HCI Group, Inc. (formerly Homeowners Choice, Inc.) — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the period ended June 30, 2011, filed August 12, 2011. The company is a Florida property and casualty insurance holding company providing homeowners, condominium-owner, and tenants insurance in Florida, primarily through policies assumed from Citizens Property Insurance Corporation. Approximately 59,500 policies were in force, representing about $130 million of annualized premiums.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2011 |
|---|---|---|
| Gross premiums earned | $31.2 million | $62.1 million |
| Net premiums earned | $17.0 million | $33.7 million |
| Total revenue | $19.8 million | $37.8 million |
| Net income | $2.3 million | $3.1 million |
| Income available to common stockholders | $1.9 million | $2.7 million |
| Diluted earnings per common share | $0.30 | $0.43 |
| Combined ratio on net premiums earned | 93.7% | 97.2% |
| Combined ratio on gross premiums earned | 51.1% | 52.7% |
| Net cash provided by operating activities | $22.9 million for six months |
Approximate net income margins were 11.6% of total revenue for the quarter and 8.2% for the six-month period. Cash and cash equivalents were $80.3 million at June 30, 2011, compared with $54.8 million at December 31, 2010. Total assets were $172.8 million and stockholders’ equity was $58.0 million. The balance sheet does not show borrowings or other conventional debt; the filing does not provide a separate debt metric.
Material Changes Versus Prior Comparable Period
- Second-quarter total revenue increased to $19.8 million from $17.4 million, while six-month revenue increased to $37.8 million from $34.4 million.
- Net income increased to $2.3 million from $1.3 million for the quarter and to $3.1 million from $2.0 million for six months. Diluted EPS rose from $0.19 to $0.30 for the quarter and from $0.29 to $0.43 for six months.
- Net premiums earned increased 9.0% for the quarter and 5.7% for six months. Net premiums written increased to $40.5 million from $34.9 million for the quarter and to $39.2 million from $29.5 million for six months.
- The quarterly loss ratio improved to 61.7% from 69.4%, and the quarterly combined ratio improved to 93.7% from 98.5%. For six months, the combined ratio improved modestly to 97.2% from 97.9%.
- The expense ratio increased to 31.9% from 29.1% for the quarter and to 35.1% from 33.1% for six months, primarily because of higher compensation, professional fees, and real estate and marina operating expenses.
- Operating cash flow declined to $22.9 million from $27.7 million, largely because the prior-year period included a $19.5 million collection related to a Citizens assumption transaction.
- The company issued 1,247,700 shares of 7% Series A cumulative convertible preferred stock for net proceeds of approximately $11.3 million. It also paid $1.4 million of dividends and repurchased $1.9 million of common stock during the first six months.
Guidance, Outlook, Risks, and Unusual Items
- Effective June 1, 2011, new catastrophe reinsurance treaties provided approximately $345 million of coverage per event for the 2011-2012 hurricane season, at expected annual premiums of approximately $55 million. Management expected reinsurance costs to equal approximately 42% of gross earned premiums, compared with 45% in the prior treaty year.
- The company acquired Tierra Verde Marina Holdings in April 2011 for $5.1 million and recognized a $936,000 bargain-purchase gain, or $575,000 after tax. The purchase price allocation remained subject to adjustment.
- Loss reserves increased from $22.1 million at year-end 2010 to $25.0 million at June 30, 2011. Management reported favorable development in prior accident years but identified reserve estimates, including $9.4 million of incurred-but-not-reported reserves, as judgmental and subject to revision.
- Florida hurricane and tropical-storm exposure is a principal risk. Results are seasonal, with potentially higher losses from June through November. The company remains liable for claims if reinsurers cannot perform.
- An IRS examination of the company’s 2008 and 2009 federal income tax returns began in the second quarter and remained ongoing at June 30, 2011.
- The acquired marina property carries a $150,000 environmental remediation liability. Additional testing or remediation could materially exceed the accrued amount, although management did not expect a material adverse effect on liquidity or financial condition based on information then available.
- Management stated that no material changes had occurred in previously disclosed risk factors and that disclosure controls were effective. The filing does not provide formal earnings guidance.
- Subsequent developments included the appointment of Paresh Patel as chief executive officer effective July 1, 2011, reaffirmation of an “A Exceptional” Demotech financial stability rating, and declaration of a $0.10 per share common dividend payable in September 2011.
Facts Investors Should Verify
- Whether catastrophe losses during the 2011 hurricane season remain within the $345 million reinsurance program and whether reinsurer credit exposure is adequately diversified.
- The sufficiency and later development of the $25.0 million loss and loss-adjustment reserve, particularly the $9.4 million incurred-but-not-reported component.
- The final purchase price allocation and sustainability of the $936,000 bargain-purchase gain from the marina acquisition.
- The outcome and potential cash or tax effects of the IRS examination.
- The cost, scope, and resolution of environmental remediation at the marina property.
- The effect of the 7% convertible preferred stock on future dividends, dilution, capital structure, and earnings per share.
- Whether higher operating expenses and diversification into marina and real estate operations improve returns without increasing execution or liquidity risk.