Kingsway Financial Services Inc

Good day and welcome to the Kingsway Second Quarter 2023 Earnings Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions and comments after the presentation. If you are with us in the webcast, you will need to dial into the number listed on 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 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 can materially differ from those contemplated by those forward-looking statements. For 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 the risk factors detailed in the company's annual report on Form 10-K, containing the subsequent field reports on Form 10-Q, as well as 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 metrics that management utilizes to analyze the company's performance. A reconciliation of such non-GAAP metrics to the most comparable GAAP measures is available in the most recent press release, as well as in our periodic filings with the SEC. Now I'd like to turn the call over to J.T. Fitzgerald, CEO of Kingsway. J.T., please proceed. J.T.

Thank you, Matthew. Good afternoon, everybody, and welcome to the Kingsway second quarter 2023 earnings call. Thank you for joining us. Our second quarter results were largely in line with our expectations. While macroeconomic conditions presented a bit of a headwind for our extended warranty business, we're pleased with the operating performance in our accelerator segment and are very encouraged by increased level of activity related to potential acquisitions in the quarter. The pipeline is in great shape and our OIRs are performing well. We believe the future is very bright for the company. Our consolidated revenue for the second quarter was up 11% over the second quarter of last year. And as of June 30th, 2023, our trailing 12-month consolidated adjusted EBITDA was 11.1 million. an increase of 40 percent over the comparable year-ago period. Our combined pro forma adjusted EBITDA for extended warranty and KSX was 15.6 million for the trailing 12 months, an increase of 54 percent over the year-ago period. Revenue and adjusted EBITDA increases were driven primarily by the continued growth of our Kingsway search accelerator segment, which more than offset slightly challenging market conditions in our extended warranty segment over the last quarter. In extended warranty, second quarter pro forma revenues were down 1.6% from the same period in 2022, as slightly higher revenue from vehicle service agreements offset most of the decline in maintenance support revenues at Trinity. Pro forma adjusted EBITDA for the segment was down 26% compared to the second quarter of last year, which I will dive into more in a minute. As a reminder, our pro forma results in the warranty segment exclude the results of PWSC, which was sold in the third quarter of last year. Diving into the warranty segment, while our teams continue to execute and find opportunities for cost improvements, higher used car prices and increasing financing costs continue to pressure near-term industry demand, constraining our growth initiatives. Importantly, though, the longer-term outlook for extended warranty remains healthy. Looking ahead, we continue to expect that declining used car prices will offset some of the impact of higher borrowing costs, particularly at the older end of the spectrum where our products are most relevant. The value proposition for extended warranties remains strong. Automotive dealers use extended warranties to acquire new customers, retain existing customers, enhance their profitability, and maintain brand loyalty for their product offerings, while credit unions view extended warranties as a benefit to their members as well as protection for the asset securing the loan. We believe that all of these factors will help stabilize and be a catalyst for growth in our auto-related extended warranty businesses going forward. Extended warranty pro forma adjusted EBITDA was down in the quarter, primarily due to increased automobile repair claims expenses incurred. While the number of claims, or frequency, were in line with expectations, the cost per claim, or severity, increased as a result of rising labor and parts costs. Claims in the quarter were $834,000 higher than the prior year quarter, which more than fully explains the negative comp to last year. Well, while we're still early in Q3, indications suggest that this spike in claims severity has abated. However, we are also proactively assessing our pricing to ensure that we are staying in front of any persistent claims severity increases. At Trinity, our maintenance support business revenues have been impacted by smaller average repair jobs. While the number of calls is consistent, the average revenue per job is lower due to ongoing supply chain backlogs for new equipment. In our mechanical and HVAC-focused warranty business at Trinity, equipment availability also continues to pose challenges. We have a healthy backlog of orders, and as the supply chain frees up and those machines are shipped and installed, we expect that the associated revenues will revert to historical growth trends. Switching now to our search accelerator, or KSX segment, Revenues grew by 121 percent compared to the second quarter of last year, while adjusted EBITDA of 1.7 million was up 79 percent, both due to the inclusion of C-suite and S&S for a full quarter in 2023. As a reminder, this segment of our business is currently comprised of three operating entities that we have recently acquired. Ravix, a provider of outsourced financial services and human resources consulting, C-Suite, a provider of financial executive services for both project and interim staffing engagements, as well as search services for full-time placements of financial leaders, and Secure Nursing Services, or SNS, a staffing agency for the nursing and healthcare vertical. Ravix and C-Suite, which are overseen by Timmy Okaw, are performing better than expectations as higher operating margins more than offset lower than expected revenues. Ravix recently hired a business development specialist, a new position, to catalyze further growth, while the C-suite team continues to refill its pipeline that was impacted during the softer M&A environment earlier in the year. At SNS, margins are slightly better than expected and cash flows remain strong, despite a shift in business mix from travel assignments to per diem assignments. We believe the long-term prospects for nurse staffing remain strong as an aging population drives demand and there remains a persistent shortage of qualified nurses to deliver care. During the second quarter, we added two new operators and residents, or OIRs, to the Search Accelerator platform, Peter Hearn and Davide Zanke. Both Peter and Davide bring a wealth of experience in strategic and financial matters to Kingsway. Peter joined us from Centerview Partners, where he advised companies across a broad range of industries on strategic matters, including M&A. He has served as a management consultant at McKinsey and in a number of roles in capital markets and investment banking at Credit Suisse. Peter holds a JD and MBA from Northwestern University and a BA from Cornell University. Davide previously worked in large pharma at Eli Lilly and Roche, as well as several venture capital firms focused on the biotech and pharmaceutical industries. Davide has a proven track record in due diligence, company formation, executive leadership, and corporate development. He graduated with an MBA from Stanford Graduate School of Business and holds a PhD in neuroscience from the University of Basel in Switzerland. We now have four highly talented and skilled professionals in the role of OIR who are actively searching for new acquisitions. Also during the quarter, we announced the appointment of Charles Joyce to the newly created role of Vice President of Business Development for our KSX platform. Charlie is working diligently to build out our deal sourcing engine for future acquisitions. While the timing of closing transactions is somewhat difficult to predict, we are experiencing a market increase in activity for potential acquisitions compared to the first quarter. We expect to have more specific news to share soon But in the meantime, I want to reassure you that we're highly focused on acquiring great businesses at reasonable valuations. Growth through acquisition requires patience, diligence in our research, and discipline to ensure potential targets align with our stated criteria and return hurdles. Our trailing 12-month adjusted EBITDA run rate of our operating business continues to be in the 18 million to 19 million range. While we believe that the higher than expected warranty claims costs incurred in Q2 will be at least partially offset by higher returns on our warranty float, we now believe the run rate is probably closer to $18 million than to $19 million. Our priorities for 2023 and beyond remain the same, strategically allocating capital to build a business that delivers sustainable long-term growth, generates positive cash flow from operations, and provides an attractive return for our shareholders. We're targeting two to three new acquisitions per year that fit our clearly defined acquisition criteria and will generate annualized EBITDA in the range of 1.5 to 3 million each. Now that most of the legacy debt and non-core investments are behind us, and assuming we can execute our strategy, I believe that Kingsway is at an inflection point where the future looks dramatically better than the past. I'll now turn the call over to Kent for a review of our financial results. Kent.

Thank you, JT. Before I get started, as a reminder, during the fourth quarter of 2022, we began executing a plan to sell one of our subsidiaries, VA Lafayette, a medical clinic, as part of our strategic shift away from the leased real estate segment. VA Lafayette is included in discontinued operations, and its assets and liabilities are reported as held for sale. The results of its operations are reported separately and not included in the results I'm about to discuss. Loss from continuing operations was $1.8 million for the second quarter of 2023 compared to a loss from continuing operations of $3.2 million in the second quarter of 2022. Consolidated adjusted EBITDA was $1.8 million for the second quarter of 2023 compared to $3.1 million last year. TTM consolidated adjusted EBITDA was $11.1 million as of June 30, 2023, a 40% increase compared to last year. A reminder that these metrics include the results of PWSC through July of 2022. Combined operating income for extended warranty in KSX was $3 million for the second quarter of 2023 compared to $3.8 million in the prior year, while combined pro forma adjusted EBITDA which excludes the results of PWSC that was sold last year, was $3.4 million in the second quarter of 2023 and $3.3 million in the second quarter of last year. I would also like to note that TTM combined adjusted for former EBITDA was $15.6 million for the period, or 54% higher than the prior TTM periods. Now breaking this down by reportable segments. In extended warranty, second quarter 2023 pro forma adjusted EBITDA was $1.7 million or 10.1% of pro forma extended warranty revenue compared to $2.3 million or 13.5% of pro forma revenue in the second quarter of last year. As JT mentioned earlier, revenues from our vehicle service agreements were slightly higher than prior year, yet we continue to be impacted by payment pressures incurred by end consumers as a result of rising interest rates and higher than expected prices for used automobiles. While the price of used automobiles has fallen since the beginning of 2023, the declines for the end consumer are not occurring as quickly as anticipated at the beginning of the year due to a persistent low level of used car inventory. Also impacting our auto extended warranties was an increase in claims expense during Q2 2023 as JT discussed earlier. Inflationary pressures have driven up the cost of labor and parts at unprecedented rates. However, our claims value remains in check. We anticipate that as these pressures ease, claims expense will be more in line with expectations. However, this is difficult to predict with certainty. We do believe that claims volume will continue to develop in a predictable fashion. The increase in claims expense was partially offset by a decrease in G&A expenses, as cost-cutting initiatives put in place last year as well as continued scrutiny of expenses benefited the 2023 period. At Trinity, lower revenue was due to a decrease in its equipment breakdown and maintenance support services due to issues with long lead times for equipment and installations. The decrease in revenue was offset by a decrease in cost of services sold and a profit sharing payment received from Trinity's primary insurer. Trinity leadership continues to focus on expanding its offerings of warranties in the HVAC and refrigeration sectors, and we believe there's a lot of room for growth in this area. Also contributing to extended warranty results is the investment income earned from our float. For the 12 months ended June 30th, 2023, Investment income earned was $825,000, compared with $290,000 for the year-ago period, an increase of over 280%. We invest our float in U.S. bonds, munis, and high-quality corporate bonds with an average duration of two to three years. As prior investments mature, we are able to reinvest at the current higher interest rates. Our total float as of June 30, 2023, was approximately $44 million. For extended warranty on a trailing 12-month basis, pro forma adjusted EBITDA was 10.3 million or 14.9% of pro forma revenue compared to 7.8 million or 11.7% of pro forma revenue in the previous trailing 12-month period. Turning now to KSX, adjusted EBITDA was 1.7 million or 18.5% of segment revenue in the second quarter of 2023 compared to 948,000, or 22.9% of segment revenue in the second quarter of last year, and as a reminder, last year just included Ravex. First, at Ravex, results were relatively flat to the prior year. A decline in revenue was essentially offset by higher gross margin, 35% in 23 versus 29% a year ago, and flat G&A expenses. The decline in revenue was due to a decrease in billable hours due to a lower-than-expected number of new clients that was partially offset by an increase in billing rates. As JT mentioned, Ravix has recently hired an experienced business development person to focus on building a pipeline of new clients. In 2023, KSX also benefited from the addition of financial results from C-Suite and S&S. At C-suite, revenue is being impacted by similar factors impacting Ravex, partially mitigated by a higher mix of revenue from search. Gross margin approved to 40%, up from 30% in the first quarter of 23, while revenue was essentially flat quarter to quarter. This helped adjusted EBITDA increase to $278,000 for Q2 of 23 from $135,000 for Q1 of 23. As JT mentioned, TIMI has been taking proactive steps to refill the pipeline of opportunities since the acquisition closed and recently filled its open business development position with an internal promotion. At S&S, we continue to see a shift in mix from travel staffing to per diem staffing. Year-to-date, 55% of the shifts were per diem. The total number of shifts in Q2 2023 was flat to that in Q1 of 23, but the shift in mix to per diem staffing resulted in a lower operating margin than expected. For the quarter, SNS had adjusted EBITDA of 491,000 down from 650,000 in the first quarter. By focusing on current clients and collections, SNS has been able to build a strong cash balance and pay off its $350,000 revolver in Q2. Near-term growth is expected to come from expanding its base of travel nurses as well as an expansion into new geographic areas. S&S has more seasonality than our other businesses, and the number of travel shifts is expected to go up as travel demand increases during the upcoming cold and flu season. Turning now to our balance sheet, at the end of the second quarter of 2023, we had cash and cash equivalents of $14.2 million compared to $64.2 million at the end of 2022. As a reminder, we repurchased a substantial portion of our subordinated debt in Q1 for $56.5 million. Cash used in operating activities from continuing operations was $8.6 million for the six months ended June 30, 2023, compared to cash provided of $4.3 million in the first six months of 2022. The current period is impacted by the following items. $5 million payment of Trump's deferred interest in Q1 of 2023, $2 million for the release of the Mendota escrow in Q1 of 2023, $1.8 million of management fees paid in Q1 and Q2 of this year related to the sale of commercial real estate investments, no inflows from PWSC, which was sold in July of last year, and lower operating income from the extended warranty segment. Our total outstanding debt is comprised of bank loans and one remaining tranche of Trump's debt. Debt associated with the VA Lafayette is included in a separate line item on our balance sheet as liabilities held for sale. As a result, we had total outstanding debt of 42 million at the end of the second quarter of 23 compared with 102.1 million at the end of 2022. Net debt decreased to $27.9 million as of June 30, 2023, compared to $37.9 million as of December 31, 2022. Earlier this year, the Board approved a one-year securities repurchase program. To date, we have repurchased 558,607 of our warrants and repurchased 68,446 shares of our common stock. After considering both stock and warrant repurchases, $7.4 million of stock repurchases or securities repurchases could be made through March 22nd of 2024. The repurchased common stock is being held as treasury stock at cost and has been removed from our common shares outstanding. Year-to-date through August 7th, 2023, about $1.8 million of our warrants have been exercised. You can see a breakdown by quarter in today's earnings release. These exercises have resulted in $8.8 million of cash to the company. As of August 7, 2023, the company had 2.1 million warrants outstanding that expire on September 15, 2023. During the second quarter of 2023, we also completed a cashless exercise of all warrants held in Lindbach Holdings Inc. and recorded an unrealized gain of $1.8 million related to the investment in the second quarter. Through August 7th, 2023, we have sold 46,000 of Limbach common shares for cash proceeds of 1.2 million. In summary, while extended warranty segment experienced some softness due to claims expense, overall we are pleased with the performance of our business and progress in KSX. We made further progress reducing our net debt. We were able to repurchase a meaningful amount of our securities and we have a robust pipeline of acquisition opportunities. I'll now turn the call back over to the operator to open the line for questions. Matthew?