Kingsway Financial Services Inc

Good day, and welcome to the Kingsway third quarter 2022 earnings call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments after the presentation. If you are with us in the webcast, you will need to dial in to the number listed in the press release to ask a question or email the address in the press release. With me on the call are J.T. Fitzgerald, Chief Executive Officer, and Kent Hansen, Chief Financial Officer. Before we begin, I want to remind everyone that today's conference call may contain forward-looking statements. Forward-looking statements include statements regarding the future, including expected revenue, operating margins, expenses, and future business outlook. Actual results or trends could materially differ from those contemplated by those forward-looking statements. For a discussion of such risks and uncertainties, which could cause actual results to differ from those expressed or implied in the forward-looking statements, Please see risk factors detailed in the company's annual report on Form 10-K, contained in the subsequent field reports on Form 10-Q, as well as in other reports that the company files from time to time with the Securities and Exchange Commission. Please note, too, that today's call may include the use of non-GAAP numbers that management utilizes to analyze the company's performance. A reconciliation of such non-GAAP numbers to the most comparable GAAP measures is available in our most recent press release as well as in our periodic filings with the SEC. Now I would like to turn the call over to JT Fitzgerald, CEO of Kingsway. JT, please proceed.

Thank you, operator. Good day, everyone, and welcome to Kingsway Financial Services Q3 2022 conference call. This is our first quarterly call in many years. It's our aim to make these calls a permanent feature of our quarterly reporting going forward. Today I'd like to focus on a quick recap of our quarter. and then move on to what I hope will be a robust and engaging question and answer session. We had a lot of great activity during the quarter and subsequent to quarter end, so I expect there will be a lot to talk about. Our results for the third quarter highlight the strength of our operating model and the progress we are making towards our stated organizational priorities. In each of my annual shareholder letters, I have reiterated the strategic priorities of the company. In the past several months, we've made significant headway on advancing these goals. One key priority is a focus on strategic capital allocation to create long-term value for our shareholders. There are three pillars to this objective. First, we aim to grow our portfolio of cash flow positive operating companies. During the quarter, we sold PWSC for $51.2 million in cash with net proceeds to Kingsway of $37.2 million. While this may seem contradictory to our goal of growing our portfolio of great companies, we feel it was a prudent capital allocation exercise. We sold a great asset for a nice price. We can now redeploy that capital in the pursuit of acquiring other great businesses, as well as reducing our debt, which we'll cover a little later on. Subsequent to quarter end, we acquired C-Suite Financial Partners in an all-cash transaction for $8.5 million. However, we believe we will be able to recapitalize the loan we took out for the Ravix acquisition in the near future in order to recoup some of that cash paid. C-Suite is the second such acquisition completed under the Kingsway Search Accelerator program and will be part of our KSX reportable segment. The Kingsway Search Accelerator is our entrepreneurial framework for growing through acquisitions by backing talented young managers. Timmy Okah began as a searcher in the accelerator program and now runs Ravix as its president and CEO. Under his leadership, Ravix has been highly successful in its first year, generating more than $2.9 million in operating income and more than $3 million in non-GAAP adjusted EBITDA and achieving nearly 90% of the earn-out related to his gross profit targets, which we have Timmy is further growing this business with our acquisition of C-Suite Financial Partners. C-Suite fits our acquisition criteria as a business with recurring revenue, low working capital demands, an impeccable reputation in its industry, and a loyal customer base. Based in Manhattan Beach, California, C-Suite is a national financial executive services firm providing financial management leadership to companies throughout the United States. Importantly, C-Suite's offerings are highly complementary to Ravix and broaden the scope of services these entities can offer. C-Suite and Ravix can each go to market as a one-stop shop of services for clients. For the 12 months ended July 31st, 2022, C-Suite had $9.4 million of unaudited revenue $900,000 of unaudited U.S. GAAP income before income taxes, and $1.8 million of unaudited non-GAAP adjusted EBITDA, making it immediately accretive to Kingsway. Another pillar of our capital allocation focus is to improve our capital structure. We continue to strengthen our balance sheet through delevering. As previously announced in August, And then subsequently in September, we made substantial progress towards eliminating our trust preferred debt instruments, or TRUPS debt as we call it, which is described as subordinated debt in our financial statements. By entering into option agreements to repurchase five of the six TRUPS for $59.4 million, which represents 83% of the total outstanding principal and accrued interest of our TRUPS debt, Those agreements give us the option to purchase 100% of the holder's principal and deferred interest for 63 to 63.75% of the outstanding principal and the deferred interest as of August 2nd. The option to repurchase a meaningful portion of our outstanding troughs at such a significant discount is highly accretive to Kingsway and our shareholders. We estimate that at current interest rates, A repurchase of 100% of the amounts currently under agreement would yield an internal rate of return in excess of 20%. The final pillar of our capital allocation focus is to monetize our portfolio of non-strategic passive investments and redeploy the capital. Through the first nine months of 2022, we have generated proceeds of approximately $7.4 million through the sale of non-strategic assets. This includes the September 2022 sale of our investment in the Flower portfolio of properties, which netted $5.8 million in cash to the company. Due to a one-quarter lag in reporting for this investment, we will fully record this transaction in our fourth quarter 2022 financial statements. We still have a few legacy investments that we view to be non-core to our business. As we move forward, we expect to monetize these investments at a price that would be beneficial to our shareholders. Additionally, we've always viewed our rail yard and VA hospital holdings, which are part of our leased real estate segment, as vehicles to monetize some of our net operating losses, which total approximately $792 million as of September 30th, 2022. We continue to work on strategies that will allow us to sell these assets at valuations that would be beneficial to our shareholders. If we are able to sell these assets along with our non-strategic real estate holdings, we expect that the debt associated with these assets would no longer be carried on our balance sheet. Debt associated with our real estate holdings, which is non-recourse to the company, totaled $199.6 million, or 70% of the total debt on our balance sheet as of September 30, 2022. We believe this non-recourse debt has created some confusion about our balance sheet, which in turn has been an overhang to our equity valuation. If we were able to sell these assets, we would generate cash while significantly de-levering our balance sheet and making it easier to understand. And finally, another stated priority we are highly focused on is attracting, developing, and retaining world-class talent. During the quarter, we welcomed Drew Richard to the Kingsway Search Accelerator Program. Drew is a graduate of West Point and Harvard Business School, and prior to Kingsway, served as a manager at Chevron. With the addition of Drew, we currently have three very talented early-career professionals that are actively searching for acquisition targets that fit our defined set of criteria. Businesses that are capital light, have recurring revenue streams, and a sticky customer base. Ideally, we are targeting two new acquisitions per year that will generate annualized non-GAAP adjusted EBITDA in the range of $1.5 to $3 million apiece. I'll now turn to Kent for a review of our financial results. Kent?

Thank you, JT. As management, we focus on the following key metrics, net income, non-GAAP adjusted net income, operating income, and non-GAAP adjusted EBITDA. As you may know, the legacy investments in debt create complexity in our financial statements. Therefore, we use these non-GAAP metrics to help focus on the economic drivers of our business. Our net income was $37.6 million for the third quarter. This compares to a net loss of $226,000 in the year-ago quarter, and a net loss of $2.4 million in the second quarter. Non-GAAP adjusted net income was $2.6 million for the third quarter compared to non-GAAP adjusted net income of $2.1 million in both the year-ago quarter and in the second quarter. Significant items impacting the 2022 third quarter were the following. $26.4 million related to the sale of PWSC after taking into account transaction costs that are included in operating expenses and taxes arising from the sale. A $13.5 million unrealized gain on the value of our truss options, which we hold on our balance sheet as an asset of $15.8 million. These options are considered to be derivative instruments for accounting purposes, and we are required to mark these the fair value. a $2.5 million loss on disposal of discontinued operations net of taxes. When we sold Mendota in 2018, we provided certain indemnities for claims outstanding as of June 30, 2018. Based on new information provided during the third quarter, we concluded that the maximum amount under the indemnity was probable. Any cash required to be paid is currently held as restricted cash, and no payments are due under the indemnity until late first quarter 2023. Also, a $1.8 million loss on change in fair value of debt. We hold our trust debt at fair value on our balance sheet. Each quarter, we update the fair value, and the change that is not attributable to instrument-specific credit risk is recorded in our statement of operations. And finally, a $1.5 million gain on change in fair value of real estate investments. As JT mentioned, in September we sold the real estate underlying our FLORA portfolio. While we received the cash in the third quarter, given we report the results of FLORA on a one-quarter lag, we recorded an unrealized gain in the quarter. This will be recorded as a realized gain in the fourth quarter. For the third quarter, our combined operating income for extended warranty in KSX was $3.2 million. compared to $1.4 million in the prior year quarter and $3.8 million in the second quarter of 2022. However, excluding the results of PwC, which we sold in July of this year, pro forma operating income was $3.3 million for the third quarter, compared to $900,000 in the prior year and $3.1 million in the second quarter of 2022. As a reminder, our 2021 third quarter results were impacted by a $1.9 million charge arising from our finalization of our PWI purchase accounting. Pro forma non-GAAP adjusted EBITDA for our extended warranty segment was $2.8 million, or 15.7% of segment revenue, compared to $1 million, or 6.4% of segment revenue in the year-ago quarter. IWS, one of our vehicle service agreement subsidiaries, continues to perform well through its strong relationships with its credit union partners and continues to grow its volume of contracts sold. For the quarter, IWS's cash sales, which is an indicator of current activity, grew by about 9% over the prior year. Our other vehicle service agreement subsidiaries, Geminis and PWI, continue to be impacted by the supply chain issues within the new and used automobile industry. However, their combined cash sales were only down about 2% from the prior year. Earlier this year, we tapped Brian Cosgrove, the president of Geminis, to oversee both Geminis and PWI. He has already brought expense discipline to both businesses, is actively working on combining back office functions, and is overhauling our sales and go-to-market strategies. We have the utmost confidence in Brian's leadership, and we are excited about the future for both Geminis and PWI. Non-GAAP adjusted EBITDA for KSX, which, as a reminder, is just our RAVIS business as of September 30, 2022, was $800,000, or 20.4% of segment revenue in the third quarter of 2022. Timmy continues to grow the business organically, and we've already seen referrals coming in from C-Suite. Now for a look at the balance sheet. At the end of the quarter, we had cash and cash equivalents of $48.6 million, an increase of nearly $36 million compared to the prior year end. The increase in cash was largely driven by proceeds from the sale of PWSC and non-strategic real estate holdings. We ended the third quarter with outstanding debt of $283.6 million, compared with $292.7 million as of December 31, 2021. We view our debt in three categories, bank loans, notes payable, and subordinated debt. Bank loans were $21.8 million and $26.7 million as of September 30, 2022 and December 31, 2021, respectively. This is debt that is secured separately by either our extended warranty companies or Ravex, and the cash flows generated by those businesses is more than sufficient to service that debt. Notes payable were $199.6 million and $205 million as of September 30, 2022 and December 31, 2021, respectively. This debt relates to our various real estate holdings and is non-recourse to Kingsway. The mortgage and additional mortgage, which totaled $177.2 million at 9-30-22, relate to CMC, a rail yard in Texas. The LA mortgage, $16.4 million at 9-30-22, relates to our VA clinic in Lafayette, Louisiana. And the flower note, which was $6 million at 9-30-22, relates to our flower portfolio that we sold in September and will no longer be outstanding beginning with our Q4 financials. Finally, the subordinated debt was $62.3 million and $61 million as of September 30, 2022 and December 31, 2021, respectively. This is our TRUPS debt for which we have options to repurchase 83% of the principal and deferred interest. This debt is carried at fair value on our balance sheet, and this also excludes the deferred interest that we continue to accrue on our balance sheet of $23.2 million as of September 30. As JT mentioned, we are pursuing strategies to monetize the remaining assets that back the notes payable. and we have options to repurchase a significant majority of our subordinated debt. If we were able to successfully execute these, then we would be able to reduce our September 30, 2022 outstanding debt by approximately $251 million, or by 89%, and our deferred interest by $19.2 million, all while retaining the operating income and adjusted EBITDA of our extended warranty and KSX segments. Finally, cash from operations for the first nine months of 2022 was $9.3 million compared to cash used in operations of $8 million in the comparable 2021 period. The 2021 period was impacted by a $10.6 million outflow related to the monetization of a CMC leave stream. but the corresponding inflow is shown in financing activities. Even after factoring this into the comparison, 2022 has been a strong operating cash year for the company as a result of our extended warranty and KSX businesses. With that, I will turn the call back to the operator to open the call for questions.

The queue is now open for questions and answers. If you have a question that you would like to pose, please press star 1 on your phone at this time. If you are joining us by the webcast, remember to dial in to the number on the press release if you would like to pose a question, or email your question to the email address listed on the press release. We will now hold for questions as we poll. We do have questioners. Our first comes from Adam Patinkin. from David Capital Partners, LLC.

Hi, JC and Kent. How are you today?

Hey, Adam.

Great, Adam. Thank you.

Great. Thank you.

Outstanding. Well, first, I want to congratulate you guys on all the progress with Kingsway and especially in the simplification of the business. I think this is absolutely the right strategy and And I congratulate you on, I know there's a lot more to go, but I congratulate you guys on all the progress so far. And I also want to start off by congratulating you on your first earnings call. I think it's great that you're sharing the Kingsway story. And for shareholders like myself, the transparency and the proactive communication is really appreciated. So I just wanted to start off by thanking you guys for that. Thanks, Adam.

Thanks, Adam. Yeah, you bet. You know, look... I like to say if the roles were reversed and you were the manager and I was the shareholder, I would expect the same. So I think having a consistent forum for our wonderful supportive shareholders to come together and ask questions in management is really important.

Yeah, that's great. And I agree 100% and thank you for it. So let's see. So I have three questions that I wanted to ask and I'm going to ask them one at a time if that's all right. So My first question is on your business acquisition strategy. So when I speak with other shareholders about the company or prospective investors, oftentimes the first question that I receive is, what do these businesses have in common? You've got warranty businesses. You've got Ravix. Why do they go together? So maybe as my first question, would you mind sharing what the commonalities are between the businesses that you're seeking to acquire and already have acquired? You know, maybe what the business characteristics are that you're looking for and what your approach is in deciding which businesses to include in Kingsway's portfolio.

Yeah, sure. Absolutely. maybe a little bit of history. When I first came to Kingsway, I came because I was very interested in the extended warranty industry, not because I knew anything about extended warranty or had any experience in there, but I liked the fundamental attributes of the businesses and the unit economics and the industry. So I came with an opportunity to Kingsway, a business that we ended up acquiring, and I originally came to Kingsway to help build out the extended warranty segment. And what I liked about it and what we also like about the businesses that we're buying within the search accelerator are kind of a handful of things. And I've outlined these in some of those shareholder letters in the past. First, from an industry perspective, we're focused on companies and industries that are large, you know, sort of like greater than a billion or $2 billion of addressable market, growing, and by that we mean at sort of greater than two times GDP, And and are fragmented when by fragmented, you know, I think that we mean lots of competitive areas to hide lots of niches and potentially lots of acquisition targets So and then within those industries, we're looking for companies that have a set of attributes the first would be sort of strong profile of recurring or reoccurring revenue at high margin and low capital intensity, which is all of that sort of shorthand for saying businesses with what we deem to be predictably high returns on tangible capital. And so if you look at the acquisitions we've done in warranty, but also within the search accelerator segment, we're looking for for businesses in large and growing industries that meet those attributes, you know, sticky customer base, low customer concentration, recurring revenue, high margin, and low or no capital intensity.

That's great, and that's really helpful, and that makes sense in terms of, you know, maybe why some of these businesses would all fit in the portfolio. So let's move to my next question, which is about how you think about Kingsway's profitability. So if I just take... your adjusted pro forma EBITDA from warranty plus Ravix plus the C-suite acquisition. You know, I'm kind of getting into the high teens millions per year, maybe somewhere between 16 and 17 million. So, you know, you take the 3.6 million of pro forma adjusted EBITDA, you multiply that by four, it's 14.4 million. You add C-suite to that with 1.8 million of EBITDA, and you're getting to kind of between that 16 to 17 million range on an annualized basis. And then hopefully there's, you know, opportunities for organic and inorganic growth from there. Is that the right number to use, or are there further adjustments that you think that I should be making? And just in general, how do you think about the run rate profitability of your operating businesses?

Yeah, definitely, right? So EBITDA is sort of the internal metric that we use. Some people call EBITDA a bullshit metric, and I think that's true in businesses where there is some capital intensity involved. In our case, there's very little depreciation, and the A is all amortization. It all comes from purchase accounting. It's not the wasting of an asset. So I think EBITDA is a very good proxy for pre-tax cash flow. In our case, because of our NOLs, also after-tax cash flow. So we use EBITDA as a proxy for cash flow. In the warranty businesses, we use something internally called modified cash EBITDA. And it's a little different than what you would see in our financial statements, and we're not permitted to disclose it because it deviates from accepted revenue recognition rules under GAAP. But we think that it is a better proxy for economic value added in a period in a business where there is significant deferred revenue. You can find the method for calculating that in our CIBC loan agreement, which was filed as an exhibit to our 2020 Form 10-K. And what I believe I can say, Adam, is that at Warranty Holdings, our total outstanding senior debt under the CIBC facility at quarter end was $16.7 million. And our senior leverage ratio under that loan agreement was 1.39 times. So you can do the math. That's sort of where we are on warranty. That's how we think about it, right? That's all I probably can say. Ravix does not have deferred revenue, and so Gap EBITDA works for our internal purposes, and the same will be true of C-suite.

Got it. That makes sense. So if I'm doing the math, that's a little bit more than $12 million on the warranty side, plus call it five or six from Ravix plus C-Suite. So if I'm thinking about kind of this proxy for economic cash flow, maybe it's a little bit higher than I suggested, something like 17 or 18 million, and then hopefully you'll be able to grow it from there. Is that fair? I think that's fair enough. Okay, that makes sense. Great. And then, you know, my last question here is maybe more a qualitative question. So, you know, it really feels like you're building a flywheel where you're continuing to add these wonderful operating businesses. You're generating a lot of cash. That cash allows you to get more of the operating businesses and, you know, one leads into the other and the flywheel kind of runs faster and faster. Okay. Can you maybe share a little bit about the opportunity that you have to deploy that capital? So maybe walk through what your strategy is for growing the operating profitability of your businesses, which, again, I think is the key metric to look at, and maybe talk to a little bit of what the key competitive advantages are that allow you to continue executing on transactions and like you have in the past, your warranty transactions, Ravix, C-Suite? What allows you to do that where maybe sellers would find it more attractive to partner with you relative to others?

Yeah, okay. So I'll break that kind of into two parts. The first is sort of the flywheel effect and how can we you know, what's the size of the opportunity set to continue to redeploy the capital? So I agree there is a flywheel effect here, right? And as we grow, obviously right now we're focused on getting out from under the Trump's debt and things. But as we grow, a combination of the de-levering of the businesses we own and the internal cash flow that they generate ought to provide all of the capital that we need to continue to do more acquisitions, right? And And so that, I think that's the flywheel that you were speaking to, right? So, you know, the business continue to grow organically and via acquisition without needing any additional capital. And so why do we think that we can, or how can we differentiate to be successful with that? And what do we think the scale of that looks like? So right now we have three entrepreneurs in our Kingsway Search Accelerator program actively looking for new acquisition opportunities. We hope to add to that. And I think kind of at any given time we would expect to probably have more like four or five people actively searching for new acquisitions, and that would probably translate into two to three acquisitions of lower middle market businesses that fit our criteria that, you know, if history is to tell, would sort of be generating in that one and a half to three million of EBITDA range. And then I think, like, the final part is how do we differentiate why do we think that we can be successful competing in what is a very competitive market for buying great businesses, right? And I think that comes back to, Adam, just sort of some of the fundamental characteristics of what has made search or what's now more commonly referred to as ETA, entrepreneurship through acquisition, what has made it successful. And if you think about the universe of operating companies in the lower middle market, A large percentage of them are still founder-led, owner-operator, and a lot of those owner-operators are reaching the age where they're thinking about retirement and getting liquidity for what is often the largest asset that they have. A lot of those founders are, one, very leery about selling to a strategic. They value their employees. They value their legacy, their brand, their products. And so they're a little nervous about selling to strategic acquirers for fear of what might happen to their employees and the thing that they built. And then on the other hand, if you think about other players in the lower middle market like private equity, typically private equity has to back an incumbent management team. And for a founder who wants to retire, it's not a perfect fit. And in small businesses, from private equity's perspective, it's not a great return on time to buy a business and then have to go kind of reload the management team. So that's where ETA, I think, is a very uniquely shaped key to solve the problem that a lot of founder-led businesses have, which is liquidity and management succession. So we like to think of it as we call it succession capital. We provide capital and we provide management talent. And I think that because of those two things, we can often differentiate and compete and win even in an auction process at a lower price because we have a really unique solution. When I say we, I mean ETA broadly. And I think that's what's made it successful. I think specific to Kingsway, we bring an extra sort of level of confidence and imprimatur of our entrepreneurs are backed by a publicly traded company. And so that just lends a lot of credibility in a deal process.

Great. Thank you, guys. I'll leave it there and I'll let the next folks ask questions. Thank you. Thank you.

Our next questioner is Richard Gatward from Freedom Capital Markets.

Hello, guys. Firstly, Adam's actually... Adam asked three questions which touch on a number of topics that I wanted to bring up. So thank you for clarifying those things. And I do absolutely want to reiterate the transparency that you are showing in terms of having these earnings calls is very helpful and will ultimately, I think, grow the value of your enterprise over the long term. So I'm very, very glad to see that. Just a couple of questions around the accelerator. And you highlighted that you have three entrepreneurs that are looking at opportunities. How are these, how are these, are they, how are these opportunities coming to you? Are you guys proactively going out and looking for them or do you have, um, small investment banks or, or individual business owners actually approaching you with these opportunities?

Yeah. I mean, I guess the answer, the quick answer is yes. Um, but, but really both. Right. And so, um, we sort of run a two pronged business development approach. So each one of the entrepreneurs has identified a handful of industries that meet our criteria. And then we use subscriptions to databases of private companies to mine for contacts, high level contacts at those companies. And we run a proprietary outbound search campaign in target industries. And that starts with outbound emails that show our criteria and our interest in the industry, snail mail, follow up a phone call. So there's a very kind of time consuming and robust effort to make direct contact with business owners in an industry, whether or not they're for sale, in a way to try to engage with that owner in a non-processed situation. But we also have a database of 3,000, maybe 4,000 intermediaries, you know, everything from brokers and investment bankers to private wealth management, accountants, law firms that we do sort of a drip marketing campaign with that continue to stay on top of their radar if they have an opportunity that fits our criteria. So we kind of run it both ways.

And just a couple of questions on the time. Firstly, you know, deleveraging the balance sheet, I think, is obviously, I mean, stating the bleeding obvious, but that's key to success going forward for you guys. So you, I just want to be clear. So you have effectively retired five of the six props at an average cost of 65 cents on a dollar, including... deferred interest. Is that accurate?

Generally accurate. Let me just maybe just kind of nitpick a little bit. We have options to retire the Trump's debt on five of the six series for between 63% and 63.75% of the cumulative outstanding principal and the interest that was deferred up until August 2nd, which is slightly less than what is showing as deferred on our balance sheet at 930.

Okay. And in terms of the real estate assets that have the non-recourse debt on your balance sheet, is there... What is the process for executing a sale of those? Is that in process? Is that something you're thinking about? Is that something that you've engaged with potential buyers of?

I guess, Richard, maybe all I can say right now is that we're working on our strategies to achieve the best return we can, right? Okay. Yeah.

All right. No, I understand that. And just finally, do you feel that you're in the position... I mean, I know that you guys are focused on running your business, but the fact that you guys are having the first conference call and discussing the results for the first time in quite a while, I think can give you the opportunity to talk about your story more to investors. You guys have a pretty... narrow shareholder base, do you see that as a priority in terms of getting out and talking to your story, engaging with an IR firm, or you really just focus on growing the business first?

No, it's a great question, Richard, and I know we talked about this a little bit a month or so ago. We recently switched IR firms. James is on the call now. And so we are at the point now, you know, in addition to doing these quarterly earnings calls where, like you said, we want to expand the group of high-quality shareholders at Kingsway. And by high-quality, I mean both long-term, right, not focused on the short-term, but really in it for the long haul, and very engaged. You know, do their work, understand the company, come to the calls with great questions. And so we're in the process of developing a campaign, if you will, to try to get out and tell our story to what we believe would be a high-quality shareholder.

Okay, JT. All right. I appreciate the answers on that. Thank you very much.

Yeah, Richard, I just wanted to clarify, you know, we haven't repurchased any debt under the options yet, and those options expire May 2nd, so we have until that time to execute a repurchase.

Okay, yeah. Okay, thank you. Yep.

Our next question comes from Christian Solberg from Sun Mountain Partners.

Hey, JT. Hey, Kent, how are you?

Christian, great. Good, thank you.

Excellent first question churn is a really important metric you know, and obviously it has many different definitions and ways to look at it. Are you able to provide any color on churn for your various businesses, the best way to look at it, what rough levels of churn are for those businesses.

Yeah, so for everyone else listening, you know, when you buy a recurring revenue business, one of the things that you want to focus on is how recurring is it? And, you know, do you have a leaky bucket or not? And so we think about churn a lot. We don't publish it because there's a lot of different definitions for churn, right? And so we kind of look at it three ways. The first is just sort of logo churn. And by that, we mean like what's the number of your total customers that you lost in any given year? as a percentage of the total number of customers you started the year with, right? And we kind of look at this at the individual company level, but, you know, so I'll kind of walk through that real quickly for you. A company like IWS, which has long-standing, like 15-year relationships with credit union customers that are both exclusive and contractual, they have basically no logo churn. You know, like 1% a year, they might lose one credit union contract. a year kind of thing where they switch or get acquired. And, you know, kind of the result of that is kind of the next type of churn. We look at gross revenue churn, which is just sort of the revenue dollars that are lost from a lost customer as a percentage of the total revenue. And, you know, at IWS, we basically have, even though they may lose 1% of customers, that customer is usually a small one. And so you have essentially no gross revenue churn. And then I'll stick on IWS, just kind of walk through it. And then we look at net revenue churn, which is sort of the revenue from the customers you maintained or kept as a percentage of their prior year revenue, and to make sure that they are like continuing you're growing those relationships. And so at IWS, we have negative net revenue churn, negative being a good thing. They're growing of like 8.7%. PWI and Penn, it's a little bit different story, right? They have hundreds and hundreds of auto dealerships all over the country. And so their logo churn is actually pretty high. Dealers are always switching. These aren't exclusive relationships. They hop around to different product providers. And so the logo churn in those businesses is 30%, 35%. But a lot of the customers that they churn out are still the smaller ones. And so their gross revenue churn is anywhere from 8% to kind of high teens percent of gross revenue. And then on a net churn basis, PWI, actually has churned about 5% of its net revenue, which means its existing customers are doing less business this year. I think we talked about that a little bit with some of the challenges in the used car market with inventory. Penn, their net churn is basically zero. Their existing customers are doing about the same level of business that they did last year. And then at Trinity, which is our other sort of warranty business, and I'll talk just about the warranty side, which is where we focus on the churn metrics, logo churn is about 14%. Gross revenue churn is very small. The customers they lose, again, are small customers. So gross revenue churn about 2.5% to 3%. And then net revenue churn is negative, again, by about 8.5%. So their existing customers are growing this year. So I think... Those dynamics really speak to the power of the attributes of extended warranty, this great recurring revenue profile with low to no gross and net churn.

That's great. That's really helpful. Thanks for breaking it down like that. How about for businesses like Ravix and C-Suite?

Yeah, so Ravix, about 20% logo churn. Their gross revenue churn is about 6.8%, so I guess that just speaks to the logos that churn out are typically smaller. And then, again, at Ravix this year, the net revenue churn is actually negative 8.5% to 9%. So the customers that they retained are growing. We haven't been able to do the full deep dive to dissect this the way that we like at C-Suite, but I will report back.

Well, it sounds like a similar type of business.

I would expect similar.

Yeah. Excellent. I've got two more quick ones. First is, how do you think about your internal hurdle rate when you're thinking about where to invest the incremental dollar of cash? So if you want to invest through the search accelerator in a new deal or in redeeming the troughs or in share repurchases, how do you think about that hurdle rate?

Yeah, so going all the way back to some of the first sort of goals we set internally, we set this sort of big, hairy, audacious goal of compounding capital at 20% per year for 20 years, right? That would be kind of a 50X type of thing. That's not a forecast. That's an audacious goal. But I think it informs how we think about our internal hurdle rate. And so when we're looking at investments, I like to think about an unlevered return on invested capital, and we use a 20% hurdle. And so, you know, not surprisingly, the calculated IRR on our Trump's repurchase, 20%, which is how, you know, one of the ways that we arrived at the percentage we were willing to pay as a discount, right? And when we're buying operating businesses, you just kind of quick math, if you're buying a business with no growth and we don't have leakage for tax, then we would be willing to pay five times cash flow to hit that 20% unlevered target. We would be willing to pay more for a growing business, right? And then within the search accelerator, we also look at it kind of through an LBO model and and look at a sort of a minimum 35% IRR target as well.

And so that, so the, in the search accelerator model, we're talking at 35% hurdle because those are levered returns.

I look at it both ways. I want a 20% unlevered and that ought to equate to a 35% levered. Yeah.

Okay. Great. And final one here. how did the buyer of PWC look at the earnings in the business? Was it that modified cash EBITDA metric that you mentioned earlier?

Yeah. Uh-huh. And then they also, so like what, um, PWC, we sold it for $51.2 million, which you guys see coming through the income statement, you know, kind of TTM at the time we sold it was probably around 2.2 million of EBITDA gap basis EBITDA. It looks like we sold it for 25 times kind of thing. Right. Um, TTM to us, modified cash was higher, about 3.3, 3.4. And then the buyer then, so 51.2 million on 3.3 million trailing, still a very juicy multiple. The buyer gave us credit pro forma for run rate, new business that we had acquired that we expected to come on, had already come on and then kind of annualized that. So I would say that they were thinking about paying 12 times to 13 times forward.

Yeah, it's incredible. Are you seeing multiples in that arena with private transactions remaining that high in this environment, or are you starting to see them, comparable transactions starting to tick down?

You know, I don't have any tangible evidence yet. I would, you know, and so, and what I'm hearing is that there's a great sorting out going on. So deals that were about to get closed or maybe on pause, and I don't know that things have reset yet, but I would say that there's going to be some movement. That said, for really high quality assets, like in the MGA space, like PWSC, there's still a lot of capital out there looking to be deployed. And so I don't, you know, obviously part of it's a function of the availability of leverage, and the pricing of that leverage, but high quality assets I think are still gonna be pretty dear to people, and there's still a lot of capital out looking for them. So I hope they reset in warranty, right, so that we have some opportunities to buy good assets at prices we would be willing to pay. but haven't seen it yet.

Got it. Very, very helpful. And it seems like it was a rational decision to sell PWSC and potentially, hopefully, but put those proceeds into redeeming the trucks. So yeah, great work. And thanks for putting together this call. I'll jump back.

Yeah, thanks. Yeah, look, we were sad to see PWSC go. We had an amazing relationship with Tyler. He was really sort of the the test case for the search accelerator segment. He was our first sort of entrepreneur, young talented guy that we brought into a business that he didn't know to transition out management and run it and grow it. And so our motivations were probably threefold. One was demonstrate the power of the model to take advantage of some pretty aggressive inbound interest. And then three, we had an immediate use for that capital at returns in excess of our internal hurdle rate.

We now turn to James Carbonara, who has questions from email.

Hey, guys. So we did have some questions come in on email. First one looks like a two-parter. Can you talk about the synergies between Ravix and C-Suite? And do you envision additional acquisitions over time for the Ravix team?

Yeah, sure. So synergies, first of all, I hate that word. Often paid for, rarely materialized. So we definitely didn't go into the deal with synergies in mind. But that said, I think that they're very complementary businesses. Yeah. Maybe start with how they're different. As most of you know, Ravix provides outsourced accounting, HR services, including fractional CFOs, but a lot of additional accounting support at lower levels from controller all the way down to bookkeeper. And their customers are predominantly portfolio companies of venture capital firms. And Ravix often can't find CFO talent when a customer or prospect is looking for an interim CFO or permanent CFO resource. On the other hand, C-suite offers only interim CFO services and CFO placement. And they refer out all of the lower level accounting from controller level on down and HR work at their clients to other firms, competitors of Ravix. and C-Suite's customers are often portfolio companies of private equity firms. So the combination of these two businesses is very complementary in that each one of them can now provide a very comprehensive service offering across each one of their sort of industry verticals, venture capital and private equity. And so any historical leakage from C-Suite's portfolio lower-level accounting and HR referral work that they used to refer to other competitors will come to Ravix. And then, likewise, in return, the CFO placement opportunities that Ravix has been referring to other outside staffing firms can be referred to C-suite. So that's sort of the complementary service and sort of product and revenue opportunity. On the cost side, you know, Timmy will be running both businesses, so I think that sort of eliminates one redundancy, but we don't really model cost synergies and approach the acquisition as if it was a standalone. And then James, I think part two was additional acquisitions for Ravix. Did I get that right? Yep, that's correct. Yeah, I think that's reasonable to expect. I mean, we don't have any view on timing. I think the first order of business here is to do a really good job of bringing C-suite into the Kingsway family of companies and making sure that transition goes very smoothly and Timmy gets his arms around that group of folks and executes their growth plan. And, you know, several months out to a year out, after some delevering, we can look at other inorganic opportunities. I know Timmy and Arthur, the former owner, have identified north of 200 potential acquisition targets, so it's certainly something they're thinking about. But in my experience, businesses more often than not die of indigestion, not starvation, so you gotta get through the one that you just took down and be prudent and patient. So I'll leave it there.

Great. The next question is, your press release mentioned how Ravix has achieved most of their earn outs from this acquisition. Can you provide more color on how the earn out works and when the money is due to the seller, what targets do they have to meet?

Yeah, so I think it's different. I think it's important to distinguish between achieved and accrued, right? So the earn-out doesn't actually – well, there was one – there's two accelerated payment timelines where a portion of the earn-out can be actually achieved. The first one happened at the end of September, and we paid the first accelerated payment of $750,000. at the end of October and so But just coming back to accrued versus achieved We have accrued through the third quarter about four million of a four and a half million dollar earn out liability and the earn out is based upon the achievement of cumulative gross profit in excess of a hurdle over the three years after closing and with the maximum payout capped at $4.5 million. And there's some math and a multiplier and things like that. But think about that. So the gross profit that the company delivers in excess of a hurdle, and that hurdle was based on management's projections at the time of closing. So it would be paying for outsized growth in excess of what they were projecting. Like I said, there are two intermediate accelerated payment dates. The first one was paid, $750. The next one is next October. And the sellers have an opportunity to earn an extra $375,000 if we're still in excess of the hurdle at that point. And then the final one is in October of 2024. And at that time, whatever the maximum they were able to earn would be $4.5 million minus whatever was paid in any accelerated payments. So I don't know if I fully answered the question there or not, James, that you think it captured the Email question, I kind of lost the thread there.

Yeah, no, it was a three-parter. You hit them all. The next one says, Timmy, the CEO of Ravix, was the first search CEO. How was the C-suite deal sourced? How did it end up with Ravix and not a standalone company?

That's an interesting question. Yeah, that's... is actually sourced by another searcher on the Search Accelerator platform, Charles Mokualu, who I think we introduced at the Shareholder Day last year. And I think maybe speaks to the power of the Search Accelerator model to find new opportunities for portfolio companies that we already have. Charles found this opportunity, developed a relationship with Arthur, the seller, and after digging in, in the C-suite and the opportunity, it became pretty evident that this would be a really great fit for Ravix. And Charles handed that relationship with Arthur over to Timmy. And Timmy and Arthur hit it off and continued to progress towards the closing and now post-closing and working together. But it was originally sourced through one of our other search entrepreneurs. It's an interesting question.

Great. And the next one is, as Kingway grows, do you think the existing CEOs like Timmy at Ravex will continue to make potential additional acquisitions in addition to the new search entrepreneurs?

Yeah, I mean, obviously the Ravix one is evidence of that. More broadly, I think that each one of the acquisitions we do under the search accelerator has the potential to be a platform for follow-on acquisitions, tuck-ins. Again, that would have to be part of the original investment thesis. If it's a high-growth business that can use all of its capital to grow at really high rates of return, I think we would you know, from a capital allocator's standpoint, we would continue to allocate that capital to that business to maximize its organic growth. But, you know, generally there's often an inorganic growth thesis to a lot of these acquisitions. So, yes, I think that's right. Like I said, you know, in the answer to an earlier question, you know, our general feeling is that a new CEO should get into the business, learn the company and the industry, de-lever and also work on that organic growth before they start looking for new acquisitions. And that might take a year or more, I mean, two years. And they hit that flywheel point where through the combination of de-levering and internally generated cash flow, they have now the resources to do a follow-on acquisition with no additional capital required. So that's kind of the model.

Got it. Okay. And then the next one is, Can you talk about how Kingsway uses its NOLs against taxable income of the subsidiary companies?

Well, this is like cash flow plumbing among all of our complicated structures. I'll flip that over to Ken. How do we use our NOLs for our operations?

I'll give JT a break here. I'll grab a sip of water or something. Yeah, so... So usually when we talk about our NOLs, it's federal NOLs. We have just under $800 million available as of the end of September. And what we do is when we look at each of our individual companies that we own, we view each of those as sort of standalone entities for federal tax purposes. And so what we'll do is we'll calculate their federal tax due as if they were their own standalone company. And so that way, even though we do a consolidated return for Kingsway at the end of the day, we start with calculating tax at each of the subs. And so in that regard, we're much like the IRS for our companies, because if they owe money as a result of that, then they'll pay that up to the holding company. But if they have some sort of tax benefit, then we'll remit that back. By way of sort of remitting that capital up to the holdco, it's sort of burning off those NOLs and monetizing those. And then as a side benefit, it's providing an additional cash flow stream for the holding company. Great.

And I would just add that those payments for the consumption of the NOLs and the cash back to Kingsway is allowed under our credit agreement. So it's a way to be... You know, air quote, receiving distributions from our operating businesses while being compliant with our bank agreement.

Because if it had been a standalone entity with a bank loan, they would have been paying that money to the IRS. Instead, they're just paying it to the parent co. Right.

Got it. Okay. And then the next one looks like a follow-up. Please remind us how long the NOLs last before they expire.

Yeah, so much of the NOLs originated in the late 2000s and early 2010s. And so at that time, they had a 20-year life to them. So we actually have a schedule in our 10, you know, if you look at our last 10K, we do schedule those out so people can see those. But I think it might be Note 15 or somewhere around there. But they begin to expire in 2027. But 2029 is the big year where we have almost 500 million of NOLs expiring in that year. And then in 2030 and the following years, there's just various amounts that expire in each of those years through. I think it's about 2037, I believe.

Great. Thank you. And it looks like there's just three more here. The first of the last three is, The search entrepreneurs so far have very strong educational credentials. Can you talk about how you are identifying these candidates and what gives you confidence you can continue to find qualified professionals?

Yeah, well, I hope we can continue to find them. Hope's not a strategy, obviously. You know, I think the way that we source them is probably several different ways. First of all, the ETA, entrepreneurship through acquisition, which I mentioned earlier, and community and ecosystem is pretty close-knit, right? And we remain active in that ecosystem, not only through the Search Accelerator, but through Argo Partners, our sort of investment management firm that makes investments in search funds. So we are sort of plugged in to that universe, so to speak, and there's a lot of word of mouth and information sharing there. We also actively recruit on the campuses of the top tier business schools. So, you know, we recently did a Lunch and Learn at HBS, University of Chicago, Northwestern, Wharton. And we've done that at Stanford and hope to do one here this spring. And we post the sort of the operator and residents job description on their internal job board. So we get a lot of sort of inbound interest through those lunch and learns and presentations and through the job postings. And then there's just a lot of overlap in people's personal networks. So we get a lot of referrals from our existing OIRs. So Drew came to us through Tyler. They were both went to West Point. They both went to HBS. Prospective searchers, people that are interested in doing entrepreneurship through acquisition, often reach out to people that have a shared background and have been successful in ETA to get the low down. And that often ends up in being a referral into our program. And I think we've got something that is a little bit differentiated within the broader universe of ETA. doesn't mean we're better, but I think we're unique. And for the right person, I think Kingsway is a really good model. And so people tend to gravitate towards it. And there's just a lot of interest in ETA on business school campuses these days. It's become kind of a real thing that people want to do postgraduate school and early in their career.

Great. And Last two here, first of which is a multi-parter. Can you talk about the process for financing the search business? What multiple leverage do you hope to place? And what is the condition of those lenders? Are the lenders open for business? And are they being competitive on their terms?

Okay, so a three-parter here. So generally, we're targeting a 50-50 debt-to-equity capital structure. And we feel like this is the right balance of, on the one hand, you make your equity sweat, the discipline through debt, while on the other hand, and also enhancing your equity returns through leverage, while on the other hand, not introducing the risk of insolvency. And so we think that's the right balance of discipline through debt and enhancing equity returns without somehow adding capital structure risk to the equity, right? And so what that means is we're typically, given the multiples we're paying, looking for like two and a half to three turns of leverage. And, you know, thus far and up and through what we're working on with Ravix, we've been able to get those kind of terms from traditional senior lenders, on pretty attractive terms and pricing, right? We have in our sort of Rolodex, if you will, although no one uses those anymore, several lenders that work with or are familiar with us and or the ETA space more broadly. And so we've got, you know, a handful of firms that we go out to and solicit term sheets. And so I guess the third part is open for business and being competitive, I think, yes, I think they're open for business. And I think the terms are competitive. The pricing is changing, obviously, with the rising interest rate environment. But for now, anyway, I can't predict what the future will hold, but they seem to be open for business.

Great. And the final question here is, can you talk about your pipeline for potential additional acquisitions?

Maybe break that apart into extended warranty and then the search accelerator. I think I've touched on this a couple times here through the questions, but I'll be a little bit more explicit. So within extended warranty, as I've said before, the universe of attractive candidates is actually pretty small. It's a large and fragmented industry, lots of companies, but the number of high-quality companies, in my view, is actually quite small. And we do see opportunities, including several this year that Kent and I really spent a lot of time on, But they've either been not a great fit for us in terms of distribution channel or the product set that they're providing service contracts on, or probably more importantly, they're selling for valuations that are just a lot higher than what we would be comfortable with. So that said, I suspect given some of the new macro backdrop that I was talking about with Christian, and the higher interest rate environment, that there may be a period of sorting out here, and then things may sort of trade at better multiples, which would get us sort of interested and excited and be able to hit our internal IRR targets. But in any event, given the smaller universe of high-quality assets, I think it will always be somewhat episodic. You know, contrast that with the search accelerator. You know, each one of our, well, we call them, the searchers, we call them OIRs, operators and residents. So each one of our OIRs maintains a very active pipeline of opportunities, and we are at any given time at various stages with dozens of potential acquisitions. It's sort of like the 100 to 1 principle, where if you want to end up with one great acquisition, you need to start with, you know, 100 opportunities at the top of the funnel. And so, you know, when Richard was talking about how you do the outreach, we're We're constantly talking to business owners, constantly reaching out to brokers and bankers and other intermediaries and fill in that pipeline and are at any given time, I don't know how many NDAs, Kent, what do you think? Probably under NDA with 30 companies at a time kind of thing it feels like?

A lot, yes.

A lot. With the goal of, you know, There are no called strikes in investing. We're going to be disciplined and wait for a fat pitch, but we've got to see a lot of pitches in order to see the fat one.

Excellent. Thank you so much. Operator?

There appear to be no further questions in the queue. Do you have any closing thoughts at this time?

No, I really appreciate everyone that took the time out of their day to come in and listen. And for those of you who asked questions, that was really great and really engaging. Hopefully you learned more. And like I said at the outset, we're really excited to make this a permanent feature of our quarterly investor communication going forward and really encourage a great dialogue with our supportive shareholders. If anyone wants to follow up with questions from either me or Kent directly, happy to answer those and just reach out to me via my email, which I believe is on the website or in our filings. So sometimes people are a little shy about asking a question in front of a group. So if you want to talk to me directly, don't hesitate.

This does conclude today's conference call. Thank you for your participation, and you may disconnect your lines at this time. Have a good day.