10. Directors and Executive Officers of the Registrant
    
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
  
 Item 13. Certain Relationships and Related Transactions
  
 Item 14. Principal Accountant Fees and Services
  
 PART IV
 
 Item 15. Exhibits and Financial Statement Schedules
  (1)
    
    Consolidated Financial Statements: See Index to Consolidated Financial Statements on
Page 39.(2)
    
    Financial Statement Schedules: All financial statement schedules are omitted as the
information is either included in the notes to the consolidated financial statements or is
not applicable.
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(3)
    
    Exhibits: See the exhibit listing set forth below.
 ExhibitNumber2.1
    
    Plan of Reorganization dated as of April 1, 1996, between the Trust and the Company
(incorporated by reference to Exhibit 2.1 of Registration Statement No. 333-07439 on Form S-4,
filed July 2, 1996 (the Registration Statement)).2.2
    
    Stock Purchase Agreement dated as of January 16, 1996, between Liberté Investors Trust and
Hunters Glen/Ford, Ltd. (the Purchaser) (incorporated by reference to Exhibit 4.1 of
Liberté Investors Trusts Current Report on Form 8-K filed with the Commission on January 24,
1996), as amended by the Amendment to the Stock Purchase Agreement, dated as of February 27,
1996, and the Second Amendment to the Stock Purchase Agreement, dated as of March 28, 1996
(incorporated by reference to Exhibit 2.1 of Liberté Investors Trusts Quarterly Report on
Form 10-Q for the quarter ended March 31, 1996).2.3
    
    Agreement and Plan of Merger by and among the Company, USAH Merger Sub, Inc., USAuto
Holdings, Inc. and the Stockholders of USAuto Holdings, Inc., dated as of December 15, 2003
(incorporated by reference to Exhibit 2.1 of Registration Statement No. 333-111161 on Form
S-1, filed December 15, 2003).3.1
    
    Restated Certificate of Incorporation of First Acceptance Corporation (incorporated by
reference to Exhibit 3.1 of the Companys Current Report on Form 8-K dated May 3, 2004).3.2
    
    Amended and Restated Bylaws of First Acceptance Corporation (incorporated by reference to
Exhibit 3.2 of the Companys Annual Report on Form 10-K dated September 28, 2004).4.1
    
    Form of Registration Rights Agreement dated August 16, 1996, between the Company and the
Purchaser (incorporated by reference to Exhibit 4.1 of the Registration Statement).4.2
    
    Form of Agreement Clarifying Registration Rights dated August 16, 1996, between the Company,
the Purchaser, the Enloe Descendants Trust, and Robert Ted Enloe, III (incorporated by
reference to Exhibit 4.3 of the Registration Statement).4.3
    
    Registration Rights Agreement dated as of July 1, 2002, by and between the Company and Donald
J. Edwards (incorporated by reference to Exhibit 4.1 of the Companys Current Report on Form
8-K dated July 11, 2002).4.4
    
    Form of certificate representing shares of common stock, par value $0.01 per share
(incorporated by reference to Exhibit 4.1 of the Companys Registration Statement on Form S-8
filed December 26, 2002).10.1
    
    Form of Indemnification Agreement for the Companys directors and officers and schedule of
substantially identical documents (incorporated by reference to Exhibit 10.2 of the
Registration Statement).10.2
    
    Employment Agreement dated as of July 1, 2002, by and between the Company and Donald J.
Edwards (incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K
dated July 11, 2002).*10.3
    
    First Acceptance Corporation 2002 Long Term Incentive Plan, as amended (incorporated by
reference to Exhibit 4.4 of the Companys Registration Statement on Form S-8 filed May 18,
2004).*10.4
    
    Nonqualified Stock Option Agreement dated as of July 9, 2002, by and between the Company and
Donald J. Edwards (incorporated by reference to Exhibit 10.3 of the Companys Current Report
on Form 8-K dated July 11, 2002).*
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ExhibitNumber10.5
    
    Indemnification Agreement dated as of July 1, 2002, by and between the Company and Donald J.
Edwards (incorporated by reference to Exhibit 10.4 of the Companys Current Report on Form 8-K
dated July 11, 2002).10.6
    
    Stock Purchase Agreement dated as of July 9, 2002, by and between the Company and Donald J.
Edwards (incorporated by reference to Exhibit 10.3 of the Companys Registration Statement on
Form S-8 dated December 26, 2002).*10.7
    
    Stock Purchase Agreement dated as of June 30, 2003, by and between the Company and Donald J.
Edwards (incorporated by reference to Exhibit 10.8 of the Companys Annual Report on Form 10-K
dated September 26, 2003).*10.8
    
    Advisory Services Agreement, dated as of April 30, 2004, by and between First Acceptance
Corporation and Edwards Capital LLC (incorporated by reference to Exhibit 10.1 of the
Companys Current Report on Form 8-K dated May 3, 2004).*10.9
    
    Separation Agreement dated as of April 30, 2004, by and between First Acceptance Corporation
and Donald J. Edwards (incorporated by reference to Exhibit 10.2 of the Companys Current
Report on Form 8-K dated May 3, 2004).*10.10
    
    Employment Agreement, dated as of April 30, 2004, by and between First Acceptance
Corporation and Stephen J. Harrison (incorporated by reference to Exhibit 10.3 of the
Companys Current Report on Form 8-K dated May 3, 2004).*10.11
    
    Employment Agreement, dated as of April 30, 2004, by and between First Acceptance
Corporation and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10.4 of the
Companys Current Report on Form 8-K dated May 3, 2004).*10.12
    
    Nonqualified Stock Option Agreement, dated as of April 30, 2004, by and between First
Acceptance Corporation and Stephen J. Harrison (incorporated by reference to Exhibit 10.5 of
the Companys Current Report on Form 8-K dated May 3, 2004).*10.13
    
    Nonqualified Stock Option Agreement, dated as of April 30, 2004, by and between First
Acceptance Corporation and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10.6
of the Companys Current Report on Form 8-K dated May 3, 2004).*10.14
    
    Registration Rights Agreement, dated as of April 30, 2004, by and among First Acceptance
Corporation, Stephen J. Harrison and Thomas M. Harrison, Jr. (incorporated by reference to
Exhibit 10.7 of the Companys Current Report on Form 8-K dated May 3, 2004).10.15
    
    Severance Compensation Agreement, dated as of August 24, 2004, by and between First
Acceptance Corporation and Charles David Hamilton (incorporated by reference to Exhibit 10.15
of the Companys Annual Report on Form 10-K dated September 28, 2004).*10.16
    
    Form of Restricted Stock Award Agreement under the Companys 2002 Long-Term Incentive Plan
(incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K dated
November 3, 2004).*10.17
    
    Form of Nonqualified Stock Option Agreement under the Companys 2002 Long-Term Incentive
Plan (incorporated by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K
dated November 3, 2004).*10.18
    
    Escrow Agreement, dated March 31, 2005, by and among First Acceptance Corporation, Stephen
J. Harrison and Thomas M. Harrison, Jr. (incorporated by reference to Exhibit 10 of the
Companys Current Report on Form 8-K dated April 6, 2005).*
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ExhibitNumber10.19
    
    First Acceptance Corporation Employee Stock Purchase Plan (incorporated by reference to
Exhibit 10.1 of the Registration Statement No. 333-121551 on Form S-8, filed December 22,
2004).10.20
    
    Summary of Compensation for
Non-Employee Directors and Named Executive Officers.*14
    
    First Acceptance Corporation Code of Business Conduct and Ethics (incorporated by reference
to Exhibit 14 of the Companys Annual Report on Form 10-K dated September 28, 2004).21
    
    Subsidiaries of First Acceptance Corporation.23
    
    Consent of KPMG LLP.31.1
    
    Certification of Chief Executive Officer pursuant to Rule 13a-14(a).31.2
    
    Certification of Chief Financial Officer pursuant to Rule 13a-14(a).32.1
    
    Chief Executive Officers Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Chief Financial Officers Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Management contract or compensatory plan or arrangement. 71




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SIGNATURES
  FIRST ACCEPTANCE CORPORATIONDate: September 13, 2005
    
    By
    
    /s/ Stephen J. HarrisonStephen J. HarrisonPresident and Chief Executive Officer
  Signature
    
    Title
    
    Date/s/ Stephen J. Harrison
    
    President, Chief Executive Officer, and
    
    September 13, 2005Stephen J. Harrison
    
    Director (Principal Executive Officer)/s/ Charles D. Hamilton
    
    Treasurer and Chief Financial Officer
    
    September 13, 2005Charles D. Hamilton
    
    (Principal Financial Officer and
Principal Accounting Officer)/s/ Gerald J. Ford
    
    Chairman of the Board of Directors
    
    September 13, 2005Gerald J. Ford/s/ Thomas M. Harrison, Jr.
    
    Executive Vice President, Secretary and
Director
    
    September 13, 2005Thomas M. Harrison, Jr./s/ Gene H. Bishop
    
    Director
    
    September 13, 2005Gene H. Bishop/s/ Rhodes R. Bobbitt
    
    Director
    
    September 13, 2005Rhodes R. Bobbitt/s/ Harvey B. Cash
    
    Director
    
    September 13, 2005Harvey B. Cash/s/ Donald J. Edwards
    
    Director
    
    September 13, 2005Donald J. EdwardsDirectorLyndon L. Olson/s/ William A. Shipp, Jr.
    
    Director
    
    September 13, 2005William A. Shipp, Jr.
 72