UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2004

or

For the transition period from                     to                    

Commission File Number: 1-6802

First Acceptance Corporation

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

Liberté Investors Inc.
200 Crescent Court, Suite 1365, Dallas, TX 75201
(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  x     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  x  

As of May 7, 2004, there were outstanding 46,363,500 shares of the registrant’s common stock, par value $0.01 per share.

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2004

INDEX

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

See accompanying notes to consolidated financial statements.

3

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

See accompanying notes to consolidated financial statements.

4

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

See accompanying notes to consolidated financial statements.

5

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

See accompanying notes to consolidated financial statements.

6

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

See accompanying notes to consolidated financial statements.

7

FIRST ACCEPTANCE CORPORATION, F/K/A LIBERTÉ INVESTORS INC.
AND SUBSIDIARY

Note A — Organization

First Acceptance Corporation, f/k/a Liberté Investors Inc., a Delaware corporation (the “Company”), was organized in April 1996 in order to effect the reorganization of Liberté Investors, a Massachusetts business trust (the “Trust”). At a special meeting of the shareholders of the Trust held on August 15, 1996, the Trust’s shareholders approved a plan of reorganization whereby the Trust contributed its assets to the Company and received all of the Company’s outstanding common stock, par value $.01 per share. The Trust then distributed to its shareholders, in redemption of all outstanding shares of beneficial interest in the Trust, the shares of the Company. The Company assumed all of the Trust’s assets and outstanding liabilities and obligations.

Since August 1996, the Company has been actively pursuing opportunities to acquire one or more operating companies in order to increase value to existing stockholders and provide a new focus and direction for the Company. The Company’s primary objective has been to seek long-term growth through an acquisition of a business rather than short-term earnings.

To that end, on April 30, 2004, the Company acquired USAuto Holdings, Inc. (“USAuto”) for consideration consisting of $76.0 million in cash, 13,250,000 shares of the Company’s common stock, and up to an additional 750,000 shares of common stock that may be issued at a later date if certain financial targets are reached. A portion of the cash consideration was raised in a stock rights offering, as discussed in Note J.

USAuto is a retailer, servicer and underwriter of non-standard personal automobile insurance based in Nashville, Tennessee. USAuto currently writes non-standard personal automobile insurance in Georgia, Tennessee, Alabama, Mississippi, Ohio and Missouri and is licensed as an insurer in 12 additional states.

Note B — Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and therefore do not include all of the information and footnotes necessary for a fair presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three- and nine-month periods ended March 31, 2004, are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2004. The Company’s earnings in the fourth quarter of its fiscal year 2004 will be affected by the Company’s acquisition of USAuto, as discussed in Note J.

The accompanying consolidated financial statements include the accounts of the Company and LNC Holdings, Inc., a wholly-owned subsidiary whose sole asset is approximately 38 acres of land located in Arlington, Texas. All intercompany balances and transactions have been eliminated.

Certain reclassifications have been made to the accompanying unaudited consolidated financial statements. Such reclassifications had no impact on net income (loss) or stockholders’ equity.

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Note C — Foreclosed Real Estate Held For Sale

At March 31, 2004, the Company held foreclosed real estate for sale in the form of undeveloped land. The March 31, 2004 carrying amount of these assets was approximately $1.1 million. The foreclosed real estate for sale consists of land totaling approximately 313 acres in San Antonio, Texas and approximately 38 acres in Arlington, Texas.

In September 2002, the Company sold 51.57 acres of land in San Antonio, Texas to a discount department store chain for a price of $538,907, less associated selling costs of $13,928. A gain of approximately $234,000 was recorded as a result of this transaction.

In September 2002, the Company recorded a write-down on the book values of three parcels of land in San Antonio, Texas for an aggregate of approximately $124,000. The write-down was recorded to adjust for decreased market values on the properties due to a softening of the local real estate market.

In November 2002, the Company sold 7.0 acres of land in San Antonio, Texas to a retail store owner for a price of $155,000, less associated selling costs of $7,000. A loss of approximately $1,000 was recorded as a result of this transaction.

In December 2002, the Company recorded a write-down on the book values of two parcels of land in San Antonio, Texas for an aggregate of approximately $17,000. The write-down was recorded to adjust for decreased market values on the properties due to a softening of the local real estate market.

In July 2003, the Company sold 3.7 acres of land in San Antonio, Texas to an individual for a price of $75,000 less associated selling costs of $3,867. A gain of approximately $18,000 was recorded as a result of this transaction.

Also in July 2003, the Company sold 1.6 acres of land in San Antonio, Texas to a discount department store chain for a price of $336,000 less associated selling costs of $20,550. A gain of approximately $285,000 was recorded as a result of this transaction.

In July 2003, the Company sold 2.0 acres of land in San Antonio, Texas to an individual for a price of $1,054,000 less associated selling costs of $57,546. A gain of approximately $984,000 was recorded as a result of this transaction.

In September 2003, the Company sold 4.9 acres of land in San Antonio, Texas to a church for a price of $130,000, less associated selling costs of $11,077. A gain of approximately $23,000 was recorded as a result of this transaction.

In October 2003, the Company sold 1.47 acres of land in San Antonio, Texas to an individual for a price of $90,000 less associated selling costs of $7,609. A gain of approximately $24,800 was recorded as a result of this transaction.

Also, in October 2003, the Company sold 3.08 acres of land in San Antonio, Texas to an individual for a price of $125,000 less associated selling costs of $9,646. A gain of approximately $74,400 was recorded as a result of this transaction.

In February 2004, the Company sold 8.1 acres of land in San Antonio, Texas to a developer for a price of $1.9 million less associated selling costs of $125,000. A gain of approximately $1.7 million was recorded as a result of this transaction.

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In March 2004, the Company sold 3.8 acres of land in San Antonio, Texas to a developer for a price of $1.1 million less associated selling costs of $56,000. A gain of approximately $1.0 million was recorded as a result of this transaction.

Note D — Commitments and Contingencies

The Company’s wholly-owned subsidiary, LNC Holdings, Inc., owns approximately 38 acres of land located in Arlington, Texas which is encumbered by property tax liens totaling $1.7 million, including penalties and interest. The property has no carrying value due to the encumbrances.

On April 16, 1997, LNC Holdings, Inc. received a notice of judgment from the City of Arlington with regard to the delinquent taxes through that date. On June 28, 2002, LNC Holdings, Inc. received an additional notice of judgment from the City of Arlington with regard to the delinquent taxes from 1997 through that date. LNC Holdings, Inc. notified the City of Arlington that it would execute a deed without warranty to allow the taxing authorities to obtain title to the property. No response has yet been received. LNC Holdings, Inc. has accrued property taxes and related penalties and interest for calendar years 1996 through 2003 and the three months ended March 31, 2004 totaling approximately $420,000. The remainder of the tax lien relates to the property prior to LNC Holdings, Inc.’s ownership of the property, and is against the property in rem only. Management believes that resolution of the delinquent tax issue with the taxing authorities will not result in a material adverse impact on the consolidated financial statements.

Note E — Federal Income Taxes

Although the Company had taxable income for the three- and nine-month periods ended March 31, 2004, no tax liability was recognized due to a reduction in the valuation allowance related to its net operating loss carryforwards. Based on historical business activity, management believes it is more likely than not that the Company will not realize the benefits of the loss carryforwards.

Note F — Concentration of Credit Risk

At March 31, 2004, the Company had certain concentrations of credit risk with three financial institutions in the form of cash, which amounted to approximately $59 million. For purposes of evaluating credit risk, the stability of financial institutions conducting business with the Company is periodically reviewed. If the financial institutions failed to completely perform under the terms of the financial instruments, the exposure for credit loss would be the amount of the financial instruments less amounts covered by regulatory insurance.

Note G — Earnings (Loss) Per Share

Statement of Financial Accounting Standard (“SFAS”) No. 128 “Earnings Per Share” (“EPS”) specifies the computation, presentation and disclosure requirements for earnings per share. Basic EPS excludes all dilution while diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares. The following table presents the basic and diluted EPS data for the three- and nine-month periods ended March 31, 2004 and 2003.

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Diluted weighted average shares for the three months ended March 31, 2003 excludes incremental shares from assumed conversion of stock options of 621,652 granted to employees of the Company under the Company’s 2002 Long Term Incentive Plan (the “Plan”) and available shares of 27,778 under the stock purchase rights granted to an officer of the Company due to the net loss for the period.

Diluted weighted average shares for the nine months ended March 31, 2003 excludes incremental shares from assumed conversion of stock options of 583,018 granted to employees of the Company under the Plan and available shares of 26,967 under the stock purchase rights granted to an officer of the Company due to the net loss for the period.

Note H — Recent Pronouncements

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” which is effective for fiscal years ending after December 15, 2002. SFAS 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure provisions of Statement 123 to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income (loss) and earnings (loss) per share in annual and interim financial statements. Effective July 1, 2003, the Company adopted the prospective method provisions of SFAS No. 148.

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Note I — Stock-based Compensation

On July 1, 2003, under the terms of the Plan, the Company’s Board of Directors granted to an employee an option to purchase 10,000 shares of common stock of the Company at an exercise price of $3.00 per share. The option expires on July 1, 2013. Twenty percent of the employee’s option shares vested and became exercisable immediately, and an additional 1 2/3% of the employee’s option shares vest and become exercisable as of the last day of each month through June 30, 2007. The fair value of the option at the grant date was approximately $35,000. For the nine months ended March 31, 2004, the Company recorded $12,250 in compensation expense related to the option.

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 income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to all stock-based employee compensation. The fair value of the options awarded was estimated at the grant date using the Black-Scholes option pricing model, which includes the following assumptions: risk-free interest rate based on the ten-year U.S. Treasury Note rate; expected option life of ten years; expected volatility of 3%; and no expected dividends.

Note J — Subsequent Event

On April 30, 2004, the Company consummated an agreement dated December 15, 2003 to acquire USAuto Holdings, Inc. for consideration consisting of $76.0 million in cash, 13,250,000 shares of the Company’s common stock that were issued at closing and up to an additional 750,000 shares that may be issued at a later date if certain financial targets are reached. The USAuto acquisition will be accounted for using the purchase method of accounting as required by SFAS 141, "Business Combinations," and, accordingly, the results of operations of USAuto will be included in the Company's consolidated financial statements from the date of acquisition. The Company raised a part of the cash portion of the consideration to fund the acquisition by offering the Company’s stockholders the opportunity to purchase shares of common stock

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through a stock rights offering at $4.00 per share, which expired April 29, 2004, and raised approximately $50 million. In order to guarantee that the Company would be able to raise the entire amount of the offering, Gerald J. Ford, the Company’s Chairman of the Board of Directors, agreed to backstop the rights offering by purchasing, at the subscription price, the shares of the stock that were not purchased by other stockholders.

At a special meeting of the Company’s stockholders on April 30, 2004, the Company’s stockholders approved, among other things, the following items:

•

the issuance of 13,250,000 shares of common stock to certain of the previous owners of USAuto as partial consideration for the acquisition of USAuto, plus up to an additional 750,000 shares that may be issued at a later date if certain financial targets are reached;

•

the issuance and sale of up to 5,711,271 shares of common stock to Hunter’s Glen/Ford and certain other affiliates of Gerald J. Ford, in the rights offering, and up to 6,848,281 shares to Hunter’s Glen/Ford under the backstop arrangement;

•

the approval of the Company’s amended and restated certificate of incorporation, which, among other things, changed the Company’s name to First Acceptance Corporation, increased the number of the Company’s authorized shares of common stock, and requires a supermajority vote to amend the number of directors which constitute the entire Board of Directors; and

•

the approval of an amendment to the Company’s 2002 Long Term Incentive Plan which increased the number of shares of common stock reserved for issuance under the plan.

On April 30, 2004, after the stockholder participation in the rights offering, which expired April 29, 2004, rights to purchase 563,728 shares of the Company’s common stock remained unexercised. Hunter’s Glen/Ford, Ltd. purchased the 563,728 shares at $4 per share pursuant to the backstop agreement dated December 15, 2003 between Hunter’s Glen/Ford, Ltd. and the Company.

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

General

First Acceptance Corporation, f/k/a Liberté Investors Inc. is a Delaware corporation that was organized in April 1996 in order to effect the reorganization of our predecessor, Liberté Investors Trust, a Massachusetts business trust. Since August 1996, the Company has been actively pursuing opportunities to acquire one or more operating companies in order to increase value to existing stockholders and provide a new focus and direction for the Company. The Company’s primary objective has been to seek long-term growth through an acquisition of a business rather than short-term earnings.

To that end, on April 30, 2004, the Company acquired USAuto Holdings, Inc. (“USAuto”). USAuto is a retailer, servicer and underwriter of non-standard personal automobile insurance based in Nashville, Tennessee. USAuto currently writes non-standard personal automobile insurance in Georgia, Tennessee, Alabama, Mississippi, Ohio and Missouri and is licensed as an insurer in 12 additional states.

As a result of the acquisition of USAuto, during the Company’s fourth fiscal quarter, the Company expects to reverse a significant portion of the valuation allowance on its deferred tax asset to reflect the amount of tax benefits that the Company believes that is more likely than not that the Company will realize.

Nine Months Ended March 31, 2004 versus Nine Months Ended March 31, 2003

Net income for the nine months ended March 31, 2004, was $2.3 million compared to a net loss of $1.1 million for the same period in 2003. The change in operating results for the nine months was due to various factors discussed below.

Interest income related to interest-bearing deposits in banks decreased to $620,000 for the nine months ended March 31, 2004 from $837,000 for the same period in 2003. This decrease is due to substantially lower interest rates on the Company’s interest-bearing deposits during the nine months ended March 31, 2004 versus the nine months ended March 31, 2003.

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Gain on the sale of foreclosed real estate was $4.1 million for the nine months ended March 31, 2004 as compared to $233,000 for the nine months ended March 31, 2003. The gain on sale of real estate represents proceeds received from the sale of foreclosed real estate in excess of carrying value. The gain recognized for the nine months ended March 31, 2004 was from the sale of 3.8 acres in San Antonio, Texas and the gain recognized for the nine months ended March 31, 2003 was from the sale of 58.6 acres in San Antonio, Texas.

Insurance expense was $133,000 for the nine months ended March 31, 2004 as compared to $107,000 for the nine months ended March 31, 2003. The increase reflects higher premiums on the insurance policies carried by the Company, primarily on the insurance policy covering directors and officers.

Legal, audit and advisory fees were $490,000 for the nine months ended March 31, 2004 as compared to $329,000 for the nine months ended March 31, 2003. The increase is primarily due to additional accounting due diligence expense on various acquisition candidates.

Foreclosed real estate expenses increased from $158,000 during the nine months ended March 31, 2003 to $198,000 for the same period in 2004. The higher expense in 2004 was primarily due to additional platting and survey expenses.

There was a loss on the write-down of foreclosed real estate of $142,000 for the nine months ended March 31, 2003. The Company recorded a write-down on the book values of certain parcels of land in San Antonio, Texas to adjust for decreased market values on the properties due to a softening of the local real estate market. No losses on write-downs of real estate were recognized in the same period in 2004.

General and administrative expense increased from $316,000 during the nine months ended March 31, 2003 to $466,000 for the same period in 2004. The increase was primarily due to increased expenses associated with travel for due dilige