Good afternoon, and welcome to the HCI Group Incorporated second quarter 2018 earnings call. My name is Tim, and I will be your conference operator this afternoon. At this time, all participants will be in a listen-only mode. 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 September 2nd, 2018, starting later this evening. This call is also being broadcast live via webcast and available via webcast replay until September 2nd, 2018, on the investor information section of the HCI Group's website at www.hcigroup.com. I would now like to turn the call over to Kevin Mitchell, HCI Senior Vice President of Investor Relations. Sir, please proceed.
Thank you and good afternoon. Welcome to HCI Group's second quarter 2018 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, Mark Harmsworth, our Chief Financial Officer. Following Paresh's opening remarks, Mark will review our financial performance for the quarter and then turn the call back to Paresh for an operational update and business outlook. Finally, we will take your questions. To access today's webcast, please visit the investor relations section of our corporate website at hcigroup.com. Before we begin, I would like to take the 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 company's business, financial conditions, and results of operations. HCI Group, Inc. disclaims all the obligations to update any forward-looking statements. With that said, I would now like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, and welcome everyone. Q2 2018 represents another hard quarter for HCI. We earned a delivered $0.92 per share, but as our earnings press release indicates, this includes some accounting noise, which Mark will discuss in his remarks. Looking at the highlights for the quarter, we continue to deliver shareholder value through our share repurchases and dividends. We increased our quarterly cash dividend per share by 7.1% to $0.375 per quarter. We completed our insurance program for the 2018-2019 contract year. The coverage in cost, excluding flood, is similar to last year, but we reduced our risk retention by almost two-thirds to $16 million. Our real estate subsidiary, Greenleaf Capital, added another property, our ninth, which is a retail shopping center to our portfolio, and it's based in Clearwater, Florida. Our technology-based subsidiary, insurance subsidiary, TypTap, reached an important milestone.
Building on the success of TypTap, we have launched TypTap Home, which is TypTap entering the homeowners' insurance business. While we could do flood before with two questions, we can now offer homeowners' insurance with just five questions. We will talk more on that later in the call. With that, I will turn it over to Mark, who will walk us through our financial performance for the second quarter. Mark?
Thanks, Paresh. I know you've all read the press release, so I'll just hit some of the highlights and explain a few things going on behind some of the numbers. In Q2, our after-tax net income was $6.4 million compared to $9.5 million in the same quarter last year. Fully diluted earnings per share were $0.92 on a GAAP basis or $1.01 on an adjusted basis versus $0.93 in the same quarter last year. While we were happy with these results, there was an unusual one-time non-cash transaction in the quarter that significantly reduced after-tax net income and earnings per share. Let me explain it. In May of 2013, we issued a block of market-based restricted shares to certain executives and board members.
May of this year was the five-year anniversary of this grant, and because the price targets were not met, 272,000 remaining unvested shares will never vest and so needed to be addressed. This impacted the financials in a few places. First, $1.7 million of cumulative dividends paid on these shares had to be expensed. This added $1.3 million to personnel expense and $400,000 to operating expenses in the second quarter. Second, this expense is a permanent difference in calculating income tax expense, therefore increased our effective tax rate for the quarter. Third, a related deferred tax asset had to be written off, and this further increased income tax expense by $1.6 million in the second quarter. The total impact of this adjustment was to reduce after-tax income in the current quarter by $3.3 million and reduce fully diluted earnings per share by $0.13.
Absent this transaction, GAAP fully diluted earnings per share would have been $1.05, and adjusted EPS would have been $1.14. Again, this was a one-time non-cash accounting adjustment. While it shows up as a negative in the financial statements, it's actually a positive in terms of its economic consequences. Because these shares will never vest, when they fully expire in a year, our share count will drop over a quarter of a million shares, which will reduce dividends, increase book value per share, and increase earnings per share. Also, this shows good alignment with shareholders. The threshold share prices were not met, and as a result, the shares will be forfeited. That said, there's just two more things I wanted to mention from the income statement. First, loss and loss adjustment expenses.
In Q2, non-CAT reported claims and reported lawsuits were down significantly from the same quarter last year. As a result of this and other factors, our loss expense is significantly lower in the second quarter than the same quarter last year. Loss expense this quarter was $21.8 million and 25% of gross premiums earned, versus $27.7 million and 31% of gross premiums earned last year. The loss expense in the second quarter was, however, slightly higher than the first quarter of this year, largely because of some weather-related claims. As you know, we recently announced our new reinsurance tower for June 2018 to May 2019. Based on these and other agreements, expected reinsurance should be between $31 million and $32 million per quarter, which, as Paresh said, is about the same as it's been over the last few quarters.
While Paresh already mentioned this, I think it deserves repeating that while our reinsurance costs are flat, our risk has been materially reduced as our consolidated retention has dropped from $50 million to $16 million. This is a tremendous enhancement to the company's financial position. Now to the balance sheet. As you know, Hurricane Irma struck in the third quarter of last year, and we estimated our ultimate expense at $267 million. In the second quarter of this year, we've increased our estimated ultimate for Hurricane Irma to $326 million, and this, of course, had no impact on the income statement. The impact is to the balance sheet, where there was an adjustment to reserves, which is offset by an adjustment to reinsurance recoverable. The other thing you might notice looking at the balance sheet is some movement in our investments.
First, as Paresh mentioned, we closed on the acquisition of a new property in our real estate portfolio. We purchased a five-acre property with a 70,000 sq ft retail building in Clearwater for about $6.3 million. $6.8 million, I'm sorry. We now have nine properties in our real estate portfolio with a cost base of about $78 million and market value of just over $110 million. Second, we rebalanced some positions in our investment portfolio. Since the beginning of the year, we have reduced fixed term securities by about $72 million and increased our investment in short-term securities by about $110 million. This has reduced our average term to maturity from five years to less than two. While the average book yield declined somewhat, that's being compensated by higher yields on cash, and the result should be slightly higher investment income with much lower risk.
More importantly, as rates increase, we will have the liquidity to take advantage of that while minimizing mark-to-market adjustments. Just a few comments on capital management. During the quarter, we bought back 175,000 shares at an average price of just under $41, bringing the total buybacks for the year to just under 360,000 shares at an average purchase price of just over $38. To the end of June, we've used $13.7 million of the $20 million committed in our 2018 buyback plan, we have about $6.3 million left. As you know, our buyback program is part of a long-term strategy to reduce share counts, and over the past 12 calendar months, we have reduced our share count by just over 7%. Back in April, we announced a dividend increase from $0.35 to $0.375 per quarter.
However, due to the steady reductions in share count I just mentioned, we were able to increase the dividends with very little impact on cash flow. While every shareholder is receiving 7% more in dividends, the total dollar amount of dividends paid in June was the same as it was a year ago. Just to quickly summarize, it was a good quarter for us. We're earning around $1 a share, keeping our combined ratio in the mid-80s, maintaining our strong balance sheet and liquidity, reducing risk, while enhancing returns in the investment portfolio and significantly reducing our exposure to a CAT event without an increase in reinsurance costs. With that, I'll turn it back to Paresh.
Thank you, Mark. I wanted to note something that's probably not significant to most people, but it is to me. Last Monday, three days ago, marked our 10th year anniversary as a publicly traded company. Looking at doing the simple math on that, this probably means this is our 39th earnings call as a public company. In every one of these calls, we discuss whatever the issues and items are that are relevant in the quarter, and we've been through a lot of them. Sometimes we discuss growth plans, sometimes we talk about how we maintain the business, but we discuss what's going on, and it's in the moment. The key item, though, is what does things happen in the long term? Out of 39 of calls, 38 of them, we reported positive results and long-term consistent profitable operation.
Obviously, we had the one quarter, Q3 last year, where we actually lost money. It's quite a record. It illustrates where we are headed to and where we're going to. From the comments Mark made about what we've been doing for the last few years while we've been maintaining the business has been, we buy back shares every quarter, we look at dividend every quarter. It doesn't show up in any given quarter, but if you look back over the last 5 years, if you owned a share of stock 5 years ago, that share represents a 30% greater stake in the company than it did 5 years ago, and it's paying a dividend that is 60% more. Dividend's gone up from $0.90 to $1.50 in 5 years, and the share count is down by about 30%.
We can keep doing this and keep providing positive outcomes for years to come. There's no reason why this won't continue in the balance of 2018, 2019, and 2020. We are also at an inflection point where great opportunity now lies ahead of us, and I wanted to make sure we talk at an earnings call because some of the shareholders, the original shareholders from 10 years ago, still listen to this call. What am I talking about? It is the technology that we've been developing over the last few years has come to maturity, and it presents a great opportunity. What is this that we're saying now? Let's talk about TypTap for a second. TypTap flood, and that business that we started two and a quarter years ago, is now profitable.
If it were just profitable and we had never had any serious CAT claims or CAT events, you could say, "Well, you just got lucky," or maybe, "How do we know you're doing better underwriting than average?" In TypTap's case, that isn't it. It's been through three hurricanes, and we have seen results as to what actually happens. The results prove the technology that we have implemented works. We've had a similar outcome on the Homeowners Choice side on the wind book. Using those items as markers to how our technology is working, we have implemented the technology in such a way that we can now expand the business. We are looking forward to now to expand both our flood business throughout the country and oh, by the way, in the second quarter, we started writing in states outside Florida.
On the Homeowners side, we are going to refocus growth in Florida and homeowners market, including Tri-County. I know for the last few years, everybody's looked at Tri-County and talked about it's terrible, and we should exit because of A or B problems, et cetera. What our technology now lets us do is we can walk through that minefield. We can write business there, and we can do it profitably. Right? This represents a great opportunity because what's been overlooked is just Dade and Broward County represent almost a $2 billion market. Right? They're not that much smaller than the entire NFIP. We are going after that market, and we are going after the NFIP market, which is a $3 billion opportunity. We are not going to get all of that $3 billion plus $3 billion, nor are we trying to.
We're trying to get a small percentage of it, but one that has more than its outside share of profits. That is where we're headed to, and that opportunity is now being layered on top of our long-term strategy of share buybacks and dividend increases. Okay, with that, I will turn the call over to questions. Operator, please provide instructions.
Thank you. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue, and you may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Arash Soleimani of KBW. Please proceed with your question.
Hi. Good evening. Quick question first on the numbers. I see that you guys had some, you call it 2018 development. Was that just current accident year development from 1Q?
We had a little bit of, less than $1 million, but we had some adverse from prior years.
That was prior years. In the press release, you do mention additional operations in reinsurance. What do you mean by that if you're not using Claddaugh anymore?
Arash, I lost what exactly you're referring to. Can you elaborate a bit?
Yeah. It just says basically in the description of HCI, we're a homeowners insurance carrier with additional operations in reinsurance. I just wanted to get more color on the reinsurance.
Yes. Claddaugh is still there and still functioning. It does have some other reinsurance contracts from the past and other things, et cetera. We haven't liquidated Claddaugh, it's just that it's not on the HCI wind book reinsurance program for the 2018-2019 year.
Does it have currently any operations that are material in any way to HCI as a whole? Would you say that that's immaterial and irrelevant to current results?
It's immaterial and irrelevant. Don't forget, Claddaugh generally gets consolidated out at the HCI Group level anyway. Yeah?
All right. There is no third party kind of transactions that Claddaugh engaged in?
No.
I guess is what I was trying to get at. Okay.
Yes.
Can you talk about potential rate increases in the pipeline for this year, or how you look at the rate environment?
Yes. Obviously, we can. We obviously do annual rate filings. We had a rate filing last year, which resulted in a rate increase that started in September of last year. Obviously, we are at the back end of running that through our book. At this moment in time, we are collecting all the data, et cetera, for our rate filing for late 2018. Obviously, when that is done, our actuaries will have some opinion as to what rate adjustment we may need. We will provide the data to the Florida OIR, who will also review it, and they will have an opinion as to what rate adjustment we may need. Then there will be a rate adjustment made.
At this moment in time, we don't have an opinion or a strong statement as to what that number would be up or down and how much, yeah?
Okay. In terms of Irma, did you guys see any gross loss creep this quarter?
I think Mark just said we bumped up the ultimate loss from $267 to $326.
Okay, thanks. Has there been any, you guys mentioned, I think last quarter, interest in buying FedNat. Have there been any further developments on that front?
Are you asking specifically about FedNat or M&A in general?
I guess both. Maybe we could start with FedNat and see if there's anything else to report on there, and then, maybe talk about any appetite you have to combine with a carrier in Florida if FedNat does not work out.
Okay. The FedNat piece is easy because even when I mentioned it in the last earnings call, I did say the conversations had been terminated at that point. It was over then and it's still over. There's been no further discussions between us. As far as other M&A, opportunities come along. I know there are some conversations that have been had, et cetera, sometimes involving us, sometimes not involving us. At the end of the day, I think there still seems to be a gap between what sellers value their companies at and what I think any rational buyer is willing to buy their companies at. I don't think any transactions are imminent, at least that I'm aware of. That doesn't mean they aren't, they're just what we're aware of.
Okay, thanks. Mark, I think you did mention this, but can you repeat the gross premiums written?
Gross premiums written total were $132.4.
Okay, great. All right. Thank you very much for the answers.
Thank you.
Thank you.
Our next question comes from the line of Matthew Carletti of JMP Securities. Please proceed with your question.
Okay, thanks. Good afternoon.
Good afternoon.
Matt.
Can you guys give us, maybe start with Irma and just kind of give us a little bit of color behind the, not huge numbers, but a little bit of increase that you had in the gross. Is it that kind of the reopening and AOB related stuff has kind of caught pace a little faster than you expected, or is there something else being the main driver of it?
Matt, it's Paresh. I think we have analyzed what's causing this, et cetera, really where it's coming from. I'm just speaking about for our policyholders. I get mostly the industry as a whole.
Sure.
At least what we are seeing in our case is, the claims that we originally got in the Keys and in like the Marco Island area, basically where Irma made landfall as a Cat 4 and a Cat 3.
Those are the places where we are picking up the additional development. Not in the form of new claims, but actually the total expense it takes to settle those claims. To illustrate what I mean by that, an example. Imagine there's a house with a roof that's severely damaged. Back in October or November, our adjuster went there, looked at the house, measured the roof and said, "This roof," and they probably used what the cost of roofs had been pre-Irma, and said that roof is going to cost $20,000 to replace. What is now developing is there is a shortage of labor and materials to get people's roofs fixed in all through the Keys and places like Marco Island. That $20,000 roof is now maybe costing $35,000. That's the best price an insurer can get.
Obviously, at that point, we stand behind our insureds and the cost of that claim will go up. That's what's driving a lot of it.
Okay. It's demand surge, not anything litigation related.
No. There is litigation coming in that, we anticipated that when we built our original estimates, we assumed litigation should never be a surprise. We assumed that there would be some, that's coming in. As Paresh said, that demand surge is sort of driving it. There are some new claims coming in, it's not a lot.
Again, they weren't anticipated.
They're smaller dollar claims.
Finite problem.
Okay, great. The other kind of topic I was hoping you'd give us some color on is just focusing on TypTap and both just kind of the success you've seen to date, kind of, lessons learned and kind of, the two and a half years and where you've gotten it to and the growth. I understand it's probably competitively a little bit of a sensitive topic, but just Paresh, you mentioned the refocusing a bit on Tri-County and being able to use the technology to, I think you said, kind of tiptoe through the minefield and find the good risks.
Can you just give us a little bit of color more on maybe even just the attributes and things like that you're looking for that clue you into maybe one house being good risk versus the one next to it not being good risk when it comes to things like that in Tri-County?
Okay. First of all, on the flood side, right?
One of the things that's happened, clearly when we started getting into the flood business several years ago, we were a lone voice in the wilderness.
Said that it could be done, it could be done profitably and at competitive prices, which wasn't a popular opinion at the time. What's happened is, at this point, I think there are lots of companies talking about getting into flood, I guess they agree with us at this point, which is good. What we know from how TypTap has gone through the three hurricanes is there's good business. You can do flood business, and there's bad flood business, which will cost you a lot of money. Case in point, TypTap is still here, is healthy, has not been bailed out by the U.S. Congress despite the events of last year and the NFIP with all their vast experience, and they needed to be bailed out because of what happened in Harvey.
In homes that they thought were good risks, right? That's where you get into different outcomes. We know from experience what actually works and what's long-term good versus it's great until a CAT comes along.
Right.
That's the flood side. We are getting increasingly confident in both the business that we want to write as well as the business that we don't want to write. We speak about that from experience, having lived through the hurricanes. On the wind side, it's the same thing in Tri-County, et cetera. We have been watching and monitoring and building data and tools and systems for the last four years as we've been making the business to see if we can get a idea as to how best to do this, how to make it a profitable book, et cetera. And having gone through Irma, our one quarter making, and that actually turned out to be very good because it completed the last piece of the puzzle for us.
Not only how does our book perform when the wind doesn't blow, but also how our book performs when the wind does blow.
Right.
Yep. That's been a big value in terms of telling us how to go about writing and assembling a profitable portfolio. Obviously, with TypTap, life is made so much easier for the insured and the agent. Because we can apply, bring all of these things together, we think it's time to grow business, including in Tri-County. Because while everybody always talks about Tri-County in a negative light, we do know there are a lot of people who live down there who are decent, hardworking people, and they need insurance. Just like five years ago, decent, hardworking people needed flood insurance. We've never been shy to offer a good product or actually a great product at a good price when others thought differently.
Great. Well, thank you very much for the color and congrats on the 10-year anniversary.
Thank you.
I would like to remind all of our participants at this time if you would like to ask a question, please press star one on your telephone keypad. Our next question comes on the line of Mark Hughes of SunTrust. Please proceed with your question.
Yeah, thank you. On the South Florida, the Tri-County, is it the pricing has come up enough to make it worthwhile? Have you spotted something in there that is presumably something proprietary that you're gonna take advantage of?
I don't know whether pricing's come up makes a difference or not. Really, all I can say is that where we've got good at being able to predict stuff is instead of looking at it and saying, "This area is good or bad," or, "Zip code is good or bad," or whatever, we can almost go down and look at it on a house-by-house, on rooftop-by-rooftop level and be able to separate what is profitable business from what is potentially unprofitable business. Just getting that edge gives you a advantage that builds over time. Looking back on it all these years later, we actually applied the same logic when we were doing takeouts out of Citizens. We used to do takeouts out of Tri-County. We were doing that when nobody else would in 2012, 2013, and so on.
We stopped in 2014, and there was still lots of business there. There's still lots of business in Citizens right now in Tri-County. Why did we stop? It's because we have tools that told us, that identified the good business, and when we ran out of good business to take, we stopped. Others didn't have those tools, they just see number of policies and pitch counts and premiums, and that's what attracts them. It's the ability to be able to distinguish between good business and any business. We now have the same capability on a rooftop-by-rooftop basis throughout the state. We can underwrite a policy almost instantaneously from when the policyholder expresses interest at whatever the premium is. Yeah?
How material will that be to the top line? I'll just sort of roll that into the broader question of last couple of quarters, your gross premiums written have been down about a point. Call it flat, but down slightly. I think you've gotten the question before. When does that transition sustainably to top-line growth? I'll ask that in the context of whatever help you might get from these Tri-County policies.
Mark, two things about that. Yes, one of the reasons we brought this up on this call is that we are thinking differently from maintaining our book to now we're talking about growth again. It's because we now feel confident that we can write business because otherwise we could have gone the top line, but unless it helps the bottom line, it seems a wasted activity. It's one of the reasons that we haven't expanded into multiple states to write homeowners policies, because unless we could see a profitable way of doing it didn't make sense. It just creates a lot of activity. We're more in the business of once we write a policy, we like to keep it in our books forever if we could.
Where we are now is we do see that opportunity throughout the state, but especially in Tri-County, that you can add business profitably. Obviously, it's early days, whether that would mean a little bit of incremental business or a lot of incremental business, time will tell. We expect that the earned premium will start growing either by Q4 or early 2019. To answer your question.
Understood. What about on the AOB front? You get any sense whether you're getting a respite here as the plaintiff's lawyers are going after the storm claims, therefore you're not feeling the direct effect. Is there any way to judge that situation?
I don't know that there's an absolutely mathematical way of judging that, but I can give you some color. Yes, on the short term, there is some risk spike as the plaintiffs' attorneys are more focused on Hurricane Irma than daily claims. There is some numbers there. Having said that, what we are also picking up, which is slightly concerning, is that new plaintiffs' law firms are setting up throughout the state because of Hurricane Irma. The concern is that when Hurricane Irma is dealt with somewhere down the road, these law firms will then be looking for other forms of revenue. That could spread AOB throughout the state. In the short term, while it might be a respite, in the long term, it could be a detrimental thing if it's not taken care of in time.
None of the things that we've talked about up to this point in the call should in any way be construed of us believing that the AOB problem is diminishing or is not a major concern to us and to the industry as a whole.
The combined ratio was up this quarter compared to premiums. Was there anything unusual?
Not that we can think of. The only reason it could have been, our book does have some seasonality to it, but Q2 tends to be when large sections of our portfolio, our policies renew. It's one of those legacy things from days gone by that we had because we wanted to go into wind season with the maximum amount of cash and unknown premiums on the books.
Hey, Mark, it's Mark. You're thinking of the relationship between the commissions and gross premiums earned. Is that right?
Correct. Yeah. All the acquisition expense.
Yeah. You got to remember that there's a bunch of things that we capitalize there, and they get amortized in different ways. There's never a direct connection to gross premiums earned. There's some things in there that are straight-line amortized. There are some that are based on gross premiums written. Operationally, there's nothing different there. It's just the way that some of those expenses are treated that they won't necessarily go up or down exactly in correlation with gross premiums earned.
What's your latest thinking on tax rates for the back half of the year for next year?
Yeah. I said on the last call that we expected our effective tax rate to be about 27%. If you look at our cumulative tax rate for the first six months, it's just under 27%. There's that kind of weird accounting treatment that I went through in my prepared remarks. It was 27 for the first half, and I would expect it to be in the similar range for the second half. Nothing much has changed since we developed those expectations. I think 27 is still about the right number.
I know it's early and you may not have a view, the weather so far in Q3, has it been raining very much?
It has been a rainy summer. Claim volumes compared to the first quarter especially are up a little bit, nothing dramatic or overly concerning. It's Florida. It rains in the summer. We get most of our rain in the summer. It's within expectations.
Yeah. Okay. Thank you very much.
Thanks, Mark.
There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to Mr. Kevin Mitchell for closing remarks.
On behalf of the entire management team, I'd like to express our appreciation for the 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. Thank you.
This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.