The unaudited pro forma results should not be considered indicative of actual results that would have been achieved had the USAuto acquisition and related transactions been consummated on July 1, 2002 and do not purport to indicate results of operations for any future period.
Prior to our April 30, 2004 acquisition of USAuto Holdings, Inc., we were engaged in pursuing opportunities to acquire one or more operating companies. In addition, we marketed for sale a portfolio of foreclosed real estate. We will continue to market the remaining real estate held (consisting of six tracts of land in San Antonio, Texas) and will attempt to sell it on a basis that provides us with the best economic return. We do not anticipate any new investments in real estate, although we acquired a tract of land adjacent to one of our properties for $0.3 million in December 2004 to enhance the marketability of the adjacent parcel.
Effective January 1, 2005, we acquired the assets (principally the book of business and retail locations) of a non-standard automobile insurance agency in Texas for $4.0 million in cash. As of September 1, 2005, we leased 334 retail locations, staffed by employee-agents. Our employee-agents exclusively sell insurance products underwritten by us. We write non-standard personal automobile insurance in 11 states and we are licensed as an insurer in 13 additional states.
Our consolidated financial statements now vary in important respects from our historical consolidated financial statements due to the acquisition of USAuto. For the year ended June 30, 2004, the recorded financial results reflect twelve months of our previous operations, but only the two months of results of the insurance operations following the April 30, 2004 acquisition date. The year ended June 30, 2005 reflects primarily the results from our insurance operations for the full year.
The acquisition of USAuto was accounted for using the purchase method of accounting. The consideration consisted of $76.0 million in cash, 13,250,000 shares of our common stock issued at closing and 750,000 shares issued upon the attainment of certain financial targets. The aggregate purchase price of $166.8 million was allocated to the tangible and intangible assets acquired and the liabilities assumed based upon their respective fair values as of the date of the acquisition. Total goodwill and identifiable intangible assets recorded from the acquisition were $110.0 million, which was net of a $41.3 million reduction in our deferred tax allowance based upon our projections of USAuto’s future taxable income. Of the purchase price, $1.2 million was allocated to an identifiable intangible asset relating to future policy renewals existing as of April 30, 2004. This asset is amortizable and resulted in amortization expense of $0.7 million and $0.4 million for the years ended June 30, 2005 and 2004, respectively. Amortization expense for the year ending June 30, 2006 will be $0.1 million.
commission income paid by our reinsurer to us for ceded premiums (through the September 1, 2004 non-renewal of our quota share reinsurance); and
The following table presents gross premiums earned by state for the insurance operations separately for policies written by the insurance company subsidiaries and for policies issued by the MGA subsidiaries on behalf of other insurance companies (which are now all assumed 100% by us through quota share reinsurance contracts), on both an actual and a pro forma basis for the periods presented. We believe this table illustrates the total gross premiums serviced by us and under our control.
Insurance companies present a combined ratio as a measure of their overall underwriting profitability. The components of the combined ratio are as follows:
The non-standard personal automobile insurance industry is cyclical in nature. In the past, the industry has been characterized by periods of price competition and excess capacity followed by periods of high premium rates and shortages of underwriting capacity. If new competitors enter this market, existing competitors may attempt to increase market share by lowering rates. Such conditions could lead to reduced prices, which would negatively impact USAuto’s revenues and profitability. However, we believe that between 2002 and 2004, the underwriting results in the personal automobile insurance industry improved as a result of favorable pricing and competitive
Fiscal Year Ended June 30, 2005 Compared With Fiscal Year Ended June 30, 2004
Net income per share for the year ended June 30, 2005 was $0.56 and $0.53 on a basic and diluted basis, respectively, as compared to a net loss per share of $0.15 on both a basic and diluted basis for the year ended June 30, 2004. The weighted average shares outstanding increased as a result of the additional shares issued in the April 2004 rights offering and the USAuto acquisition, as well as the 750,000 contingent shares issued effective December 31, 2004 in connection with the USAuto acquisition.
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. Such decrease was a result of taxable income for the year ended June 30, 2005 exceeding the estimate used by management in establishing the valuation allowance at June 30, 2004 in addition to a revision in management’s estimate for our future taxable income based on the results for the most recent fiscal year. Net income per share for the year ended June 30, 2005 was increased by $0.23 and $0.22 on a basic and diluted basis, respectively, as a result of this change in the valuation allowance.
On a pro forma basis, income before income taxes for the year ended June 30, 2004 was $16.6 million compared to actual income before income taxes of $25.6 million for the year ended June 30, 2005.
Net premiums earned increased by 129% to $132.3 million for the year ended June 30, 2005 from $57.7 million on a pro forma basis for the year ended June 30, 2004. A significant part of this increase is the result of eliminating our 50% quota share reinsurance on the September 1, 2004 renewal date. As a result, our reinsurance was only in effect for two months of year ended June 30, 2005 and for all of the year ended June 30, 2004. Had we renewed the 50% quota share reinsurance, net premiums earned would have been reduced by $49.5 million for the year ended June 30, 2005.
To a lesser extent, net premiums earned also increased as we continued to write more of our insurance business in Georgia through our insurance company subsidiaries rather than through our managing general agency (“MGA”) operations for other insurance companies. Gross premiums earned through the Georgia MGA operations decreased from $11.6 million for the year ended June 30, 2004 to $2.4 million for the year ended June 30, 2005.
The expense ratio increased from 15.8% for the year ended June 30, 2004 to 17.7% for the year ended June 30, 2005. Operating expenses incurred for new retail locations contributed to the increase in the expense ratio. In addition, the expense ratio has also increased as a result of declining fee income from ancillary products (which reduces expenses in calculating the expense ratio), and the fact that this fee income was spread over a larger base of net premiums earned as result of not renewing the quota share reinsurance. To a lesser extent, the expense ratio also increased as net operating expenses increased due to the elimination of ceding commissions received, which were at a slightly lesser rate than actual operating expenses incurred. The increase for the year ended June 30, 2005, however, was tempered by the additional ceding commission of $1.0 million.
On a pro forma basis, income before taxes for the year ended June 30, 2004 was $2.0 million. These results exclude compensation of terminated employees and reflect only the real estate operations and costs related to acquisition opportunities. The results also reflect interest expense on USAuto’s note payable.
Fiscal Year Ended June 30, 2004 Compared With Fiscal Year Ended June 30, 2003
Loss before income taxes for the year ended June 30, 2004 was $9.2 million versus a loss before income taxes of $1.9 million for the year ended June 30, 2003.
Gains on sales of foreclosed real estate for the year ended June 30, 2004 were $4.1 million resulting from the sale of a total of ten parcels, as compared to $0.2 million for fiscal 2003. Gains on sales of real estate represents proceeds received from the sale of foreclosed real estate in excess of carrying value, less selling costs.
Stock-based compensation for the year ended June 30, 2004 was $7.9 million compared to $0.5 million for fiscal 2003. This increase was primarily the result of recognizing the expense for the immediate vesting, upon his termination, of nonqualified stock options granted to our former President and Chief Executive Officer, Donald J. Edwards, for an option to purchase 2,573,678 shares of our common stock at an exercise price of $3.00 per share. Additionally, this expense also includes the cost associated with an option to purchase 1,152,000 shares granted to Mr. Edwards as a result of the rights offering in accordance with the anti-dilution terms of his employment agreement, and options to purchase 392,000 shares granted to other former employees.
Prior to the USAuto acquisition, our historical funding requirements were operating expenses, including legal, audit, and consulting expenses incurred in connection with evaluation of potential acquisition candidates and other strategic opportunities. Our historical primary sources of funding for operating expenses were proceeds from the sales of foreclosed real estate, investment income on cash and cash equivalents, and cash on hand.
Since the completion of the USAuto acquisition, our liquidity and capital resources have become more reflective of those of a vertically-integrated insurance company, performing all sales, servicing and underwriting of non-standard personal automobile insurance. Our primary sources of funds are from premiums received, commission and fee income and investment income. Funds are used to pay claims and operating expenses.
Operating activities for the year ended June 30, 2005 provided $45.4 million of cash compared to $.5 million used in the prior year. The increase is the direct result of the inclusion of our insurance operations in the current period.
Net cash used by investing activities for the year ended June 30, 2005 was $55.2 million as compared to $67.5 million used in the prior year. The fiscal 2005 results primarily reflects the additions to our investment portfolio as well as the $4.0 expended to fund the Texas acquisition. The fiscal 2004 results include the net cash of $72.4 million used in the acquisition of USAuto, $49.4 million of which was provided from the net proceeds of the issuance of stock in a rights offering in April 2004.
During the year ended June 30, 2005, we increased the statutory capital and surplus of the insurance company subsidiaries by $9.5 million to support additional premium writings. At June 30, 2005, we had $11.2 million available in unrestricted cash and investments outside of the insurance company subsidiaries.
In April 2005, we used $3.3 million of cash to repay in full our note payable to a financial institution. This term loan was repaid ahead of its contractual maturity to eliminate interest expense of LIBOR plus 366 basis points. This prepayment resulted in a $0.1 million charge related to unamortized loan costs.
State insurance laws limit the amount of dividends that may be paid from the insurance company subsidiaries. These limitations relate to statutory capital and surplus and net income. In addition, the National Association of Insurance Commissioners Model Act for risk-based capital (“RBC”) provides formulas to determine the amount of statutory capital and surplus that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. A low RBC ratio would prevent an insurance company from paying dividends.
The following table summarizes all of our contractual obligations by period as of June 30, 2005:
Valuation of deferred tax asset. Income taxes are maintained in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” whereby deferred income tax assets and liabilities result from temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and operating loss and tax credit carryforwards and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. Valuation of the deferred tax asset is considered a critical accounting policy because the determination of our ability to utilize the asset involves a number of management assumptions relating to future operations that could materially affect the determination of the ultimate value and, therefore, the carrying amount of our deferred tax asset.
Losses and loss adjustment expense reserves. Months and sometimes years may elapse between the occurrence of an automobile accident covered by one of our insurance policies, the reporting of the accident and the payment of the claim. We record a liability for estimates of losses that will be paid for accidents that have been reported, which is referred to as case reserves. In addition, since accidents are not always reported when they occur, we estimate liabilities for accidents that have occurred but have not been reported, which are referred to herein as “incurred but not reported,” or IBNR reserves.
Goodwill and identifiable intangible assets. The USAuto and Texas acquisitions resulted in goodwill of $104.0 million and $3.8 million, respectively. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. These acquisitions also resulted in other identifiable intangible assets with a current book value of $4.9 million. As required by SFAS No. 142 “Goodwill and Other Intangible Assets,” we perform an annual impairment test of goodwill and identifiable intangible assets. If impairment indicators exist between the annual testing periods, management will perform an interim impairment test. Should either an annual or interim impairment test determine that the fair value of USAuto or the Texas operations is below the carrying value, a write-down of these assets will be required. In evaluating whether impairment exists, management also considers the fair value in excess of the carrying value for certain assets. At June 30, 2005, impairment tests were performed and in management’s opinion, no impairment exists.
In November 2003, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force (“EITF”) 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The guidance applies to all investment securities accounted for under SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” EITF 03-1 provides guidance in identifying whether an unrealized loss on an investment security should be treated as an other-than-temporary impairment of the security’s recorded value. Among other things, the guidance provides that other-than-temporary impairment loss recognition would depend on market conditions, management’s intent and a company’s ability to hold a potentially impaired security for a period sufficient for recovery of the loss. In September 2004, the FASB delayed the effective date of many provisions of EITF 03-1 until certain implementation issues could be resolved. The full impact on our financial statements of EITF 03-1 will not be determined until the final guidance is available.
statements from our use of the words “may,” “should,” “could,” “potential,” “continue,” “plan,” “forecast,” “estimate,” “project,” “believe,” “intent,” “anticipate,” “expect,” “target,” “is likely,” “will,” or the negative of these terms, and similar expressions. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may include, among other things:
We believe that our expectations are based on reasonable assumptions. However, these forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results to differ materially from our expectations of future results, performance or achievements expressed or implied by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. We discuss these and other uncertainties in the “Business - Risk Factors” section of this report.
Consolidated Statements of Cash Flows for the Years Ended June 30, 2005, 2004 and 2003
We have audited the accompanying consolidated balance sheets of First Acceptance Corporation and subsidiaries (the Company) as of June 30, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended June 30, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 9, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, that First Acceptance Corporation and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of June 30, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Since August 1996, the Company had been actively pursuing opportunities to acquire one or more operating companies in order to increase value to existing stockholders and to provide a new focus and direction for the Company. The Company’s primary objective had been to seek long-term growth through an acquisition of a business rather than short-term earnings. As further discussed in Note 2, to that end, on April 30, 2004, the Company acquired USAuto Holdings, Inc. (“USAuto”) for consideration consisting of $76.0 million in cash, 13,250 shares of the Company’s common stock, and an additional 750 shares of common stock that were issued effective December 31, 2004 upon the attainment of certain financial targets. A portion of the cash consideration was raised in a stock rights offering.
Realized gains and losses on sales of securities are computed based on specific identification.
Deferred acquisition costs include premium taxes and other variable underwriting and direct sales costs incurred in connection with writing business. These costs are deferred and amortized, net of deferred ceding commission income from our reinsurer, over the policy period in which the related premiums are earned.
Loss and loss adjustment expense reserves are undiscounted (except for the purchase accounting as discussed below) and represent case-basis estimates of reported losses and estimates based on certain actuarial assumptions regarding the past experience of reported losses, including an estimate of losses incurred but not reported (“IBNR”). Management believes that the losses and loss adjustment reserves are adequate to cover the ultimate liability. However, such estimate may be more or less than the amount ultimately paid when the claims are finally settled.
Under purchase accounting, the fair value of loss and loss adjustment expense reserves and related reinsurance recoverables as of the April 30, 2004 acquisition date was estimated based on the present value of the expected underlying cash flows of the loss reserves and reinsurance recoverables, and included a profit and risk margin. In determining the fair value estimate, USAuto’s historical undiscounted net loss reserves were adjusted to present value assuming a 1.5% discount rate, which approximated the two-year U.S. Treasury rate. The discounting pattern was actuarially developed from USAuto’s historical loss data. An estimated profit and risk margin of 4% was then applied to the discounted loss reserves to reflect an estimate of the cost USAuto would incur to reinsure the full amount of the net loss and loss adjustment expense reserves with a third party reinsurer. This margin was based upon management’s assessment of the uncertainty inherent in the net loss reserves and our knowledge of the reinsurance marketplace. For the years ended June 30, 2005 and 2004, $219 and $214, respectively, of the net margin/discount were accreted to income.
Motor club fees written by an affiliate are earned on a pro-rata basis over the respective terms of the contracts. Fees are paid monthly by motor club members and are generally collected in advance of providing coverage, minimizing the Company’s exposure to credit risk.
In November 2003, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force (“EITF”) 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The guidance applies to all investment securities accounted for under SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” EITF 03-1 provides guidance in identifying whether an unrealized loss on an investment security should be treated as an other-than-temporary impairment of the security’s recorded value. Among other things, the guidance provides that other-than-temporary impairment loss recognition would depend on market conditions, management’s intent and a company’s ability to hold a potentially impaired security for a period sufficient for recovery of the loss. In September 2004, the FASB delayed the effective date of many provisions of EITF 03-1 until certain implementation issues could be resolved. The full impact on the Company’s financial statements of EITF 03-1 will not be determined until the final guidance is available.
In December 2004, the FASB issued SFAS No. 123 (Revised), “Share Based Payment,” (“SFAS No. 123(R).” SFAS No. 123(R), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” supersedes Accounting Procedures Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition). SFAS No. 123(R) is effective for public companies at the beginning of the first annual period beginning after June 15, 2005. The Company has already adopted the provisions of SFAS No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure” and uses the fair value method for expensing stock-based compensation. However, the Company continues to analyze the expected impact of SFAS No. 123(R).
During the years ended June 30, 2005 and 2004, the Company paid $1,775 and $670, respectively, in income taxes and $233 and $44, respectively, in interest.
Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares, while diluted net income per share is computed by
Effective July 1, 2003, the Company adopted the prospective method provisions of SFAS No. 148 in accounting for employee stock options and subscriptions to purchase shares under the Company’s Employee Stock Purchase Plan. Compensation expense is calculated under the fair value method and is recorded on a straight-line basis over the vesting period.
Prior to July 1, 2003, the Company applied Accounting Principles Board (“APB”) Opinion No. 25 in accounting for employee stock options. Under ABP No. 25, the difference between the aggregate market value and exercise price of the securities underlying the stock options at grant date, or intrinsic value, is recorded as compensation expense on a straight-line basis over the vesting period. If the employee stock options had been accounted for under SFAS No. 123, the fair value of the stock options would have been recorded as compensation expense on a straight-line basis over the vesting period. The following table, as prescribed by SFAS No. 148, illustrates the effect on net loss and net loss per share for the years ended June 30, 2004 and 2003 if the Company had applied the fair value recognition provisions of SFAS No. 123 to all stock-based compensation. The fair value of the options awarded was estimated at the grant date using the Black-Scholes option pricing model, which includes the following assumptions: risk-free interest rate based on the ten-year U.S. Treasury Note rate; expected option life of ten years; expected volatility of 36% to 38%; and no expected dividends.
There is no effect for the year ended June 30, 2005 since all stock options issued under APB No. 25 were fully vested prior to July 1, 2004.
On April 30, 2004, the Company consummated an agreement dated December 15, 2003 to acquire 100% of the outstanding common stock of USAuto. The results of USAuto’s operations have been included in the consolidated financial statements since that date.
As a result of the USAuto acquisition, management reduced the Company’s deferred tax allowance by $41,277 based upon internally-prepared projected operating results for USAuto and such amount was recorded as a reduction in goodwill.
At June 30, 2005, the Insurance Companies had fixed maturities and cash with a market value of $6,227 (amortized cost of $6,039) on deposit with various insurance departments as a requirement of doing business in those states.
The composition of the portfolio at June 30, 2005 and 2004 was as follows:
Prior to September 1, 2004, the Company reinsured risks on a quota-share basis with another insurance organization to provide it with additional underwriting capacity and minimize its risk. Such reinsurance was nonrenewed as of that date on a cut-off basis whereby the reinsurer is not liable for any losses occurring after such date. Subsequent to this date, the Company utilizes only excess-of-loss basis reinsurance for catastrophic auto physical damage exposures. Although the reinsurance agreements contractually obligate the reinsurers to reimburse the Company for their share of losses, they do not discharge the primary liability of the Company, who remains contingently liable in the event the reinsurers are unable to meet their contractual obligations. The Company evaluates the financial condition of its reinsurers and monitor concentrations of credit risk to minimize its exposure to significant losses from reinsurer insolvencies.
At June 30, 2005, the Insurance Companies had an unsecured aggregate reinsurance recoverable of $4,490 from Transatlantic Reinsurance Company. Such amount included $3,608 related to unpaid losses (including IBNR), $353 related to paid losses recoverable and $529 in accrued ceding commission income.
The net change in the valuation allowance for the years ended June 30, 2005, 2004 and 2003 was a (decrease) increase of ($10,594), ($39,171), and $632, respectively. Prior to the acquisition of USAuto, a full valuation allowance had been established, as management believed that it was more likely than not that the Company would not realize the benefits of the loss carryforwards. However, as result of the acquisition, management reduced the valuation allowance based upon internally-prepared projected operating results. Subsequently, such projections were revised after considering the actual results for the year ended June 30, 2005, and the allowance was further reduced.
The following table sets forth the computation of basic and diluted net income per share for the year ended June 30, 2005:
The Employment Agreement further granted Mr. Edwards, as an inducement to his employment with the Company, the right to purchase up to 333 shares of common stock of the Company (the “Purchased Shares”) at a price of $3.00 per share. Mr. Edwards purchased 166 and 167 shares contemplated by the Employment Agreement on July 9, 2002 and June 30, 2003, respectively. The aggregate market value of the Purchased Shares at the grant date was $1,200. The difference between the aggregate market value and purchase price of the Purchased Shares of $200 was recorded as stock-based compensation expense in the consolidated statement of operations for the year ended June 30, 2003.
Employees of the Company are eligible to participate in the Employee Stock Purchase Plan (the “Plan”). Plan participants can authorize payroll deductions, administered through an independent plan custodian, of up to
Summarized balance sheets, statements of operations and statements of cash flows of First Acceptance Corporation (parent company), are presented below:
Information regarding the reserve for unpaid losses and loss adjustment expenses is as follows.
The Company is committed under various lease agreements for office space and equipment. Rental expense for 2005, 2004 and 2003 was $3,196, $528 and $87, respectively. Future minimum lease payments under these agreements are as follows:
The Company primarily transacts business either directly with its policyholders or through four independently-owned insurance agencies in Tennessee who exclusively write insurance policies on behalf of the Company. Direct policyholders make payments directly to the Company. Balances due from policyholders are generally secured by the related unearned premium. The Company requires a down payment at the time the policy is originated and subsequent scheduled payments are monitored in order to prevent the Company from providing coverage beyond the date for which payment has been received. If subsequent payments are not made timely, the policy is generally cancelled at no loss to the Company. Policyholders whose premiums are written through the
Reinsurance is subject to credit risk relating to the Company’s ability to collect the payments from reinsured losses due from reinsurers. Since December 1, 2000, the Company’s primary reinsurer has been Transatlantic Reinsurance Company and since September 1, 2004, the Company has only purchased excess-of-loss reinsurance for catastrophic auto physical damage exposures.
Since the USAuto acquisition, the Company sponsors a defined contribution retirement plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees who meet specified service requirements. Under this plan, the Company may, at its discretion, match 50% of each employee’s contribution up to 6% of the employee’s salary. The Company’s contributions to the plan for the years ended June 30, 2005 and 2004 were $282 and $38, respectively.
The Company is named as a defendant in various lawsuits, arising in the ordinary course of business, generally relating to its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves. Management believes that the ultimate resolution of these matters will not materially affect the consolidated financial statements.
The fair value of financial instruments has been estimated by the Company using available market information as of June 30, 2005 and 2004, and valuation methodologies considered appropriate to the circumstances:
The Real Estate and Corporate segment consists of the Company’s above-mentioned business activities prior to the USAuto acquisition in addition to interest expense associated with all debt and the costs associated with being a public company. Total assets by segment are those assets used in the operation of each segment.
To record accretion of fair value adjustment to loss and loss adjustment expense reserves.
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.
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).
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.