HCI Group, Inc. (HCI) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to HCI Group's First Quarter 2017 Earnings Call. My name is Jen, and I will be your conference operator this afternoon. At this time, all participants will be in a listen-only mode. [Operator Instructions] Before we begin today's call, I would like to remind everyone that this conference call is being recorded and will be available for replay through June 4, 2017, starting later this evening. The call is also being broadcast live via webcast and available via webcast replay until June 4, 2017, on the Investor Information section of the HCI Group website, at www.hcigroup.com. I would now like to turn the call over to Kevin Mitchell, the Vice President of Investor Relations for HCI Group. Sir, please proceed.

Thank you, and good afternoon. Welcome to HCI Group's First Quarter 2017 Earnings Call. With me today are Paresh Patel, our Chairman and Chief Executive Officer; Richard Allen, our Chief Financial Officer; and Mark Harmsworth, our Senior Vice President of Finance. Following Paresh's opening remarks, Richard will review our financial performance for the quarter and then turn the call back to Paresh for an operational update and business outlook. And finally, we will answer questions. To access today's webcast, please visit the Investor Relations section of our corporate website at hcigroup.com. Before we begin, I'd like to take an opportunity to remind our listeners that today's presentation and responses to questions may contain forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995. Words such as anticipate, estimate, expect, intend, plan and project and other similar words and expressions are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions, but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company's filings with the Securities and Exchange Commission. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on the company's business, financial conditions and results of operations. HCI Group, Inc. disclaims all the obligations to update any forward-looking statements. With that, I would now like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?

Thank you, Kevin, and welcome, everyone. First, I'd like to provide a brief overview of our company. As most of you know, HCI Group is a holding company with subsidiaries engaging in diverse yet complementary business activities. Our principal operating subsidiary is Homeowners Choice Property & Casualty Insurance Company, which provides homeowners insurance in Florida. We also have TypTap Insurance Company, which currently focuses in providing flood insurance to Florida homeowners. TypTap features typtap.com, our internally developed online platform for quoting and binding flood insurance policies. Accessible from any Internet-capable device, including your mobile phone, typtap.com provides a quote in seconds and a policy in minutes. Additionally, we have a Bermuda-based reinsurance subsidiary called Claddaugh Casualty Insurance Company, which participates in our reinsurance programs. To support all of our insurance operations, we also have an information technology operation called Exzeo that develops insurance-related products and services. For example, it developed the technology that powers typtap.com. It also developed Atlas Viewer, our map-based technology that allows us in real-time to identify, track and manage daily claims as well as claims associated with catastrophic events. In the future, we expect to find other means to leverage day-to-day [ph] technologies, including the delivery of products and services to third parties. Finally, we have Greenleaf Capital, which owns and manages our growing portfolio of Florida real estate, that currently includes two office buildings, two parcels of waterfront property and two grocery-anchored shopping centers. Turning to the quarter, the first quarter was a solid start of 2017. I am pleased to tell you that it was HCI's 38th consecutive quarter of profitability. And net income for the quarter nearly doubled from that of Q1 2016. Other highlights from the quarter were we increased our quarterly dividend by $0.05 to $0.35 per share; we also completed the sale of $143.75 million of 4.25% senior convertible notes; we used portions of these proceeds from the offering to repurchase common shares and also to retire all of our 8% senior notes, that redemption was finalized in April 3 after the end of the quarter. Now, I would like to invite our CFO, Richard Allen, to walk us through our financial performance for the first quarter. Richard?

Thank you, Paresh, and good afternoon, everyone. For the first quarter of 2017, income available to common stockholders totaled $12 million compared to the same quarter of 2016 with net income of $6.1 million. Diluted earnings per share for the current quarter was $1.15 compared to $0.60 diluted earnings per share for the same quarter of 2016. Gross premiums earned was $91.6 million for the current quarter, compared to $98.8 million for the comparable quarter a year ago. This decrease is attributable to normal policy attrition and the impact of the 5% rate reduction effective on new and renewal policies beginning in January of 2016. Ceded premiums were $28.6 million as compared to $40.4 million. For the first quarter of 2017, reinsurance costs were 31.2% of gross premiums earned, as compared to 40.9% in the same quarter a year ago. This decrease is a result of the reduced reinsurance cost for the treaty year effective June 1, 2016. Through March of 2017 and for the reinsurance treaty years beginning June of 2016, with the replacement of the multiyear reinsurance treaty as discussed in prior calls, benefits of $2.5 million and approximately $8.3 million were recognized, respectively. Net premiums earned for the first quarter of 2017 were $63 million compared to $58.4 million in the first quarter of 2016. Gross written premiums were $71.4 million for the first quarter of 2017 as compared to $75.6 million in the same period of 2016. For the same periods, net written premiums were $42.5 million, compared to $35.2 million for their respective periods. Loss and loss adjustment expenses for the quarter totaled $25.8 million compared to the first quarter of 2016 of $27 million. As of March 31, 2017, we have strengthened reserves for incurred but unreported losses and for development on reported claims to the current carried level of $50.2 million, compared to the carried IBNR and bulk reserve amount at March 31 of $30.5 million. In addition, we have continued to strengthen our reserves as seen in the minimal increase in our loss ratio. Our loss ratio applicable to the first quarter of 2017, which we define as loss and loss adjustment expenses related to gross premiums earned, was 27.9% compared with 27.4% in the first quarter of 2016. Loss and loss adjustment expenses for the first quarter of 2016 were impacted by tornadoes and hailstorms. Investment income and related investment items increased by approximately $2.6 million, primarily resulting from increases in net investment income of $1.3 million, realized gains of $800,000 and a reduction in net other than temporary investment losses of $500,000, as compared to the first quarter of 2016. Interest expenses increased by $713,000, primarily as the result of interest on recently completed bond issue in March of this quarter. The expense ratio applicable to the first quarter of 2017, which we define as underwriting expenses, interest and other operating expenses related to gross premiums earned, totaled 25.1% compared with 24.3% in the first quarter of 2016. Expressed as a total of all expenses related to net premiums earned, the combined loss and expense ratio for the first quarter of 2017 was 77.1% compared with 87.3% in the same quarter of 2016. These fluctuations in the ratios reflect the variances in gross premiums earned and reinsurance cost. We are constantly monitoring claim activities for development of trends in frequency, severity and litigation situation reaching all carriers in the state. Investments in fixed maturity securities and equities increased to $230.2 million from $219.3 million at December 31, 2016, an increase of 4.9%. Cash and cash equivalents increased by $127.4 million during the quarter, primarily the result of the senior note debt offering, which provided net proceeds of $109 million. On March 3, 2017, we closed our new convertible senior notes issue with total principal amount of $143.75 million. As part of this transaction, we repurchased 413,600 shares at $49.19 per share and entered a prepaid forward contract for a further repurchase of 191,100 shares at $49.19 per share, for a combined total of 604,700 shares at a total of $29.7 million. After paying transaction fees of approximately $5 million, the net cash from this offering was approximately $109 million. Subsequent to the end of the quarter, $48.8 million of these proceeds were used to redeem our 8% senior notes. The balance of approximately $68 million will be used for general corporate purposes. Coupon interest rate on the new convertible senior notes is 4.25%. However, the effective rate of interest is 7.6%. The carrying value of the new senior notes is $123.6 million. Total stockholders' equity at March 31 of $232.1 million reflects the decrease generated through the prepaid stock repurchase agreement discussed previously. Net book value per share has increased to $25.63 per share at the end of March 2017 from $25.23 at December 31, 2016. In the quarter, our basic earnings per share was $1.27. For purposes of calculating basic earnings per share, the weighted average share-count for the quarter was 8,918,000 shares. The issues [ph] of the convertible senior notes were dilutive in the quarter and our fully diluted earnings per share was $1.15 per share. For purposes of calculating the fully diluted earnings per share, the weighted average share count for the quarter was 11,140,200 shares, and the interest expense add-back was $1,499,000. Fully diluted share count at March 31, 2017 is approximately 12,400,000 shares. We are pleased with our first quarter results, led by strong fundamentals throughout our organization. And we remain committed to increasing shareholder value in future periods. Now I'd like to turn the call back over to Paresh. Paresh?

Thank you, Richard. First, a few Hurricane Matthew comments. Most of the Matthew claims are now closed, and we remain comfortable with our reserve levels. But keep in mind that claims can have a long tail, especially in the current litigation environment. Looking ahead, we expect Florida insurance regulators will approve a 8% average rate increase for our Homeowners Choice HO3 and HO6 books of business. We expect that that rate increase to go into effect with new and renewal policies sometime in Q3 of this year. 8% is a blended average. Many policyholders will receive a smaller increase or actually no increase at all. The increase will primarily impact policyholders in Southeastern Florida where litigation Assignment of Benefit abuses have been most prevalent. We don't take these rate changes lightly. Homeowners Choice has not raised rates since 2013 and will be one of the last companies to raise rates this year, but unfortunately, at this point, we have to do out of prudence. Looking to reinsurance, we have substantially completed our 2017/2018 reinsurance program. We expect the cost to be similar to last year, but with much better coverage. Moving to TypTap, our recently formed flood insurance subsidiary, since inception, TypTap has sold over 4,000 policies with gross written premiums over $4 million. We believe there is significant room for growth. Finally, our balance sheet is strong and, obviously, is stronger because of the recent transactions. And we have significant amounts of cash to invest in our businesses, enhance our technologies and pursue accretive opportunity that may arise. Finally, before I take questions, I have an announcement to make. For some time now, Richard Allen has indicated his desire to retire from the CFO role. We have not yet set a final date and we have some formalities that needs more work to do. However, on the call today is Mark Harmsworth, our Senior Vice President of Finance who joined us last December, and has been designated by the Board of Directors as Richard's successor. Mark has considerable financial experience, and we are pleased to welcome him to the company. And I expect Mark will step into the role of CFO soon, probably before the next earnings call. Richard is not leaving us. He will remain with HCI and assume the title of Senior Vice President of Finance and provide ongoing strategic and financial guidance. I want to take a moment to thank Richard for his commitment and service to the company. Richard has been our CFO since the company's inception. He was there to file the original certificate of authority with the Office of Insurance Regulation. His expertise in the insurance industry has been extremely valuable during our initial public offering and subsequent growth. We are pleased that he will continue to work with us going forward. With that, we are ready to open the call for questions. Operator, please provide the proper instruction.

Thank you. [Operator Instructions] Our first question comes from the line of Matt Carletti with JMP Securities. Please process with your question.

Hi, thanks. Good afternoon.

Good afternoon, Matt.

Got a few questions. Maybe we could start with - I think the last time we spoke in this forum, Demotech had just announced some actions it was taking. I'd be curious your view on what impact that's had on the market. I know that the thought process at that time was that some of the smaller, less capitalized competitors of yours could be pressured. Have you seen anything take place as you look at the competitive landscape?

Matt, there are two things, I think, that have been - actually, three items that have been - that have occurred in the industry for those who may not be aware. I think Prepared Insurance Company was sold. Elements Property Insurance Company was also acquired by somebody else. And I think the wind down of Mount Beacon was greatly accelerated. I think some of these things may have occurred or been accelerated due to Demotech's actions. Beyond that, I think everybody else either put in more capital or did whatever they had to do to get their ratings reaffirmed. But I do know that Demotech is still concerned and watching everybody's balance sheets and income statements on a quarter-by-quarter basis. It's - they're a regulator - they're a ratings agency. That's what they're supposed to do. And I can tell you, that's what they're doing.

Okay. Great. And then maybe shifting gears to TypTap. Thanks for the update on policies and premiums. I'd be curious, if there's any update in terms of plan or timeline in terms of getting them licensed to write homeowners or plans longer term about - as a vehicle to enter maybe other states.

Okay. So I'll take the question in two parts. Let's talk about the writing homeowners policies.

Okay.

TypTap has been - has had its COA amended and has had rates and forms approved to do homeowners insurance in Florida. Having said all of that, we have made no announcements and have not done any marketing or anything else to actually write our first homeowners policy for TypTap in the State of Florida. So I think that is something that's coming. And the rate filing, et cetera, I think, are a matter of public record at this point. As far as expansion beyond Florida, I think given TypTap seasoning, Homeowners Choice and the state it finds itself in at this point, we may - I think it's imminent that both companies will expand beyond Florida sometime in the near future, obviously, subject to all the regulatory approvals, both from Florida and from any state that they wish to apply to, yes?

Great. Last question, just a numbers question. Cash on the balance sheet, obviously, took a step-up following the convertible issuance. I'm just curious your thoughts on how we should think about that. Are rates attractive enough here for you to invest some of that in yielding instruments? Are you more comfortable maintaining a high cash balance for the foreseeable future?

A bit of both in terms of that, I think, the high cash balance and as the Fed has been raising interest rates, you can easily pick up 1% to 2% in anything that's liquid from - immediately liquid to liquid over the next two years. So we will pick-up some money from that. The big cash balance is really there to - in case opportunities or needs arise for the business. So we're not necessarily committing to do anything just yet. Having said that, we did all of these transactions because we saw a window of opportunity whereby we could remove any concerns of debt being maturing and being due anytime in the next few years. And doing it in a way whereby actually our cash requirements to service the debt didn't actually go up and yet we netted about $70 million in cash. So it's a very good transaction.

Yes. Wonderful. All right. Thank you very much for the answers and congrats on a very nice start to the year.

Thank you.

Thank you.

Thank you. Our next question comes from the line of Mark Hughes with SunTrust. Please proceed with your question.

Yes. Thank you. Good afternoon.

Good afternoon.

The 8% average rate hike seems to be bigger than, I think, what you might have contemplated previously. What drove that bigger number?

Great question. As we've always - as we've told everybody, how this works is that we submit all of our data and information to the - to actuaries who run up the numbers. Obviously, all of this stuff is a little bit backward-looking and delayed. So the data that's been used is probably a few months old. But anyway, based on that, they come up with what they think an actually sound rate should be charged. The OIR, our regulator, also get the - do the same kind of things with their models and their actuaries. And they come up with an answer. And then everybody has a conversation as to what they think is a prudent number. And there's always a certain amount of discussion on the matter, because unlike what people perceive these things to be, the OIR has a mandate to try and make sure that our rates are not so high as to be too high nor to be too low that we may be in a degree of insolvency or anything of that nature. In the course of this year's conversations, they felt it was - given the logjam that AOB seems to be in the legislature, et cetera, they felt that out of abundance of caution, it might be worth taking a slightly higher rate just in case AOB and litigation spread beyond Tri-County to the rest of the state. So yes, it is higher than we had anticipated. It's higher than we thought we would do. But at some point, the regulators are extremely concerned, as is Demotech for that matter, and as are we to some degree in case AOB spreads beyond the Tri-County area.

The gross premiums written were a little bit better than we had look for - the - you still were down a bit year-over-year, but seemingly not down as much as you'd been in the preceding quarters, excluding the fourth quarter takeout. Did you do a little bit better on voluntary in the first quarter? Anything that was more beneficial in the period in terms of new business?

My simple answer to that would be I don't think so.

Basically, it was renewal and slight reduction in the…

Well, actually, the one item that you would see why that gross written might not be going down as much is because the rate decrease went through starting January 1 of 2016. So when you are now renewing in Q1 of 2017, there's no rate decrease anymore.

In the quarter, you had the impact of TypTap. Yes.

Right. And when does the 8% take effect, I'm sorry?

It's not quite been finalized yet, but it will sometime be - it'll either be August or September of this year, late Q3.

All right. What's your sense on the AOB issue? Has it stabilized here, getting worse, getting better?

We've been tracking lawsuit filings, et cetera, as you know, for several months. Not just our - lawsuits filed against us, but against the top dozen or so carriers in the state, et cetera. And from everything we see, while our lawsuit count year-over-year has been flat, still way too high, but hasn't increased any. I cannot say that is the case across the industry. We have seen a couple of carriers with large increases in number of lawsuit in first quarter of 2017 versus what they had in first quarter of 2016. And I think the overall lawsuit filing in those Tri-County area has gone up. And I think there is some uptick in some other parts of the state. But I - there, you're talking from a very small number. It could just be no, it is supposed to be an actual trend.

The loss ratio in the quarter, did you break out current accident year versus prior year?

Current accident year was $23.2 million for about 25.3%. And for the entire quarter, it was 27.86%.

And that the delta is obviously prior development of about $4 million, $5 million - $4 million?

Yes, $2.49 million.

Okay. I'm sorry, the 27.9 was the percent, not the number. Yes, okay, I'm sorry. Okay. I think that's it. And I'll just extend my congratulations to both Richard and Mark for the nice transition there.

Thanks, Mark.

Thank you, Mark.

Thank you very much.

Thank you. Our next question comes from the line of Arash Soleimani with KBW. Please proceed with your question.

Thanks. Good evening.

Good evening, Arash.

Just a quick numbers question, what is interest expense roughly going forward?

It's about $16.9 million.

Annually, right?

Yes, per year.

Per year. Okay. And you just said, was it $2.49 million was the number for prior period development?

Correct.

Okay, $2.49 million. And you mentioned earlier that the reinsurance costs should stay the same just for the 2017-2018 year. Is that on an absolute dollar basis or a percentage basis?

I think it's in dollar basis.

Okay. And should we expect the percentage to stay consistent as well more or less, I guess?

Arash, that depends on what you have as projections for revenue.

That's true. Yes, that's a fair point. But I guess, just to ask differently. When we look forward a little - I guess, when we look forward a little bit, do you expect that TypTap and maybe other initiatives that you might have could offset that? I know on past calls you mentioned that you thought TypTap could potentially prevent PIF from declining further. Do you still have that thought? Or sort of how do you kind of think about that?

Yes, look, where this is going to get complicated - and this is where you make the big bucks is, there is going to be some attrition, but - and TypTap is growing so that offsets some of that. The other thing you will also have is this rate increase that we're talking about. It's going to have two opposite effects. It's a question of which one dominates. One obviously, and this is especially I'm talking about in the Tri-County and the Southeast Florida area. You're going to see a rate increase on the one hand, which would increase premiums, et cetera, but despite the rate increase, may also cause retention rates to drop in those areas, which would tend to bring the premium down. So it's too early to tell which of those two forces will dominate and that may change the trajectory of revenue changes.

Okay. And is it fair to think of the 8% - is it partly due to the fact that when you took the 5% rate decrease, it's kind of before everything sort of blew up in Florida? So because of that, you're taking, I guess, a larger increase this year to almost undo the decrease last year, if that makes sense? Because like did you feel that the decrease last year in retrospect shouldn't have happened since AOB started to become even crazier by - I think even when Heritage reported results in the first quarter, they had the development and you saw every quarter basically everybody in Florida taking development. So in retrospect, was that kind of where the 8% came from?

Arash, I tell you what. Playing Monday morning quarterback and what you should have done two years ago, it's always right - in hindsight, everything looks very clear at the time you make the decisions based on the best information you have. So the 5% rate decrease was - in order for it to go into effect on January 1, 2016 was probably approved in late September, October 2015, right. And at that - and they were, obviously, measuring the sort of data that was even older than that, right. So they were looking at it from what the results looked like in 2014 and maybe the early part of 2015. Based on those numbers, a 5% decrease was appropriate. This time around, obviously, looking at the data from the recent past and you come to a very different conclusion, right. But as with all of these things, it's - it would be inappropriate to second-guess decisions made with new information - second-guess decisions made with all information when new information comes to light, yes. So we tend not to look at it that way.

And I know you said $4 million of TypTap premiums. What was the policy count there?

I think it's about 4,000 in-force at the moment or 4,000 have been sold, yes.

Okay. 4,000 have been sold. Okay. Perfect. Okay. That's all my questions for now. Thanks for the answer. Congrats to Richard and Mark, as well.

Thank you, Arash.

Thanks.

Thank you.

Thank you. Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back to management for any closing comments.

On behalf of the entire management team, I'd like to express our appreciation in continued support we receive from our shareholders, employees, agents and most importantly, our policyholders. We look forward to updating you on our progress in the near future.