Greetings, welcome to the HCI Group Inc. second quarter 2014 earnings call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kevin Mitchell, investor relations for HCI Group Inc. Thank you, Mr. Mitchell. You may now begin.
Thank you, good afternoon. Welcome to the HCI Group second quarter 2014 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, and Richard Allen, our Chief Financial Officer. Following Paresh's opening remarks, Richard will review our financial performance for the quarter turn the call back to Paresh for an operational update and business outlook. Finally, we will open up the call to your questions. To access today's webcast, please visit the investor relations section of our corporate website, hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today's presentation and responses to our 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, 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 a material adverse effects on the company's business, financial conditions, and results of operations. HCI Group Inc. disclaims all obligations to update any forward-looking statements. Now I would like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, good afternoon, everyone. As Richard will demonstrate in a moment, the fundamental insurance business remains strong as we continue to build a solid platform of diverse yet complementary business units. Among the highlights for Q2 2014, first, we repurchased and retired 277,510 shares of HCI common stock at a total cost of approximately $10 million, or an average purchase price of $36.03 per share. This brings the total number of shares repurchased and retired in 2014 to 488,346 shares at a total cost of $17.8 million, with an average purchase price of $36.45. As of June 30, 2014, we have $22.2 million remaining under our board-approved plan that was implemented in March of 2014. This reaffirms our commitment to the shareholders as we continue to create long-term value. Secondly, we redeemed all of our preferred shares. Third, our flood insurance rollout has progressed modestly.
Much of the momentum has been diminished by the changes to the Biggert-Waters Act. However, we remain optimistic that the glide path to growing that business is still intact and growing. Fourth, we finalized our reinsurance program for the current wind season. We believe we are well reinsured. The program provides for coverage for a one in 182 year event. Looking at it differently, our program covers 2% of our total exposure statewide, 6% of our peak regional exposure, and 10% of our peak county exposure. To elaborate, on an absolute basis, we have enough reinsurance to cover the total destruction of about one in 50 homes we insure statewide, or one in 16 homes in our peak region, which is Southeast Florida from Miami to West Palm Beach.
Finally, you could look at it as one in 10 homes in Broward County, which is Fort Lauderdale, could be destroyed, and we have enough reinsurance for that. This represents high rates of losses that obviously would not be isolated just to us, but to the entire industry should they occur. Secondly, we have also reduced our exposure that we're retaining within our captive for this wind season, and we did this as the rates have softened dramatically. As for our other divisions, the real estate division continues to evaluate opportunities and has begun to add to its portfolio of real estate holdings. We expect more to come from this division in the future. Our technology division, Exzeo, rolled out Proplet to a small but growing number of agencies. It represents the second product in service and more products are on the way.
Before I go on, I would like to invite our Chief Financial Officer, Richard Allen, to take us through our financial performance for the second quarter. Richard?
Thank you, Paresh. Good afternoon, everyone. For the second quarter of 2014, income available to common stockholders totaled $16.4 million, or $1.39 diluted earnings per common share. This compares to $16.2 million or $1.40 diluted earnings per common share in the second quarter of 2013. Gross premiums earned in the second quarter of 2014 increased 11.3% to $91.2 million from $82 million reported in the second quarter of 2013. This increase is primarily due to the renewal premiums of policies assumed from Citizens in 2012 and 2013. Net premiums earned for the second quarter of 2014 increased 9.3% to $62.6 million, from $57.3 million in the same year-ago period. Premiums ceded in the second quarter of 2014 were 31.3% of gross premiums earned. This compares with 30% in the second quarter of 2013.
Quarterly reinsurance costs for the treaty year ending May 31st, 2013 increased approximately $6 million per quarter from the prior treaty year. As discussed on previous earnings calls, included in the ceded premiums for the three and six-month periods of 2014 are the benefits from the multiyear reinsurance treaties entered into in June of 2013 of $5.1 million and $10.5 million, respectively. The amount recorded in inception to date of these treaties is $23.1 million. We do anticipate that reinsurance costs for the treaty year starting June 1, 2014, will be less than the prior treaty year. Since year-end 2013, we have increased our fixed income position in our investment portfolio, which led to $1.5 million in net investment income for the second quarter of 2014, a significant improvement from $295,000 in the same period a year ago.
Losses and loss adjustment expenses during the quarter of 2014 were $18.4 million, compared with $17.4 million in the second quarter of 2013. Policy acquisition and other underwriting expenses in the second quarter of 2014 were $9.6 million, compared with $7.3 million in the same year-ago period. The year-over-year increase was primarily attributable to the renewal of policies assumed from Citizens in 2012 and 2013, which are subject to commissions and premium taxes on renewal. Other operating expenses, which include a variety of general and administrative expenses, totaled $9.4 million in the second quarter of 2014, compared with $7.4 million in the second quarter of 2013. This increase is primarily due to an increase in compensation of $2 million, which includes stock-based compensation. Interest expense from our senior notes totaled $2.6 million in the second quarter of 2014.
The company's 3.875% convertible notes that were issued in December of 2013 were the main reason for the increase, compared with $846,000 in the second quarter of 2013. Turning to our financial ratios. Due to the impact that reinsurance costs have on net premiums earned from quarter to quarter, we believe the combined ratio measured to gross premiums earned is more useful in assessing HCI's overall underwriting performance. Our loss ratio applicable to the second quarter of 2014, which we define as losses and loss adjustment expenses related to gross premiums earned, was 20.2% and 21.2% in the second quarter of 2013. For the six-month periods ending June 30th, comparable loss and loss expense ratios were 20% and 20.2%, respectively.
The expense ratio applicable to the second quarter of 2014, which we define as underwriting expenses, interest, and other operating expenses related to gross premiums earned, was 23.6%, compared with 19% in the same period last year. For the six months, the expense ratio was 23.1% for 2014 and 17.2% for 2013. A significant factor in the profitability is the ratio of ceded premiums to gross premiums earned. For the second quarter of 2014, this ratio is 31.3% compared to 30% for 2013. For the six-month period, the corresponding ratios are 30.3% for 2014 and 28.4% for 2013. Combined expense ratios, which we define as the total of all expenses in relation to gross premiums earned for the three-month periods ending June 30th, 2014 and 2013, are 75.1% and 70.2%, respectively. Comparable ratios for the six-month period were 73.4% for 2014 and 65.8% for 2013.
On the balance sheet, investments in fixed maturity and equity securities totaled $160.2 million at June 30th, 2014. An increase from $129.8 million at December 31st of 2013. Total stockholders' equity at June 30th was $176.1 million, up 9.7% from $160.5 million at December 31st, 2013. Book value per common share has increased to $16.47, compared with $14.68 per share at December 31st of 2013. With that, I'd like to turn the call back over to Paresh. Paresh?
Thank you, Richard. With the numbers Richard gave, we are now clearly seeing the company achieving a rare feat, and a feat that we see continuing going forward. It is pursuing growth opportunities while simultaneously paying a healthy dividend, reducing share count meaningfully, increasing book value, and increasing shareholder equity at the same time. In summary, our profitable core insurance business, coupled with our strong cash position, allows us to patiently seek accretive growth opportunities. We have the benefits of in-house technology, a strong balance sheet, and a highly experienced management team. These factors, combined with our disciplined underwriting approach, have led to a sustainable model for long-term viability and growth. We look forward to the challenges and opportunities ahead. With that, we're ready to open the call for your questions. Operator, please provide the appropriate instructions.
Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you'd 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. Thank you. Our first question comes from the line of Matt Carletti with JMP. Please proceed with your question.
Hey, good afternoon.
Good afternoon, Matt.
Just had, I guess, one kind of high level question, then a couple numbers questions. On the high level question, I was hoping maybe you could expand a little more on the traction that Proplet is getting thus far in terms of lead generation or policy generation with agents for HCI. Also too, whether it's Proplet itself or the kind of the database behind it, some of your thoughts on kind of potential other applications for the technology.
Sure, Matt. As far as the traction with the agents, it's getting to be very interesting because the whole idea behind Proplet and when people see it sort of reverses how they're used to doing business. It's taking a little while for everybody to sort of figure out how to exploit the technology to its fullest advantage, right? Having said that, you're starting to see the early adopters starting to understand what it could mean, then going forward from there. It is starting to have an effect. Over the course of time, obviously, it's one aspect of all the other aspects of the business, but it is showing very promising early results. As far as the underlying technology and everything else, the more people that are seeing it, the more folks are coming up with new and innovative ways of using it.
I don't want to make this too big of a thing, but it's sort of like when iPhones came out. When they first came out, it was just like a cool little phone with an iPod built into it that you could make phone calls on. Then people started thinking of different ways you could use it, now it's going into a whole different direction. We're sort of seeing similar kinds of traction with Proplet, it's early days yet.
Okay. I mean, are some of those potential other uses, I mean, do you see down the road, obviously not next quarter per se or anything, but taking a longer term view, whether like licensing type applications and fee income potential or something else?
Well, it's too early to tell, but what happens every time we show it to people, they sort of say, "Hey, we could use it this way," or, "We could use it that way to market to" Instead of waiting for people to walk in into an agency and then you give them a quote, how about we mail them a quote right to their address? If they're interested, they call us. It's almost like getting pre-approved credit card applications in the mail. Those kinds of things people are looking at and what works effectively, et cetera. Some of those things are going to be a little bit of hit and miss in the early months, but I think eventually somebody will figure out the right formula, and off we go. This is just one thread.
There's lots of different threads like that people are looking at.
Okay, thanks. Then just a couple quick numbers questions, if you have them. I'd love to know what gross written and net written premiums were for the quarter.
I think Richard's looking at that.
Matt, if you can give me Can I get back to you before this call is over?
That would be great.
I've got it here.
All right.
I've just got to find it.
No problem. Thanks a lot, and congrats on the quarter.
Thank you.
Our next question is from the line of Casey Alexander of Gilford Securities. Please proceed with your question.
Hi, good afternoon. The interest expense was a little higher than I calculated. Is there some amortization of the offered expenses built in there?
Yes, there is.
Okay. All right, great. Secondly, I know the way that the reinsurance contracts are structured, you start to build this asset of prepaid reinsurance premiums that would have to be reversed in the event of a major storm. Is that entire balance reversible, or is some of that applicable to prepaid reinsurance premiums from periods past that now accrue to the company? Can you kind of reconcile that for me a little bit?
It's all on multiyear treaties, that depending on the severity of the storm and the layer that it would attach, that's dependent on how much would have to be rolled back.
All right. Okay. Hang on one second. I know you're just getting started with the flood insurance program, how much of the gross written premium was applicable to flood insurance for the quarter?
Let's just say negligible.
Negligible. Okay. All right. I'll step out and let some other questions come in. If I have some more questions, I'll come back in.
Okay.
Thank you. Our next question comes from the line of Dan Farrell, Sterne Agee. Please go ahead with your question.
Hi, good afternoon, everyone. A question on your cash position, which continues to grow. I was wondering if you could just talk about thoughts there, and any plans to try and deploy. Obviously, I know you're focused on preservation of capital first, and the current industry environment might not cooperate, but I just want to get your thoughts both around traditional investments and also the real estate portfolio. Thank you.
Okay. I'll take the real estate portfolio first. The real estate portfolio, obviously, if and when they find opportunities and they meet our criteria, we invest in those things. Going forward, I think it's going to involve some degree of debt along with the equity in real estate. Having said that, in this yield hungry environment, opportunities are not as easy to come by as you would like them to be, but we are patient. As far as the traditional side of the investment portfolio, we had stated almost a year ago that when 10-year treasuries peaked over 3%, that it could be a good time to start rolling out money. We started doing that. Unfortunately, as it seems to surprise most of the world, yields instead of going up, have sort of come down.
At that point, we now reached that disciplined situation where if the yield is too little, we just look at this and say it's too risky to put money to work. That's preventing us for putting more money to work in the form of bonds and debt and that kinds of stuff. When we don't put it to work, the cash just builds up because it's a healthy company, like I said, that's just generating cash at a prodigious rate at this point.
Okay, great. Thanks. Just a question on the expense ratio side. There's been some volatility there in different quarters, I think some of that also might be related to different timing of reinsurance purchase and where it comes through. Can you help us think about a level of both the acquisition ratio, which has moved around a lot, and also other expense ratio, then just the $1.5 million of comp-related stock in the quarter. I just want to confirm, is that sort of a run rate to be thinking about on a quarterly basis? Thank you.
The compensation rate is going to be leveling off and probably decreasing slightly as the compensation related to the restricted stock is amortized.
Okay.
The other question about there is no real reinsurance cost floating through expenses. A little bit of brokerage fee income and everything that I think, if I remember correctly, for GAAP reporting is netted against the no, that does flow through the policy.
I think more acquisition costs would be the area that I was thinking might have some volatility there.
There's a little bit of reinsurance brokerage commission that floats through there, and that all depends on the timing of the payments. Other than that, the regular commission should be running about the same % on a consistent basis.
Okay. All right. Thank you very much, guys.
Thank you.
Our next question is from the line of Arash Soleimani with KBW. Please go ahead with your question.
Hi, thanks. One question I had with, obviously you said with the flood initiative, you expect that to take off more as the glide path of rates sort of plays out. In the meantime, is there any way to quantify what your organic growth is currently?
Arash, I will tell you our organic growth, especially this time of year, is negative.
Okay.
It has been negative for the last seven years. We have always run a slightly different model and different kind of insurance company in the sense of, if you look back over each of the last seven years. I'm putting it through all kinds of growth phase here, right?
Right.
You find the company's always bigger on December 31st than it is on January 1 of the year.
Right.
If you look month-to-month in between, the company tends to generally shrink from, let's say, February through November.
Right.
Then grows rapidly in the last couple of months of the year and then repeats the cycle. We are basically on track with that same cycle that we repeated for the past seven years, and we're comfortable that we're going to do the same kind of growth shape this year. Unlike most companies, the fact I'm telling you that growth is negative for the second quarter, and I'll give you a headline that it's going to be negative for the third quarter, is not unexpected.
Okay. I guess I'm trying to think of it maybe in a different way. I know you said the growth is like a slump year. It's not organic growth throughout the year. In the past, for example, if a lot of the growth has come from Citizens or Homeowners Choice, if we assume that we're in a world where the opportunities from Citizens are less than when there were 1.4 million policies in Citizens, looking forward to December, is that a place where organic growth will play more of a role than it has in the past? Or do you think it's going to be more of still, maybe a takeout type driven growth or an opportunistic type acquisition growth? I guess I'm trying to see, is organic more of a factor now than it has been in the past, is I guess a simple way of asking it.
Yeah. Look, the simple answer to that is organic will play a part. Actually, funny enough, it's always played a part, but the problem that happens with organic growth is any time you get an acquisition like Homeowners Choice or you do a takeout, those numbers dwarf any organic growth because just by the sheer lumpiness and size of it. Absent, if we don't do a takeout, if we don't buy anybody, if we just do nothing but just write voluntary policies, organic growth will be meaningful in the fourth quarter. If we do any of the other stuff, it'll quickly dwarf any organic numbers very quickly. Just how unfortunately the numbers play out. Yeah?
No, that makes sense. What is it, the organic growth that you said you would have in the fourth quarter that would be meaningful if there were no takeouts or anything? I'm sorry.
Probably 300 or 400 policies a week.
Okay. Do you expect Proplet to play a role in that yet at this point, or do you think that's still more kind of like a further out type of thing?
No, I think it'll play a role, and that's part of the whole item. One other thing about the difference between growth and how we see growth versus the way everybody else sees growth. Everybody seems to see growth as the only way of growing earnings. We have managed to do this without necessarily growth. I'm not saying growth is bad, but I'm saying that's not the be all and end all as far as we are concerned. Part of what we are blessed with and constrained with at the same time is that we have an existing book that is already performing very well. If you just grow the top line or to grow policy count and cause a detrimental to that well-performing book, doesn't really make a lot of sense.
Sure.
Therefore, we are a lot more cautious about growth than some of our other brethren would be. To give you an idea, I think I just looked at the second quarter numbers. I think we were accepting about 6% of the policies we were quoting.
Right.
A lot of guys have much higher numbers and looking to increase it even further. Our growth number is that low, not because we're not getting the quotes, but we're becoming much more discriminating in terms of which policies we take.
Right. That makes sense.
Yeah. If we wanted to really show top-line growth, instead of taking 6% acceptance, we could, say, ratchet up to 50%. It really would show nice monthly growth, but it wouldn't lead to the results everybody's expecting. Yeah?
Yeah. That's true. In terms of ceded premiums. Given that reinsurance was obviously cheaper this year than last year, should we interpret that as the ceded ratio should decline starting in the third quarter since you're paying less for the coverage?
I think that's a valid statement, Arash. Basically, we're going to be amortizing $108 million compared to $113 million. The track we're on, our gross earned premium is continuing to increase.
Right.
As a percentage, it should.
Right. I know there were a couple numbers questions that you were looking up. I just wanted to know if I could add a couple more to those. One was, do you know the duration of the fixed income portfolio as of 2Q?
Offhand, no, but I think it'll be spelled out in the Q, which should be filed.
Which will be filed tomorrow.
Yeah.
Okay.
What about prior period reserve development?
It's all been very favorable, and again, that's identified in the Q2.
Okay. That's fair. My very last question is, what are you guys seeing in 2014 in terms of the rate environment for homeowners in terms of the rate filings that you're looking to put through this year?
I think it's the same item that we've stated since the beginning of the year, that the rate environment is softening, and I think people are looking at mid-single digit decreases at a minimum.
Okay, you're saying we could be, like, 5% down?
Yeah.
Okay. Basically, the point is that even if rates are 5% down, the improvement in reinsurance pricing far more than offsets that.
That's a tough one to answer.
Yeah. On a simple basis, we went down from 113 to 108.
Right.
If you are a $360 million company and you knock 5% off, not that it happens in the same fashion, right?
Right.
It has to roll through the rate filing and roll through the book and everything else. 5% of 360 is $18 million, not $5 million. Yeah?
Right.
It would take several months to roll through. There's lots of other factors to Richard's point about why it's difficult to answer, yeah.
Sure. All right. Thank you for the answers.
Richard, do you want to give the?
Matt?
Just read them out.
Matt, gross written premiums for the quarter were $140.9 million, compared to 2013 of $132.4. For the six months, the gross was $219.8 million, compared to $201.6 million. If you need any other information, give us a call, and we'll be glad to get back to you.
Thank you.
Our next question comes from the line of Matt Carletti of JMP. Please go ahead with your question.
Hey. Thanks for those numbers, Richard. A couple other numbers questions, share count related. Do you have the weighted number for the quarter, and then what it stood at quarter end, diluted share count?
Yes, I do. I've got it here. It's in the Q, if you could-
Any other questions?
Oh, is the queue out already? If it is, I can just go get it.
It will be filed tomorrow.
Okay.
It will be filed tomorrow. Okay?
Any other questions?
Thank you. There are no additional questions at this time. I will now turn the floor back to Kevin Mitchell for closing comments.
On behalf of the entire management team, I would 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 the continued success during the remainder of 2014. Thank you, everyone. Look forward to next quarter.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you.