You should read the following discussion in conjunction with our condensed
consolidated financial statements and related notes and information included
under this Item 2 and elsewhere in this quarterly report on Form 10-Q and in our
Form 10-K filed with the Securities and Exchange Commission ("SEC") on March 30,
2012. Unless the context requires otherwise, as used in this Form 10-Q, the
terms "HCI," "we," "us," "our," "the Company," "our company," and similar
references refer to Homeowners Choice, Inc. and its subsidiaries.
Forward-Looking Statements
In addition to historical information, this quarterly report contains
forward-looking statements as defined under federal securities laws. Such
statements involve risks and uncertainties, such as statements about our plans,
objectives, expectations, assumptions or future events. These statements involve
estimates, assumptions, known and unknown risks, uncertainties and other factors
that could cause actual results to differ materially from any future results,
performances or achievements expressed or implied by the forward-looking
statements. Typically, forward-looking statements can be identified by
terminology such as "anticipate," "estimate," "plan," "project," "continuing,"
"ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and
similar expressions. Among the important factors that could cause actual results
to differ materially from those indicated by such forward-looking statements
include but are not limited to the effect of governmental regulation; changes in
insurance regulations; the frequency and extent of claims; uncertainties
inherent in reserve estimates; catastrophic events; a change in the demand for,
pricing of, availability or collectability of reinsurance; restrictions on our
ability to change premium rates; increased rate pressure on premiums; changing
rates of inflation; and other risks and uncertainties detailed herein and from
time to time in our SEC reports.
OVERVIEW
General
Homeowners Choice, Inc. is a property and casualty insurance holding company
incorporated in Florida in 2006. Through our subsidiaries, we provide property
and casualty homeowners' insurance, condominium-owners' insurance, and tenants'
insurance to individuals owning property in Florida. We offer these insurance
products at competitive rates, while pursuing profitability using selective
underwriting criteria. Our principal revenues are earned premiums, which are
reported net of reinsurance costs, and investment income. We cede a substantial
portion of our earned premiums to reinsurers to mitigate risks primarily
associated with hurricanes and other catastrophic events. Our principal expenses
are claims from policyholders, policy acquisition costs, and other underwriting
expenses. As of June 30, 2012, we had total assets of $280.8 million and
stockholders' equity of $98.0 million. Our net income was approximately $7.3
million and $14.2 million, respectively, for the three and six months ended
June 30, 2012. Income available to common stockholders was approximately $7.2
million and $14.0 million, respectively, for the three and six months ended
June 30, 2012.
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We began operations in June of 2007 by participating in a "take-out program"
through which we assumed insurance policies held by Citizens Property Insurance
Corporation ("Citizens"), a Florida state-supported insurer. The take-out
program is a legislatively mandated program designed to reduce the state's risk
exposure by encouraging private companies to assume policies from Citizens.
Policies were assumed in eight separate assumption transactions which took place
from July 2007 through December 2010. In November 2011, we completed an
assumption transaction with HomeWise Insurance Company ("HomeWise") through
which we acquired the Florida policies of HomeWise. Substantially all of our
premium revenue since inception has come from the policies acquired in these
assumption transactions. Our current policies in force represent approximately
$220 million in annualized premiums. Through the Citizens assumptions and
HomeWise acquisition, we have been able to increase our geographic
diversification within the state of Florida.
We strive to retain these policies by offering competitive rates to our
policyholders at premiums we consider commensurate with the risk.
We face various challenges to implementing our operating and growth strategies.
Since our policies cover Florida homeowners, condominium owners, and tenants, we
cover losses that may arise from, among other things, catastrophes such as
hurricanes, tropical storms and tornadoes, which could have a significant effect
on our business, results of operations, and financial condition. To mitigate our
risk of such catastrophic losses, we cede a portion of our exposure to
reinsurers under catastrophe excess of loss reinsurance treaties. Even without
catastrophic events, we may incur losses and loss adjustment expenses that
deviate substantially from our estimates and that may exceed our reserves, in
which case our net income and capital would decrease. Our operating and growth
strategies may also be impacted by regulation and supervision of our business by
the state of Florida, which must approve our policy forms and premium rates as
well as monitor our insurance subsidiary's ability to meet all requirements for
regulatory compliance. Additionally, we compete with large, well-established
insurance companies as well as other specialty insurers that, in most cases,
possess greater financial resources, larger agency networks, and greater name
recognition. We believe recent trends in the competitive environment in Florida
however, such as a de-emphasis of Florida property risk by large national
insurers and efforts by the state of Florida to reduce exposure at Citizens,
bode well for our competitive position in the market.
Recent Developments
Effective June 1, 2012, we entered into excess catastrophe reinsurance treaties,
which provide approximately $531 million of coverage through non-affiliates for
aggregate losses and loss adjustment expenses per event during the 2012-2013
hurricane season. We expect to be charged approximately $96.0 million in annual
premiums with respect to these new reinsurance treaties, with such costs to be
recognized over the reinsurance treaty period covering June 1, 2012 through
May 31, 2013. In comparison, our reinsurance treaties covering the 2011-2012
hurricane season provided $345 million of coverage through non-affiliates for
aggregate losses and loss adjustment expenses per event at a cost to us of
approximately $55 million, which we recognized over the period from June 1, 2011
through May 31, 2012. The increase in reinsurance premiums applicable to the
2012-13 reinsurance treaty year primarily results from the increase in exposure
as a result of our acquisition of the Florida HomeWise policies in November
2011. Our reinsurance costs are expected to be approximately 43% to 45% of gross
earned premiums during the period from June 1, 2012 through May 31, 2013.
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RESULTS OF OPERATIONS
The following table summarizes our results of operations for the three and six
months ended June 30, 2012 and 2011 (dollars in thousands, except per share
amounts):
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Operating Revenue
Gross premiums earned $ 53,772 31,218 108,470 62,114
Premiums ceded (17,497 ) (14,174 ) (31,826 ) (28,396 )
Net premiums earned 36,275 17,044 76,644 33,718
Net investment income 302 507 824 1,071
Policy fee income 1,028 667 1,543 854
Realized investment gains 9 140 30 293
Gain on bargain purchase 179 936 179 936
Other Income 1,062 187 1,287 658
Total operating revenue 38,855 19,481 80,507 37,530
Operating Expenses
Losses and loss adjustment expenses 16,197 10,523 35,365 20,926
Policy acquisition and other underwriting expenses 5,915 2,780 12,500 7,043
Other operating expenses 4,734 2,357 9,252 4,484
Total operating expenses 26,846 15,660 57,117 32,453
Income before income taxes 12,009 3,821 23,390 5,077
Income taxes 4,747 1,520 9,160 1,983
Net income $ 7,262 2,301 14,230 3,094
Preferred stock dividends (63 )
(361 ) (244 ) (378 )
Income available to common stockholders $ 7,199
1,940 13,986 2,716
Ratios to Net Premiums Earned:
Loss Ratio 44.65 % 61.74 % 46.14 % 62.06 %
Expense Ratio 29.36 % 30.14 % 28.38 % 34.19 %
Combined Ratio 74.01 % 91.88 % 74.52 % 96.25 %
Ratios to Gross Premiums Earned:
Loss Ratio 30.12 % 33.71 % 32.60 % 33.69 %
Expense Ratio 19.80 % 16.46 % 20.05 % 18.56 %
Combined Ratio 49.92 % 50.17 % 52.65 % 52.25 %
Per Share Data:
Basic earnings per common share $ .85 .32 1.89 .44
Diluted earnings per common share $ .74 .30 1.60 .43
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Comparison of the Three Months ended June 30, 2012 to the Three Months ended
June 30, 2011
Our results of operations for the three months ended June 30, 2012 reflect
income available to common stockholders of $7.2 million, or $0.74 earnings per
diluted common share, compared to income available to common stockholders of
$1.9 million, or $0.30 earnings per diluted common share, for the three months
ended June 30, 2011.
Revenue
Gross Premiums Earned for the three months ended June 30, 2012 were $53.8
million and principally reflect the revenue from policies acquired from HomeWise
and policies originally acquired from Citizens. The policies acquired from
HomeWise in November 2011 contributed approximately $13.9 million to our gross
premiums earned for the three months ended June 30, 2012. Gross premiums earned
for the three months ended June 30, 2011 were $31.2 million and principally
reflect the revenue from policies assumed from Citizens.
Premiums Ceded for the three months ended June 30, 2012 and 2011 were
approximately $17.5 million and $14.2 million, respectively. Our premiums ceded
represent amounts paid to reinsurers to cover losses from catastrophes that
exceed the thresholds defined by our catastrophe excess of loss reinsurance
treaties. Our reinsurance rates are based primarily on policy exposures
reflected in gross premiums earned. Premiums ceded were 32.5% and 45.4% of gross
premiums earned during the three months ended June 30, 2012 and 2011,
respectively. The decrease in 2012 is primarily due to lower costs during the
first two months of the quarter related to policies assumed from HomeWise in
November 2011, which were subject to minimal reinsurance premiums. We anticipate
our reinsurance cost will range from 43% to 45% of gross premiums earned for the
reinsurance treaty year beginning in June 2012.
Net Premiums Earned for the three months ended June 30, 2012 and 2011 were $36.3
million and $17.0 million, respectively, and reflect the gross premiums earned
less the appropriate reinsurance costs as described above. Net premiums earned
increased by $19.3 million in 2012 as compared to 2011 as a result of the $22.6
million increase in gross premiums earned and the $3.3 million increase in
premiums ceded.
Net Premiums Written during the three months ended June 30, 2012 and 2011
totaled $65.8 million and $40.5 million, respectively. Net premiums written
represent the premiums charged on policies issued during a fiscal period less
any applicable reinsurance costs.
The following is a reconciliation of our total Net Premiums Written to Net
Premiums Earned for the three months ended June 30, 2012 and 2011 (dollars in
thousands):
Three Months Ended
June 30,
2012 2011
Net Premiums Written $ 65,830 40,507
Increase in Unearned Premiums (29,555 ) (23,463 )
Net Premiums Earned $ 36,275 17,044
Net Investment Income for the three months ended June 30, 2012 and 2011 was $0.3
million and $0.5 million, respectively. There were no other-than-temporary
impairments recorded during the three months ended June 30, 2012 and 2011.
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Realized Investment Gains for the three months ended June 30, 2012 and 2011 of
$9,000 and $140,000, respectively, reflect the net gain realized from sales of
securities during the period.
Policy Fee Income for the three months ended June 30, 2012 and 2011 was $1.0
million and $0.7 million, respectively, and reflects the policy fee income we
earn with respect to our issuance of renewal policies.
Gain on Bargain Purchase was $179,000 ($119,000 net of tax), or $0.02 diluted
earnings per common share, for the three months ended June 30, 2012. The bargain
purchase gain relates to our business acquisition completed in April 2012. In
the prior year, we had a gain on bargain purchase of $936,000 ($575,000 net of
tax), or $0.07 diluted earnings per common share, related to our business
acquisition completed in April 2011.
Other Income for the three months ended June 30, 2012 and 2011 was $1.1 million
and $0.2 million, respectively. During the three months ended June 30, 2012,
other income is primarily related to approximately $0.2 million of rental income
from our Tampa office building and approximately $0.9 million from nonrecurring
items. During the three months ended June 30, 2011, other income is primarily
related to rental income from our Tampa office building.
Expenses
Our Losses and Loss Adjustment Expenses amounted to $16.2 million and $10.5
million, respectively, during the three months ended June 30, 2012 and 2011. Our
losses for the three months ended June 30, 2012 include approximately $2.0
million related to 274 claims from Tropical Storm Debby, which occurred in June
2012. Our losses and loss adjustment expense reserves are more fully described
below under the "Expenses" comparative for the six months ended June 30, 2012
and 2011 and, additionally, under "Critical Accounting Policies and Estimates"
below.
Policy Acquisition and Other Underwriting Expenses for the three months ended
June 30, 2012 and 2011 of $5.9 million and $2.8 million, respectively, primarily
reflect the amortization of deferred acquisition costs, commissions payable to
agents for production and renewal of policies, and premium taxes and policy
fees.
Other Operating Expenses for the three months ended June 30, 2012 and 2011 were
$4.7 million and $2.4 million, respectively. The $2.3 million increase is
primarily attributable to a $1.3 million increase in compensation and related
expenses and a $1.0 million increase in our other administrative costs, which
include a variety of professional service fees, license fees, corporate
insurances, lease expense, information system expense, and other general
expenses. As of June 30, 2012, we had 121 employees located at our headquarters
in Tampa, Florida compared to 88 employees as of June 30, 2011. We also have 63
employees located in Noida, India at June 30, 2012 versus none at June 30, 2011.
Income Taxes for the three months ended June 30, 2012 and 2011 were $4.7 million
and $1.5 million, respectively, for state and federal income taxes resulting in
an effective tax rate of 39.5% for 2012 and 39.8% for 2011.
Ratios:
The loss ratio applicable to the three months ended June 30, 2012 (loss and loss
adjustment expenses related to net premiums earned) was 44.7% compared to 61.7%
for the three months ended June 30, 2011.
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The expense ratio applicable to the three months ended June 30, 2012 (policy
acquisition and other underwriting expenses related to net premiums earned plus
compensation, employee benefits, and other operating expenses) was 29.4%
compared to 30.1% for the three months ended June 30, 2011.
The combined loss and expense ratio (total of all expenses related to net
premiums earned) is the key measure of underwriting performance traditionally
used in the property and casualty industry. A combined ratio under 100%
generally reflects profitable underwriting results. A combined ratio over 100%
generally reflects unprofitable underwriting results. Our combined ratio for the
three months ended June 30, 2012 was 74.0% compared to 91.9% for the three
months ended June 30, 2011.
Due to the impact our reinsurance costs have on net premiums earned from period
to period, our management believes the combined loss and expense ratio measured
to gross premiums earned is more relevant in assessing overall performance. The
combined loss and expense ratio to gross premiums earned for the three months
ended June 30, 2012 was 49.9% compared to 50.2% for the three months ended
June 30, 2011.
Comparison of the Six Months ended June 30, 2012 to the Six Months ended
June 30, 2011
Our results of operations for the six months ended June 30, 2012 reflect income
available to common stockholders of $14.0 million, or $1.60 earnings per diluted
common share, compared to income available to common stockholders of $2.7
million, or $0.43 earnings per diluted common share, for the six months ended
June 30, 2011. Our results for the six months ended June 30, 2012 and 2011
include bargain purchase gains on acquisitions of $179,000 ($119,000 net of tax)
and $936,000 ($575,000 net of tax), respectively, or $0.02 and $0.08 diluted
earnings per common share, respectively.
Revenue
Gross Premiums Earned for the six months ended June 30, 2012 were $108.5 million
and reflect the revenue from policies acquired from HomeWise and policies
originally assumed from Citizens. The policies acquired from HomeWise in
November 2011 contributed approximately $35.3 million to our gross premiums
earned for the six months ended June 30, 2012. Gross premiums earned for the six
months ended June 30, 2011 were $62.1 million and principally reflect the
revenue from policies assumed from Citizens.
Premiums Ceded for the six months ended June 30, 2012 and 2011 were $31.8
million and $28.4 million, respectively. Our premiums ceded represent amounts
paid to reinsurers to cover losses from catastrophes that exceed the thresholds
defined by our catastrophe excess of loss reinsurance treaties. Our reinsurance
rates are based primarily on policy exposures reflected in gross premiums
earned. Premiums ceded were 29.3% and 45.7% of gross premiums earned during the
six months ended June 30, 2012 and 2011, respectively. The decrease in 2012 is
primarily due to lower costs during the first five months of 2012 related to
policies assumed from HomeWise, which were subject to minimal reinsurance
premiums. We anticipate our reinsurance cost will range from 43% to 45% of gross
premiums earned for the reinsurance treaty year beginning in June 2012.
Net Premiums Earned for the six months ended June 30, 2012 and 2011 were $76.6
million and $33.7 million, respectively, and reflect the gross premiums earned
less reinsurance costs as described above. Net premiums earned increased by
$42.9 million in 2012 as compared to 2011 as a result of the $46.3 million
increase in gross premiums earned and $3.4 million increase in premiums ceded.
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Net Premiums Written during the six months ended June 30, 2012 and 2011 totaled
$88.4 million and $39.2 million, respectively. Net premiums written represent
the premiums charged on policies issued during a fiscal period less reinsurance
costs.
The following is a reconciliation of our total Net Premiums Written to Net
Premiums Earned for the six months ended June 30, 2012 and 2011 (in thousands):
Six Months Ended June 30,
2012 2011
Net Premiums Written $ 88,396 39,214
Increase in Unearned Premiums (11,752 ) (5,496 )
Net Premiums Earned $ 76,644 33,718
Net Investment Income for the six months ended June 30, 2012 and 2011 was $0.8
million and $1.1 million, respectively.
Policy Fee Income for the six months ended June 30, 2012 and 2011 was $1.5
million and $0.9 million, respectively, and reflects the policy fee income we
earn with respect to our issuance of renewal policies.
Realized Investment Gains for the six months ended June 30, 2012 and 2011 of
$30,000 and $293,000, respectively, reflects the net gain realized from sales of
securities during the period.
Gain on Bargain Purchase was $179,000 ($119,000 net of tax), or $0.02 diluted
earnings per common share, and $936,000 ($575,000 net of tax), or $0.08 diluted
earnings per common share, for the six months ended June 30, 2012 and 2011,
respectively. The bargain purchase gains relates to our business acquisitions
completed in April 2012 and in April 2011.
Other Income for the six months ended June 30, 2012 and 2011 was $1.3 million
and $0.7 million, respectively. During the six months ended June 30, 2012, other
income is primarily related to approximately $0.4 million of rental income from
our Tampa office building and approximately $0.9 million from nonrecurring
items. During the six months ended June 30, 2011, other income is primarily
related to rental income from our Tampa office building.
Expenses
Our Losses and Loss Adjustment Expenses amounted to $35.4 million and $20.9
million, respectively, during the six months ended June 30, 2012 and 2011. Our
losses for the six months ended June 30, 2012 include approximately $2.0 million
related to 274 claims from Tropical Storm Debby, which occurred in June 2012.
Our losses and loss adjustment expense reserves ("Reserves"), which are more
fully described below under "Critical Accounting Policies and Estimates," are
specific to homeowners insurance, which is our only line of business. These
Reserves include both case reserves on reported claims and our reserves for
incurred but not reported ("IBNR") losses. At each period-end date, the balance
of our Reserves is based on our best estimate of the ultimate cost of each claim
for those known cases and the IBNR loss reserves are estimated based primarily
on our historical experience. Our Reserves increased from $27.4 million at
December 31, 2011 to $37.3 million at June 30, 2012. The $9.9 million increase
in our Reserves is comprised of $21.3 million in new reserves specific to the
six months ended June 30, 2012 offset by reductions of $8.8 million and $2.6
million in our Reserves for
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2011 and 2010 and prior accident years, respectively. The $21.3 million in
Reserves established for 2012 claims is due to the increase in our policy
exposure, which resulted in an increase in the amount of reported losses in
2012. The decrease of $11.4 million specific to our 2011 and 2010 and prior
accident-year reserves is due to favorable development arising from lower than
expected loss development during 2012 relative to expectations used to establish
our Reserve estimates at the end of 2011. Factors that are attributable to this
favorable development may include a lower severity of claims than the severity
of claims considered in establishing our Reserves and actual case development
may be more favorable than originally anticipated.
Policy Acquisition and Other Underwriting Expenses for the six months ended
June 30, 2012 and 2011 were $12.5 million and $7.0 million, respectively, and
primarily reflect the amortization of deferred acquisition costs, commissions
payable to agents for production and renewal of policies, and premium taxes and
policy fees. The $5.5 million increase in 2012 is primarily attributable to an
increase in our commissions and premium taxes for policy renewals combined with
the one-time, $1.2 million adjustment specific to our adoption in January 2012
of Financial Accounting Standards Board Accounting Standards Update No. 2010-26
(see Note 2 - "Recent Accounting Pronouncements" to the unaudited condensed
consolidated financial statements).
Other Operating Expenses for the six months ended June 30, 2012 and 2011 were
$9.3 million and $4.5 million, respectively. The $4.8 million increase is
primarily attributable to a $2.4 million increase in compensation and related
expenses and a $2.4 million increase in our administrative costs, which include
a variety of professional service fees, license fees, corporate insurances,
lease expense, information system expense, and other general expenses. As of
June 30, 2012, we had 121 employees located at our headquarters in Tampa,
Florida compared to 88 employees as of June 30, 2011. We also have 63 employees
located in Noida, India at June 30, 2012 versus none at June 30, 2011.
Income Taxes for the six months ended June 30, 2012 and 2011 were $9.2 million
and $2.0 million, respectively, for state and federal income taxes resulting in
an effective tax rate of 39.2% for 2012 and 39.1% for 2011.
Ratios:
The loss ratio applicable to the six months ended June 30, 2012 (loss and loss
adjustment expenses related to net premiums earned) was 46.1% compared to 62.1%
for the six months ended June 30, 2011.
The expense ratio applicable to the six months ended June 30, 2012 (policy
acquisition and other underwriting expenses related to net premiums earned plus
compensation, employee benefits, and other operating expenses) was 28.4%
compared to 34.2% for the six months ended June 30, 2011 (see Other Operating
Expenses above).
The combined loss and expense ratio (total of all expenses related to net
premiums earned) is the key measure of underwriting performance traditionally
used in the property and casualty industry. A combined ratio under 100%
generally reflects profitable underwriting results. A combined ratio over 100%
generally reflects unprofitable underwriting results. Our combined ratio for the
six months ended June 30, 2012 was 74.5% compared to 96.3% for the six months
ended June 30, 2011.
Due to the impact our reinsurance costs have on net premiums earned from period
to period, our management believes the combined loss and expense ratio measured
to gross premiums earned is more relevant in assessing overall performance. The
combined loss and expense ratio to gross premiums earned for the six months
ended June 30, 2012 was 52.7% compared to 52.3% for the six months ended
June 30, 2011.
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Seasonality of Our Business
Our insurance business is seasonal as hurricanes and tropical storms typically
occur during the period from June 1 through November 30 each year. With our
reinsurance treaty year effective June 1 each year, any variation in the cost of
our reinsurance, whether due to changes in reinsurance rates or changes in the
total insured value of our policy base, will occur and be reflected in our
financial results beginning June 1 each year.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, our liquidity requirements have been met through issuance of
our common and preferred stock and funds from operations. We expect our future
liquidity requirements will be met by funds from operations, primarily the cash
received by our insurance subsidiary from premiums written and investment
income.
Our insurance subsidiary requires liquidity and adequate capital to meet ongoing
obligations to policyholders and claimants and to fund operating expenses. In
addition, we attempt to maintain adequate levels of liquidity and surplus to
manage any differences between the duration of our liabilities and invested
assets. In the insurance industry, cash collected for premiums from policies
written is invested, interest and dividends are earned thereon, and loss and
loss adjustment expenses are paid out over a period of years. This period of
time varies by the circumstances surrounding each claim. A substantial portion
of our losses and loss expenses are fully settled and paid within 90 days of the
claim receipt date. Additional cash outflow occurs through payments of
underwriting costs such as commissions, taxes, payroll, and general overhead
expenses.
We believe that we maintain sufficient liquidity to pay our insurance
subsidiary's claims and expenses, as well as satisfy commitments in the event of
unforeseen events such as reinsurer insolvencies, inadequate premium rates, or
reserve deficiencies. We maintain a comprehensive reinsurance program at levels
management considers adequate to diversify risk and safeguard our financial
position.
In the future, we anticipate our primary use of funds will be to pay claims and
operating expenses.
Common Stock
On April 19, 2012, we entered into an underwriting agreement (the "Underwriting
Agreement") pursuant to which we agreed to sell 1,600,000 shares of the
Company's common stock, no par value per share (the "Common Stock"), for $11.75
per share, less a 6.0% underwriting commission. Under the terms of the
Underwriting Agreement, we granted the underwriter an option to purchase up to
an additional 240,000 shares of Common Stock at the public offering price, less
a 6.0% underwriting commission, within 45 days from the date of the Underwriting
Agreement to cover over-allotments, if any. The offering was made pursuant to
our effective registration statement on Form S-3, as amended (Registration
Statement No. 333-180322), and the Prospectus Supplement dated April 19, 2012.
On April 23, 2012, the underwriter elected to fully exercise its overallotment
option. The closing of the sale of an aggregate of 1,840,000 shares of Common
Stock occurred on April 25, 2012. The offering resulted in aggregate gross
proceeds to the Company of approximately $21.6 million and net proceeds of
approximately $20.1 million after underwriting commissions and offering
expenses.
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Preferred Stock
On March 25, 2011, we closed our preferred stock offering under which a total of
1,247,700 shares of our Series A cumulative convertible preferred stock ("Series
A Preferred") were sold for gross proceeds of approximately $12.5 million and
net proceeds after offering costs of approximately $11.3 million. Dividends on
the Series A Preferred are cumulative from the date of original issue and accrue
on the last day of each month, at an annual rate of 7.0% of the $10.00
liquidation preference per share, equivalent to a fixed annual amount of $0.70
per share. Accrued but unpaid dividends accumulate and earn additional dividends
at 7.0%, compounded monthly.
Shareholders of Series A Preferred may convert all or any portion of their
shares, at their option, at any time, into shares of the Company's common stock
at an initial conversion rate of one share of common stock for each share of
Series A Preferred, which is equivalent to an initial conversion price of $10.00
per share; provided, however, that we may terminate this conversion right on or
after March 31, 2014, if for at least twenty trading days within any period of
thirty consecutive trading days, the market price of our common stock exceeds
the conversion price of the Series A Preferred by more than 20% and our common
stock is then traded on the New York Stock Exchange, the NASDAQ Global Select
Market, the NASDAQ Global Market, the NASDAQ Capital Market, or the NYSE Amex.
Under certain circumstances, we will be required to adjust the conversion rate.
The initial conversion price of $10.00 per share is subject to proportionate
adjustment in the event of stock splits, reverse stock splits, stock dividends,
or similar changes with respect to our common stock. During the six months ended
June 30, 2012, holders of 655,376 shares of Series A Preferred converted their
Series A Preferred shares to 655,376 shares of common stock. As of June 30,
2012, 592,324 shares of Series A Preferred remain outstanding. Shareholders of
record of our Series A Preferred at the close of business on a date for
determining shareholders entitled to dividends will be entitled to receive the
dividends payable on their Series A Preferred shares on the corresponding
dividend payment date notwithstanding the conversion of such Series A Preferred
shares before the dividend payment date. The Series A Preferred terms include a
provision requiring such shareholders to pay an amount equal to the amount of
the dividend payable. That requirement has been permanently waived by the
Company.
The Series A Preferred is not redeemable prior to March 31, 2014. If the Company
issues a conversion cancellation notice, the Series A Preferred will be
redeemable on or after March 31, 2014 for cash, at our option, in whole or in
part, at $10.00 per share, plus accrued and unpaid dividends to the redemption
date. Otherwise, the Series A Preferred will be redeemable for cash, at our
option, in whole or in part, at a redemption price equal to $10.40 per share for
redemptions on or after March 31, 2014; $10.20 per share for redemptions on or
after March 31, 2015; and $10.00 per share for redemptions on or after March 31,
2016 plus accrued and unpaid dividends to the redemption date.
The Series A Preferred shares have no stated maturity and are not subject to any
sinking fund or mandatory redemption requirements.
Holders of the Series A Preferred shares generally have no voting rights, except
under limited circumstances, and holders are entitled to receive cumulative
preferential dividends when and as declared by our Board of Directors.
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Cash Flows
Our cash flows from operating, investing and financing activities for the six
months ended June 30, 2012 and 2011 are summarized below.
Cash Flows for the Six months ended June 30, 2012
Net cash provided by operating activities for the six months ended June 30, 2012
was approximately $24.0 million, which consisted primarily of cash received from
net written premiums less cash disbursed for operating expenses and losses and
loss adjustment expenses. Net cash used in investing activities of $12.0 million
was primarily due to our business acquisition completed in April 2012 of $8.2
million, the purchases of available-for-sale securities of $11.5 million,
purchases of other investments of approximately $1.0 million, and the purchase
of $0.5 million in property and equipment offset by redemptions of time deposits
of $5.2 million, the proceeds from sales of available-for-sale securities of
$3.9 million. Net cash provided by financing activities totaled $18.7 million,
which was primarily due to $20.1 million from the issuance of common stock and
$1.4 million from the exercise of common stock warrants offset by $3.2 million
in cash dividends paid.
Cash Flows for the Six months ended June 30, 2011
Net cash provided by operating activities for the six months ended June 30, 2011
was approximately $22.9 million, which consisted primarily of cash received from
net written premiums less cash disbursed for operating expenses and losses and
loss adjustment expenses. Net cash used in investing activities of $6.0 million
was primarily due to our business acquisition completed in April 2011. Net cash
provided by financing activities totaled $8.5 million, which was primarily due
to $11.3 million from the issuance of preferred stock offset by $1.4 million in
cash dividends paid and $1.9 million used to repurchase our common shares.
Investments
The main objective of our investment policy is to maximize our after-tax
investment income with a minimum of risk given the current financial market. Our
excess cash is invested primarily in money market accounts, time deposits (i.e.
CDs maturing in more than twelve months), and available-for-sale investments.
At June 30, 2012, we have $40.1 million of available-for-sale investments, which
are carried at fair value. Changes in the general interest rate environment
affect the returns available on new fixed-maturity investments. While a rising
interest rate environment enhances the returns available on new investments, it
reduces the market value of existing fixed-maturity investments and thus the
availability of gains on disposition. A decline in interest rates reduces the
returns available on new fixed-maturity investments but increases the market
value of existing fixed-maturity investments, creating the opportunity for
realized investment gains on disposition.
With the exception of large national banks, it is our current policy not to
maintain cash deposits of more than an aggregate of $5.5 million in any one bank
at any time. From time to time, we may have in excess of $5.5 million of cash
designated for investment and on deposit at a single national brokerage firm. In
the future, we may alter our investment policy to include or increase
investments in federal, state and municipal obligations, preferred and common
equity securities and real estate mortgages, as permitted by applicable law,
including insurance regulations.
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OFF-BALANCE SHEET ARRANGEMENTS
As of June 30, 2012 and December 31, 2011, we had no off-balance sheet
arrangements as defined in Item 303(a)(4) of Regulation S-K.
CONTRACTUAL OBLIGATIONS
As a smaller reporting company as defined by Rule 229.10(f)(1) of the Exchange
Act, we are not required to provide the information under this item.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have prepared our condensed consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America.
The preparation of these condensed consolidated financial statements requires us
to make estimates and judgments to develop amounts reflected and disclosed in
our financial statements. Material estimates that are particularly susceptible
to significant change in the near term are related to our losses and loss
adjustment expenses ("Reserves"), which include amounts estimated for claims
incurred but not yet reported. Reserves are determined by establishing
liabilities in amounts estimated to cover incurred losses and loss adjustment
expenses. Such Reserves are determined based on our assessment of claims
reported and the development of pending claims. These Reserves are based on
individual case estimates for the reported losses and loss adjustment expenses
and estimates of such amounts that are incurred but not reported ("IBNR").
Changes in the estimated liability are charged or credited to operations as the
losses and loss adjustment expenses are adjusted.
The IBNR reserves represent our estimate of the ultimate cost of all claims that
have occurred but have not been reported to us and, in some cases, may not yet
be known to the insured. Estimating the IBNR component of our Reserves involves
considerable judgment on the part of management. At June 30, 2012, $17.3 million
of the total $37.3 million we have reserved for losses and loss adjustment
expenses is specific to our estimate of claims incurred but not reported. The
remaining $20.0 million relates to known cases which have been reported but not
yet fully settled in which case we have booked a reserve based on our best
estimate of the ultimate cost of each claim. At June 30, 2012, $8.7 million of
the $20.0 million in reserves for known cases relates to claims incurred during
prior years.
Based on all information known to us, we believe our Reserves at June 30, 2012
are adequate to cover our claims for losses that had occurred as of that date
including losses yet to be reported. However, these estimates are subject to
trends in claim severity and frequency and must continually be reviewed by
management. As part of the process, we review historical data and consider
various factors, including known and anticipated regulatory and legal
developments, changes in social attitudes, inflation and economic conditions. As
experience develops and other data becomes available, these estimates are
revised, as required, resulting in increases or decreases to the existing unpaid
losses and loss adjustment expenses. Adjustments are reflected in the results of
operations in the period in which they are made and the liabilities may deviate
substantially from prior estimates.
In addition to Reserves, we believe our accounting policies specific to premium
revenue recognition, losses and loss adjustment expenses, reinsurance, deferred
policy acquisition costs, income taxes, and stock-based compensation expense
involve our most significant judgments and estimates material to our
consolidated financial statements. These accounting estimates and related risks
that we consider to be our critical accounting estimates are more fully
described in our Annual
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Report on Form 10-K, which we filed with the SEC on March 30, 2012. For the six
months ended June 30, 2012, there have been no material changes with respect to
any of our critical accounting policies.
RECENT ACCOUNTING PRONOUNCEMENTS
For information with respect to recent accounting pronouncements and the impact
of these pronouncements on our consolidated financial statements, see Note 2 to
our Notes to Condensed Consolidated Financial Statements.
