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.