Kevin Mitchell - VP, IR Paresh Patel - Co-Founder, Chairman, President & CEO James Harmsworth - CFO

Matthew Carletti - JMP Securities Mark Hughes - SunTrust Robinson Humphrey Christopher Campbell - KBW

Thank you, and good afternoon. Welcome to HCI Group's Third Quarter 2018 Earnings Call.

With me today are Paresh Patel, our Chairman and Chief Executive Officer; and 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 Information 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 obligation 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.

I want to make a quick comment about Hurricane Michael. Our primary focus is on taking care of our policyholders and ensuring that their claims are handled quickly and efficiently.

But having said that, our initial estimated pretax gross losses from Hurricane Michael are between $6 million and $18 million. We remain comfortable with that range and as a note, our retention level for wind claims is $16 million before the reinsurance kicks in.

Now turning to some of our highlights for the third quarter. We earned $1 per share diluted earnings for the quarter or $1.02 on an adjusted basis.

This extends our record of profitability to 43 out of the past 44 quarters. We also paid our 32nd consecutive quarterly dividend, that's eight years of dividends returning about $8.65 to shareholders, cumulatively.

We also repurchased 149,000 shares of our common shares during the quarter, at an average price of $41.35 per share. Also, we, once again, started writing new homeowners business in South Florida, it's progressing well.

And lastly, but not least, we sold our first flood policies outside the State of Florida, and we've expanded into four additional states. In summary, Q3 was another solid quarter for the company, and we look forward to building on this progress.

At this time, I'll turn it over to our CFO, Mark Harmsworth, who will walk us through our financial performances for the third quarter. Mark?

Thanks, Paresh. So as mentioned, diluted earnings per share in the third quarter were $1 on a GAAP basis and $1.02 on an adjusted basis.

Year-to-date, fully diluted earnings per share are $3.03 on a GAAP basis and $3.30 on an adjusted basis. There are a few things that I wanted to point out from the income statement: first, while gross premiums earned were down 3% from the third quarter of last year, they were up slightly from the second quarter of this year.

This is the second consecutive quarter where gross premiums earned were higher than the previous quarter. This is attributable, in part, to the increase in gross premiums earned in TypTap, which is obviously, a positive trend for us.

Second, investment-related income of $6.3 million was $4 million higher than in the third quarter of last year, this was driven by higher limited partnership income and higher interest rates on fixed term securities, short-term investments and cash. We proactively repositioned our investment portfolio to take advantage of higher interest rates, and this is beginning to pay off.

Third, I wanted to give a little bit of color on the loss expenses for the quarter, which are higher than the first and second quarters. This includes some development from prior periods, some development for Matthew, but, of course, nothing related to Irma.

Lastly, our effective tax rate this quarter is slightly lower than normal at 24.5%. This reflects a return to provision adjustment of about $260,000, and our normal effective tax rate, going forward, should still be 26% to 27%.

As you look at the balance sheet, a few quick things to notice: first, total investments are down somewhat from the start of the year. A number of securities matured on the last day of September and settled on the first day of October, so there's about $17 million that are showing in other assets rather than investments.

Second, we have around $250 million in cash and cash equivalents, but most of this is invested in money markets and short-term paper. The increasing yield on cash and cash equivalents is helping to drive the higher investment income.

For some time now, we've been talking about our strategy of reducing share count through our buyback plan. In the third quarter, we bought back 149,000 shares, bringing the total for the year to 508,000.

Our basic share count is now 7.5% lower than it was a year ago. This means that each individual share continues to represent a higher percentage of ownership, and we can increase dividends without much increase in actual cash flows.

The total cash paid out in dividends this quarter, for example, was less than what we paid in the same quarter last year despite a 7% increase in the dividend paid per share. Now I wanted to take a minute to talk about our capital structure.

As you know, we have an $89.9 million convertible debt issue that is maturing in March of 2019. We have the cash set aside and are fully prepared to pay this obligation when it comes due.

We are announcing today that we are electing the physical settlement method for any conversion of those notes occurring on or after January 1, 2019. Conversions, if any, will be settled by the delivery of shares and notes not converted, will be fully settled in cash.

As you know, the conversion price - conversion price, I am sorry, is approximately $62. So how will this impact the company?

Either outcome is a very - is very positive for us. If all notes were to be settled in stock, our book value per share will go up between $5 and $6 beyond what it otherwise would have been.

If all notes were to be settled in cash, fully diluted earnings per share should increase by $0.08 to $0.12 per share per quarter or $0.32 to $0.48 per share per year from what it otherwise would have been. That's the impact on earnings per share and book value per share, but what about holding company liquidity?

Let's assume for a minute that the notes are paid out in cash. If this were to happen, we should still have about $25 million of cash and investments left in the holding company after the notes are paid.

We recently announced the range of losses for Hurricane Michael, but even a full retention loss should not change this liquidity picture. Both of our insurance companies are well-capitalized, and we will have very comfortable RBC ratios with no need for capital from the holding company.

One last thing. For the past year or so, we've had a significant amount of dry powder at the holding company level to be able to take advantage of any strategic opportunities that may arise.

While the holding company will still have significant liquidity after the notes are settled under either option, to further increase our strategic capacity, we have received a commitment from Fifth Third Bank for a $65 million revolving credit facility at a rate of LIBOR plus two. At today's rate, that means our borrowing rate would be a little over 4.25% if we were to draw on that facility.

The great advantage of this type of facility is that we don't pay for it if we don't use it. And so this is a very efficient way to have access to additional source of capital should any opportunity arise.

So to summarize. If the 2019 notes are settled in cash, we will still have about $25 million in cash and investments in the holding company plus access to a $65 million revolving credit facility and diluted earnings per share will go up.

If, on the other hand, the notes are converted, we will still have - we will have significantly more cash and higher book value per share. And with that, I will turn it back to Paresh.

Thank you, Mark. Obviously, with Hurricane Michael, the fourth quarter will be challenging.

But looking ahead to 2019, we expect Homeowners Choice to continue to perform well and generate profits in cash. We believe, our primary driver of growth in 2019 will be TypTap Insurance Company, our technology-based insurance subsidiary.

TypTap primarily offers its flood insurance product in Florida. However, we recently expanded the TypTap brand in Maryland, New Jersey, Pennsylvania and South Carolina, with more states to follow.

There are a few TypTap metrics worth noting. So far, TypTap has sold over 10,000 policies with $12.5 million premium in force as of the end of September.

Gross earned premiums are growing at about $200,000 per week, and TypTap is profitable inception to date, despite the five hurricanes, the surplus is growing around 8% per year on an annualized third quarter growth. Through third quarter of 2018, TypTap's combined ratio for 2018 was 51% on a stat basis, that is stunning.

Finally, TypTap has entered, as stated earlier, the South Florida homeowners market. We believe, we can leverage our technology and analytics to profitably navigate the nuance South Florida market.

Strategically, we plan to limit our wind-related products to Florida, where, we believe, we have the expertise. In the case of flood, however, we believe, we have the know-how to expand nationwide and are in the process of doing so.

At this point, I'd like to reiterate some of Mark's comments about the future. As he stated, we have about $90 million of convertible notes coming due in March of 2019.

Despite being impacted by five hurricanes in the last three years, we have the cash set aside to pay this debt. If we settle the debt in cash, our earnings per share should get a boost next year of between $0.32 and $0.48 per share.

On the other hand, if our share price should exceed $62, and the owners of the notes choose to convert them to stock, our book value per share will increase between $5 and $6 per share, over what it would otherwise be. Also, as Mark said, our risk-based capital ratios remain strong as we entered 2019.

Even after the impact of Hurricane Michael, not to mention, the four other storms that went before that. None of our additional - none of our companies will need additional capital for operations.

Finally, we have repositioned investment portfolio to take advantage of higher interest rates. Switching to another aspect of the company, Greenleaf Capital, our real estate division.

We have often discussed our real estate portfolio, highlighting our long-term strategy to acquire and develop income-producing properties, while acquiring other properties on an opportunistic basis. The values of these properties are not well-represented on the balance sheet.

To give you an example, we have recently decided to list one of our properties for sale. It is 9.5-acre waterfront property, located in Treasure Island, Florida, near St.

Petersburg. It includes a restaurant, a marina and several acres of developable land.

The asking price for this parcel is $40 million. The property is listed on our books at about $9.7 million from when it was purchased about eight years ago.

I'd like to point out that our intangible investments in technology also do not appear on our balance sheet. Our technology analytics permit us to achieve this industry-leading ratios like the stunning combined ratio we're experiencing in TypTap.

We believe, these margins will be the key drivers for our business and future growth prospects. And with that, I would like to open the call for questions.

Operator, please provide the appropriate instructions.

A couple of questions. One, numbers related and one, the bigger picture.

On the numbers, Mark, I caught your comments in the opening about some moving pieces in the loss ratio, a little bit of prior period and you referenced Matthew, not Irma. Sorry, if I missed it, but can you, kind of, take us through, in a little more detail, kind of, what the puts and takes were there?

Yes. So there's about $4.5 million of total adverse included in the $25.7 million income statement.

And of that - some of that is - about $0.75 million is Matthew, and then the rest is just adverse development on prior years for regular daily claims.

Makes sense. Would you - would - I know it's sometimes hard to decipher, which is which, but would you credit, kind of, the larger AOB issues that is driving a lot of that or there are other things going on?

Yes, I mean, it's - there's nothing really unusual, it's sort of - we made some tweaks in last year and a small tweak in the first quarter of this year. And yes, it's just the advancement for those policy years, '14 through '16, largely just related to the development on litigation.

Okay, all right. That's helpful.

And then shifting a little to bigger picture. Paresh, maybe, could you update us on, kind of, your views on M&A, and then the Florida market or elsewhere, kind of, what you're seeing broadly if there's, kind of, - where, kind of - I know, asking multiples were high, have you seen those come down at all?

And then HCI's interest, if that's changed at all?

Yes. Matt, on a general basis, I think, we live - what's the Chinese curse, we live in interesting times.

The things will change over the next 10 days, mainly because of the election tonight, where most of the Florida Cabinet will change hands, the people on the table, whether they're Republican or Democrat, will be different to - who they were this morning. So we are going to see some change coming up in that situation.

And then beyond that, I think, given Florence in Q3 and Michael in Q4, I think, we're going to go through our annual ritual of RBC challenges coming up for the year-end, and that might cause some shift in people's expectations and/or what they're looking for in terms of maybe selling out. And to be very clear about it, given what Mark said about the line of credit and the $90 million cash, plus the other $25 million that we have, we stand very well-poised to merge with anybody who might feel the need.

I missed the first couple of minutes, did you provide an update on written premium for TypTap?

I think, we just, sort of, said there was $12.5 million premium in force at the end of the quarter, and it's growing by about $200,000 written premium a week.

And then the - how do you look at the South Florida market? I think you suggested the growth, going forward, probably be more driven by TypTap, but you're also targeting South Florida.

How has your reception been there so far? And should we expect that - the pace of growth there to pick up in coming quarters?

Simple answer is, it's been very well received. And yes, you should - we expect growth to accelerate in those areas.

As word gets out, I will bring more agents online, et cetera.

And is there some point, at which - anything you could - might be able to share with us, about the performance of those new policies based on the updated underwriting. I'd be curious, it would be interesting to get updates on how you're doing with that initiative?

I know it's too early at this point, but in the future, might be very helpful.

Yes. And I think, eventually, we will, to lead the - what our future comment could be, is the numbers we are seeing are very, very encouraging and, in fact, they're so amazing that it almost seems to defy expectation.

So we're, kind of, letting them season out a little bit more before we comment on them publicly.

Very good. And then the LP income in the quarter, could you size that, how much of the upside might have been from the better interest rates versus LP income?

And what typically drives that? Does that go along with equity market performance?

Yes. So Mark, if you look at the increase from the third quarter last year to the third quarter this year, $1.6 million of that is from limited partnerships and about $600,000 of that - the other $600,000 is interest income being higher than it was.

And is that equity market performance that usually drives that or something else?

Which, the LP's?

That's right.

No. I mean - yes, I mean - no, I mean, it's more - this has really been - just being driven by the interest increase.

So that $600,000 I talked about is purely interest income. There isn't any equity piece to that at all.

And the higher limited partnership income, I mean, it depends on the limited partnership. The ARK Life was the one that was up the most in Q3, I think.

And final question. The operating expenses came in at about $20 million, $19.5 million, any moving parts there that were unusual?

Or is that, kind of, a level that makes sense going forward?

Yes. Nothing really unusual.

I mean, as you know, that can move around a little bit from quarter-to-quarter. If you look at labor and OpEx together for the first 9 months, it's down very, very slightly from the first 9 months of last year.

We typically run about $10 million a quarter for the two combined and I think that's still a good target for what to expect.

I guess the first question is just the elevated loss ratio, does that include any non-cat weather that we've seen from other insurers? And if so, how much did that impact the loss ratio in the quarter?

Well, I mean, if you just look at, sort of, the natural loss ratio and you factor out the adverse development and then look at the three quarters, this year is not that different than most other years. I mean, first quarter was a little quiet, second quarter was a little bit more weather and third quarter, the weather-related losses were similar to the second quarter.

And then things typically slow down in the fourth quarter. And that pattern this year is pretty consistent with the pattern from last year as well.

So I don't think there's really anything unusual going on this year. As I said, third quarter, weather-related, third quarter was pretty similar to second quarter.

Okay, great. Well, that's very helpful.

Just - have there been any buybacks in the fourth quarter to date?

So I can give you the exact number. So the total for the buyback program is $20 million, and we had used up all, but I think about $148,000 of it, at the end of Q3, and then that was used in the first few trading days of Q4.

Okay. And you haven't reauthorized - your board hasn't reauthorized another one?

No.

Not yet.

Is that something that you're, kind of, planning on doing or?

I think the board reviews it about this time of the year every year. So I'm presuming that it will be reviewed sometime between now and at the end of the year.

Okay. And can we get your latest gross Irma estimates?

And did they move any in the quarter?

Yes. I mean, we - and the latest is $327 million, which is the same as it was at the end of Q2.

So as you probably know, we increased our ultimate by about 20% in the second quarter, and we've not made any changes in the third quarter.

And you haven't seen any increase in just - in severities on the cases that - or on the claims that you have on the books, on the case reserves, does those get settled or any spike in frequency of, kind of, late reported claims?

What we have seen has been within expectations. So when we set the number, we were anticipating some of that, and we've seen some of that play out.

But we - as time goes on, Irma is more and more in the rearview mirror and the expected adjustments tend to look smaller and smaller. With one caveat if something strange comes out in this AOB world that we live in, then it could change.

But, at least, so far, we don't see anything to materially make us be concerned about the estimate that we have out there.

Yes. Just to pick up on what Paresh said and to go to your question, as you get further down the line, it's natural for the average severity as you are paying to increase a little bit, but that's, as Paresh's said, that's - you expect that, that's just a natural part of the process as you deal with some of the more complicated claims towards the - later on.

Okay. And just a question on the - it sounded like you are not writing wind outside of Florida, just curious what's the strategy behind that?

I'm just thinking that you can - you could part as the potential reinsurance synergies if you did?

Great question and I think that's been the accepted - was the accepted rationale for several folks to expand beyond Florida. Watching the results for most of these carriers who have written multiple states, I think, you just seem to be picking up multiple headaches from multiple hurricanes.

It does not seem to have actually yielded in the positive benefit that was held out as hope when they did on the multistate expansion. So having watched all of that, we figured it's much better to be a specialist in Florida, than to be a generalist from Texas to Maine.

Great. Well, that's very helpful.

And then just one final one, is there - are there any rate increases in the pipeline? Or anything that's ready to be filed?

I know there's a moratorium right now, but just after that's lessened?

So we had our annual rate filing filed with the state prior to the moratorium. It was in the review phase when the moratorium got set after Hurricane Michael.

One presumes when the moratorium is lifted, I think, it's scheduled on January 7, the rate filing will have been reviewed and whatever the appropriate rate adjustment is, will be carried out. So that's basically where we sit right now.

Okay, great. And just one final one, the property that's for sale in Greenleaf, that was $40 million, correct?

Yes.

And what is the plan to proceed from that? Could those be used for buybacks as you, kind of, harness those investments and you get those gains?

I will give you the standard corporate answer, they will be used for general corporate purposes.

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 updating you on our progress in the near future.