UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-12117

FIRST ACCEPTANCE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		75-1328153 (I.R.S. Employer Identification No.)
3813 Green Hills Village Drive Nashville, Tennessee (Address of principal executive offices)		37215 (Zip Code)

(615) 844-2800
(Registrant’s telephone number, including area code)

3322 West End Ave, Suite 1000
Nashville, Tennessee 37203
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Yes þ       No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

     Yes o       No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller Reporting Company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

     Yes o       No þ

At February 8, 2010, there were 48,489,717 shares outstanding of the registrant’s common stock, par value $0.01 per share.

 

 

FIRST ACCEPTANCE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2009

INDEX

PART I – FINANCIAL INFORMATION			1
Item 1. Financial Statements			1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures About Market Risk			26
Item 4T. Controls and Procedures			29
PART II – OTHER INFORMATION			30
Item 4. Submission of Matters to a Vote of Security Holders			30
Item 6. Exhibits			30
SIGNATURES			31

PART I – FINANCIAL INFORMATION

Item 1.		Financial Statements

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

		December 31,				June 30,
		2009				2009
		(Unaudited)
ASSETS
Fixed maturities, available-for-sale at fair value (amortized cost of $183,318 and $140,849, respectively)		$	186,328			$	140,311
Cash and cash equivalents			29,227				77,201
Premiums and fees receivable, net of allowance of $531 and $419			39,212				45,309
Other assets			9,543				11,866
Property and equipment, net			3,546				3,921
Deferred acquisition costs			3,641				3,896
Goodwill			70,092				70,092
Identifiable intangible assets			6,360				6,360
TOTAL ASSETS		$	347,949			$	358,956
LIABILITIES AND STOCKHOLDERS’ EQUITY
Loss and loss adjustment expense reserves		$	77,546			$	83,973
Unearned premiums and fees			50,160				57,350
Debentures payable			41,240				41,240
Other liabilities			10,676				16,537
Total liabilities			179,622				199,100
Stockholders’ equity:
Preferred stock, $.01 par value, 10,000 shares authorized			—				—
Common stock, $.01 par value, 75,000 shares authorized; 48,490 and 48,312 shares issued and outstanding, respectively			485				483
Additional paid-in capital			465,406				464,720
Accumulated other comprehensive income (loss)			3,010				(538	)
Accumulated deficit			(300,574	)			(304,809	)
Total stockholders’ equity			168,327				159,856
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	347,949			$	358,956

See notes to consolidated financial statements.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share data)

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Revenues:
Premiums earned		$	45,199			$	54,823			$	93,666			$	116,661
Commission and fee income			6,966				7,675				13,920				15,918
Investment income			2,033				2,608				3,946				5,331
Net realized losses on fixed maturities, available-for-sale			(423	)			(26	)			(445	)			(1,241	)
			53,775				65,080				111,087				136,669
Costs and expenses:
Losses and loss adjustment expenses			29,871				37,553				63,024				81,285
Insurance operating expenses			19,711				21,510				39,281				42,956
Other operating expenses			750				314				1,023				706
Litigation settlement			102				5,089				(279	)			5,234
Stock-based compensation			272				514				655				1,009
Depreciation and amortization			500				455				964				924
Interest expense			992				1,033				1,981				2,190
			52,198				66,468				106,649				134,304
Income (loss) before income taxes			1,577				(1,388	)			4,438				2,365
Provision (benefit) for income taxes			102				(385	)			203				1,527
Net income (loss)		$	1,475			$	(1,003	)		$	4,235			$	838
Net income (loss) per share:
Basic and diluted		$	0.03			$	(0.02	)		$	0.09			$	0.02
Number of shares used to calculate net income (loss) per share:
Basic			47,960				47,658				47,919				47,656
Diluted			48,551				47,658				48,720				49,088
Reconciliation of net income (loss) to comprehensive income (loss):
Net income (loss)		$	1,475			$	(1,003	)		$	4,235			$	838
Net unrealized change in investments			(627	)			1,790				3,548				(1,673	)
Comprehensive income (loss)		$	848			$	787			$	7,783			$	(835	)
Detail of net realized losses on fixed maturities, available-for-sale:
Net realized gains (losses) on sales		$	15			$	(26	)		$	314			$	24
Unrealized losses on fixed maturities with other-than-temporary impairment charges			(1,128	)			—				(1,449	)			(1,265	)
Non-credit portion included in comprehensive income (loss)			(690	)			—				(690	)			—
Other-than-temporary impairment charges recognized in income (loss)			(438	)			—				(759	)			(1,265	)
Net realized losses on fixed maturities, available-for-sale		$	(423	)		$	(26	)		$	(445	)		$	(1,241	)

See notes to consolidated financial statements.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)

		Six Months Ended
		December 31,
		2009				2008
Cash flows from operating activities:
Net income		$	4,235			$	838
Adjustments to reconcile net income to cash used in operating activities:
Depreciation and amortization			964				924
Stock-based compensation			655				1,009
Deferred income taxes			—				1,346
Other-than-temporary impairment on investment securities			759				1,265
Net realized gains on sales of investments			(314	)			(24	)
Other			789				82
Change in:
Premiums and fees receivable			5,566				14,655
Loss and loss adjustment expense reserves			(6,427	)			(7,604	)
Unearned premiums and fees			(7,190	)			(16,870	)
Litigation settlement			669				880
Other			(3,903	)			(2,671	)
Net cash used in operating activities			(4,197	)			(6,170	)
Cash flows from investing activities:
Purchases of fixed maturities, available-for-sale			(61,439	)			(14,225	)
Maturities and paydowns of fixed maturities, available-for-sale			6,704				6,476
Sales of fixed maturities, available-for-sale			11,566				4,425
Net change in receivable/payable for securities			—				(1,045	)
Capital expenditures			(592	)			(463	)
Other			(21	)			(99	)
Net cash used in investing activities			(43,782	)			(4,931	)
Cash flows from financing activities:
Payments on borrowings			(28	)			(4,026	)
Net proceeds from issuance of common stock			33				37
Net cash provided by (used in) financing activities			5				(3,989	)
Net decrease in cash and cash equivalents			(47,974	)			(15,090	)
Cash and cash equivalents, beginning of period			77,201				38,646
Cash and cash equivalents, end of period		$	29,227			$	23,556

See notes to consolidated financial statements.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. General

     The consolidated financial statements of First Acceptance Corporation (the “Company”) included herein have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been omitted. In the opinion of management, the consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the interim periods. Certain reclassifications have been made to the prior year’s consolidated financial statements to conform with the current year presentation.

     In connection with the preparation of these consolidated interim financial statements, the Company has evaluated subsequent events through February 8, 2010, which is the date the financial statements were issued. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the fiscal year ended June 30, 2009.

2. Investments

     Fair Value

     Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company holds available-for-sale fixed maturity investments, which are carried at fair value.

     Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs are based on market data from independent sources, while unobservable inputs reflect the Company’s view of market assumptions in the absence of observable market information. All assets and liabilities that are carried at fair value are classified and disclosed in one of the following categories:

		Level 1 -		Quoted prices in active markets for identical assets or liabilities.
		Level 2 -		Quoted market prices for similar assets or liabilities in active markets; quoted prices by independent pricing services for identical or similar assets or liabilities in markets that are not active; and valuations, using models or other valuation techniques, that use observable market data. All significant inputs are observable, or derived from observable information in the marketplace, or are supported by observable levels at which transactions are executed in the market place.
		Level 3 -		Instruments that use non-binding broker quotes or model driven valuations that do not have observable market data.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The following table presents the fair-value measurements for each major category of assets that are measured on a recurring basis at December 31, 2009 (in thousands).

						Fair Value Measurements Using
						Quoted Prices
						in Active				Significant
						Markets for				Other				Significant
						Identical				Observable				Unobservable
						Assets				Inputs				Inputs
Description		Total				(Level 1)				(Level 2)				(Level 3)
Fixed maturities, available-for-sale:
U.S. government and agencies		$	29,903			$	29,903			$	—			$	—
State			8,255				—				8,255				—
Political subdivisions			1,832				—				1,832				—
Revenue and assessment			26,092				—				26,092				—
Corporate bonds			76,784				—				72,810				3,974
Collateralized mortgage obligations:															—
Agency backed			30,283				—				30,283				—
Non-agency backed — residential			6,362				—				3,762				2,600
Non-agency backed — commercial			6,817				—				6,817				—
Total fixed maturities, available-for-sale			186,328				29,903				149,851				6,574
Cash and cash equivalents			29,227				29,227				—				—
Total		$	215,555			$	59,130			$	149,851			$	6,574

     The fair values of the Company’s fixed maturities are determined by management after taking into consideration available sources of data. All of the portfolio valuations classified as Level 1 or Level 2 in the above table are priced exclusively by utilizing the services of independent pricing sources using observable market data. The Level 2 classified security valuations are obtained from a single independent pricing service. The Level 3 classified securities in the table above consist of three collateralized mortgage obligations (“CMOs”) and one corporate bond that are priced from non-binding broker quotes obtained from a single dealer familiar with each particular security or model driven valuations that do not have observable market data. Based on the nature of these securities and the lack of similar securities trading to obtain observable market data, the Company believes that these Level 3 valuations are more subjective in nature. The Company has not made any adjustments to the prices obtained from the independent pricing sources and dealers.

     The Company has reviewed the pricing techniques and methodologies of the independent pricing sources and dealers and believes that their policies adequately consider market activity, either based on specific transactions for the security valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. The Company monitored security-specific valuation trends and discussed material changes or the absence of expected changes with the pricing sources to understand the underlying factors and inputs and to validate the reasonableness of the pricing.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     Based on the above categorization, the following tables represent the quantitative disclosure for those assets included in category Level 3 at December 31, 2009 (in thousands).

		Fair Value Measurements Using
		Significant Unobservable Inputs (Level 3)
						Collateralized mortgage obligations
						Non-agency				Non-agency
		Corporate				backed –				backed –
Three Months Ended December 31, 2009:		bonds				residential				commercial				Total
Balance at October 1, 2009		$	—			$	3,294			$	—			$	3,294
Total gains or losses (realized or unrealized):
Included in net income (loss)			—				(97	)			—				(97	)
Included in other comprehensive income (loss)			71				221				—				292
Purchases, sales, issuances and settlements			3,903				—				—				3,903
Transfers in to Level 3			—				870				—				870
Transfers out of Level 3			—				(1,688	)			—				(1,688	)
Balance at December 31, 2009		$	3,974			$	2,600			$	—			$	6,574

		Fair Value Measurements Using
		Significant Unobservable Inputs (Level 3)
						Collateralized mortgage obligations
						Non-agency				Non-agency
		Corporate				backed –				backed –
Six Months Ended December 31, 2009:		bonds				residential				commercial				Total
Balance at July 1, 2009		$	—			$	1,930			$	707			$	2,637
Total gains or losses (realized or unrealized):
Included in net income (loss)			—				(97	)			—				(97	)
Included in other comprehensive income (loss)			71				424				91				586
Purchases, sales, issuances and settlements			3,903				—				—				3,903
Transfers in to Level 3			—				880				—				880
Transfers out of Level 3			—				(537	)			(798	)			(1,335	)
Balance at December 31, 2009		$	3,974			$	2,600			$	—			$	6,574

     Investment Income and Net Realized Gains and Losses

     The major categories of investment income follow (in thousands).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Fixed maturities, available-for-sale		$	2,164			$	2,582			$	4,193			$	5,213
Cash and cash equivalents			4				107				23				286
Other			29				29				59				58
Investment expenses			(164	)			(110	)			(329	)			(226	)
		$	2,033			$	2,608			$	3,946			$	5,331

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The components of net realized losses on fixed maturities, available-for-sale are as follows (in thousands).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Gains		$	16			$	3			$	319			$	62
Losses			(1	)			(29	)			(5	)			(38	)
Other-than-temporary impairment			(438	)			—				(759	)			(1,265	)
		$	(423	)		$	(26	)		$	(445	)		$	(1,241	)

     Realized gains and losses on sales of securities are computed based on specific identification. The non-credit related portion of other-than-temporary impairment (“OTTI”) charges are included in other comprehensive income (loss). The amounts of such charges taken for securities still owned were $1.3 million for non-agency backed residential CMOs and $0.6 million for non-agency backed commercial CMOs at December 31, 2009 and $0.6 million for non-agency backed residential CMOs and $0.6 million for non-agency backed commercial CMOs at June 30, 2009.

     Fixed Maturities, Available-for-Sale

     The following tables summarize the Company’s fixed maturity securities (in thousands).

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
December 31, 2009		Cost				Gains				Losses				Value
U.S. government and agencies		$	29,505			$	434			$	(36	)		$	29,903
State			7,962				299				(6	)			8,255
Political subdivisions			1,826				51				(45	)			1,832
Revenue and assessment			25,546				739				(193	)			26,092
Corporate bonds			74,674				2,608				(498	)			76,784
Collateralized mortgage obligations:
Agency backed			28,874				1,409				—				30,283
Non-agency backed — residential			7,316				20				(974	)			6,362
Non-agency backed — commercial			7,615				57				(855	)			6,817
		$	183,318			$	5,617			$	(2,607	)		$	186,328

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
June 30, 2009		Cost				Gains				Losses				Value
U.S. government and agencies		$	10,744			$	473			$	(37	)		$	11,180
State			8,238				344				(19	)			8,563
Political subdivisions			1,834				52				(32	)			1,854
Revenue and assessment			27,816				831				(166	)			28,481
Corporate bonds			45,737				1,654				(665	)			46,726
Collateralized mortgage obligations:
Agency backed			30,656				1,270				—				31,926
Non-agency backed — residential			8,178				1				(2,561	)			5,618
Non-agency backed — commercial			7,646				—				(1,683	)			5,963
		$	140,849			$	4,625			$	(5,163	)		$	140,311

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The following table sets forth the scheduled maturities of our fixed maturity securities at December 31, 2009 based on their fair values (in thousands). Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.

										Securities
										with No
		Securities				Securities				Gross
		with Gross				with Gross				Unrealized				All
		Unrealized				Unrealized				Gains or				Fixed Maturity
		Gains				Losses				Losses				Securities
One year or less		$	—			$	—			$	—			$	—
After one through five years			81,536				9,047				—				90,583
After five through ten years			27,865				13,055				—				40,920
After ten years			3,183				8,180				—				11,363
No single maturity date			34,084				9,378				—				43,462
		$	146,668			$	39,660			$	—			$	186,328

     The following table reflects the number of securities with gross unrealized gains and losses. Gross unrealized losses are further segregated by the length of time that individual securities have been in a continuous unrealized loss position.

Gross Unrealized Losses

Less than

Greater

Gross

or equal to

than 12

Unrealized

At:

12 months

months

Gains

December 31, 2009

13

24

144

June 30, 2009

3

37

133

     The following tables reflect the fair value and gross unrealized losses of those securities in a continuous unrealized loss position for greater than 12 months. Gross unrealized losses are further segregated by the percentage of amortized cost (in thousands, except number of securities).

		Number								Gross
Gross Unrealized Losses		of				Fair				Unrealized
at December 31, 2009:		Securities				Value				Losses
Less than 10%			11			$	7,925			$	(407	)
Greater than 10%			13				6,634				(1,904	)
			24			$	14,559			$	(2,311	)

		Number								Gross
Gross Unrealized Losses		of				Fair				Unrealized
at June 30, 2009:		Securities				Value				Losses
Less than 10%			17			$	15,368			$	(766	)
Greater than 10%			20				8,970				(4,348	)
			37			$	24,338			$	(5,114	)

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The following tables set forth the amount of gross unrealized losses by current severity (as compared to amortized cost) and length of time that individual securities have been in a continuous unrealized loss position (in thousands).

		Fair Value of
		Securities with								Severity of Gross Unrealized Losses
Length of		Gross				Gross												Greater
Gross Unrealized Losses		Unrealized				Unrealized				Less				5% to				than
at December 31, 2009:		Losses				Losses				than 5%				10%				10%
Less than or equal to:
Three months		$	24,521			$	(281	)		$	(281	)		$	—			$	—
Six months			543				(14	)			(14	)			—				—
Nine months			—				—				—				—				—
Twelve months			37				(1	)			(1	)			—				—
Greater than twelve months			14,559				(2,311	)			(71	)			(336	)			(1,904	)
Total		$	39,660			$	(2,607	)		$	(367	)		$	(336	)		$	(1,904	)

		Fair Value of
		Securities with								Severity of Gross Unrealized Losses
Length of		Gross				Gross												Greater
Gross Unrealized Losses		Unrealized				Unrealized				Less				5% to				than
at June 30, 2009:		Losses				Losses				than 5%				10%				10%
Less than or equal to:
Three months		$	—			$	—			$	—			$	—			$	—
Six months			1,011				(38	)			(38	)			—				—
Nine months			—				—				—				—				—
Twelve months			533				(11	)			(11	)			—				—
Greater than twelve months			24,338				(5,114	)			(249	)			(517	)			(4,348	)
Total		$	25,882			$	(5,163	)		$	(298	)		$	(517	)		$	(4,348	)

     Other-Than-Temporary Impairment

     Effective April 1, 2009, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320-10-65, Recognition and Presentation of Other-Than-Temporary Impairments (Prior authoritative literature: FASB Staff Position No. FAS 115-2) (“FASB ASC 320-10-65”). Under this guidance, the Company separates OTTI into the following two components: (i) the amount related to credit losses, which is recognized in the consolidated statement of operations, and (ii) the amount related to all other factors, which is recorded in other comprehensive income (loss). The credit-related portion of an OTTI is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield at the date of acquisition.

     The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. The Company routinely monitors its fixed maturity portfolio for changes in fair value that might indicate potential impairments and performs detailed reviews on such securities. Changes in fair value are evaluated to determine the extent to which such changes are attributable to (i) fundamental factors specific to the issuer or (ii) market-related factors such as interest rates or sector declines.

     Securities with declines attributable to issuer-specific fundamentals are reviewed to identify all available evidence to estimate the potential for impairment. Resources used include historical financial data included in filings with the Securities and Exchange Commission for corporate bonds and performance data regarding the underlying loans for CMOs. Securities with declines attributable solely to market or sector declines where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before the full recovery of its amortized cost basis are not deemed to be other-than-temporary.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The issuer-specific factors considered in reaching the conclusion that securities with declines are not other-than-temporary include (i) the extent and duration of the decline in fair value, including the duration of any significant decline in value, (ii) whether the security is current as to payments of principal and interest, (iii) a valuation of any underlying collateral, (iv) current and future conditions and trends for both the business and its industry, (v) changes in cash flow assumptions for CMOs and (vi) rating agency actions. Based on these factors, the Company makes a determination as to the probability of recovering principal and interest on the security.

     The number and amount of securities for which the Company has recorded OTTI are presented in the following tables (in thousands, except for the number of securities).

		Three Months Ended December 31,
		2009								2008
		Number								Number
		of								of
		Securities				OTTI				Securities				OTTI
Corporate bonds			—			$	—				—			$	—
Collateralized mortgage obligations:
Non-agency backed — residential			7				(438	)			—				—
Non-agency backed — commercial			—				—				—				—
			7			$	(438	)			—			$	—

		Six Months Ended December 31,
		2009								2008
		Number								Number
		of								of
		Securities				OTTI				Securities				OTTI
Corporate bonds			—			$	—				2			$	(721	)
Collateralized mortgage obligations:
Non-agency backed — residential			8				(759	)			3				(283	)
Non-agency backed — commercial			—				—				3				(261	)
			8			$	(759	)			8			$	(1,265	)

     Since the adoption of FASB ASC 320-10-65, the following is a progression of the credit-related portion of OTTI on fixed maturity securities owned at December 31, 2009 (in thousands).

		Three Months Ended				Six Months Ended
		December 31, 2009				December 31, 2009
Beginning balance		$	(2,639	)		$	(2,870	)
Additional credit impairments on:
Previously impaired securities			(221	)			(270	)
Securities without previous impairments			(217	)			(489	)
			(438	)			(759	)
Reductions for securities sold			—				552
Balance at December 31, 2009		$	(3,077	)		$	(3,077	)

     On a quarterly basis, the Company reviews cash flow estimates for certain non-agency backed CMOs of lesser credit quality following the guidance of FASB ASC 325-40-65, Amendments to the Impairment Guidance of EITF Issue No. 99-20 (Prior authoritative literature: FSP EITF 99-20-1) (“FASB ASC 325-40-65”). Accordingly, when changes in estimated cash flows from the cash flows previously estimated occur due to actual or estimated prepayment or credit loss experience, and the present value of the revised cash flows is less than the present value previously estimated, OTTI is deemed to have occurred. For non-agency backed CMOs not subject to FASB ASC 325-40-65, the Company prepares quarterly projected cash flow analyses and recognizes OTTI when it determines that a loss is probable. The Company has recognized OTTI related to certain non-agency backed CMOs as the underlying cash flows have been adversely impacted due to a reduction in prepayments from mortgage refinancing and an increase in actual and projected delinquencies in the underlying mortgages.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The Company’s review of non-agency backed CMOs included an analysis of available information such as collateral quality, anticipated cash flows, credit enhancements, default rates, loss severities, the securities’ relative position in their respective capital structures, and credit ratings from statistical rating agencies. The Company reviews quarterly projected cash flow analyses for each security utilizing current assumptions regarding (i) actual and anticipated delinquencies, (ii) delinquency transition-to-default rates, and (iii) loss severities. Based on its quarterly reviews, the Company determined that there had not been an adverse change in projected cash flows, except in the case of those securities for which OTTI charges have been recorded. The Company believes that the unrealized losses on these securities are not necessarily predictive of the ultimate performance of the underlying collateral. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before the recovery of their amortized cost basis.

     The OTTI charges on corporate bonds for the six months ended December 31, 2008 were recorded as these bonds were considered to be impaired based on the extent and duration of the declines in their fair values and issuer-specific fundamentals relating to (i) poor operating results and weakened financial conditions, (ii) negative industry trends further impacted by the recent economic decline, and (iii) a series of downgrades to their credit ratings. Based on the factors that existed at the time of impairment, the Company did not believe that these bonds would recover their unrealized losses in the near future.

     The Company believes that the remaining securities having unrealized losses at December 31, 2009 were not other-than-temporarily impaired. The Company also does not intend to sell any of these securities and it is more likely than not that the Company will not be required to sell any of these securities before the recovery of their amortized cost basis.

3. Net Income (Loss) Per Share

     The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share data).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Net income (loss)		$	1,475			$	(1,003	)		$	4,235			$	838
Weighted average common basic shares			47,960				47,658				47,919				47,656
Weighted average effect of dilutive securities			591				—				801				1,432
Weighted average common dilutive shares			48,551				47,658				48,720				49,088
Basic and diluted net income (loss) per share		$	0.03			$	(0.02	)		$	0.09			$	0.02

     For the three months ended December 31, 2009, options to purchase approximately 4.6 million shares of common stock, a dilutive effect of approximately 0.2 million shares, and 0.5 million shares of unvested restricted common stock were included in the computation of diluted income per share. For the three months ended December 31, 2008, options to purchase approximately 5.3 million shares of common stock, a dilutive effect of approximately 0.8 million shares, and 0.4 million shares of unvested restricted common stock were not included in the computation of diluted loss per share as their inclusion would have been anti-dilutive.

     For the six months ended December 31, 2009, options to purchase approximately 4.6 million shares of common stock, a dilutive effect of approximately 0.4 million shares, and 0.5 million shares of unvested restricted common stock were included in the computation of diluted income per share. For the six months ended December 31, 2008, options to purchase approximately 5.3 million shares of common stock, a dilutive effect of approximately 1.0 million shares, and 0.4 million shares of unvested restricted common stock were included in the computation of diluted income per share.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

4. Income Taxes

     The provision (benefit) for income taxes consisted of the following (in thousands).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Federal:
Current		$	—			$	(72	)		$	—			$	(28	)
Deferred			—				(535	)			—				1,152
			—				(607	)			—				1,124
State:
Current			102				42				203				209
Deferred			—				180				—				194
			102				222				203				403
		$	102			$	(385	)		$	203			$	1,527

     The provision (benefit) for income taxes differs from the amounts computed by applying the statutory federal corporate tax rate of 35% to income (loss) before income taxes as a result of the following (in thousands).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Provision (benefit) for income taxes at statutory rate		$	552			$	(486	)		$	1,553			$	828
Tax effect of:
Tax-exempt investment income			(4	)			(1	)			(8	)			(7	)
Change in the beginning of the period balance of the valuation allowance for deferred tax assets allocated to income taxes			(516	)			(252	)			(1,471	)			—
State income taxes, net of federal income tax benefit			65				208				120				330
Other			5				146				9				376
		$	102			$	(385	)		$	203			$	1,527

     The Company had a valuation allowance of $22.2 million and $24.9 million at December 31, 2009 and June 30, 2009, respectively, to reduce net deferred tax assets to the amount that is more likely than not to be realized, which included all net deferred tax assets at December 31, 2009 and June 30, 2009. For the six months ended December 31, 2009, the change in the valuation allowance included the unrealized change on investments of $1.2 million included in other comprehensive income (loss).

     In assessing the realization of deferred tax assets, management considered whether it was more likely than not that some portion or all of the deferred tax assets will not be realized. The Company is required to assess whether a valuation allowance should be established against the Company’s deferred tax assets based on the consideration of all available evidence using a more likely than not standard. In making such judgments, significant weight is given to evidence that can be objectively verified. In assessing the Company’s ability to support the realizability of its deferred tax assets, management considered both positive and negative evidence. The Company placed greater weight on historical results than the Company’s outlook for future profitability and established a valuation allowance against all net deferred tax assets at December 31, 2009 and June 30, 2009. The deferred tax valuation allowance may be adjusted in future periods if management considers that it is more likely than not that some portion or all of the deferred tax assets will be realized. In the event the deferred tax valuation allowance is adjusted, the Company would record an income tax benefit for the adjustment.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

5. Goodwill and Identifiable Intangible Assets

     Goodwill and other identifiable intangible assets are attributable to the Company’s insurance operations and were initially recorded at their estimated fair values at the date of acquisition. Goodwill and other intangible assets having an indefinite useful life are not amortized for financial statement purposes. The Company performs required annual impairment tests of its goodwill and intangible assets as of the last day of the fourth quarter of each fiscal year. In the event that facts and circumstances indicate that the goodwill and other identifiable intangible assets may be impaired, an interim impairment test would be required. Intangible assets with finite lives have been fully amortized over their useful lives.

     The goodwill impairment test is a two-step process that requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit based on valuation techniques, including a discounted cash flow model using revenue and profit forecasts, and comparing those estimated fair values with the carrying values of those assets and liabilities, which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment, if any, by determining an “implied fair value” of goodwill. The determination of the “implied fair value” of goodwill of a reporting unit requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.

     As a result of the adverse impact of difficult economic conditions on the Company’s customers and business and the resulting decline in its share price during the fourth quarter of fiscal year 2009, the Company estimated that a goodwill impairment was probable. Accordingly, the Company recognized an estimated non-cash, pre-tax goodwill impairment charge of $68.0 million in the fourth quarter of fiscal year 2009. Due to the complexity of the fair value calculations involved, the analysis of the goodwill impairment charge recognized during the fourth quarter of fiscal year 2009 was finalized during the first quarter of fiscal year 2010 and the amount of the impairment did not differ from the initial estimate.

     The Company’s evaluation includes multiple assumptions, including estimated discounted cash flows and other estimates that may change over time. If future discounted cash flows become less than those projected by the Company, further impairment charges may become necessary that could have a materially adverse impact on the Company’s results of operations and financial condition. As quoted market prices in active stock markets are relevant evidence of fair value, a significant decline in the Company’s common stock trading price may indicate an impairment of goodwill.

6. Litigation

     The Company is named as a defendant in various lawsuits, arising in the ordinary course of business, generally relating to its insurance operations. All legal actions relating to claims made under insurance policies are considered by the Company in establishing its loss and loss adjustment expense reserves. The Company also faces lawsuits that seek damages beyond policy limits, commonly known as bad faith claims, as well as class action and individual lawsuits that involve issues arising in the course of the Company’s business. The Company continually evaluates potential liabilities and reserves for litigation of these types using the criteria established by FASB ASC 450-20, Loss Contingencies (Prior authoritative literature: FASB Statement No. 5) (“FASB ASC 450-20”). Pursuant to FASB ASC 450-20, reserves for a loss may only be recognized if the likelihood of occurrence is probable and the amount can be reasonably estimated. If a loss, while not probable, is judged to be reasonably possible, management will disclose, if it can be estimated, a possible range of loss or state that an estimate cannot be made. Management evaluates each legal action and records reserves for losses as warranted by establishing a reserve in its consolidated balance sheets in loss and loss adjustment expense reserves for bad faith claims and in other liabilities for other lawsuits. Amounts incurred are recorded in the Company’s consolidated statements of operations in losses and loss adjustment expenses for bad faith claims and in insurance operating expenses for other lawsuits unless otherwise disclosed.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

     The Company has established an accrual for losses related to the litigation settlements entered into during fiscal year 2009 related to litigation brought against the Company in Alabama and Georgia with respect to its sales practices, primarily the sale of ancillary motor club memberships currently or formerly sold in those states. Pursuant to the terms of the settlements, eligible class members are entitled to certain premium credits towards a future automobile insurance policy with the Company or a reimbursement certificate for future rental or towing expenses. Benefits to the Georgia and Alabama class members commenced January 1, 2009 and March 7, 2009, respectively. Any premium credits issued to class members as described above will be prorated over a twelve-month term not to extend beyond August 2011, and the class member will be entitled to the prorated premium credit only so long as their insurance premiums remain current during the twelve-month term.

     At December 31, 2008, the Company accrued $5.2 million for premium credits available to class members who were actively insured by the Company. The following is a progression of the activity associated with the estimated premium credit liability (in thousands).

Balance at December 31, 2008		$	5,227
Credits utilized			(1,338	)
Credits forfeited			(904	)
Balance at June 30, 2009			2,985
Credits utilized			(1,939	)
Credits forfeited			(234	)
Balance at December 31, 2009		$	812

     The Company has not established an accrual for $0.3 million in potential premium credits available to class members who were not actively insured by the Company upon commencement of the settlement due to the uncertainty associated with this group having to purchase a new automobile insurance policy. Based on experience to date, the Company does not expect any significant costs associated with the reimbursement certificates. The final costs of the settlements will depend on, among other factors, the rate of redemption and forfeiture of the premium credits and reimbursement certificates.

     The litigation settlement costs are classified in the litigation settlement expenses line item in the Company’s consolidated statements of operations. The litigation settlement accrual for those currently estimable costs associated with the utilization of premium credits is classified in other liabilities in the Company’s consolidated balance sheet. Management intends to adjust the estimated accrual as necessary during future periods to account for the impact of the actual rate of redemption and forfeiture of the premium credits and reimbursement certificates.

     The Company received $2.95 million in July 2009 from its insurance carrier regarding coverage for the costs and expenses incurred by the Company relating to the settlement of the Georgia and Alabama litigation. The insurance recovery was accrued in fiscal year 2009 and is included in other assets in the Company’s consolidated balance sheet at June 30, 2009.

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

7. Fair Value of Financial Instruments

     The carrying values and fair values of certain of the Company’s financial instruments were as follows (in thousands).

		December 31, 2009								June 30, 2009
		Carrying				Fair				Carrying				Fair
		Value				Value				Value				Value
Assets:
Fixed maturities, available-for-sale		$	186,328			$	186,328			$	140,311			$	140,311
Cash and cash equivalents			29,227				29,227				77,201				77,201
Premiums and fees receivable, net			39,212				39,212				45,309				45,309
Liabilities:
Capitalized lease obligations			196				196				224				224
Debentures payable			41,240				19,176				41,240				15,568

     The fair values as presented represent the Company’s best estimates and may not be substantiated by comparisons to independent markets. The fair value of the debentures payable was based on current market rates offered for debt with similar risks and maturities. Certain financial instruments and all non-financial instruments are not required to be disclosed. Therefore, the aggregate fair values presented in the table do not purport to represent the Company’s underlying value.

8. Segment Information

     The Company operates in two business segments with its primary focus being the selling, servicing and underwriting of non-standard personal automobile insurance. The real estate and corporate segment consists of the activities related to the disposition of foreclosed real estate held for sale, interest expense associated with debt and other general corporate overhead expenses.

     The following table presents selected financial data by business segment (in thousands).

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Revenues:
Insurance		$	53,745			$	65,046			$	111,028			$	136,603
Real estate and corporate			30				34				59				66
Consolidated total		$	53,775			$	65,080			$	111,087			$	136,669
Income (loss) before income taxes:
Insurance		$	3,560			$	438			$	8,035			$	6,200
Real estate and corporate			(1,983	)			(1,826	)			(3,597	)			(3,835	)
Consolidated total		$	1,577			$	(1,388	)		$	4,438			$	2,365
		December 31,				June 30,
		2009				2009
Total assets:
Insurance		$	336,700			$	348,801
Real estate and corporate			11,249				10,155
Consolidated total		$	347,949			$	358,956

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

9. Recent Accounting Pronouncements

     In June 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-01, Generally Accepted Accounting Principles (Topic 105) (“FASB ASU No. 2009-01”), which establishes the FASB Accounting Standards Codification as the single source of authoritative accounting principles recognized by the FASB. This codification does not create new accounting and reporting standards but organizes their structure and requires the Company to update all existing U.S. generally accepted accounting principles references to the new codification references for all future filings. The Company adopted the provisions of FASB ASU No. 2009-01 in the quarter ended September 30, 2009.

     In August 2009, the FASB issued ASU No. 2009-05, Measuring Liabilities at Fair Value (Topic 820) (“FASB ASU No. 2009-05”), which amends FASB ASC 820, Fair Value Measurements and Disclosures (Prior authoritative literature: FASB SFAS No. 157), by clarifying that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses either the quoted price of the identical liability when traded as an asset or quoted prices for similar liabilities when traded as assets. The Company adopted the provisions of FASB ASU No. 2009-05 upon issuance. The adoption did not have an impact on the Company’s results of operations or financial condition.

FIRST ACCEPTANCE CORPORATION 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include those discussed in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009. The following discussion should be read in conjunction with our consolidated financial statements included in this report and our consolidated financial statements and related Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended June 30, 2009 included in our Annual Report on Form 10-K.

General

     At December 31, 2009, we leased and operated 409 retail locations (or “stores”) staffed by employee-agents. Our employee-agents exclusively sell non-standard automobile insurance products underwritten by us. At December 31, 2009, we wrote non-standard personal automobile insurance in 12 states and were licensed in 13 additional states. See the discussion in Item 1. “Business - General” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2009 for additional information with respect to our business.

     The following table shows the change in the number of our retail locations for the periods presented. Retail location counts are based upon the date that a location commenced or ceased writing business.

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2009				2008				2009				2008
Retail locations — beginning of period			415				429				418				431
Opened			—				—				—				1
Closed			(6	)			(5	)			(9	)			(8	)
Retail locations — end of period			409				424				409				424

     The following table shows the number of our retail locations by state.

		December 31,								September 30,								June 30,
		2009				2008				2009				2008				2009				2008
Alabama			25				25				25				25				25				25
Florida			34				39				36				39				39				40
Georgia			61				61				61				61				61				61
Illinois			76				81				78				81				78				80
Indiana			18				18				18				19				18				19
Mississippi			8				8				8				8				8				8
Missouri			12				12				12				13				12				14
Ohio			27				28				27				29				27				29
Pennsylvania			17				18				17				18				17				19
South Carolina			27				27				27				28				27				28
Tennessee			19				20				20				20				20				20
Texas			85				87				86				88				86				88
Total			409				424				415				429				418				431