UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2004

or

For the transition period from __________ to __________

Commission File Number: 001-12117

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

N/A
(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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No þ

As of February 11, 2005, there were outstanding 46,691,438 shares of the registrant’s common stock, par value $0.01 per share.

FIRST ACCEPTANCE CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2004

INDEX

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PART I  -  FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES

See notes to consolidated financial statements.

1

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES

See notes to consolidated financial statements.

2

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES

See notes to consolidated financial statements.

3

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES

See notes to consolidated financial statements.

4

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES

1. General

     First Acceptance Corporation (the “Company”) is a retailer, servicer and underwriter of non-standard personal automobile insurance based in Nashville, Tennessee. The Company currently writes non-standard personal automobile insurance principally in Georgia, Tennessee and Alabama. Business is also written in 6 additional states and the Company is licensed as an insurer in 14 additional states. Business is written through two insurance company subsidiaries, USAuto Insurance Company, Inc. and Village Insurance Company, Inc. In Alabama, the Company assumes business through reinsurance contracts with unaffiliated insurance companies, since neither of the Company’s insurance company subsidiaries is currently licensed there. Incidental run-off operations are also conducted by the Company as a managing general agency whereby premiums are written on behalf of other insurance companies.

2. Basis of Presentation

     The unaudited consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and six months ended December 31, 2004 are not necessarily indicative of the results that may be expected for the year ending June 30, 2005. These unaudited consolidated financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

     The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. It also requires disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates.

     Certain amounts in the consolidated financial statements for the prior period have been reclassified to conform with the current period’s presentation.

3. Income Taxes

     There was no income tax expense recorded for the three and six months ended December 31, 2003 as a result of net operating losses available to offset federal taxable income for which a full valuation allowance had been established. The valuation allowance was adjusted in connection with the April 30, 2004 acquisition of USAuto Holdings, Inc. (“USAuto”). For the three and six months ended December 31, 2004, there was no change in the deferred tax asset valuation allowance. For the six months ended December 31, 2004, substantially all of the Company’s current income tax expense has been offset by its tax net operating loss carryforwards which has resulted in a reduction in the deferred tax asset.

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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except per share data)
(Unaudited)

4. Net Income (Loss) per Share

     The following table sets forth the computation of basic and diluted net income (loss) per share:

     Weighted average common diluted shares for the three months ended December 31, 2003 excludes incremental shares from assumed conversion of stock options of 622 due to the net loss incurred for the quarter.

5. Stock-Based Compensation

     Effective July 1, 2003, the Company adopted the prospective method provisions of SFAS No. 148 in accounting for employee stock options. 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 APB No. 25 in accounting for employee stock options. Under APB 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 income (loss) and net income (loss) per share for the three and six months ended December 31, 2003 if the Company had applied the fair value recognition provisions of SFAS No. 123 to all stock-based compensation. There is no effect for the three and six months ended December 31, 2004 since all stock options issued under APB No. 25 were fully vested prior to July 1, 2004.

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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except per share data)
(Unaudited)

6. Reinsurance

     Effective September 1, 2004, the Company elected to not renew its 50% quota-share reinsurance treaty. As part of such non-renewal, an election was also made to “cut-off” the reinsurance as of the non-renewal date. Therefore, on such date, the reinsurer returned the ceded unearned premium (prepaid reinsurance premiums) to the Company, and the reinsurer is not liable for any losses incurred after the non-renewal date.

7. Subsequent Event

     Effective January 1, 2005, the Company acquired the assets (principally the book of business and retail locations) of a non-standard automobile insurance agency in Texas for $4,000 in cash. As a result, the Company is now writing business through 15 company-owned retail locations in Texas.

8. Business Combination

     Pursuant to the terms of the acquisition of USAuto, the Company has accrued a liability for contingent shares valued at $6,720 relating to an additional 750 shares to be issued based upon the attainment of certain financial targets as of December 31, 2004. Such amount has been recorded as additional goodwill related to the acquisition.

     The following pro forma consolidated statements of income have been derived by the application of pro forma adjustments to the Company’s historical consolidated statements of income. The pro forma consolidated statements of income for the three and six months ended December 31, 2003 give effect to the acquisition of USAuto and related transactions as if they had been consummated on July 1, 2003. Assumptions underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with these pro forma consolidated statements of income.

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FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except per share data)
(Unaudited)

8

FIRST ACCEPTANCE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands, except per share data)
(Unaudited)

     Notes to pro forma consolidated statements of income:

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

     The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in this report.

General

     Prior to our April 30, 2004 acquisition of USAuto Holdings, Inc. (“USAuto”), 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. New investments in real estate are not anticipated, although a $0.3 million tract of land adjacent to one of our properties was acquired in December 2004 to enhance the marketability of the owned parcel.

     As a result of the USAuto acquisition, we are now 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 and, in most instances, who are required by law to buy a minimum amount of automobile insurance.

     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 January 31, 2005, including the Texas acquisition, we owned and operated 197 retail locations, staffed by employee-agents. Our employee-agents exclusively sell insurance products either underwritten or serviced by us. Effective January 1, 2005, we write non-standard personal automobile insurance in 10 states and we are also licensed as an insurer in 14 additional states.

     The following table shows the changes in the number of our retail locations for the periods presented.

     Our consolidated financial statements vary in important respects from our historical consolidated financial statements due to the acquisition of USAuto. The three and six months ended December 31, 2003 reflect the results from our previous acquisition activities and real estate operations, while the three and six months ended December 31, 2004 reflect primarily the results from our insurance operations.

     Our results for the three and six months ended December 31, 2003 included expenses that have been discontinued as a result of the acquisition of USAuto. These expenses principally consisted of compensation to employees who were terminated in connection with the acquisition. However, the current periods include (as will future periods) the cost of an advisory services agreement with an entity controlled by Donald J. Edwards, our former Chief Executive Officer. These items have been incorporated into the presentation of pro forma operating results for the three and six months ended December 31, 2003, which assume that the acquisition of USAuto occurred on July 1, 2003. See note 8 to the consolidated financial statements.

Consolidated Results of Operations

Overview

     The three and six months ended December 31, 2004 reflect the results of our insurance operations, while the three and six months ended December 31, 2003 reflect the results of our acquisition activities and real estate operations. In addition to the actual results, we discuss pro forma operating results for the three and six months ended December 31, 2003 that assume that the USAuto acquisition occurred on July 1, 2003. We also separately

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discuss both the results of the insurance operations and the real estate and corporate activities. Segment information is summarized below on both an actual and pro forma basis for the periods presented.

     Our insurance operations derive revenues from selling, servicing and underwriting non-standard personal automobile insurance policies in nine states. We conduct our underwriting operations through two insurance company subsidiaries, USAuto Insurance Company, Inc. and Village Auto Insurance Company, Inc. Our insurance operations revenues are primarily from:

		•	premiums earned from sales of policies issued by the insurance company subsidiaries, net of the portion of those premiums that have been ceded to reinsurers;
		•	fee income, which includes policy and installment billing fees on policies written as well as fees for other ancillary services (principally a motor club product);
		•	commission income paid by our reinsurer to us for ceded premiums (up until the September 1, 2004 non-renewal of our quota-share reinsurance); and
		•	investment income earned on the invested assets of the insurance company subsidiaries.

To a lesser extent, we are also winding down operations in which our managing general agency subsidiaries (MGA subsidiaries) receive commissions for selling and servicing policies on behalf of third-party insurance companies.

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     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, 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.

     The following table presents the change in the total number of policies in force for the insurance operations separately for business written by the insurance company subsidiaries and for policies issued by the MGA subsidiaries on behalf of other insurance companies for the periods presented.

     The following table presents net premiums earned by state for the insurance operations on both an actual and a pro forma basis for the periods presented. This table represents the net underwriting risk retained by us after considering the effects of reinsurance. Note that the Alabama premiums shown are assumed by us through a quota share reinsurance contract, which was increased from 15% to 50%, effective February 1, 2004.

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     Insurance companies present a combined ratio as a measure of their overall underwriting profitability. The components of the combined ratio are as follows:

     Loss Ratio — Loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment expenses incurred to premiums earned and is a basic element of underwriting profitability. We calculate this ratio based on all direct and assumed premiums earned, net of ceded reinsurance.

     Expense Ratio — Expense ratio is the ratio (expressed as a percentage) of operating expenses to premiums earned. This is a measurement that illustrates relative management efficiency in administering our operations. We calculate this ratio on a net basis as a percentage of net premiums earned. Insurance operating expenses are reduced by fee income from insureds and ceding commissions received from our reinsurer as compensation for the costs we incur in servicing this business on their behalf.

     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 bonds. At December 31, 2004, approximately 43% of our fixed maturities portfolio was tax-exempt. This percentage has reduced and will continue to reduce over time as we move to a taxable portfolio. Most securities held are 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.

     The non-standard personal automobile insurance industry is somewhat 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 have a negative impact on our revenues and profitability. However, we believe that during 2002 and 2003, the underwriting results in the personal automobile insurance industry improved as a result of favorable pricing and competitive conditions that allowed for broad increases in rate levels by insurers, while rates and premium levels for non-standard automobile insurance stabilized during 2004.

Three and Six Months Ended December 31, 2004 Compared With Three and Six Months Ended December 31, 2003

Actual Consolidated Results

     Net income for the three months ended December 31, 2004 was $4.7 million versus a loss of $0.8 million for the three months ended December 31, 2003 and net income for the six months ended December 31, 2004 was $8.6 million versus $0.1 million for the six months ended December 31, 2003. The prior fiscal year’s results reflect only real estate operations and the costs associated with acquisition opportunities, while the current fiscal year’s results reflects insurance operating results.

     Net income per share on both a basic and a diluted basis for the three months ended December 31, 2004 was $0.10 as compared to a loss of $0.04 for the three months ended December 31, 2003 and net income per share on both a basic and a diluted basis for the six months ended December 31, 2004 was $0.18 as compared to $0.01 for the six months ended December 31, 2003. No tax expense was recognized for the three and six month periods ended

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December 31, 2003, as a result of net operating losses available to offset federal taxable income for which a full valuation allowance had been established.

Pro forma Consolidated Results

     On a pro forma basis, net income was $0.8 million for the three months ended December 31, 2003 and $3.9 million for the six months ended December 31, 2003. Pro forma net income per share on both a basic and a diluted basis was $0.02 for the three months ended December 31, 2003 and $0.08 for the six months ended December 31, 2003.

Actual Results – Insurance Operations

     For the three months ended December 31, 2004, the insurance operations recorded income before income taxes of $7.4 million. The combined ratio for this period was 79.6%, which was comprised of a loss and loss adjustment expense ratio of 65.4% and an expense ratio of 14.2%.

     For the six months ended December 31, 2004, the insurance operations recorded income before income taxes of $13.5 million. The combined ratio for this period was 78.0%, which was comprised of a loss and loss adjustment expense ratio of 64.0% and an expense ratio of 14.0%.

Pro forma Results – Insurance Operations

     On a pro forma basis, income before income taxes for the three months ended December 31, 2003 was $1.6 million compared to the actual income before income taxes of $7.4 million for the three months ended December 31, 2004. On a pro forma basis, income before income taxes for the six months ended December 31, 2003 was $5.6 million compared to the actual income before income taxes of $13.5 million for the six months ended December 31, 2004.

     Net premiums earned increased 153% and 116% to $31.1 million and $52.8 million, respectively, for the three and six month periods ended December 31, 2004 from $12.3 million and $24.5 million, respectively, on a pro forma basis for the same periods last year. This increase is primarily the result of electing to not renew our 50% quota share reinsurance commencing September 1, 2004. As a result, the three months ended December 31, 2004 reflect no quota share reinsurance. Such reinsurance was in effect for one month in the six months ended December 31, 2004 and for all of the six months ended December 31, 2003.

     In addition to the above factor, 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 operations for other insurance companies and effective February 1, 2004 we increased our assumed reinsurance percentage from 15% to 50% for our Alabama business, which is written through other insurance companies. Overall, the number of insured policies in force at December 31, 2004 increased 32% over the same date in 2003.

     Likewise, as a result of shifting the insurance underwriting to our insurance company subsidiaries, commissions and fees declined as a percentage of net premiums earned over these same periods and, as a result of not renewing the quota share reinsurance, ceding commissions from our reinsurer also decreased. The three months ended December 31, 2004, however, include an additional ceding commission of $1.7 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.

     During the three months ended December 31, 2004, the number of sales offices (or “stores”) increased by 24, increasing to 178 at December 31, 2004. During the same period last year, we opened 9 stores. During the six months ended December 31, 2004, the number of stores increased by 40 compared with 13 during the same period last year.

     Investment income increased primarily as a result of the increase in invested assets as a result of our growth. We expect investment income to continue to increase as we shift the investment portfolio from tax-exempt to taxable investments. The weighted average investment yield for the fixed maturities portfolio was 3.69% at December 31,

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2004 with a duration of 4.1 years. The yield for the comparable Lehman Brothers municipal bond indices at December 31, 2004 was 3.57%.

     The loss and loss adjustment expense ratio improved to 65.4% and 64.0%, respectively, for the three and six month periods ended December 31, 2004 from 70.5% and 69.3%, respectively, on a pro forma basis for the same periods in fiscal 2004. The loss ratio for the three months ended December 31, 2004 increased slightly as a result of not renewing the quota share reinsurance. This occurred since the previously-reinsured business carried a slightly higher loss ratio than our retained business did since our net loss ratio was favorably impacted by the fact that we received 100% of the policy fees which are a component of net premiums earned.

     Insurance operating expenses increased 14% and 10%, respectively, to $11.5 million and $21.9 million, respectively, for the three and six month periods ended December 31, 2004 from $10.1 million and $ 19.9 million on a pro forma basis for the same periods in fiscal 2004. These increases are primarily due to expenses that vary along with the increase in net premiums earned.

     The expense ratio decreased from 16.8% for the three months ended December 31, 2003 to 14.2% for the three months ended December 31, 2004, primarily due to the additional ceding commission of $1.7 million. This favorable impact however was partially offset by 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. The expense ratio increased from 13.5% for the six months ended December 31, 2003 to 14.0% for the six months ended December 31, 2004 as a result of these same factors

     Overall, the combined ratio improved to 79.6% and 78.0%, respectively, for the three and six month periods ended December 31, 2004 from 87.3% and 82.8%, respectively, on a pro forma basis for the same periods last year.

     In addition, during the three months ended December 31, 2004, we recognized a $0.2 million gain on the sale of property and equipment as a result of the sale of an aircraft previously used in the insurance operations.

Actual Results – Real Estate and Corporate

     Loss before income taxes for the three months ended December 31, 2004 was $0.1 million versus loss before income taxes of $0.8 million for the three months ended December 31, 2003. Loss before income taxes for the six months ended December 31, 2004 was $0.3 million versus income before income taxes of $0.1 million for the six months ended December 31, 2003. For the three months ended December 31, 2004 a gain on sale of foreclosed real estate of $0.8 million was recognized versus a gain of $0.1 million in the same period in fiscal 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.

     Investment income was $0.2 million and $0.5 million, respectively, for the three and six month periods ended December 31, 2004, compared to $0.2 million and $0.4 million, respectively, for the same periods in fiscal 2004. The decrease in available cash equivalents as a result of the USAuto acquisition was offset by a higher return earned during the current periods on our investment in mutual fund.

     Other operating expenses decreased for the three months ended December 31, 2004, primarily as a result of the elimination of the cost of former employees who were terminated as a result of the USAuto acquisition. The reduction in costs was partially offset by additional costs associated with being an operating public company.

Pro forma Results – Real Estate and Corporate

     On a pro forma basis, loss before taxes for the three months ended December 31, 2003 was $0.6 million and income before taxes for the six months ended December 31, 2003 was $0.4 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.

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Liquidity and Capital Resources

     Prior to the USAuto acquisition, our historical funding requirements were for operating expenses, including legal, audit and consulting expenses incurred in connection with the 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 and 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 fully-integrated retailer, servicer and underwriter of non-standard personal automobile insurance. Primary sources of funds are premiums, commission and fee income and investment income. Funds are used to pay claims and operating expenses, pay interest and principal under the terms of our loan agreement and purchase investments.

     Operating activities for the six months ended December 31, 2004 provided $19.3 million of cash compared to $1.4 million used in the same period in fiscal 2004. The increase is the direct result of the inclusion of insurance operations in the current period.

     Net cash used by investing activities for the three months ended December 31, 2004 was $26.5 million as compared to $1.7 million provided in the same period in fiscal 2004. The fiscal 2005 period reflects the additions to our investment portfolio, while the fiscal 2004 period results include proceeds from the sales of foreclosed real estate.

     During the six months ended December 31, 2004, we increased the statutory capital and surplus of the insurance company subsidiaries by $5.0 million to support additional premium writings. At December 31, 2004, we had $19.8 million available in unrestricted cash and investments outside of the insurance company subsidiaries. However, $4.0 million of these available funds were used in January 2005 in connection with the acquisition of the assets of a non-standard automobile agency in Texas.

     The note payable to a financial institution at December 31, 2004 consisted of a term loan with an unpaid balance of $3.5 million that bears interest at LIBOR plus 366 basis points. The note is payable in scheduled quarterly installments through June 30, 2007 and is secured by the common stock and certain assets of USAuto’s direct wholly-owned subsidiaries. The term loan contains certain financial covenants and requires USAuto to maintain certain financial ratios. At December 31, 2004, USAuto was in compliance with all provisions of the loan agreement, including the financial covenants and ratios, except for the 2003 Risk Based Capital ratio for which a waiver had been obtained and the 2004 Risk Based Capital ratio which has not been determined.

     As a result of the USAuto acquisition, we are now part of an insurance holding company system with substantially all of our operations conducted by our insurance company subsidiaries. Accordingly, the holding company will only receive cash from operating activities as a result of investment income and the ultimate liquidation of our foreclosed real estate held for sale. Cash could be made available through loans from financial institutions, the sale of common stock, and dividends from our insurance company subsidiaries. In addition, as a result of our tax net operating loss carryforwards, taxable income generated by the insurance company subsidiaries will provide cash to the holding company through an intercompany tax allocation agreement through which the insurance company subsidiaries will reimburse the holding company for current tax benefits utilized through recognition of the net operating loss carryforwards.

     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.

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     We believe that existing cash and investment balances, when combined with anticipated cash flows generated from operations, 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.

Forward-Looking Statements

     This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements made in the report, other than statements of historical fact, are forward-looking statements. You can identify these 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:

	•	statements and assumptions relating to future growth, income, income per share and other financial performance measures, as well as management’s short-term and long-term performance goals;
	•	statements relating to the anticipated effects on results of operations or financial condition from recent and expected developments or events;
	•	statements relating to our business and growth strategies; and
	•	any other statements or assumptions that are not historical facts.

     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 the Annual Report on Form 10-K for the year ended June 30, 2004, filed with the Securities and Exchange Commission on September 28, 2004.

     You should not place undue reliance on any forward-looking statements. These statements speak only as of the date of this report. Except as otherwise required by applicable laws, we undertake no obligation to publicly update or revise any forward-looking statements or the risk factors described in this report, whether as a result of new information, future events, changed circumstances or any other reason after the date of this report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We have an exposure to interest rate risk relating to fixed maturity investments. Changes in market interest rates directly impact the market value of our fixed maturity securities. Some fixed income securities have call or prepayment options. This subjects us to reinvestment risk as issuers may call their securities, which could result in us reinvesting the proceeds at lower interest rates. We manage exposure to interest rate risks by adhering to specific guidelines in connection with our investment portfolio. We invest primarily in municipal bonds that have been rated “A” or better by Standard & Poors. At December 31, 2004, 98.2% of the portfolio was invested in securities rated “AA” or better by Standard & Poors, and 100% was invested in securities rated “A” or better by Standard & Poors. We have not recognized any other than temporary losses on the investment portfolio. We also utilize the services of a professional fixed income investment manager.

     As of December 31, 2004, the impact of an immediate 100 basis point increase in market interest rates on our fixed maturities portfolio would have resulted in an estimated decrease in fair value of 4.7%, or approximately $2.4 million. Conversely, as of the same date, the impact of an immediate 100 basis point decrease in market interest rates on our fixed maturities portfolio would have resulted in an estimated increase in fair value of 4.3%, or approximately $2.2 million.