UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the quarterly period ended June 30, 2008
 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 001-33077
 FIRST MERCURY FINANCIAL CORPORATION
  Delaware
(State or other jurisdiction of incorporation or organization)
    
    38-3164336
(I.R.S. Employer Identification No.)29110 Inkster Road 
Suite 100
Southfield, Michigan
(Address of Principal Executive Offices)
    
    48034
(Zip Code)
  þ o
  Large accelerated filer oAccelerated filer þNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company o o þ




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TABLE OF CONTENTS
 Item
    
    
    
    PagePART I  FINANCIAL INFORMATION1.
    
    Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets
    
    3Condensed Consolidated Statements of Income
    
    4Condensed Consolidated Statements of Stockholders Equity
    
    5Condensed Consolidated Statements of Cash Flows
    
    6Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    72.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    183.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    364.
    
    Controls and Procedures
    
    36PART II  OTHER INFORMATION4.
    
    Submission of Matters to a Vote of Security Holders
    
    376.
    
    Exhibits
    
    37
 2




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 PART I.  FINANCIAL INFORMATION
 
 ITEM 1. Condensed Consolidated Financial Statements
 
 Condensed Consolidated Balance Sheets
 June 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)(Dollars in thousands,except share and per share data)ASSETSInvestmentsDebt securities
    
    $
    437,952
    
    
    $
    402,418Equity securities and other
    
    
    21,516
    
    
    
    4,529Short-term
    
    
    64,811
    
    
    
    52,341Total Investments
    
    
    524,279
    
    
    
    459,288Cash and cash equivalents
    
    
    20,790
    
    
    
    18,432Premiums and reinsurance balances receivable
    
    
    61,565
    
    
    
    38,278Accrued investment income
    
    
    4,733
    
    
    
    4,481Accrued profit sharing commissions
    
    
    9,811
    
    
    
    14,220Reinsurance recoverable on paid and unpaid losses
    
    
    118,981
    
    
    
    96,995Prepaid reinsurance premiums
    
    
    47,596
    
    
    
    52,718Deferred acquisition costs
    
    
    21,852
    
    
    
    14,257Intangible assets, net of accumulated amortization
    
    
    40,476
    
    
    
    36,651Goodwill
    
    
    25,090
    
    
    
    Other assets
    
    
    15,597
    
    
    
    11,964Total Assets
    
    $
    890,770
    
    
    $
    747,284LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    324,502
    
    
    $
    272,365Unearned premium reserves
    
    
    140,117
    
    
    
    123,469Long-term debt
    
    
    67,013
    
    
    
    67,013Funds held under reinsurance treaties
    
    
    42,522
    
    
    
    35,799Premiums payable to insurance companies
    
    
    22,945
    
    
    
    2,163Reinsurance payable on paid losses
    
    
    2,803
    
    
    
    3,958Deferred federal income taxes
    
    
    3,228
    
    
    
    217Accounts payable, accrued expenses, and other liabilities
    
    
    20,540
    
    
    
    12,920Total Liabilities
    
    
    623,670
    
    
    
    517,904Stockholders EquityCommon stock, $0.01 par value; authorized 100,000,000 shares; issued
and outstanding 18,335,852 and 17,972,353 shares
    
    
    183
    
    
    
    180Paid-in-capital
    
    
    168,594
    
    
    
    165,836Accumulated other comprehensive income (loss)
    
    
    (1,788
    )
    
    
    1,177Retained earnings
    
    
    100,610
    
    
    
    62,187Treasury stock; 33,600 and 0 shares
    
    
    (499
    )
    
    
    Total Stockholders Equity
    
    
    267,100
    
    
    
    229,380Total Liabilities and Stockholders Equity
    
    $
    890,770
    
    
    $
    747,284
  3




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Income
(Unaudited)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands, except share and per share data)Operating RevenueNet earned premiums
    
    $
    46,559
    
    
    $
    43,571
    
    
    $
    90,130
    
    
    $
    88,500Commissions and fees
    
    
    7,086
    
    
    
    2,064
    
    
    
    11,139
    
    
    
    3,917Net investment income
    
    
    5,216
    
    
    
    3,870
    
    
    
    10,064
    
    
    
    7,164Net realized gains (losses) on investments
    
    
    (1,812
    )
    
    
    627
    
    
    
    (1,811
    )
    
    
    762Total Operating Revenues
    
    
    57,049
    
    
    
    50,132
    
    
    
    109,522
    
    
    
    100,343Operating ExpensesLosses and loss adjustment expenses, net
    
    
    25,732
    
    
    
    22,488
    
    
    
    49,177
    
    
    
    46,442Amortization of deferred acquisition expenses
    
    
    9,096
    
    
    
    7,557
    
    
    
    17,310
    
    
    
    16,296Underwriting, agency and other expenses
    
    
    11,615
    
    
    
    4,642
    
    
    
    17,598
    
    
    
    7,307Amortization of intangible assets
    
    
    515
    
    
    
    167
    
    
    
    913
    
    
    
    333Total Operating Expenses
    
    
    46,958
    
    
    
    34,854
    
    
    
    84,998
    
    
    
    70,378Operating Income
    
    
    10,091
    
    
    
    15,278
    
    
    
    24,524
    
    
    
    29,965Interest Expense
    
    
    1,476
    
    
    
    986
    
    
    
    2,940
    
    
    
    1,968Change in Fair Value of Derivative Instruments
    
    
    (262
    )
    
    
    (127
    )
    
    
    174
    
    
    
    (19
    )Income From Continuing Operations Before
Income Taxes
    
    
    8,877
    
    
    
    14,419
    
    
    
    21,410
    
    
    
    28,016Income Taxes
    
    
    2,641
    
    
    
    4,984
    
    
    
    6,540
    
    
    
    9,601Income From Continuing Operations
    
    
    6,236
    
    
    
    9,435
    
    
    
    14,870
    
    
    
    18,415Income From Discontinued Operations
(including Gain on Sale of $21.4 million),
Net of Taxes
    
    
    22,467
    
    
    
    1,069
    
    
    
    23,553
    
    
    
    2,055Net Income
    
    $
    28,703
    
    
    $
    10,504
    
    
    $
    38,423
    
    
    $
    20,470Basic Net Income Per Share:Income From Continuing Operations
    
    $
    0.34
    
    
    $
    0.54
    
    
    $
    0.82
    
    
    $
    1.06Income From Discontinued Operations
    
    
    1.23
    
    
    
    0.06
    
    
    
    1.30
    
    
    
    0.12Total
    
    $
    1.57
    
    
    $
    0.60
    
    
    $
    2.12
    
    
    $
    1.18Diluted Net Income Per Share:Income From Continuing Operations
    
    $
    0.33
    
    
    $
    0.52
    
    
    $
    0.79
    
    
    $
    1.01Income From Discontinued Operations
    
    
    1.19
    
    
    
    0.06
    
    
    
    1.25
    
    
    
    0.11Total
    
    $
    1.52
    
    
    $
    0.58
    
    
    $
    2.04
    
    
    $
    1.12Weighted Average Shares Outstanding:Basic
    
    
    18,259,602
    
    
    
    17,428,006
    
    
    
    18,182,832
    
    
    
    17,380,219Diluted
    
    
    18,943,262
    
    
    
    18,254,015
    
    
    
    18,803,719
    
    
    
    18,220,558
  4




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Stockholders Equity
(Unaudited)
 AccumulatedOtherCommon
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    TreasuryStock
    
    
    Capital
    
    
    Loss
    
    
    Earnings
    
    
    Stock
    
    
    Total(Dollars in thousands, except share data)Balance, January 1, 2007
    
    $
    174
    
    
    $
    153,600
    
    
    $
    (761
    )
    
    $
    20,323
    
    
    $
    (598
    )
    
    $
    172,738Common stock issued, net of issuance costs
    
    
    7
    
    
    
    12,242
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,249Cumulative effect adjustment upon
adoption of SFAS 155
    
    
    
    
    
    
    
    
    
    
    (133
    )
    
    
    133
    
    
    
    
    
    
    
    Stock-based compensation expense
    
    
    
    
    
    
    511
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    511Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,470
    
    
    
    
    
    
    
    20,470Other comprehensive loss, net of taxUnrealized holding losses on securities
arising during the period, net of tax of $748
    
    
    
    
    
    
    
    
    
    
    (1,389
    )
    
    
    
    
    
    
    
    
    
    
    (1,389
    )Change in fair value of interest rate swap, net of tax of
($124)
    
    
    
    
    
    
    
    
    
    
    230
    
    
    
    
    
    
    
    
    
    
    
    230Less reclassification adjustment for
gains included in net income, net of tax of $224
    
    
    
    
    
    
    
    
    
    
    (416
    )
    
    
    
    
    
    
    
    
    
    
    (416
    )Total other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,575
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,895Balance, June 30, 2007
    
    $
    181
    
    
    $
    166,353
    
    
    $
    (2,469
    )
    
    $
    40,926
    
    
    $
    (598
    )
    
    $
    204,393Balance, January 1, 2008
    
    $
    180
    
    
    $
    165,836
    
    
    $
    1,177
    
    
    $
    62,187
    
    
    $
    
    
    
    $
    229,380Exercise of stock options
    
    
    3
    
    
    
    597
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    600Stock-based compensation expense
    
    
    
    
    
    
    1,026
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,026Stock-based compensation excess tax benefits
    
    
    
    
    
    
    1,135
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,135Common stock repurchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (499
    )
    
    
    (499
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,423
    
    
    
    
    
    
    
    38,423Other comprehensive loss, net of taxUnrealized holding losses on securities
arising during the period, net of tax of $1,609
    
    
    
    
    
    
    
    
    
    
    (2,989
    )
    
    
    
    
    
    
    
    
    
    
    (2,989
    )Change in
fair value of interest rate swap, net of tax of ($16)
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    29Less reclassification adjustment for
gains included in net income, net of tax of $3
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )Total other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,965
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,458Balance, June 30, 2008
    
    $
    183
    
    
    $
    168,594
    
    
    $
    (1,788
    )
    
    $
    100,610
    
    
    $
    (499
    )
    
    $
    267,100
  5




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(Unaudited)
 Six Months EndedJune 30,2008
    
    
    2007(Dollars in thousands)Cash Flows from Operating ActivitiesNet Income
    
    $
    38,423
    
    
    $
    20,470Less: Income from discontinued operations
    
    
    23,553
    
    
    
    2,055Income from continuing operations
    
    
    14,870
    
    
    
    18,415Adjustments to reconcile income from continuing operations to
net cash provided by operating activitiesDepreciation and amortization
    
    
    1,656
    
    
    
    689Realized (gains) losses on investments
    
    
    1,811
    
    
    
    (762
    )Deferrals of acquisition costs, net
    
    
    (7,595
    )
    
    
    5,963Deferred income taxes
    
    
    (906
    )
    
    
    (3,511
    )Stock-based compensation expense
    
    
    1,026
    
    
    
    511Increase (decrease) in cash resulting from changes in assets
and liabilitiesPremiums and reinsurance balances receivable
    
    
    (3,717
    )
    
    
    13,920Accrued investment income
    
    
    (251
    )
    
    
    (899
    )Receivable from related entity
    
    
    76
    
    
    
    (50
    )Accrued profit sharing commissions
    
    
    4,409
    
    
    
    (1,803
    )Reinsurance recoverable on paid and unpaid losses
    
    
    (21,985
    )
    
    
    (10,058
    )Prepaid reinsurance premiums
    
    
    5,122
    
    
    
    (32,392
    )Loss and loss adjustment expense reserves
    
    
    47,647
    
    
    
    44,849Unearned premium reserves
    
    
    14,914
    
    
    
    24,899Funds held under reinsurance treaties
    
    
    6,723
    
    
    
    19,268Reinsurance payable on paid losses
    
    
    (1,156
    )
    
    
    1,951Premiums payable to insurance companies
    
    
    (2,437
    )
    
    
    1,054Other
    
    
    (1,585
    )
    
    
    (2,086
    )Net Cash Provided By Operating Activities  Continuing Operations
    
    
    58,622
    
    
    
    79,958Net Cash Provided By Operating Activities  Discontinued Operations
    
    
    2,376
    
    
    
    1,752Net Cash Provided By Operating Activities  Total
    
    
    60,998
    
    
    
    81,710Cash Flows From Investing ActivitiesCost of short-term investments acquired
    
    
    (291,974
    )
    
    
    (224,301
    )Proceeds from disposals of short-term investments
    
    
    262,194
    
    
    
    194,124Cost of debt and equity securities acquired
    
    
    (121,635
    )
    
    
    (99,662
    )Proceeds from debt and equity securities
    
    
    69,863
    
    
    
    30,733Acquisition, net of cash acquired
    
    
    (18,476
    )
    
    
    Cost of fixed asset purchases
    
    
    (543
    )
    
    
    (2,117
    )Net Cash Used In Investing Activities  Continuing Operations
    
    
    (100,571
    )
    
    
    (101,223
    )Net Cash Provided By Investing Activities  Discontinued Operations
    
    
    41,830
    
    
    
    Net Cash Used In Investing Activities  Total
    
    
    (58,741
    )
    
    
    (101,223
    )Cash Flows From Financing ActivitiesIssuance of common stock, net of issuance costs
    
    
    
    
    
    
    12,249Stock issued on stock options exercised
    
    
    600
    
    
    
    Purchase of treasury stock
    
    
    (499
    )
    
    
    Net Cash Provided By Financing Activities
    
    
    101
    
    
    
    12,249Net Increase (Decrease) In Cash and Cash Equivalents
    
    
    2,358
    
    
    
    (7,264
    )Cash and Cash Equivalents, beginning of period
    
    
    18,432
    
    
    
    14,335Cash and Cash Equivalents, end of period
    
    $
    20,790
    
    
    $
    7,071Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    3,199
    
    
    $
    1,911Income taxes
    
    $
    8,000
    
    
    $
    13,415
  6




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Notes to Condensed Consolidated Financial Statements
(Unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
   Use
of Estimates
  Recently Issued Accounting Standards
 Fair Value
Measurements Effective Date of FASB
Statement No. 157
 Business
Combinations (SFAS
141(R))
 Noncontrolling Interests in Consolidated
Financial Statementsan amendment of Accounting Research
Bulletin No. 51 (SFAS 160)
 Disclosures
about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133
(SFAS 161).
 7




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 2. MERGERS AND ACQUISITIONS
 American Management Corporation
     $ in thousandsAssets AcquiredInvestments
    
    $
    8,988Cash and cash equivalents
    
    
    20,012Premiums receivable
    
    
    19,570Other assets
    
    
    1,133Goodwill
    
    
    25,090Intangible assets:Agent relationships
    
    
    9,150Tradename
    
    
    2,130Customer relationships
    
    
    520Total Assets Acquired
    
    $
    86,593Liabilities AssumedPremiums payable to insurance companies
    
    $
    23,218Loss and loss adjustment expense reserves
    
    
    4,490Unearned premium reserves
    
    
    1,734Deferred federal income taxes
    
    
    3,917Accounts payable, accrued expenses, and other liabilities
    
    
    14,745Total Liabilities Assumed
    
    
    48,104Net Assets Acquired
    
    $
    38,489
  8




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 2. MERGERS AND ACQUISITIONS  (Concluded)
   Pro Forma for the
    
    Pro Forma for theThree Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007(Dollars in thousands,
    
    (Dollars in thousands,except per share data)
    
    except per share data)Revenues
    
    $
    57,049
    
    
    $
    60,602
    
    
    $
    112,717
    
    
    $
    119,330Income from continuing operations
    
    
    6,236
    
    
    
    10,680
    
    
    
    14,897
    
    
    
    20,196Income from ontinuing operations per basic share
    
    
    0.34
    
    
    
    0.61
    
    
    
    0.82
    
    
    
    1.16Income from continuing operations per diluted share
    
    
    0.33
    
    
    
    0.59
    
    
    
    0.79
    
    
    
    1.11
 3. DISCONTINUED OPERATIONS
   Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2008
    
    2007
    
    2008
    
    2007(Dollars in thousands,
    
    (Dollars in thousands,except per share data)
    
    except per share data)Revenues
    
    $
    2,908
    
    
    $
    2,839
    
    
    $
    5,884
    
    
    $
    5,642Income Before Income Taxes
    
    $
    1,620
    
    
    $
    1,727
    
    
    $
    3,533
    
    
    $
    3,325
 9




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##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 4. NET INCOME PER SHARE
   Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands, except share and per share data)Income From Continuing Operations
    
    $
    6,236
    
    
    $
    9,435
    
    
    $
    14,870
    
    
    $
    18,415Income From Discontinued Operations
    
    
    22,467
    
    
    
    1,069
    
    
    
    23,553
    
    
    
    2,055Net income available to common
    
    $
    28,703
    
    
    $
    10,504
    
    
    $
    38,423
    
    
    $
    20,470Weighted-average number of common and common equivalent shares outstanding:Basic number of common shares outstanding
    
    
    18,259,602
    
    
    
    17,428,006
    
    
    
    18,182,832
    
    
    
    17,380,219Dilutive effect of stock options
    
    
    678,837
    
    
    
    823,432
    
    
    
    616,572
    
    
    
    831,270Dilutive effect of unvested restricted stock
    
    
    4,823
    
    
    
    2,577
    
    
    
    4,315
    
    
    
    9,069Dilutive number of common and common equivalent shares outstanding
    
    
    18,943,262
    
    
    
    18,254,015
    
    
    
    18,803,719
    
    
    
    18,220,558Basic Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.34
    
    
    $
    0.54
    
    
    $
    0.82
    
    
    $
    1.06Income from Discontinued Operations
    
    
    1.23
    
    
    
    0.06
    
    
    
    1.30
    
    
    
    0.12Total
    
    $
    1.57
    
    
    $
    0.60
    
    
    $
    2.12
    
    
    $
    1.18Diluted Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.33
    
    
    $
    0.52
    
    
    $
    0.79
    
    
    $
    1.01Income from Discontinued Operations
    
    
    1.19
    
    
    
    0.06
    
    
    
    1.25
    
    
    
    0.11Total
    
    $
    1.52
    
    
    $
    0.58
    
    
    $
    2.04
    
    
    $
    1.12Anti-dilutive shares excluded from diluted net income per common share
    
    
    932,188
    
    
    
    95,292
    
    
    
    932,188
    
    
    
    49,273
 10




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 5. INCOME TAXES
 Accounting for Uncertainty
in Income Taxes, an Interpretation of SFAS No. 109 Accounting for Income Taxes,
   6. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)Balance,beginning of period
    
    $
    301,314
    
    
    $
    211,271
    
    
    $
    272,365
    
    
    $
    191,013Less reinsurance recoverables
    
    
    103,068
    
    
    
    69,126
    
    
    
    91,444
    
    
    
    66,926Net Balance,beginning of period
    
    
    198,246
    
    
    
    142,145
    
    
    
    180,921
    
    
    
    124,087AUIC net reserves, date of acquisition
    
    
    
    
    
    
    
    
    
    
    4,490
    
    
    
    Incurred Related ToCurrent year
    
    
    25,732
    
    
    
    23,225
    
    
    
    49,177
    
    
    
    47,294Prior years
    
    
    
    
    
    
    (737
    )
    
    
    
    
    
    
    (852
    )Total Incurred
    
    
    25,732
    
    
    
    22,488
    
    
    
    49,177
    
    
    
    46,442Paid Related ToCurrent year
    
    
    2,004
    
    
    
    977
    
    
    
    2,338
    
    
    
    1,154Prior years
    
    
    11,381
    
    
    
    5,179
    
    
    
    21,657
    
    
    
    10,898Total Paid
    
    
    13,385
    
    
    
    6,156
    
    
    
    23,995
    
    
    
    12,052Net Balance
    
    
    210,593
    
    
    
    158,477
    
    
    
    210,593
    
    
    
    158,477Plus reinsurance recoverables
    
    
    113,909
    
    
    
    77,385
    
    
    
    113,909
    
    
    
    77,385Balance,end of period
    
    $
    324,502
    
    
    $
    235,862
    
    
    $
    324,502
    
    
    $
    235,862
 11




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 7. REINSURANCE
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)Written PremiumsDirect
    
    $
    75,761
    
    
    $
    74,217
    
    
    $
    151,974
    
    
    $
    133,551Assumed
    
    
    4,153
    
    
    
    3,101
    
    
    
    9,146
    
    
    
    4,367Ceded
    
    
    (27,673
    )
    
    
    (33,241
    )
    
    
    (50,376
    )
    
    
    (59,381
    )Net Written Premiums
    
    $
    52,241
    
    
    $
    44,077
    
    
    $
    110,744
    
    
    $
    78,537Earned PremiumsDirect
    
    $
    69,571
    
    
    $
    56,818
    
    
    $
    138,224
    
    
    $
    110,192Assumed
    
    
    4,231
    
    
    
    2,751
    
    
    
    7,983
    
    
    
    3,837Ceded
    
    
    (27,818
    )
    
    
    (17,410
    )
    
    
    (55,497
    )
    
    
    (28,474
    )Earned but unbilled premiums
    
    
    575
    
    
    
    1,412
    
    
    
    (580
    )
    
    
    2,945Net Earned Premiums
    
    $
    46,559
    
    
    $
    43,571
    
    
    $
    90,130
    
    
    $
    88,500
    8. RELATED PARTY TRANSACTIONS
  9. HYBRID INSTRUMENTS
 Accounting for Certain Hybrid Financial Instruments Accounting for Derivative Instruments and
Hedging Activities
 12




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 9. HYBRID INSTRUMENTS  (Concluded)
  10. STOCK COMPENSATION PLANS
   13




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 10. STOCK COMPENSATION PLANS  (Continued)
  1998 Plan
    
    
    Omnibus PlanWeighted Average
    
    
    
    
    
    
    Weighted AverageNumber of Options
    
    
    Exercise Price
    
    
    Number of Options
    
    
    Exercise PriceOustanding at January 1, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    250,000
    
    
    $
    17.00Granted during the period
    
    
    
    
    
    
    
    
    
    
    226,188
    
    
    
    20.74Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at June 30, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    476,188
    
    
    $
    18.78Oustanding at January 1, 2008
    
    
    927,775
    
    
    $
    2.24
    
    
    
    573,688
    
    
    $
    19.10Granted during the period
    
    
    
    
    
    
    
    
    
    
    374,500
    
    
    
    16.38Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    12,700
    
    
    
    18.77Exercised during the period
    
    
    302,575
    
    
    
    1.80
    
    
    
    3,300
    
    
    
    17.00Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at June 30, 2008
    
    
    625,200
    
    
    $
    2.50
    
    
    
    932,188
    
    
    $
    18.02Exercisable at:June 30, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    
    
    
    $
    June 30, 2008
    
    
    625,200
    
    
    
    2.50
    
    
    
    152,566
    
    
    
    18.80
    Options Outstanding
    
    Options ExercisableWeighted-Average
    
    Weighted-Average
    
    
    
    
    
    Weighted-AverageRange of
    
    Outstanding as of
    
    Remaining
    
    Exercise Price Per
    
    Exercisable as of
    
    Exercise Price PerExercisable Price
    
    June 30, 2008
    
    Contractual Life
    
    Share
    
    June 30, 2008
    
    Share1998 Plan$1.73  $1.95
    
    
    508,187
    
    
    3.06 Years
    
    $
    1.72
    
    
    
    508,187
    
    
    $
    1.72$4.86  $6.49
    
    
    117,013
    
    
    
    2.26
    
    
    
    5.92
    
    
    
    117,013
    
    
    
    5.92Total
    
    
    625,200
    
    
    
    2.91
    
    
    
    2.50
    
    
    
    625,200
    
    
    
    2.50Omnibus Plan$14.93  $20.75
    
    
    932,188
    
    
    8.34 Years
    
    $
    18.02
    
    
    
    152,566
    
    
    $
    18.80Total
    
    
    932,188
    
    
    
    8.34
    
    
    
    18.02
    
    
    
    152,566
    
    
    
    18.80
  14




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 10. STOCK COMPENSATION PLANS  (Concluded)
  Six Months EndedJune 30,2008
    
    2007Omnibus PlanExpected term
    
    
    6.0
    
    
    
    5.0Expected stock price volatility
    
    
    29.78
    %
    
    
    26.50
    %Risk-free interest rate
    
    
    3.12
    %
    
    
    4.50
    %Expected dividend yield
    
    
    
    
    
    
    Estimated fair value per option
    
    $
    5.79
    
    
    $
    6.71
 (SAB 110) Share-Based Payment (SFAS 123(R))
   11. FAIR VALUE MEASUREMENT
 Accounting for Certain
Investments in Debt and Equity Securities
 The Fair Value Option of Financial Assets and Financial
Liabilities
 Fair Value Measurements
 15




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 11. FAIR VALUE MEASUREMENT  (Continued)
 Effective Date of FASB Statement No. 157
  
 
 
  16




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Concluded)
(Unaudited)
 11. FAIR VALUE MEASUREMENT  (Concluded)
  Fair Value Measurements UsingTotal
    
    
    Level 1
    
    
    Level 2(Dollars in thousands)Available for sale investments:Fixed maturity securities
    
    $
    408,511
    
    
    $
    6,265
    
    
    $
    402,246Equity securities
    
    
    545
    
    
    
    545
    
    
    
    Short-term investments
    
    
    64,811
    
    
    
    62,647
    
    
    
    2,164Hybrid securities
    
    
    35,726
    
    
    
    
    
    
    
    35,726Alternative investments
    
    
    14,686
    
    
    
    
    
    
    
    14,686Total
    
    $
    524,279
    
    
    $
    69,457
    
    
    $
    454,822
   12. ACCUMULATED OTHER COMPREHENSIVE LOSS
  Six Months EndedJune 30,2008
    
    
    2007(Dollars in thousands)Unrealized holding losses on securities, net of tax
    
    $
    (1,193
    )
    
    $
    (2,691
    )Fair value of interest rate swap, net of tax
    
    
    (595
    )
    
    
    222Total accumulated other comprehensive loss
    
    $
    (1,788
    )
    
    $
    (2,469
    )
 17




---



##### 



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
 ®
     18




---



##### 



Premiums Produced
  Critical Accounting Policies
   Use of Estimates
  Loss and Loss Adjustment Expense Reserves
  19




---



##### 




    
    actuarial projections of what we, at a given time, expect to be the cost of the ultimate
settlement and administration of claims reflecting facts and circumstances then known;
    
    estimates of future trends in claims severity and frequency;
    
    assessment of asserted theories of liability; and
    
    analysis of other factors, such as variables in claims handling procedures, economic
factors, and judicial and legislative trends and actions.
    June 30,
    
    
    December 31,2008
    
    
    2007(Dollars in thousands)GrossCase reserves
    
    $
    85,500
    
    
    
    $  69,699IBNR and ULAE reserves
    
    
    239,002
    
    
    
    202,666Total reserves
    
    $
    324,502
    
    
    
    $272,365Net of reinsuranceCase reserves
    
    $
    62,009
    
    
    
    $  52,668IBNR and ULAE reserves
    
    
    148,584
    
    
    
    128,253Total
    
    $
    210,593
    
    
    
    $180,921
 20




---



##### 



Revenue Recognition
 Premiums
 Commissions and Fees
 Investments
 Accounting for Certain Hybrid Financial Instruments The Fair Value Option of Financial Assets and
Financial Liabilities
  Deferred Policy Acquisition Costs
  Intangible Assets
 Goodwill and Other Intangible Assets,
 Accounting for the Impairment or Disposal of Long-lived
Assets,
 21




---



##### 



Results of Operations
 Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007
  Three Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    46,559
    
    
    $
    43,571
    
    
    
    7
    %Commissions and fees
    
    
    7,086
    
    
    
    2,064
    
    
    
    243Net investment income
    
    
    5,216
    
    
    
    3,870
    
    
    
    35Net realized gains (losses) on investments
    
    
    (1,812
    )
    
    
    627
    
    
    
    (389
    )Total Operating Revenues
    
    
    57,049
    
    
    
    50,132
    
    
    
    14Operating ExpensesLosses and loss adjustment expenses, net
    
    
    25,732
    
    
    
    22,488
    
    
    
    14Amortization of intangible assets
    
    
    515
    
    
    
    167
    
    
    
    208Other operating expenses
    
    
    20,711
    
    
    
    12,199
    
    
    
    70Total Operating Expenses
    
    
    46,958
    
    
    
    34,854
    
    
    
    35Operating Income
    
    
    10,091
    
    
    
    15,278
    
    
    
    (34
    )Interest Expense
    
    
    1,214
    
    
    
    859
    
    
    
    41Income From Continuing Operations Before
Income Taxes
    
    
    8,877
    
    
    
    14,419
    
    
    
    (38
    )Income Taxes
    
    
    2,641
    
    
    
    4,984
    
    
    
    (47
    )Income From Continuing Operations
    
    
    6,236
    
    
    
    9,435
    
    
    
    (34
    )%Income From Discontinued Operations,
Net of Income Taxes
    
    
    22,467
    
    
    
    1,069
    
    
    
    2,002Net Income
    
    $
    28,703
    
    
    $
    10,504
    
    
    
    173
    %Loss Ratio
    
    
    55.3
    %
    
    
    51.6
    %
    
    3.7 pointsUnderwriting Expense Ratio
    
    
    28.7
    %
    
    
    22.4
    %
    
    6.3 pointsCombined Ratio
    
    
    84.0
    %
    
    
    74.0
    %
    
    10.0 points
 Premiums Produced
  22




---



##### 



Operating Revenue
 Net Earned Premiums
 Three Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    75,761
    
    
    $
    74,217
    
    
    
    2
    %Assumed
    
    
    4,153
    
    
    
    3,101
    
    
    
    34Ceded
    
    
    (27,673
    )
    
    
    (33,241
    )
    
    
    (17
    )Net written premiums
    
    $
    52,241
    
    
    $
    44,077
    
    
    
    19
    %Earned premiumsDirect
    
    $
    69,571
    
    
    $
    56,818
    
    
    
    22
    %Assumed
    
    
    4,231
    
    
    
    2,751
    
    
    
    54Ceded
    
    
    (27,818
    )
    
    
    (17,410
    )
    
    
    60Earned but unbilled premiums
    
    
    575
    
    
    
    1,412
    
    
    
    (59
    )Net earned premiums
    
    $
    46,559
    
    
    $
    43,571
    
    
    
    7
    %
     23




---



##### 



Commissions and Fees
 Three Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    1,426
    
    
    $
    2,064
    
    
    
    (31
    )%Insurance services commissions and fees
    
    
    5,660
    
    
    
    
    
    
    
    N/MTotal commissions and fees
    
    $
    7,086
    
    
    $
    2,064
    
    
    
    243
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Operating Expenses
 Losses and Loss Adjustment Expenses
 Other Operating Expenses
 Three Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    9,096
    
    
    $
    7,557
    
    
    
    20
    %Ceded reinsurance commissions
    
    
    (8,313
    )
    
    
    (10,611
    )
    
    
    (22
    )Other underwriting and operating expenses
    
    
    19,928
    
    
    
    15,253
    
    
    
    31Other operating expenses
    
    $
    20,711
    
    
    $
    12,199
    
    
    
    70
    %
  24




---



##### 



Interest Expense
  Income taxes
 Discontinued Operations
 25




---



##### 



Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007
  Six Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    90,130
    
    
    $
    88,500
    
    
    
    2
    %Commissions and fees
    
    
    11,139
    
    
    
    3,917
    
    
    
    184Net investment income
    
    
    10,064
    
    
    
    7,164
    
    
    
    40Net realized gains (losses) on investments
    
    
    (1,811
    )
    
    
    762
    
    
    
    338Total Operating Revenues
    
    
    109,522
    
    
    
    100,343
    
    
    
    9Operating ExpensesLosses and loss adjustment expenses, net
    
    
    49,177
    
    
    
    46,442
    
    
    
    6Amortization of intangible assets
    
    
    913
    
    
    
    333
    
    
    
    174Other operating expenses
    
    
    34,908
    
    
    
    23,603
    
    
    
    48Total Operating Expenses
    
    
    84,998
    
    
    
    70,378
    
    
    
    21Operating Income
    
    
    24,524
    
    
    
    29,965
    
    
    
    (18
    )Interest Expense
    
    
    3,114
    
    
    
    1,949
    
    
    
    60Income From Continuing Operations BeforeIncome Taxes
    
    
    21,410
    
    
    
    28,016
    
    
    
    (24
    )Income Taxes
    
    
    6,540
    
    
    
    9,601
    
    
    
    (32
    )Income from Continuing Operations
    
    
    14,870
    
    
    
    18,415
    
    
    
    (19
    )Income from Discontinued Operations,
Net of Income Taxes
    
    
    23,553
    
    
    
    2,055
    
    
    
    1,046Net Income
    
    $
    38,423
    
    
    $
    20,470
    
    
    
    88
    %Loss Ratio
    
    
    54.6
    %
    
    
    52.5
    %
    
    2.1 pointsUnderwriting Expense Ratio
    
    
    25.1
    %
    
    
    21.4
    %
    
    3.7 pointsCombined Ratio
    
    
    79.7
    %
    
    
    73.9
    %
    
    5.8 points
 Premiums Produced
  26




---



##### 



Operating Revenue
 Net Earned Premiums
 Six Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    151,974
    
    
    $
    133,551
    
    
    
    14
    %Assumed
    
    
    9,146
    
    
    
    4,367
    
    
    
    109Ceded
    
    
    (50,376
    )
    
    
    (59,381
    )
    
    
    (15
    )Net written premiums
    
    $
    110,744
    
    
    $
    78,537
    
    
    
    41
    %Earned premiumsDirect
    
    $
    138,224
    
    
    $
    110,192
    
    
    
    25
    %Assumed
    
    
    7,983
    
    
    
    3,837
    
    
    
    108Ceded
    
    
    (55,497
    )
    
    
    (28,474
    )
    
    
    95Earned but unbilled premiums
    
    
    (580
    )
    
    
    2,945
    
    
    
    (120
    )Net earned premiums
    
    $
    90,130
    
    
    $
    88,500
    
    
    
    2
    %
     27




---



##### 



Commissions and Fees
 Six Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    2,755
    
    
    $
    3,917
    
    
    
    (30
    )%Insurance services commissions and fees
    
    
    8,384
    
    
    
    
    
    
    
    N/MTotal commissions and fees
    
    $
    11,139
    
    
    $
    3,917
    
    
    
    184
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Operating Expenses
 Losses and Loss Adjustment Expenses
 Other Operating Expenses
 Six Months EndedJune 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    17,310
    
    
    $
    16,296
    
    
    
    6
    %Ceded reinsurance commissions
    
    
    (16,795
    )
    
    
    (18,098
    )
    
    
    (7
    )Other underwriting and operating expenses
    
    
    34,393
    
    
    
    25,405
    
    
    
    35Other operating expenses
    
    $
    34,908
    
    
    $
    23,603
    
    
    
    48
    %
  28




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##### 



Interest Expense
  Income
taxes
 Discontinued Operations
 Liquidity and Capital Resources
 Sources and Uses of Funds
 FMFC
 Insurance Subsidiaries
  Non-insurance Subsidiaries
 29




---



##### 



Cash Flows
  Six Months EndedJune 30,2008
    
    
    2007(Dollars in thousands)Cash and cash equivalents provided by (used in):Operating activities  continuing operations
    
    $
    58,622
    
    
    $
    79,958Operating activities  discontinued operations
    
    
    2,376
    
    
    
    1,752Investing activities  continuing operations
    
    
    (100,571
    )
    
    
    (101,223
    )Investing activities  discontinued operations
    
    
    41,830
    
    
    
    Financing activities
    
    
    101
    
    
    
    12,249Change in cash and cash equivalents
    
    $
    2,358
    
    
    $
    (7,264
    )
       Long-term debt
 Junior Subordinated Debentures
 30




---



##### 



31




---



##### 



Credit Facility
 Derivative Financial Instruments
 Cash and Invested Assets
  June 30, 2008Market Value
    
    
    % of Portfolio(Dollars in thousands)Money Market Funds
    
    $
    62,646
    
    
    
    11.9
    %Certificates of Deposit
    
    
    2,164
    
    
    
    0.4
    %Treasury Securities
    
    
    6,265
    
    
    
    1.2
    %Agency Securities
    
    
    1,454
    
    
    
    0.3
    %Corp / Preferred
    
    
    63,034
    
    
    
    12.0
    %Municipal Bonds
    
    
    211,495
    
    
    
    40.3
    %Asset backed Securities
    
    
    49,346
    
    
    
    9.4
    %Mortgages
    
    
    76,918
    
    
    
    14.7
    %Convertible Securities
    
    
    35,726
    
    
    
    6.8
    %High Yield Convertible Fund
    
    
    9,686
    
    
    
    1.9
    %Structured Finance Fund
    
    
    5,000
    
    
    
    1.0
    %Common Stock
    
    
    545
    
    
    
    0.1
    %Total
    
    $
    524,279
    
    
    
    100.0
    %
  32




---



##### 



% of TotalAverage Life
    
    InvestmentLess than one year
    
    
    21.9
    %One to two years
    
    
    8.9
    %Two to three years
    
    
    15.0
    %Three to four years
    
    
    16.9
    %Four to five years
    
    
    12.5
    %Five to seven years
    
    
    11.0
    %More than seven years
    
    
    13.8
    %Total
    
    
    100.0
    %
   % of TotalS&P Rating
    
    InvestmentsAAA
    
    
    59.3
    %AA
    
    
    20.9
    %A
    
    
    10.7
    %BBB
    
    
    5.3
    %BB
    
    
    1.4
    %B
    
    
    2.2
    %CCC
    
    
    0.1
    %NR
    
    
    0.1
    %Total
    
    
    100.0
    %
    33




---



##### 



Deferred Policy Acquisition Costs
  34




---



##### 



Reinsurance
  Six Months EndedJune 30,2008
    
    
    2007(Dollars in thousands)Direct written premiums
    
    $
    151,974
    
    
    $
    133,551Ceded written premiums
    
    
    50,376
    
    
    
    59,381Net written premiums
    
    $
    101,598
    
    
    $
    74,170Ceded written premiums as percentage of direct written premiums
    
    
    33.1
    %
    
    
    44.5
    %
  Six Months EndedJune 30,2008
    
    2007(Dollars in thousands)Ceded written premiums
    
    $
    50,376
    
    
    $
    59,381Ceded premiums earned
    
    
    55,497
    
    
    
    28,474Losses and loss adjustment expenses ceded
    
    
    29,347
    
    
    
    14,282Ceding commissions
    
    
    19,716
    
    
    
    8,365
    Recent Accounting Pronouncements
 Fair Value Measurements Effective Date of FASB Statement No. 157
 35




---



##### 



Business Combinations (SFAS 141(R))
 Noncontrolling Interests in Consolidated
Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160)
 Disclosures about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133 (SFAS 161).
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  36




---



##### 



PART II.  OTHER INFORMATION
 
 Item 4. Submission of Matters to a Vote of Security Holders
  (i)
    
    elected to the Board of Directors of First Mercury Financial Corporation three class III
directors; and(ii)
    
    ratified the appointment of BDO Seidman, LLP as independent registered public accounting
firm for the Company for the year ending December 31, 2008.
   Director Nominee
    
    Votes For
    
    Votes WithheldLouis J. Manetti
    
    
    14,813,302
    
    
    
    2,640,066Robert A. Oakley, Ph.D
    
    
    15,800,910
    
    
    
    1,652,458Hollis W. Rademacher
    
    
    15,801,440
    
    
    
    1,651,928
  For
    
    Against
    
    AbstainRatification of appointment of BDO Seidman, LLP
    
    
    17,335,987
    
    
    
    116,939
    
    
    
    442
 
 Item 6. Exhibits
  37




---



##### 



SIGNATURES
  FIRST MERCURY FINANCIAL CORPORATIONBy:
    /s/ RICHARD  H. SMITHRichard H. SmithChairman, President  and Chief Executive OfficerBy:
    /s/ JOHN A. MARAZZAJohn A. MarazzaExecutive Vice President and Chief Financial OfficerDate:
    August 8, 2008 38




---



##### 



INDEX OF EXHIBITS
 ExhibitNumber
    
    Note
    
    Description31 (a)
    
    
    (1
    )
    
    Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 193431 (b)
    
    
    (1
    )
    
    Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 193432 (a)
    
    
    (1
    )
    
    Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the
Securities Exchange Act of 193432 (b)
    
    
    (1
    )
    
    Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the
Securities Exchange Act of 1934
 
 (1)
    
    - Filed herewith 39