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Amtrust Financial Services Inc. (NASDAQ:AFSI)

Q3 2007 Earnings Call

November 9, 2007 10:00 am ET

Executives

Hilly Gross - Vice President, Investor Relations

Barry Zyskind -President & CEO

Ron Pipoly - CFO

Analysts

Bijan Moazami - FBR

Adam Klauber - FPK Securities

Bruce Wilcox - CumberlandAssociates

Operator

Good morning, everyone and welcome to the Amtrust FinancialServices Third Quarter 2007 Earnings Call. Today's call is being recorded. Atthis time I would like to turn the conference call over to Mr. Hilly Gross,Vice-President of Investors Relations. Please go ahead, sir.

Hilly Gross

Thank you. Good morning and welcome to our third quarterearnings conference call. With me here this morning is our President and CEO, Barry Zyskind and our Chief FinancialOfficer Mr. Ron Pipoly.

Before I introduce both these gentlemento you, I would like to read in to the record the mandatory paragraph onforward-looking statements. Since this morning's conference call will containforward-looking statements, which are made pursuant to the Safe Harborprovisions of the Private Securities Litigation Reform Act of 1995. Theforward-looking statements are based on the Company's current expectations andbeliefs concerning future developments and their potential effects on thecompany. There can be no assurance that actual developments will be thoseanticipated by the Company.

Actual results may differ materially from those projected asa result of significant risks and uncertainties, including non-receipt of theexpected payments, changes in interest rates, effect of the performance offinancial markets on investment income, and fair values of investments;development of claims and the effect on loss reserves, accuracy in projectingthose loss reserves, the impact of competition and pricing environments,changes in the demand for the company's products, the effect of generaleconomic conditions, adverse State and Federal Legislation, regulations andregulatory investigations into industry practices, developments relating toexisting agreements, heightened competition, changes in pricing environments,and changes in asset valuations. The Company undertakes no obligation topublicly update any forward-looking statements.

Having taken care of the legal formalities, it is now mypleasure to introduce AmTrust’s President and Chief Executive Officer, Mr. BarryZyskind.

Barry Zyskind

Good morning and welcome. I am pleased to report thatAmTrust has had an outstanding third quarter, carrying forward the momentum ofour record first and second quarter. We achieved both top line and bottom linegrowth this quarter. For the quarter, our gross premium was $193 million, anincrease of 42% from the third quarter of 2006. Our net income was $24.4million, an increase of 96.8% over third quarter in 2006.

For the nine months, our gross premium was $593 million, anincrease of 59% over the same period in 2006. Our net income for the ninemonths was $67.3 million, an increase of a 115% over the same period in 2006.

As our business grows, we continue to reduce our expenseratios. Our quota-share arrangementwith Maiden Insurance Company, which is effective July 1, 2007, has reallyproven to be accretive to AmTrust. We anticipate that our arrangement withMaiden will continue to enable us to leverage our balance sheet, increase ourwritings and most importantly increase our return on equity.

Our three segments continue to perform very well. In ourworkers' compensation segment we continue to demonstrate pricing and riskselection discipline, as certain regions have experienced increasedcompetition. However, because we operate in small niche markets our rates ofrenewal remain high. Integration of Associated Industry Insurance Company isgoing very well. Associated with one of the lean providers of workers'compensation for small businesses in Floridaand we believe it will be an accretive acquisition for AmTrust.

On September 5th, 2007 Unitrin announced that it had reachedan agreement in principle to sell its Unitrin Business Insurance segment toAmTrust. We are currently in the final stages of documentation and discussionwith Unitrin. We believe that Unitrin should be a very strategic acquisitionfor AmTrust, as it would allow us to diversify and expand in to the area ofproperty and casualty, commercial packages for small businesses.

Should this acquisition be completed we anticipate it wouldbe immediately accretive to AmTrust. In addition it provides us with otherprofitable niche products, namely small commercial packages that we can offerthrough our agents and brokers. [Feasibility] to market more commercialpackages is important in the climate we are operating in. Furthermore weanticipate that UBI's expenses can be leveraged down by our existing infrastructure.

The Specialty Warranty segment continue to grow. In thethird quarter we wrote $76.2 million, an increase of 88% over the third quarter2006. This growth is attributable to organic growth as well as acquisitions.Because of the specialized nature we enjoy in this segment and unique expertisewe have in underwriting, this segment affords us a stability that leaves usmore sensitive to market cycle.

Our Specialty Middle Market segment continues to increasethrough the growth of existing programs and addition of new programs. In thirdquarter of 2007, Specialty Middle Market wrote $50 million, an increase of 69%over third quarter 2006. We feel very good as to the prospects of all thesesegments continuing the possibility during the remainder of 2007 and 2008.Because our segments are specialty niche business, we are not as sensitive tothe market cycle. As we continue to growing our businesses, both organicallyand by acquisition, we will continue to focus on specialty lines that havestability in all cycles of the markets.

As we reported during the last conference call, AmTrust hasno investment exposure to sub prime mortgages. Virtually all of themortgage-backed securities in our portfolio are government or agencyguaranteed. We continue to be conservative and diligent in our investmentactivities and protecting our balance sheets.

In summary, we believe that our continued success comes froma focused adherence to carefully managed growth, strategic acquisitions,disciplined underwriting and pricing and diligent cost control. We believe weare in an excellent position to build on this success and momentum through theend of this year and 2008.

And now, I would like to take the opportunity to turn thediscussion over to our Chief Financial Officer, Ron Pipoly to report on ourthird quarter financial highlights.

Ron Pipoly

Thank you, Barry. Good morning. I am pleased to report thatthe third quarter of 2007 produced a significant increase in our earnings pershare. Overall, earnings per share from operations, was $0.43 per sharecompared to $0.17 per share for the third quarter of 2006.

Driving the increase in earnings per share was a combinationof continued profitable premium growth as well as the effects of the premiumaccessioned to Maiden Insurance Company. Gross written premiums for the thirdquarter, was a $193.2 million, which was $57.3 million increase over the thirdquarter of 2006. Our Specialty Middle Markets and Specialty Risked and ExtendedWarranty Segments experienced significant growth during the quarter. For thenine months ended September 30th, 2007, our gross written premium was $593million, compared to $373 million for the nine months ended September 30th,2006.

The Company ceded a $190.8 million of premiums to Maidenduring the quarter. This cession caused written premium to be $293.4 millionfor the nine months ended September 30th, 2007, compared with $314.3 millionfor the same period in 2006. This was expected as the Maiden re-insuranceagreement covered 40% of the company's subject unearned premium as of June30th, 2007, as well as, the subject premium written during the quarter.

Earned premium for the third quarter of 2007 was $81.8million, as compared to $83.5 million for the third quarter of 2006. Thedecrease in earned premium was also a result of our re-insurance agreement withMaiden. We ceded $63 million of earned premium to Maiden during the quarter.Offsetting the session of earned premium was the $40 million of cedingcommission revenue the company recognized during the third quarter.

Total revenue for the third quarter was $137.5 million,compared to $97.9 million for the third quarter of 2006. For the nine monthsended September 30th, 2007, total revenues were $432.7 million compared to[$263.8] million for 2006. As discussed during the second quarter conferencecall, the Maiden re-insurance transaction has been accretive.

For the quarter, our Small Business Workers’ Compensationssegment increased gross premium production by $1.2 million. As Barry mentioned,the company continues to demonstrate pricing and risk selection discipline atcertain regions have experienced increased compensation

The Specialty Middle-Market segment increased premiumproduction by $20.3 million; this increase was the result of the Company’sgrowing build, the existing programs organically, as well as, increasing thenumber of programs underwritten.

The Specialty Risk and Extended Warranty segments increasedgross written premium production by $35.8 million. The growth in this segmentis a result of both organic growth and existing relationships, as well as,successful integration of IGI, which produced $24.8 million of premium duringthe quarter.

The overall combined ratio for the third quarter was 74.6%compared to 91.6% for the third quarter of 2006

The components of our third quarter combined ratio were aloss ratio of 63.9% compared to 66.3% in the third quarter of 2006.

The expense ratio for the third quarter was 10.7% comparedto 25.4% for the third quarter of 2006. The significant decrease in the expenseratio was primarily caused by the $40 million of ceding commission revenuerecognized by the Company during the quarter.

The company reduces its expenses by this ceding commissionrevenue in arriving at the expense ratio. The Company continues to becomfortable with the trends it observes in both the loss and expense ratios.

Loss ratios for all three segments improved in the thirdquarter of 2007 compared to the third quarter of 2006. The loss ratio of theWorker’s Compensation segment was 60.2% for the third quarter compared to 61.8%for 2006.

Specialty Middle Market’s loss ratio was 63.8% compared to65.9% for the third quarter of 2006. Specialty Risk and Extended Warranty lossratio was 74.5% compared to 81.6% for the third quarter of 2006.

Now turning to some of our nine months highlights. Aspreviously mentioned our gross written premium for the nine months – the firstnine months of 2007 was $593 million, which represents a 59% increase over thenine months ended September 30th 2006.

Gross written premium for small business workerscompensation was $235.5 million for the first nine months of 2007, whichrepresents a 20.9% increase over the equivalent period in 2006.

Specialty Middle Markets gross written premium was a $164million for the first nine months of 2007, which increased by $71.3 million or76.8% over the first nine months of 2006. Specialty Risk and ExtendedWarranty's gross written premium for the first nine months of 2007 was a $193.5million, which was a $107.9 million or 126.1% increase over the equivalentperiod in 2006.

Our overall year-to-date combined ratio was 85.9%, whichcompares to 92.3% for the same period in 2006. The loss ratio for the ninemonths ended September 30, 2007 was 64% compared to 64.7% for the nine monthsended September 30th 2006.

The expense ratio for the nine months was 21.9%, whichcompares to 27.7 for the nine months ended September 30th 2006. Again theexpense ratio was positively impacted by the effect of $40 million of ceding commissionrevenue that the company received from Maiden.

The combined ratio for the small business worker'scompensation segment was 84.5%, compared to 90.8% for 2006. The combined ratiofor the Specialty Middle Market segments was 91.4%, compared to 92.7% for 2006.Specialty Risk and Extended Warranty's combined ratio was 83.9% compared to 98%for 2006.

For the third quarter of 2007 net income was $24.4 millionor $0.41 per share, and for the nine month period, net income was $67.3 millionor a $12 per share. For the third quarter our investment income was $13.9million and realized losses were $2.1 million.

For the year our average rate of return on fixed maturities,cash and short term investments was 5.8% and average rate of return, includingrealized activity on invested assets was 6.3%. The Company’s commission and feerevenue income for the third quarter was $7.9 million, compared to $2.9 millionfor the third quarter of 2006. For the nine months commission and fee revenuewas $16.7 million, compared to $8.9 million.

The Company continues to develop fee generating business.Annualized return on equity was 26.9% for the third quarter and 25.3% for thenine months ended September 30th, 2007. The Company generated over $72 millionpositive cash flow from operations in the third quarter and it has generatedover a $188 million of positive cash flow for the nine month period.

Total shareholders' equity was $383.2 million whichrepresents the book value of $6.39 per share; our debt-to-total-capitalizationwas 24.4%. We also declared a quarterly dividend of $0.025 per common shareduring the third quarter.

Total assets as of September 30th, were approximately $2.2billion. Total invested assets were approximately $1.2 billion, which consistedof fixed maturities of $808 million, equity holdings of $94 million and cash inshort term investments of $289 million.

Thank you, with that I would turn it back over to Hilly.

Hilly Gross

Thank you Ron and thank you Barry. Both Mr. Zyskind and Mr.Pipoly have indicated their willingness to entertain any of the questions, youin the listening audience of the conference call may have. For that purpose Iwill turn it back to control which will outline to you the correct procedure inaccessing us. Central control.

Question-and-AnswerSession

Operator

Thank you, sir. Today's question and answer session will beconducted electronically. (Operator Instructions) And we'll take our firstquestion today from Bijan Moazami of FBR.

Bijan Moazami - FBR

Good morning, everyone, a number of questions, first of all,did the quarter included any of the benefit of the Associated acquisition?

Barry Zyskind

Associated, we closed that transaction on September 7th,and the premium associated with that was $4.3 million for the month.

Bijan Moazami - FBR

How much of additional premium volume per quarter you areexpecting from the Associated?

Barry Zyskind

We would expect Associated for the fourth quarter to producea premium of somewhere between $12 million and $13 million.

Bijan Moazami - FBR

Wonderful. And if you guys close on the Unitrin transactionwhat would be the expected time of the closing?

Barry Zyskind

If we closed, we probably would sign documents, Bijan, bythe end of hopefully this month, and then closing would be some time firstquarter or the end of first quarter of '08.

Bijan Moazami - FBR

First quarter of '08. Barry, regarding with what's going onin the capital market and also with the spreads, would you be considering toinvesting some of the higher yielding securities going forward?

Barry Zyskind

Can you repeat the question again, Bijan?

Bijan Moazami - FBR

I am just wondering if you would take some investment riskand maybe invest in securities that would be yielding higher that what you areearning right now in your investment portfolio?

Barry Zyskind

I think right now, Bijan, our philosophy is during thismarket environment we want to stay as conservative as possible, and reallysafety of principle, and as we've been taking opposite approach we've reallyapplied to quality. We’ve been putting more of our assets in higher quality,and right now we really don’t want to increase the risk on our balance sheetuntil we feel that the environment is a safe environment.

Bijan Moazami - FBR

Thank you.

Operator

And we will take our next question from Adam Klauber of FPKSecurities.

Adam Klauber - FPKSecurities

Thank you. Could you give us an idea what you think theexpense ratio is going to look like going forward, and also an idea with whywas the ceding commission higher than usual this time? And mechanically, what'sthe difference between now and how it's going to unfold in the future?

Ron Pipoly

In terms of the mechanics, obviously, if you are hitting aportion of the $191 million that we ceded to Maiden during the third quarterrelated to unearned premium that was on our books as of June 30th.So the ceding commission for the quarter reflected that initial cession. So, ona go-forward basis, our ceding commission revenue recognized will be based onthe premium ceded during that quarter as opposed to being a combination ofquarterly plus the initial unearned premium cession.

Adam Klauber - FPKSecurities

Okay. And Ron, just a jump-in, what's the ceding percent weshould look at?

Ron Pipoly

Our ceding commission is provisionally 31% of subjectpremium.

Adam Klauber - FPKSecurities

Okay.

Barry Zyskind

I think, Adam this is Barry, a way to look at it would be,when you look at the nine months numbers that is in just the quarter, that's apretty good indication because what you did by taking the unearned premium youeffectively almost took what you wrote for the year and ceded around 40%. Sothat's a good indication of how we would look going forward.

Ron Pipoly

And to put it in light, in terms of the effect of theone-time transaction we’ve made, our expense ratio for the nine-month periodwithout the effects of Maiden was 25.8%. So our expense ratio has been veryconsistent with where we were for the first two quarters of the year.

Adam Klauber - FPKSecurities

Okay, that’s helpful. And as far as the Unitrin transaction,after you took a hard look at their book of business, how much premium do youthink that will bring on to your books?

Barry Zyskind

You know this acquisition is different from the other ones,and the reason being is, this is a very healthy company, some of theacquisitions we have done in the past, when we picked by renewal rights indistress situations, we looked at the books and we took a smaller percentage.We feel, based on the book and based on the performance of the loss ratios, andbased on the niche and the geographic areas that they are in. And we think thatwe would take a majority of the book going forward.

Adam Klauber - FPKSecurities

Okay.

Barry Zyskind

There will be some falloff because of transition which isnormal, we can carry as a paper to paper, but our intent would be to take avery high percentage of the book based on our review and based on the qualityof the business.

Adam Klauber - FPKSecurities

Okay. And Unitrin is a good sized deal for you. It's thesecond deal you've done in the last six months or so. Are you pretty full, andis your plate full or can we look for more acquisitions over the next twelvemonths?

Barry Zyskind

I think, we are always looking for opportunities, I meanUnitrin will be a big opportunity for us. It has a very important strategiclong-term plan for us of being able to have these additional products. One isbeing able sell some of the small comp to some of their agents and vice-versa.Taking some of there products and regions where they are not in and offering itto some of our agents.

So, we think because of the importance and what are thepositive affects this could have on AmTrust, this is reallygoing to be a very big undertaking in terms of management's time andeverything. So, unless something comes up that's very attractive for us, thisis the number 1 focus for us right now.

Adam Klauber - FPKSecurities

Okay. And as far as the gross premiumline, very strong growth, but obviously down from 2Q. Could you remind us ofthe couple of lumpy hits in 2Q that bumped it up or is there anotherreason that sequentially third quarter is down from second quarter?

Barry Zyskind

I think historically in our program division second quarterand fourth quarter are higher, because of some of the programs and some of therenewals that they have. So if you probably look at Q2 and Q1 compared to Q3comp, historically it's slower in the second half of the year, compared to thefirst half and program peaks in the second quarter and the fourth quarter.

Adam Klauber - FPKSecurities

Okay and finally in the loss ratio, is there any developmenteither way in that number?

Ron Pipoly

From a loss ratio perspective, for actually all three of oursegments we are very encouraged by the trends we're seeing. We continue tobelieve that our loss reserves were set at a very conservative loss peaks andthere is nothing really to report on in terms of any dramatic changes nowvis-à-vis to last year and any of the underlying data that supports that.

Adam Klauber - FPKSecurities

So, no favorable or negative development in the number thisquarter?

Barry Zyskind

No.

Adam Klauber - FPKSecurities

Okay. Thank you very much.

Barry Zyskind

Thank you.

Operator

(Operator Instructions) We will go next to Bruce Wilcox ofCumberland Associates.

Bruce Wilcox - Cumberland Associates

Hi good morning Barry and Ron. Hi guys. I am a little -- Imean on the accounting restructure, I feel like I'm missing a $20 million ofequity. You had net income of $24 million. You had second quarter ending equityof $379. So I am assuming some of the losses ran through other comprehensiveincome, but could you just parse that out for me, please?

Ron Pipoly

That's correct. I mean in terms of the effects on thequarter, I mean obviously we had very stronger earnings but partiallyoffsetting that was an increase in other comprehensive loss for the quarter, aswell as for the year. Again we are in a position on the both the equitysecurities that we hold they are currently valued at before we have anunrealized loss position as well, some of the fixed maturities that thesesituations are temporary, and we are positive that they will turn in future.

Bruce Wilcox - Cumberland Associates

So that was about $20 million bucks?

Ron Pipoly

It was about 17.4 million.

Bruce Wilcox - Cumberland Associates

All right. Thanks for the quarter. What was the splitbetween equity and FI?

Ron Pipoly

It was about half in half.

Bruce Wilcox - Cumberland Associates

Okay. And I am not sure that, I mean, I know you've got alot of capital with usage on your plate, but have you guys given any thought tobumping your quarterly dividend?

Barry Zyskind

Currently not, but we will review that with the Board. Weare always looking at the dividend, we increased it this year compared to lastyear, but if something if there is excess capital we are always looking toincrease dividends then increase our return to our shareholders.

Bruce Wilcox - Cumberland Associates

Okay Barry, thanks a lot.

Barry Zyskind

Thank you.

Operator

And gentlemen we have no further questions at this time Mr.Gross, I will turn the call back over to you for any additional or closingremarks.

Hilly Gross

Thank you, Jana. We thank every one of you for joining us.We wish you a pleasant day. Jana, take it back from Central control.

Operator

Thank you, sir. And that does conclude today's conferencecall. Thank you for your participation. You may disconnect at this time.

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