Amerisafe Inc (AMSF) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Amerisafe fourth quarter 2006 earnings conference call. [Operator Instructions] I would now like to turn our conference over to Karen Roan with DRG&E. Please go ahead, ma'am.

Thank you, Rose, and good morning, everyone. We appreciate you joining us for Amerisafe's conference call to review 2006 fourth quarter and year end results. We would also like to welcome our internet participants listening to the call as it is being simulcast live over the web.

Before I turn the call over to management, I have the normal housekeeping details to cover. You could have received a fax or an email of the earnings release yesterday afternoon. Occasionally, there are technical difficulties experienced during these broadcasts. If you did not get your release, please call our offices are DRG&E and we'll get one right out to you. That number is 713-529-6600.

If you would like to be on the permanent email distribution list, please provide that information to us.

There will be a replay of today's call, and it will be available via webcast by going to the company's website. That is www.Amerisafe.com, or there will be a telephonic recorded replay available until March 14th. Details on how to access that feature are in the press release.

Please note that information reported on this call speaks only as of today, February 28th, 2007, and therefore you are advised that time sensitive information may no longer be accurate as of the time of any replay. Also, statements made in this press release that are not historical facts, including statements accompanied by words such as will, believe, anticipate, expect, estimate, or similar words, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, regarding Amerisafe plans and performance.

These statements are based on management estimates, assumptions, and projections as of the date of this call, and are not guarantees of future performance. Actual results may differ from the results expressed or implied in these statements as a result of risks, uncertainties, and other factors, including but not limited to factors set forth in the company's filings with the Securities and Exchange Commission, including Amerisafe's prospectus, dated November 16, 2006.

Amerisafe cautions that you do not place undue reliance upon forward-looking statements contained in the release or in the conference call. Amerisafe does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information, or circumstances that arise after the date of the release and call.

For further information, please refer to the company's filings with the Securities and Exchange Commission.

With me this morning are Allen Bradley, the company's Chairman, President, and Chief Executive Officer, and Geoff Banta, the company's Executive Vice President and Chief Financial Officer. I will now turn the call over to Allen.

Thank you, Karen, and good morning, ladies and gentlemen. Thank you very much for joining us for our quarterly investor conference call. Of course, Geoff is with me today, and I'll make a few general comments before turning it over to him.

We had an outstanding quarter and record annual results in 2006. Gross premiums were up for the year about 14.3% over 2005. And more importantly, we were able to maintain our pricing at an effective LCM of 1.54 as compared to 1.56 in 2005.

Additionally, we experienced favorable prior year development during the fourth quarter. This favorable development resulted in a $2.2 million reduction of prior year reserves.

With respect to the current accident year, as a result of the continued decline in both the frequency of claims and the severity of those claims for the current accident year, we reduced our loss and loss adjustment ratios, and at the same time continued a prudent and appropriate reserving approach.

Despite the increased public company costs and the costs associated with our secondary offering, our expense ratio was 23.8%, as compared to 24.7% in the preceding year.

Now at this time, I'm going to turn it over to Geoff, who has much more detailed information about the finances. Geoff?

Thank you, Allen, and good morning, everyone. As Allen stated, we did have a terrific year in 2006, but I'll begin my remarks by focusing on the fourth quarter.

We reported net income for the quarter of $14 million, compared to $5.4 million in the fourth quarter of 2005, an increase of 159%. This marked increase in quarter over quarter net income was due to the following factors. First, our top line growth as measured by gross premiums written increased 28.2%, from $59.7 million to $76.6 million, as our pricing continued to hold and demand remained strong in the high hazard groups in which we write our business.

Our fourth quarter growth included $5.3 million of earned but unbilled premium, or EBUB, as it is known in the industry. Without the effect of the EBUB adjustment, our growth in gross premiums written in the fourth quarter of 2006 as compared to Q4 '05 would have been 19.3% instead of 28.2%. I'll talk more about EBUB later on in this call.

Also in the fourth quarter, net premiums earned increased by 25.5% from $67.2 million to $84.3 million. Net investment income grew by 48.1%, from $49 million [sic - see press release] to $7.3 million. Our net investment income growth was largely the result of a 28.3% growth in average cash and invested assets during the quarter, as we realized the full benefit from the cash we received in 2005 from our IPO.

Also in the fourth quarter, net realized gains on investments increased from $935,000 in the fourth quarter of '05 to $4.8 million in the fourth quarter of '06, as we restructured our equity portfolio, which was discussed in part in yesterday's earnings release.

And finally, overall revenue grew 31.9% from $73.2 million in the fourth quarter of '05 to $96.5 million in the fourth quarter of '06.

Now some discussion about EBUB. Prior to 2006, we regularly reviewed our EBUB premium trends. However, the variability in those trends caused us to conclude at those times that EBUB premium could not be reasonably estimated. As a result, we recorded EBUB premium as gross written premium and earned premium in the period that the premium audit was completed.

In 2006, we retained the assistance of outside actuaries to help us better estimate the impact of this EBUB on our premium earnings. We completed this analysis in the fourth quarter of 2006, and as a result of that work, we recorded an inception to date estimate for EBUB premium of $5.3 million or 6.9% of gross premiums written in the fourth quarter of 2006, and 1.6% of total 2006 gross premium.

After recording related losses and expenses, the effect of the EBUB adjustment was an increase in net income in the fourth quarter of 2006 of $712,000. In future periods, we'll review our estimate of EBUB premiums on a quarterly basis and record the change in the estimate.

Now I'll discuss our operating ratios for the fourth quarter. Our net loss ratio for the fourth quarter of 2006 was 58.7% compared to 72.1% for that same period in 2005. For the current accident year, our loss ratio decreased from 72.1% in the fourth quarter of '05 to 61.3% for the fourth quarter of 2006. Additionally, we recorded favorable loss development for prior accident years of $2.2 million.

Our net underwriting expense ratio for the fourth quarter of 2006 decreased from 22% to 25.3% -- to 22% from 25.3% in the fourth quarter of 2005.

The final component of our published insurance operating ratios is our dividend ratio. In the fourth quarter, this ratio increased from -0.7% in 2005 to 6.4% in 2006. This increase was due to $5.2 million of dividends accrued in Florida under a state law that requires payment of dividends to Florida policy holders pursuant to a formula based on underwriting results from policies written in Florida in a consecutive three-year period.

Altogether, our combined ratio for the fourth quarter of 2006 was 87.1% compared to 96.7% for that same period in 2005.

In terms of earnings per share, briefly, we recorded fully diluted EPS of $0.70 for quarter four of '06 versus $0.39 for the same quarter in 2005.

In 2006, we had net -- the full year 2006, we had net income of $37.4 million, compared to $5.9 million in 2005, a more than fivefold increase. For the full year 2006, gross premiums written increased by 14.3% from $290.9 million to $332.5 million, while net premiums earned increased by 16.5%. Without the effect of EBUB, these increases would have been 12.5% and 14.6%, respectively.

Net investment income for the year was $25.4 million, compared to $16.9 million in 2005, an increase of 50.4%. This increase was due to an increase in cash and invested assets, which grew from $583 million at year end '05 to $666 million at the end of '06. Net realized gains also increased from $2.3 million in 2005 to $7.4 million in 2006.

Finally, total revenues for the year increased by 20.4%, from $276.3 million to $332.7 million.

In terms of our full year operating ratios, our net loss ratio for 2006 was 66.6%, compared to 79.5% in 2005. The decrease was due to a 3.7 percentage point decrease in the 2006 accident year loss ratio and a reduction of $2.2 million from the prior year accident -- from prior accident year reserves -- in prior accident year reserves.

Our net -- our underwriting expense ratio in 2006 decreased by 0.9 percentage points, from 24.7% in 2005 to 23.8% in 2006. This ratio decreased in spite of increased public company costs, including the costs of implementing Sarbanes-Oxley controls and procedures, as well as the cost of our secondary offering in late 2006.

Our full year dividend ratio was 2% in 2006, compared to 0% in 2005, due to the accrual for the Florida excess profits dividend I talked about earlier.

For the full year 2006, our combined ratio was then 92.4%, compared to 104.2% in 2005.

A few words about cash flow. In 2006, we generated $81.8 million in cash flow from operations compared to $142.1 million in 2005. That year, of course, included $51.6 million of cash from our 2005 commutation with Converium. Our operational cash flow combined with proceeds from sales and maturity of investments resulted in net cash used in investing activities of $105 million in 2006.

On the subject of investing, please remember that as mentioned in the press release, we performed a strategic review of our investment management and related policies in 2006. That will all -- that is also going to be explained in detail in our 10K.

Turning to our balance sheet, we continued to experience healthy growth in our invested asset base in 2006, as well as the ratio of our cash and invested assets to shareholders' equity and redeemable preferred stock. Additionally, our reinsurance recoverables decreased from $122.6 million as of 12/31/05 to $109.6 million as of 12/31/06. And the ratio of recoverables to shareholders' equity and redeemable preferred stock fell to 59% in 2006, the lowest level we've seen since 1997.

Finally, as part of our secondary offering, the balance of our series C redeemable preferred stock, which we classify as [inaudible] equity, was reduced from $30 million to $5 million in the fourth quarter.

That concludes my prepared remarks. I'll now turn it back to Allen.

Thanks, Geoff. In terms of the marketplace, we will acknowledge that there has been some increased competition during the second half of 2006, and of course, during the last quarter of 2006. Fortunately, to this date, we've been able to maintain our pricing and to meet our revenue growth targets without compromising that pricing.

At this point in time, we do not see this competition as impairing our ability to make an underwriting profit, to grow our business, and produce attractive returns for shareholder equity.

Now as mentioned in our earnings release, we are providing general guidance for 2007. We do not provide quarterly guidance. We provide annual guidance. And that guidance is based upon the results of 2006 and the acknowledgement of the increased presence of competition. We expect to grow our gross written premium on a rate of 7% to 10% without giving effect to the EBUB calculation over our 2006 numbers. Now that would produce gross written premium of $350 million to $360 million.

We expect the full year combined ratio to be 95% or better, and return on average equity of 16% or better. For clarification, our calculation of return on equity includes the net realized gains of investments, and do keep in mind that we have repositioned our investment portfolio and deemphasized the equity portion of that portfolio.

Obviously, we're very pleased with the financial results and the performance in 2006. Remember that our long term financial objective is to produce a return on shareholder equity of 15% or better during the long term.

At this point, I'll open it up for questions.

[Operator Instructions] Our first question comes from David Lewis from SunTrust Robinson Humphrey. Please go ahead.

Thank you, and good morning.

Good morning, David.

Allen, a couple of quick big picture questions for you. First, can you kind of provide your general thoughts regarding your gross premiums written growth objective of 7% to 10% for 2007? What assumptions do you have for pricing conditions and geographic expansion versus kind of market share gains in your existing markets?

Okay. Let's talk about perhaps the last one first. I -- as you know, and as we announced earlier, we have entered selected portions of Colorado and Nevada and are looking at some potential expansion into the New England area. I would not attribute much if any growth in 2007 to those expansion areas.

Our approach to those markets has been cautious in terms of underwriting and pricing, and we're not really counting on large or really any significant dollars from those increased markets. Our growth will primarily come from the states where we currently write our business. And in those states, there's more than $16 billion of premium in the class codes which we target. And with us writing only $330 million of that business, that's only a 2% market share.

And additionally, we believe that we'll have the opportunity to penetrate those markets as we've expanded our distribution system within our existing area.

With respect to -- I think your first question was about the -- where rates are going. Is that correct, David?

Yes. Just a general sense. I mean, I think the more main line, non-hazardous industries, we were talking about anywhere down 5% to 15%. How does that reflect on the hazardous industry?

It's far less. It's far less. And then that really is reflected in the LCM change from 1.56 to 1.54. I would expect that would decline some in 2007, and I would be more concerned about the second half of the year than the first half, quite frankly.

The other thing, though, that I think we're watching and we do pay attention to, there are states that have announced reductions in loss costs, or in the case of Florida, just a reduction of rates. And those could have an impact. And quite frankly, that's why our guidance is 7% to 10% rather than taking a more aggressive stand.

So you would say [in general] down to the 5% maybe?

The rates? Yes. 2% to 5% would be what I would expect. I certainly would not expect anything -- what Main Street carriers are experiencing at this time.

And just as a follow-up, I believe your construction segment accounts for roughly 40% of your business mix. It appears to me that Amerisafe is somewhat insulated, at least over the next couple of years, due to the robust building trends here in the Southeast. What are your thoughts on that?

I think that's correct. I will tell you that our construction component actually decreased slightly in 2006 to about I want to say 39.7% of our business.

I think that's just about right. Yes.

We principally work in the commercial area as opposed to the residential, so I think we are insulated from that. As a follow-up to your comment there, David, we have seen growth in sectors, including oil and gas, trucking, marine business, agricultural business, as well as our trucking and construction business. So we feel very comfortable that there's a diversification of the class codes we write, which will insulate us somewhat, not entirely, but somewhat, from competition.

Great. Thank you very much.

Our next question comes from Mark Lane from William Blair & Company.

Good morning.

Good morning, Mark.

I had really one question regarding underwriting margins. So given the fact that the benefits from severity and frequency, to say the least, continued to help your fourth quarter results, why are your expectations for underwriting profitability in 2007 the same that they've been over the last quarter or two?

Okay. Well -- and I knew I was going to get that question this morning, Mark. The -- first of all, with respect to severity, the drop in severity is so many times driven by the absence of very large claims. And I think that is not something that can be predicted as a long term trend, necessarily.

And I think the results that we experienced this year, quite frankly, are a combination of continuing the course in terms of underwriting approach, the heavy utilization of free quotation safety inspection, intensive claim services, and the intensive on-site premium audit services. But all of that is coupled with a bit of good fortune. And so it's difficult to predict that severity on a long term basis is trending down, particularly in the face of 8.5% medical cost inflation.

Now in terms of the frequency, we dropped our target loss ratio from 96% at the beginning of the year. At the end of the third quarter, we said 95%. And we're continuing on with that. I'm just a little cautious about declaring victory too early in the battle.

Okay. But with severity actually -- so severity was negative for the year?

Oh, no. It was -- well, actually, I think our average [case] reserve, and I do not have those numbers, is below. Our average case incurred -- I'm sorry -- is below where it was in 2005. That's correct.

Okay. That's all I have. Thanks.

Thanks.

Our next question comes from Matt Carletti from Cochran Caronia Waller.

Hi. Good morning.

Good morning, Matt. How are you doing?

Good. Just a couple of questions. What is -- could you remind me? What is your reinsurance renewal?

[Inaudible].

And did that go as expected, or -- I mean, were there any benefits in terms of -- compared to the '06?

Geoff, do you want to handle that?

Sure. We -- and we've disclosed this fully in the 10K, which you'll see, but we decreased our annual aggregate deductible, which you may remember, Matt, was pretty high in the layer from $1 million, [X] of $1 million.

Yes.

We increased pure retention to $2 million, and we increased the upper limit from $30 million to $50 million. In terms of rates, I think we probably improved some, not to the extent that we would have liked. But certainly, the good 2006 year we were seeing, which the reinsurers got a hold of, probably, with only two quarters of true results, benefited us some.

We were pretty happy with the results, and our retention continues to be on the high side versus what we -- what our ideal would be, but we're pleased with where we are, and think that's going to suit us well in 2007.

Okay. Great.

Matt, one other comment on that. We have now I think 16 reinsurers participating in our program. And we believe the credit quality of our reinsurers is outstanding. There was a greater interest in our program this year than there has been in years past.

Okay. Great. Let's see. The favorable development in the quarter, did that relate to any particular accident years? Or it's kind of the spread across the board?

No. It related to 2003 and 2004.

'03, '04? Okay. Great. And then could you give a little bit more color on the excess profits tax in Florida? Why you don't think that'll -- I think your comment in the release is you don't anticipate it being a real factor going into '07.

First of all, it's not a tax. It's a state-mandated dividend which returns premium back to policy holders as of the last day of the three-year underwriting [inaudible].

Okay.

But I had already called it an excess profits tax, too, until it became $5.2 million.

There you go.

The reason is that under the statutory scheme, dividends that we will -- or, by the way, they're either cash returns or credits against future purchase of insurance.

Okay.

Those payments, which we will have to make in the second half of 2007, are then recorded as dividend expense in 2006.

Okay.

And then [inaudible] the calculation going forward. Additionally, we have looked at our loss ratios in Florida for the 2006 year and think that, coupled with the dividend, will pretty well insulate us from paying that for at least 2007, and potentially beyond.

Okay. And the formula. Is it a pretty complex formula, or is more of like a combined ratio hurdle?

It's a -- yes. It's an underwriting margin calculation, Matt.

Okay.

And we use the -- you have the option of using company development factors or NCCI development factors.

Okay. Okay. Great. Last question, hopefully pretty straightforward. Do you have the paid loss number for paid losses in 2006?

Yes. I believe it was --

Let's look and see.

$151 million.

All right. Great. All right. Thanks, guys. Congrats on a great quarter.

Thank you very much.

Thank you. [Operator Instructions] We have a follow-up question from David Lewis. Please go ahead.

Thanks. A couple of questions for Geoff. Given -- let's assume first of all that the favorable claim trends don't improve or deteriorate as we go throughout 2007. If that's your assumption, where do you think your current accident year loss ratio would start in the first quarter?

I would start it about where it ended in the fourth quarter. With the -- I would take the full year 2006, I think, if you're going to model that, David.

So we'd start with a current year -- or a current accident year loss ratio of somewhere in the 67% range as kind of a starting point?

I might be a little more conservative than that.

Okay. So we'll say 68%, 69% range. And you had some nice improvement in the expense ratio on the fourth quarter, despite the offering expenses. What drove that, and where do you think that goes for the 2007 period?

I'd feel comfortable, if I was modeling that, Matt, with a -- or David, with a 25%.

And why do you think that would be higher in 2007 than it was for the full year, at 23.8%? I guess I'm trying to figure out what the drivers are.

Geoff's being conservative again. We don't know what's going to happen in South Carolina with the loss-based assessments. It's not the control -- what we call the controllable expenses that we're hugely concerned with. It's the non-controllables, like the premium-based and especially the loss-based assessments.

We also will have some effect from the EBUB as we make our estimates each quarter, and that could either increase or decrease, depending on what's happening with audit premiums.

Okay. And what about the tax rate outlook for '07, based on your current guidance?

I would use, if I were you, the fourth quarter of '06 as a benchmark.

Of the year. The full year, wouldn't you?

Fourth quarter '06, if I include everything on operating, isn't that close to 35%? [Inaudible] for the year, or --

28.8%. It was what we had in the full year. That's what -- yes.

28.8%?

Yes.

So somewhere in that 28.5%, 29% range would be a good starting point?

I think so.

Okay. And Geoff, if we kind of look at the fully diluted share count, isn't it about [19.94]? Is that kind of where you come out?

Yes.

And just lastly, again, if you assume that the kind of claim trends that you ended the year hold for '07, would you anticipate further redundant reserve releases? And I know that's hard to predict, but just kind of generally speaking.

I -- if I were modeling this, I would not.

Right. But clearly, it's possible, if you end up with the same kind of claim trends that you finished the year at. Correct?

It absolutely is.

Right. Congratulations on a fine year. Thank you.

Thank you, David.

Thank you. And we have no further audio questions at this time. Please continue.

Okay. Well, thank all of you for joining us this morning. We appreciate your support of Amerisafe, and we are pleased to bring you the outstanding results. Thank you very much.

Thank you. Ladies and gentlemen, this does conclude the Amerisafe fourth quarter 2006 earnings conference call.