The following tables provide selected historical consolidated financial and operating data of the Company as of the dates and for the periods indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the accompanying notes included in this report. We derived our selected historical consolidated financial data as of June 30, 2006 and 2005 and for the years ended June 30, 2006, 2005, and 2004 from our audited consolidated financial statements included in this report. We derived our selected historical consolidated financial data as of June 30, 2004, 2003 and 2002 and for the years ended June 30, 2003 and 2002 from our audited consolidated financial statements not included in this report. The results for past accounting periods are not necessarily indicative of the results to be expected for any future accounting period.
We are principally a retailer, servicer and underwriter of non-standard personal automobile insurance, based in Nashville, Tennessee. Non-standard personal automobile insurance is made available to individuals who are categorized as “non-standard” because of their inability or unwillingness to obtain standard insurance coverage due to various factors, including payment history, payment preference, failure in the past to maintain continuous insurance coverage, driving record and/or vehicle type. Generally, our customers are required by law to buy a minimum amount of automobile insurance.
As of September 1, 2006, we leased and operated 458 retail locations, staffed by employee-agents. Our employee-agents exclusively sell insurance products either underwritten or serviced by us. As of June 30, 2006, we wrote non-standard personal automobile insurance in 12 states and were licensed 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 years ended June 30, 2006 and 2005 reflect the results from our insurance operations for the full year periods.
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 in 2005 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.
We have also since acquired certain assets of insurance agencies operating in Texas and Chicago, Illinois and now write business in these areas through company-operated retail locations. These assets were acquired for a total of $34.2 million in cash and resulted in total goodwill and identifiable intangible assets of $33.9 million.
Our results for the year ended June 30, 2004 included expenses that have been discontinued as a result of the acquisition of USAuto. These principally consisted of compensation to employees who were terminated in connection with the acquisition. However, the subsequent periods include, as will future periods, the cost of the advisory services agreement with an entity controlled by Donald J. Edwards, one of our directors and our former President and Chief Executive Officer, as described in Note 18 to our consolidated financial statements. These items have been incorporated into the presentation of pro forma operating results for the year ended June 30, 2004, which assumes that the acquisition of USAuto occurred on July 1, 2003.
Our primary focus is the selling, servicing and underwriting of non-standard personal automobile insurance. Our real estate and corporate segment consists of activities related to the disposition of foreclosed real estate held for sale, interest expense associated with debt, other general corporate overhead expenses and acquisition activities prior to the USAuto acquisition in April 2004.
Combined Ratio - Combined ratio is the sum of the loss ratio and the expense ratio. If the combined ratio is at or above 100, an insurance company cannot be profitable without sufficient investment income.
The following table presents the combined ratios for the insurance operations on both an actual and a pro-forma basis for the periods presented.
The invested assets of the insurance operations are generally highly liquid and consist substantially of readily marketable, investment grade, municipal and corporate bonds and collateralized mortgage obligations. At June 30, 2006, approximately 6% of our fixed maturities portfolio was tax-exempt. All cash equivalents are taxable. We invest in certain securities issued by political subdivisions in the states of Georgia and Tennessee, as these type of investments enable our insurance company subsidiaries to obtain premium tax credits. Investment income is composed primarily of interest earned on these securities, net of related investment expenses. Realized gains and losses on our investment portfolio may occur from time-to-time as changes are made to our holdings based upon changes in interest rates and changes in the credit quality of securities held.
Year Ended June 30, 2006 Compared With Year Ended June 30, 2005
Net premiums earned increased 56% for the year ended June 30, 2006 over the same period last year. In addition to the increase in total gross premiums earned, net premiums earned also increased as a result of two changes involving reinsurance. Net premiums earned increased as a result of the change in the assumed reinsurance percentage for our Alabama business (written through other insurance companies) from 50% to 100% effective February 1, 2005. For the year ended June 30, 2005, $8.8 million in premiums earned in Alabama were not assumed by us. We are now licensed in Alabama and, starting in May 2005, we began writing all new policies in Alabama on a direct basis. As a result, in Alabama, we no longer incur the contractual costs associated with writing business through another insurance company. Net premiums earned for the year ended June 30, 2006 also increased as the result of eliminating our 50% quota share reinsurance effective September 1, 2004. This reinsurance was in effect for two months of the year ended June 30, 2005 and resulted in an $8.6 million reduction in net premiums earned, which we ceded to the reinsurer.
Commissions and fees declined as a percentage of net premiums earned during the year ended June 30, 2006 compared with the prior year as a result of not renewing the quota share reinsurance and increasing the assumed reinsurance percentage for our Alabama business. Ceding commissions from our reinsurer were eliminated with the non-renewal of the quota share reinsurance agreement. Total revenues for the year ended June 30, 2006 included a $4.2 million transaction service fee earned in connection with the Chicago acquisition for servicing the run-off business previously written by the Chicago agencies whose assets we acquired on January 12, 2006.
Investment income increased primarily as a result of the increase in invested assets as a result of our growth and to a lesser extent as we shifted the portfolio from tax-exempt to taxable investments. The weighted average investment yield for our fixed maturities portfolio was 5.62% at June 30, 2006 with an effective duration of 3.83 years. The yield for the comparable Lehman Brothers indices at June 30, 2006 was 5.46%.
Overall, the combined ratio increased to 88.8% for the year ended June 30, 2006 from 83.8% for the year ended June 30, 2005.
Income before income taxes for the year ended June 30, 2006 was $0.6 million versus a loss before income taxes of $1.6 million for the year ended June 30, 2005. The year ended June 30, 2006 included gains on the sales of foreclosed real estate held for sale of $3.6 million compared with $0.8 million for the year ended June 30, 2005. Investment income declined from $1.1 million for the year ended June 30, 2005 to $0.8 million for the year ended June 30, 2006 primarily due to a reduction in the amount of invested assets.
Year Ended June 30, 2005 Compared With Year Ended June 30, 2004
The income tax benefit for the year ended June 30, 2005 includes a $10.6 million 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, net income for the year ended June 30, 2004 was $11.6 million. Pro forma net income per share for the year ended June 30, 2004 was $0.25 and $0.24 on a basic and diluted basis, respectively.
On a pro forma basis, income before income taxes for the year ended June 30, 2004 was $16.6 million compared with 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. Overall, the number of insured policies in force at June 30, 2005 increased 31% over the same date in 2004. Net premiums earned for the year ended June 30, 2005 also increased as a result of the Texas operations, which were acquired effective January 1, 2005. In addition to Texas, during the year ended June 30, 2005, we also commenced operations in Illinois, Florida and Pennsylvania. During the year ended June 30, 2005, the number of stores in operation increased by 115, from 133 stores at June 30, 2004 to 248 stores at June 30, 2005. Included in the fiscal 2005 figure are the 15 stores acquired in Texas on January 1, 2005.
As a result of not renewing the quota share reinsurance and shifting the insurance underwriting from the MGA operations to our insurance company subsidiaries, commissions and fees declined as a percentage of net premiums earned during the year ended June 30, 2005 compared with the prior year and ceding commissions from our reinsurer also decreased. The year ended June 30, 2005, however, includes an additional ceding commission of $1.0 million, which has been recorded based upon the favorable loss experience during the last contract year of the quota share reinsurance program which was non-renewed effective September 1, 2004.
The loss and loss adjustment expense ratio increased to 66.1% for the year ended June 30, 2005 from 63.4% on a pro forma basis for the year ended June 30, 2004. We did not experience any significant development for losses occurring in prior accident periods. The loss ratio for the year ended June 30, 2005 increased slightly over the prior year as a result of the non-renewal of the quota share reinsurance, which resulted in a higher percentage increase in losses and loss expenses incurred than the percentage increase in net premiums earned. This occurred since policy and renewal fees (included in net premiums earned) were not ceded to the reinsurer and therefore remained the same relative to dollar amounts in both periods.
Insurance operating expenses increased 21% to $49.9 million for the year ended June 30, 2005 from $41.1 million on a pro forma basis for the year ended June 30, 2004. This increase is primarily due to expenses, such as advertising, employee-agent compensation, rent and premium taxes that vary along with the increase in net premiums earned and the addition of new retail locations.
Loss before income taxes for the year ended June 30, 2005 was $1.6 million versus loss before income taxes of $9.2 million for the year ended June 30, 2004. For the year ended June 30, 2005, gains on sales of foreclosed real estate were $0.8 million, compared with $4.1 million for the year ended June 30, 2004. Gains on sales of real estate represents proceeds received from the sale of foreclosed real estate in excess of carrying value, less selling costs.
Our primary sources of funds are premiums, commission and fee income and investment income. Our primary uses of funds are the payment of claims and operating expenses. Operating activities for the year ended June 30, 2006 provided $52.9 million of cash, compared with $45.4 million provided in the same period in fiscal 2005. Net cash used by investing activities for the year ended June 30, 2006 was $70.8 million, compared with $55.2 million in the same period in fiscal 2005. Both periods reflect additions to our investment portfolio as a result of the increase in net premiums earned and the fiscal 2006 amount also includes $29.9 million paid for the Chicago acquisition, net of tangible assets acquired. During the year ended June 30, 2006, we increased the statutory capital and surplus of the insurance company subsidiaries by $17.2 million to support additional premium writings. This capital contribution came from funds our holding company received from the insurance company subsidiaries through an intercompany tax allocation agreement under which the holding company was reimbursed for current tax benefits utilized through the recognition of tax net operating loss carryforwards. At June 30, 2006, we had $7.6 million available in unrestricted cash and investments outside of the insurance company subsidiaries.
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. Statutory guidelines suggest that the insurance company subsidiaries should not exceed a ratio of net premiums written to statutory capital and surplus of 3-to-1. We believe that the insurance company subsidiaries have sufficient financial resources available to support their net premium writings in both the short-term and the reasonably foreseeable future.
We believe that existing cash and investment balances, when combined with anticipated cash flows generated from operations and dividends from our insurance company subsidiaries, will be adequate to meet our expected liquidity needs in both the short term and the reasonably foreseeable future. Our growth strategy includes possible acquisitions. Any acquisitions or other growth opportunities may require external financing, and we may from time to time seek to obtain external financing. We cannot assure you that additional sources of financing will be available to us or that any such financing would not negatively impact our results of operations.
In order to gain a presence in the market, on January 12, 2006, we acquired certain assets (principally the trade names, customer lists and relationships and the lease rights to 72 retail locations) of two non-standard automobile insurance agencies under common control in Chicago, Illinois for $30.0 million in cash. We also agreed to pay the agencies up to $4 million in additional consideration if certain financial targets relating to the acquired business for the twelve months ending January 31, 2007 are reached. As a result of this acquisition, we are now writing business through First Acceptance Insurance Company, Inc. from these locations. We did not acquire any policies in force as part of the transaction. However, we receive a transaction service fee from the agencies as compensation for servicing the run-off of the policies previously written by the agencies through other insurance companies. The total amount payable to us under this contract is $5.0 million, of which $4.2 million was earned during the year ended June 30, 2006. The fee is being paid and earned in accordance with the estimated run-off of the number of policies being serviced.
June 30, 2010. Both facilities bear interest at LIBOR plus 175 basis points per annum. We entered into an interest rate swap agreement on January 17, 2006 that fixed the interest rate on the term loan facility at 6.63% through June 30, 2010. The term loan facility is due in equal quarterly installments of $1.4 million, plus interest, beginning April 30, 2006 and ending April 30, 2010, with a final payment of $1.4 million due on June 30, 2010. During fiscal 2006, we repaid $6.4 million of indebtedness under the debt facilities, which included repayment of the full $5.0 million borrowed under the revolving facility. Both facilities are secured by the common stock and certain assets of selected subsidiaries. The credit agreement contains certain financial covenants regarding (1) a minimum fixed charge coverage ratio, (2) a minimum consolidated tangible net worth, (3) a maximum net premiums written to surplus ratio, (4) a maximum combined ratio and (5) a minimum RBC. At June 30, 2006, we were in compliance with all such covenants except for the net premiums written to surplus ratio for which a waiver has been obtained.
We have no off-balance sheet arrangements or financing activities with special-purpose entities, other than leases accounted for as operating leases in accordance with generally accepted accounting principles.
The following table summarizes all of our contractual obligations by period as of June 30, 2006:
estimates after considering the actual results for the year ended June 30, 2006 and 2005, the allowance was reduced by an additional $10.5 million in 2006 and by an additional $10.6 million in 2005. At June 30, 2006, our total gross deferred tax asset is $68.5 million, and we had net operating loss carryforwards for federal income tax purposes of approximately $165.3 million. On a net basis, the deferred tax asset is $48.1 million after an allowance of $20.4 million. Realization of this deferred tax asset is dependent upon our generation of sufficient taxable income in the future. If future taxable income is not sufficient to recover the deferred tax asset, the maximum charge to the provision for income taxes will be $48.1 million. If we generate sufficient future taxable income to fully utilize the deferred tax asset as of June 30, 2006, the maximum additional benefit for income taxes will be $20.4 million.
Losses and loss adjustment expense reserves. Loss and loss adjustment expense (LAE) reserves represent our best estimate of our ultimate liability for losses and LAE relating to events that occurred prior to the end of any given accounting period, but have not been paid. Months and sometimes years may elapse between the occurrence of an automobile accident covered by one of our insurance policies, the reporting of the accident and the payment of the claim. We record a liability for estimates of losses that will be paid for accidents that have been reported, which is referred to as case reserves. In addition, since accidents are not always reported when they occur, we estimate liabilities for accidents that have occurred but have not been reported, which are referred to herein as incurred but not reported, or IBNR, reserves.
We have audited the accompanying consolidated balance sheet of First Acceptance Corporation and subsidiaries as of June 30, 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of the Company for the years ended June 30, 2005 and 2004 were audited by other auditors whose report dated September 9, 2005 expressed an unqualified opinion on those statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of First Acceptance Corporation and subsidiaries’ internal control over financial reporting as of June 30, 2006, 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 11, 2006 expressed an unqualified opinion thereon.
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, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of June 30, 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the year then ended, and our report dated September 11, 2006, expressed an unqualified opinion thereon.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2005, and the results of its operations and its cash flows for each of the years in the two-year period ended June 30, 2005, in conformity with U.S. generally accepted accounting principles.
Effective at the consummation of the acquisition of USAuto, the Company changed its name to First Acceptance Corporation. At such time, the executive officers of USAuto were appointed as executive officers of the newly combined enterprise and the Company’s previous executive officers resigned from their positions, and their employment was terminated.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries which are all wholly owned. All intercompany accounts and transactions are eliminated in consolidation.
Fixed maturities, available for sale, includes bonds with fixed principal payment schedules and loan-backed securities which are amortized using the retrospective method. These securities are carried at market value with the corresponding unrealized appreciation or depreciation, net of deferred income taxes, reported in other comprehensive income or loss. Market values are obtained from a recognized pricing service.
In November 2005, the FASB issued Staff Position (FSP) FAS115-1 and FAS 124-1, which nullifies certain provisions of EITF Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, and completely supersedes EITF Topic D-44, “Recognition of Other Than Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value”. This staff position addresses (1) determining when an investment should be considered impaired, (2) determining whether an impairment should be deemed other than temporary, and (3) measuring impairment loss. The application of FAS 115-1 and FAS 124-1 did not have a material impact to the Company’s consolidated financial statements.
In July 2006, FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes -- An Interpretation of FASB Statement No. 109 (‘‘FIN 48”), was issued. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’’s financial statements with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, as well as providing guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 with earlier application permitted as long as the enterprise has not yet issued financial statements, including interim financial statements, in the period of adoption. The Company has not yet evaluated the requirements of FIN 48 and as a result has not yet determined if FIN 48 will have a material impact on its future consolidated financial statements.
There is no effect for the years ended June 30, 2006 and 2005 since all stock options issued under APB No. 25 were fully vested prior to July 1, 2004.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised), “Share Based Payment,” (“SFAS No. 123(R)”). SFAS No. 123(R), which replaced SFAS No. 123, “Accounting for Stock-Based Compensation,” superseded Accounting Procedures Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and amended 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. SFAS No. 123(R) is effective for public companies at the beginning of the first annual period beginning after June 15, 2005. The Company previously had 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. Therefore, the Company’s adoption of SFAS No. 123(R) as of July 1, 2005 had no impact on the Company’s consolidated financial position, results of operations, cash flows or net income per share.
Of the $6,000 in acquired identifiable intangible assets, $1,500 and $3,300 were assigned to state insurance licenses and trademark and trade names, respectively, that are not subject to amortization. The remaining $1,200 of acquired identifiable intangible assets relates to the value of policy renewals was amortized over a 24-month period in proportion to anticipated policy expirations.
In order to gain a presence in the market, on January 12, 2006, the Company acquired certain assets (principally the trade names, customer lists and relationships and the lease rights to 72 retail locations) of two non-standard automobile insurance agencies under common control in Chicago, Illinois for $30,000 in cash plus $183 in acquisition expenses. Goodwill and identifiable intangible assets from this acquisition will be deductible for tax purposes. The purchase price was financed through a newly executed credit agreement (see note 13). Up to $4,000 in additional consideration must also be paid to the seller if certain financial targets relating to the acquired business for the twelve months ending January 31, 2007 are reached. As a result of this acquisition, the Company is now writing business from these locations. The Company is also receiving a monthly fee from the seller through December 31, 2006 totaling $5,000 ($4,150 for the year ended June 30, 2006) as compensation for servicing the run-off of business previously written by the agencies through other insurance companies. The fee is being paid and earned in accordance with the estimated runoff of the number of policies being serviced.
Net realized capital gains (losses) on investments derived from fixed maturities available for sale follow:
As of June 30, 2006, the Company has determined that all of the unrealized losses in the table above were temporary and were the result of changes in interest rates. There were no fundamental issues with any of these securities and the Company has the ability and intent to hold the securities until there is a recovery in fair value. There were no securities with unrealized losses of greater than 10% of book value.
At June 30, 2006 and 2005, the Insurance Companies had unsecured aggregate reinsurance recoverables of $1,344 and $4,490, respectively, from Transatlantic Reinsurance Company. At June 30, 2006, such amount included $1,301 related to unpaid losses (including $769 in IBNR), and $43 related to paid losses recoverable. At June 30, 2005, such amount included $3,608 related to unpaid losses (including $1,930 in IBNR), $353 related to paid losses recoverable and $529 in accrued ceding commission income.
The federal income tax expense (benefit) differs from the amounts computed by applying the U.S. Federal corporate tax rate of 35% to income (loss) before income taxes as follows:
The tax effects of temporary differences that give rise to the net deferred tax asset at June 30, 2006 and 2005 are presented below:
At June 30, 2006, $1,212 of the valuation allowance was related to the net unrealized depreciation on investments as management believes that it is more likely than not that this tax benefit will not be realized. For the year ended June 30, 2006, the change in the valuation allowance related to this amount of $1,212 is included as part of other comprehensive loss.
At June 30, 2006, the Company had net operating loss (NOL) carryforwards for federal income tax purposes of $165,277, which are available to offset future federal taxable income. In addition, at June 30, 2006 the Company had alternative minimum tax credit carryforwards of $1,154 that have no expiration date. The NOL carryforwards will expire in 2007 through 2023, as shown in the table below.
The Company has issued stock options to employees under its 2002 Long Term Incentive Plan (the “Plan”). At June 30, 2006, there were 3,982 shares remaining available for issuance under the Plan and options outstanding were as follows:
Options to purchase 3,731 shares at $3.00 per share issued to former employees that are all fully vested and exercisable. These options expire on July 9, 2012 (3,726 shares) and on June 30, 2013 (5 shares).
Options to purchase 200 shares at $6.64 per share issued to USAuto executives as a closing condition to the USAuto acquisition that vest monthly over a five-year period (87 exercisable at June 30, 2006). These options expire on April 30, 2014.
Options to purchase 150 shares at $8.13 per share issued to employees that vest equally in five annual installments (30 exercisable at June 30, 2006). These options expire on October 27, 2014.
Compensation expense related to stock options is calculated under the fair value method and is recorded on a straight-line basis over the vesting period. Fair value of the options was estimated at the grant dates using the Black-Sholes option pricing model, which includes the following assumptions: risk-free interest rate based on ten-year U.S. Treasury Note rate; expected option life of ten years; expected volatility of 36% to 38%; and no expected dividends. Compensation expense related to stock options was $452 for year ended June 30, 2006, which included $142 related to the full vesting of existing options upon the resignation of a former employee. Total unamortized compensation cost related to non-vested awards at June 30, 2006 was $891, of which $418 will be amortized through April 2009 and $473 will be amortized through October 2009.
The Plan commenced February 1, 2005 and the Company has reserved 100 shares of common stock for issuance under the Plan and 22 and 11 shares were issued during the years ended June 30, 2006 and 2005, respectively. Compensation expense attributable to subscriptions to purchase shares under the Plan was $22 and $11 for the years ended June 30, 2006 and 2005.
could subject the Insurance Companies to regulatory action and maintaining an adequate RBC could restrict the payment of dividends. As of December 31, 2005, the Insurance Companies’ “RBC” levels did not subject them to any regulatory action.
In connection with the acquisition of the Chicago, Illinois non-standard automobile insurance agencies, on January 12, 2006, the Company entered into, and borrowed under, a credit agreement with two banks consisting of a $5,000 revolving facility and a $25,000 term loan facility, both maturing on June 30, 2010. Outstanding borrowings under the term loan facility bear interest at LIBOR plus 175 basis points per annum (6.88% at June 30, 2006). At June 30, 2006, there were no borrowings outstanding under the revolving facility. The Company entered into an interest rate swap agreement on January 17, 2006 that fixed the interest rate on the term loan facility at 6.63% through June 30, 2010. The term loan facility is due in equal quarterly installments of $1,388, plus interest, beginning April 28, 2006 and ending on April 30, 2010 with a final payment of $1,404 due on June 30, 2010. Both facilities are secured by the common stock and certain assets of selected subsidiaries. The credit agreement contains certain financial covenants regarding (1) a minimum fixed charge coverage ratio, (2) a minimum consolidated
tangible net worth, (3) a maximum net premiums written to surplus ratio, (4) a maximum combined ratio and (5) a minimum RBC. At June 30, 2006, the Company was in compliance with all such covenants except for the net premiums written to surplus ratio for which a waiver has been obtained.
The Company is committed under various lease agreements for office space and equipment. Rental expense for 2006, 2005 and 2004 was $8,077, $3,196 and $528, respectively. Future minimum lease payments under these agreements follow:
Effective with the USAuto acquisition and in accordance with the terms of the severance agreement of Donald J. Edwards, the Company’s former President and Chief Executive Officer, the Company has assigned and transferred to a new entity controlled by Mr. Edwards, all of the Company’s rights, title and interest in its lease for office space in Chicago, Illinois. Such entity has assumed all obligations under the lease and such obligations will be reimbursed to the entity by the Company during the term of the lease. The total future cost of this obligation was $1,086 and such amount was accrued as of the acquisition date in the consolidated financial statements by the Company as part of the cost of Mr. Edward’s severance. At June 30, 2006, $710 remained to be paid under this obligation.
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 100% of the first 3% of an employee’s salary plus 50% of the next 2% up to the maximum allowed by Internal Revenue Code. The Company’s contributions to the plan for the years ended June 30, 2006, 2005 and 2004 were $396, $282 and $38, respectively.
The fair values of cash and cash equivalents, fiduciary funds-restricted, premiums and fees receivable and reinsurance recoverables approximate their carrying amounts based upon their short maturities.