HCI Group, Inc.

Good afternoon and welcome to HCI Group's first quarter 2020 earnings call. My name is Dagma and I will be your conference operator this afternoon. At this time, all participants will be in a listen-only mode. Before we begin today's call, I would like to remind everyone that this conference call is being recorded and will be available for replay through June 7, 2020, starting later this evening. This call is also being broadcast live via webcast and available via webcast replay until August 7th, 2020 on the investor information section of HCI Group website at www.hcigroup.com. I would now like to turn the call over to Rachel Swanfiger, investor relations for HCI. Rachel, please proceed.

Thank you and good afternoon. Welcome to HCI Group's first quarter 2020 earnings call. With me on today's call is Parish Patel, our Chairman and Chief Executive Officer, and Mark Harmsworth, our Chief Financial Officer. Following Parish's opening remarks, Mark will review our financial performance for the first quarter of 2020, and then turn the call back to Parish 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 www.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 the company's business, financial conditions, and results of operations. HCI Group disclaims all the obligations to update any forward-looking statement. Now with that, I would like to turn the call over to Parish Patel, our Chairman and CEO. Parish?

Thank you, Rachel, and welcome, everyone. I'd like to start today's call by first addressing the impact of COVID-19 pandemic. The crisis has impacted companies and people all over the world, and our hearts and thoughts go out to those who have been affected by it. Since the beginning of the crisis, our priority has been the health and well-being of our employees and maintaining superior service to our policyholders. So in early March, we implemented our work-from-home arrangements, and I am pleased to report that we have done so without significant impact to our operational effectiveness or capabilities. Our adept and talented IT team enabled us to service our policyholders and handle claims normally. I can tell you that responding to a pandemic is not unlike responding to a weather catastrophe event. and we were well prepared. Also, to our knowledge, none of HCI's employees have tested positive for the virus so far. We have exceptional people who are vital to our success, and we are committed to supporting them through this critical time. Turning to the business. Outside of the decline in our investment portfolio, the COVID-19 pandemic has not materially affected our business, and nor do we expect it to do so. Our insurance companies have received a few COVID claims, but we believe that our exposure is very limited. We have also offered to defer some policyholder premium. We have also offered to defer some policyholder premium payments that are coming due. Homeowner's insurance premiums are usually paid annually and in most cases connected to a mortgage payment. We do not view premium collectability to be a significant issue at this time. Turning to Greenleaf, our real estate division, we are working with some tenants on the lease payments. Some of these tenants are restaurants, gyms, and retail establishments, and they've been hit hard by the crisis. But keep in mind that most of our anchor tenants are grocery stores and a large bank, which are doing just fine. Also, we own and operate two marinas and a restaurant. And while we continue to pay the employees at those facilities, those operations have been closed temporarily or running at very reduced capacity. So what is the combined impact of all of this stuff? The combined operational impacts are not material. For context, the total costs of all of these impacts equals about one major fire loss a month on a business that generates about 36 million of revenue a month, so not material at all. Incidentally, we have not applied for any government loans, including loans under the Payroll Protection Program, and nor do we expect to do so in the near future. As Mark will elaborate in a moment, our cash flow is healthy, our balance sheet is strong, and with the exception of the unrealized investment losses, We had a very good quarter, and we continue to pay our normal dividend of 40 cents per share. I will now turn the call over to our CFO, Mark Homsworth, who will walk us through the financial performance for the first quarter. Mark.

Thanks, Parish. On a GAAP basis, net income for the quarter was just over $500,000, or 7 cents per share. On an adjusted basis, net income was $4.2 million or $0.54 per share up from $2.8 million or $0.35 per share in the first quarter last year. Before getting to the numbers, I wanted to turn the clock back a year. On our first earnings call in 2019, we talked about growth. We laid out three phases of growth, how they would show up in the numbers, and ultimately how they would start to positively impact our results. Twelve months later, it all played out as we described. In Q2 last year, gross premiums written were up over the same quarter of the previous year. In Q4, gross premiums earned were up, and this quarter is where it really starts to impact our financial results. In Q1, gross premiums earned were up 12%. This growth, as well as the growth in written premiums, was driven by our technology-enabled insurance company, TipTap. While gross premiums earned were up 12%, net premiums earned were up 20%, or about $10.5 million over the same quarter last year. The growth in net earned premiums helped to drive our consolidated combined ratio down to 88% for the quarter, and we think this is the most important indicator of what happened operationally this quarter. So with all that positive momentum, why was GAAP net income only about $500,000? First, investment income, which is normally about $3 million or so per quarter, was negative, which was very unusual for us. This was largely related to investments in limited partnerships. As we know, the capital markets had one of their worst quarters in history, and this impacted our limited partnerships. In Q1, we recorded a loss of $3 million for limited partnerships, which, combined with lower rates on cash, dragged investment income negative. Also in the quarter, we recognized a $2.2 million realized investment loss as we made some changes to our portfolio to rebalance it, and in the process triggered a few realized losses. Lastly, and this was the biggest impact, we recorded an unrealized investment loss of just over $4.8 million as equity investments dropped along with the decline in the overall financial markets. When the new accounting standards came into effect for equity securities, we commented that equity market volatility could translate into earnings volatility in some quarters, and this was one of them. Investment volatility, most of which is not cash-related, had a dampening effect on what was otherwise a very strong quarter. Again, the most important result for the quarter is the combined ratio of 88%. While on the income statement, a quick update on loss expenses, which are up slightly. This increase was driven by the increase in gross premiums earned, offset by a reduction in weather-related losses. You may recall that we had a significant hailstorm in the first quarter last year. Now let's turn to the balance sheet for a minute. As mentioned, most of the investment-related items were non-cash. Cash flow from operations in the first quarter was $25 million, more than double the $11 million of operational cash flow in the first quarter last year. Cash flow is important. If you look all the way back to the beginning of 2017, the ratio of cash flow from operations to dividends paid has steadily increased. So that's our cash flow. What about cash position? At the end of Q1, we had just over $317 million in cash, an increase of about $88 million for the quarter. That increase is somewhat higher than the cash flow from operations of $25 million I just discussed because, in addition to that, we also received $30 million in advanced premiums from Anchor. Further, we had a net reduction in fixed-term securities as some investments matured. As we know, there is considerable uncertainty with respect to the COVID-19 outbreak. And in times like this, our strong financial position bears mentioning again. We have two well-capitalized insurance companies with significant excess surplus under a holding company with excess liquidity. At the end of last year, Homeowners Choice had an RBC ratio of 625%, and TipTap had an RBC ratio of 432%. and both insurance companies made money in the first quarter of this year. So we do not need to put money into either of the insurance companies. Having said that, should we ever need to, we have $58 million of cash and investments at the holding company level, as well as $40 million available on a revolving credit facility. A quick update on the buyback program. At the end of 2019, we had about $1.2 million left available on the 2019 buyback program, and we executed purchases in the first two months of 2020 to close out that program. In March, the Board approved a new buyback program for 2020, and we began execution on that program as well. During the quarter, under the two plans combined, we bought back a total of 76,850 shares at an average price of $39.55. As I mentioned before, the buyback program has a significant cumulative effect. Basic share count is now 7,735,000 shares, down by 625,000 shares from 12 months ago. As a result, total cash dividends paid this quarter were $250,000 less than Q1 last year, despite paying the same amount per share. Just one other note in the balance sheet, book value per share of $23.17 is down 72 cents from the end of last year, as it was impacted by the investment adjustments we discussed, most notably the unrealized losses on equity securities. So in summary, net income this quarter was adversely impacted by some adjustments to our investment portfolio as part of the general decline in the capital markets. But operationally, this was another good quarter for us. Premiums are growing. The combined ratio is down. Cash flow and liquidity are strong and getting stronger. We are bringing on a new book of business in the second quarter, and we look forward to the balance of the year. And with that, I'll turn it back to Parrish.

Thanks, Mark. We are very pleased with our first quarter performance and the return to revenue and income growth that it demonstrates. Looking forward, on April 1, we transitioned 41,000 policies from under the carrier, representing approximately $66 million in annualized premium. It will take some time to optimize this book of business and to ensure its profitability, but this transaction ensures our revenue growth in the second quarter. As Mark has elaborated, we have a healthy cash flow, and a very strong balance sheet. Our principal revenues are assured. We have no significant debts that are coming due this year or the next, and we have no immediate need of cash. And our quarter dividends are safe. And we're in this position because we are in a very strong financial position, and part of that comes from planning ahead for potential opportunities. With that, I would like to mention that we may in the future file a form S3 universal shelf registration in the near future to take advantage of any such opportunities that may arise. However, please note that we have no offerings or acquisitions planned at this time. And with that, we're ready to open the call to your questions. Operator, please provide the appropriate instructions.

Thank you. The floor is now open for questions. If you do have a question, please press star one on your telephone keypad at this time. Questions will be taken in the order they were received. If at any time your question has been answered, you can remove yourself from the queue by pressing one. Again, ladies and gentlemen, if you do have a question, please press star one on your telephone keypad at this time. Okay, our first question comes from Matt Carletti with JMT. Please state your question.

Hey, thanks. Good afternoon. Good afternoon, Matt. Um, I have a couple of questions, one for you, one probably for Mark. Um, you know, first one on, I was just curious on, as we've gotten into the current situation of, of stay at home in a lot of places. Um, so maybe it's March and Q1 and then whatever you observed so far in April. Um, you know, what has been kind of production trends, you know, um, retention trends, stuff like that for both, whether it's tip-tap, maybe if you give us a kind of tip-tap in legacy homeowner's choice separately. I'm just curious to see how maybe people's shopping habits have changed better or worse as we've kind of changed the environment we're in.

Sure, Matt. So let's talk about homeowner's choice first. Homeowner's choice has generally run a retention rate around 90%, over 90%. And I think even with the, if you factor out the people that we're giving some help to, because they're like some defer on some payments, we are basically got a retention rate that's within 2% of where we were before. So we're not really seeing any major impact. That retention is very strong and continues to happen. TIP-TAP is obviously a different item because It's a growing company, et cetera. And two things are going on. Because of the rate at which you've grown and reinsurance is coming up, et cetera, we have sort of tried to put the brakes on or pause TIPSAP's growth for the immediate future just because demand was so strong and we need to manage our growth, reinsurance, and everything else. But having said, yeah, but despite that, TipTap keeps adding policies. And what I can tell you what it looks like is that this crisis is actually made for a company like TipTap. Because you ask the five questions, you can add a policy or get behind a policy, et cetera. It's much more set up for the unfortunate world we find ourselves in the present time and probably the new normal going forward. You know, I think TIPDAP could be a very huge beneficiary of this in the long term.

Yeah, absolutely. Great. And then maybe just another one from Mark. You know, just on some of your comments, you know, kind of the half a million of income in the quarter, but very strong cash flow production. I mean, some of the pieces are obvious, but I was hoping that you could kind of walk us through that. You know, how you get from A to B, kind of what are the major moving pieces? Just want to make sure that we're understanding maybe what's a little bit of gap counting versus, you know, market markets versus, you know, cash flow of the business.

Sure. So first thing I should mention, when the queue comes out, you'll actually see cash flow from operations of $55 million. I mentioned $25 million in my prepared remarks. The reason for that difference is the $30 million from Anchor. So in the $25 million, I'm not including that because the $25 million is just straight cash flow from sort of ongoing operations. So I think your question is how do you get from half a million of net income to that $25 million. Exactly. Yeah. So the way that you sort of get there is, first of all, as I sort of mentioned, there's a number of – investment-related hits, if you will, that we took to the income statement that are not cash-related. And I listed them all. They add up to about $10.5 million. So if you add that $10.5 million to the half a million of net income, that'll get you to about $11 million of more sort of like normalized cash net income, if you will. And then to that, there's about $4 million of A combination of depreciation and stock-based compensation, which are non-cash, those are standard every quarter. So that will take you up to about $15 million. And then the other thing is daily reserves are up about $8 million. So what I mean by that is you see the $28 million in loss expense in the P&L there. We expensed about $8 million more than we actually paid out. So reserves, daily reserves went up by about $8 million. So if you take the 15 I mentioned before, you add the 8, that gets you to 23. And then, you know, the rest of it is sort of, you know, rounding error. But does that answer your question? That's sort of how you get from...

Yeah, yeah, particularly that last little bit. Yeah, I mean, some of the stuff you list out was pretty straightforward. And then, yeah, yeah, that's very helpful.

Great.

Well, hey, thank you for the color and best of luck on board.

Thank you. Thanks, Matt.

Okay, our next question comes from Mark Hughes with SunTrust. Please state your question.

Yeah, thank you. Good afternoon.

Good afternoon, Mark.

Could you give us kind of the latest take on the impact of Anchor on the P&L, how it influences loss ratio, expense ratio, and then kind of the net bottom line, at least in the near term, how that will trend over time?

Hey, Mark. It's Mark. So we mentioned, I think, in the press release about $60 million, $65 million of premium capital that as of April 1st. Of course, none of that is in the Q1 numbers at all. That'll eventually start to earn in. As I think we mentioned when we talked about the deal, the uplift in the income statement, you won't see it immediately because a lot of those, some of those policies are going to be at the existing rates. But as they start to renew in our rates, the deal will start to be more accretive. So we don't really give guidance, but in Q2, you'll see the combined ratio will probably go up a little bit and loss expenses will go up a bit because we're going to be booking losses off of those lower premiums per policy initially. So in Q2, you'll see loss expense rate go up a bit and you'll see the combined ratio go up a bit. And then after that, as they transition onto our rates, you'll start to see that sort of normalize out.

You mentioned how the lower yields impacted net investment income. How much of that is enduring? If you look at what your cash was throwing off before the crisis to today, how much of that will be with us in the 2Q and beyond?

So, you know, we're driving investment income, obviously, from, you know, fixed-term securities and also from cash. You know, it's no secret that yields on cash are down a little bit. You know, if you look at investment income in the first quarter, it was a couple hundred thousand dollars negative. You take out the impact, the negative impact of limited partnerships, that takes you to about 2.8%. That's a little bit less than it has been in the past, and that would probably give you an indication of what that delta is. So your question was how much of that is enduring. There's probably, you know, $200,000 to $300,000 a quarter that investment in income going forward is probably going to be a little bit lower because of the lower yields on cash.

And Matt? Sorry, Mark, to that point. Some of that is also us taking positions for what the future now holds. We don't feel like chasing your single BIP or 20 BIPs commission checks or interest rate checks kind of thing. So we have made a conscious decision to just have a very solid amount of cash in the bank. And not because it earns a particularly good investment income, but it gives us the operational flexibility for any opportunities that may arise in the near future. So we're not reaching for yield, which would be the temptation to try and replace the $300,000. We're rather going the other way, saying that we'd rather have the cash, and hence Mark's comments about how much cash we were sitting on at the end of Q1.

Understood. Thank you.

Okay, our next question comes from Bill Blumo with Dowling and Partners. Please state your question.

Thank you. Just following up, Parrish, on your comment about the shelf registration, and I know you don't have any acquisitions planned right now, but how do you think about balancing growth at TIPTAP and the growing through inorganically. How do you balance that?

Inorganically or organically?

Sorry, inorganically. You know, going out and maybe doing another, something similar to you did it with Anchor.

Okay, yeah. Bill, the best way of answering that is we know what we can do with anchor. And once in a while, an opportunity comes along that is significantly better than that. And if we see that, we might do something. Now, the other side of this is we also sit in a spot whereby I think if you go by the numbers Mark talked about, about the surpluses we have in various places, we could grow the insurance companies to have about $700 million in premium. before we would need to go to outside sources for capital. So with that much firepower, we have the luxury of being able to do both if we choose to, right? But equally well, what I think we've proven over the last decade or so is we're all interested in growth if there's a material opportunity in doing so. growth for growth's sake has never been our mantra. So we are preparing in various ways that we think given all the disruptions that have occurred in the last 60 days, shall we say, there may be opportunities that will be forthcoming, just like there were in the Great Recession about a decade ago. So should those opportunities come along, we want to be prepared, and that's what we are clearing the decks for at this point, yeah?

Thank you. And this might be a little nuanced, but with the anchor, the 41, I believe at the time you announced the deal, you mentioned 43. So was there about 2,000 policies that didn't come over? Is that how my understanding is correctly?

That's exactly how you should think of it. Yeah, because the 43,000 was there in February or January when we announced the deal. We wanted to put out the $41,000 as to what seems to have netted across on April 1.

Got it. And then last one on reinsurance. I don't know if you have any perspective on how that is progressing at this point. If you wouldn't mind sharing your thoughts, that would be helpful.

Yeah. Bill, we're in the middle of the negotiations, as would be expected at this time of year. So, obviously, We don't necessarily comment on the specifics till everything is done and dusted. But having said that, it's not too much of a reach for everybody to appreciate that we are in a very unusual year where everybody's under pressure, both on the insurance side and on the reinsurance side. And given that, the negotiations are a little bit more intense than their normal years. But at the end of it, there's still a functioning market, and I think we will get our insurance placed. Perfect. I think that's all I have. Thank you. Thank you.

I would like to turn it back over to management.

On behalf of the entire management team, I would like to thank our shareholders, employees, agents, and most importantly, our policyholders for their continued support. We look forward to updating you on our progress in the near future.

Thank you.

Thank you. This concludes today's conference call. We thank you for your participation. You may disconnect your lines at this time, and have a great day.