Kingsway Financial Services Inc

Good day, and welcome to the Kingsway Third 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 would like to ask a question, please press star 1 on your telephone keypad at any time. With me on the call are JT Fitzgerald, Chief Executive Officer, and Kent Hanson, 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 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 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 others that the company files from time to time with the Securities and Exchange Commission. Please note also 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, Paul. Good afternoon, everybody, and welcome to the Kingsway third quarter 2023 earnings call. Thank you for joining us. We've been busy since our last earnings call, so let me go over the highlights. Our third quarter results were largely in line with our expectations, consolidated revenue of $24.8 million, up 11% from a year ago, while consolidated adjusted EBITDA decreased to $2.3 million in 2023 compared to $3.6 million last year. Combined pro forma adjusted EBITDA for the extended warranty segment and KSX segment was a total of $3.2 million in 2023 compared to a total of $4.55 million in the third quarter of 2022. We continued to repurchase a number of shares of our common stock and warrants, which Kent will detail later. Our $5 strike warrants expired on September 15, 2023, with all but 39,000 exercising. We believe the overhang concerns that created are now largely behind us. In September, we acquired Systems Products International, or SPI, And in October, we acquired Digital Diagnostics Imaging, or DDI, our fourth and fifth acquisitions under the Kingsway Search Accelerator platform. And in October, we signed a definitive agreement to purchase 95 percent of the shares of National Institute of Clinical Research, or NICR. This is a lot to unpack, so I'd like to start with our extended warranty segment, which delivered revenue of $17.3 million in the current quarter compared to pro forma revenue of $17.9 million a year ago. Adjusted EBITDA for the current quarter was $2.1 million compared to pro forma adjusted EBITDA of $3.8 million a year ago. As a reminder, pro forma results exclude PWSC, which we sold in July last year. As we discussed on our last earnings call, our vehicle service agreement, or VSA, companies continue to be impacted by an increase in claims paid and persistent macro-level revenue headwinds that impact consumers, primarily tighter credit conditions and persistently high used car prices. At Trinity, our maintenance support business revenues have been impacted by decreases in its equipment breakdown and maintenance support services due to mild weather conditions, which results in fewer service calls. Both of Trinity's segments have also been negatively impacted by long lead times on parts and installations. However, we've been able to mitigate some of this impact through lower operating expenses at all of our extended warranty companies in 2023 as compared to a year ago. In addition to these headwinds, last year IWS had some very favorable realized gains from some of its investments in search funds, coincidentally, as well as a release in GAAP product reserves that didn't repeat this year. Even with all of these challenges, it's worth noting that the extended warranty segment had its strongest quarter this year with adjusted EBITDA up 23% sequentially from Q2 2023. Switching now to our search accelerator, or KSX segment, we had revenue of $7.5 million in the current quarter compared to revenue of $3.8 million a year ago. Adjusted EBITDA for the current quarter was $1.1 million compared to adjusted EBITDA of $0.8 million a year ago. These increases are due to C-suite and SNS acquisitions that were completed in November 2022, and to a lesser extent, the acquisition of SPI in September of this year. The Ravix C-suite business is performing better than expected from a profitability perspective as higher operating margins more than offset lower than expected revenues. Ravix is performing slightly ahead of where it was last year in terms of operating income and adjusted EBITDA. Through the quality of services provided, Tim Iocca and his team are retaining customers at Ravix and in certain instances have improved pricing. At C-suite, the team is rebuilding its pipeline and advancing new business opportunities to reignite growth. Both companies have recently added talent in the business development function to drive revenue growth. SNS is performing at or near our internal plans despite a shift in business mix from higher margin travel assignments to per diem assignments. As we head into winter, we have not yet seen the typical spike in demand for travel nurses, but we are still early in the season. Importantly, we believe long-term demand for nurse staffing will be strong, and the shortage of qualified nurses to deliver care persists. In September, we acquired SPI, a privately held vertical market software company. It was the fourth acquisition completed under our search accelerator. SPI fit our investment criteria with recurring revenue, strong margins, and low capital demands. It operates in a growing industry and we expect it will be immediately accretive. SPI has world-class software products for the timeshare and vacation rental industries. Its platform includes a comprehensive set of modules with software solutions that cover the entire vacation ownership enterprise. Operator and resident Drew Richard has transitioned into the day-to-day operating role as CEO of the company. In October, we acquired DDI, a provider of fully managed outsourced cardiac monitoring telemetry services. We are excited about this transaction because DDI has a high level of recurring revenue, is scalable, and operates in a stable growing market. DDI is the industry standard for outsourced telemetry and has established itself as a trusted partner to its customers through its focus on a dependable, high-quality service offering. Peter Dousman, the operator in residence for this transaction, has transitioned into the CEO role for DDI. We held separate conference calls to discuss each of the SPI and DDI acquisitions, and I encourage you to listen to those replays if you weren't able to make those calls. Also in October, we announced the signing of a definitive agreement to purchase 95% of the shares of National Institute of Clinical Research, or NICR. The remaining 5% will remain with the seller. NICR is a provider of clinical trial site management and recruitment services for nephrology, cardiometabolic, infectious diseases, and gastroenterology clinical trials. NICR participates in the development of innovative and lifesaving therapies through its dedication to and focus on clinical research. NICR was attractive to us because of its track record of growth and profitability with a strong pipeline of clinical trials with some of the world's largest pharmaceutical companies. The outlook for clinical trial site management is favorable, and NICR has an impressive reputation as a provider of quality services. Its commitment to delivering the highest level of service to clients and patients is foundational, and we are committed to continuing this legacy. Dr. Davide Zanke, the operator in residence responsible for finding and executing this transaction, has a successful career in pharma and biotech and will transition to chief executive officer following the close of the transaction. We expect the closing, which is subject to certain closing conditions, will occur in first quarter 2024. Shortly after the deal closes, we intend to host a conference call to discuss NICR further. As we've said in the past, the timing of closing an M&A transaction is difficult to predict. But in recent weeks, we have taken several deals across the finish line. For several quarters, we have spoken about the quality of our pipeline and conveyed the confidence we have in our OIRs to identify attractive targets and execute transactions. In the third quarter, we added a new operator in residence, or OIR, Miles Mammon, to the KSX platform. Miles joined us from Morgan Stanley, where as vice president, he was responsible for acquisitions and asset management within the Merchant Banking and Real Estate Investing Group. He began his career as an air and missile defense officer in the United States Army, where he served in a Patriot missile unit supporting a NATO operation to protect the Turkish southern border during the Syrian civil war. Miles holds a JD and an MBA from Northwestern. and also a BA from Northwestern. We continue to believe that the future is extremely bright for the company given the talent we have on our team and the quality of opportunities they are identifying, pursuing, and closing. I'd like to turn now to our trailing 12-month adjusted EBITDA run rate. On our last earnings call, we reiterated our range of 18 to 19 million and indicated it was likely closer to $18 million than to $19 million. As a result of our recent acquisitions, we are increasing our trailing 12-month adjusted EBITDA run rate range to $19 to $20 million. This includes the extended warranty companies, the existing KSX companies, as well as SPI, DDI, and NICR results. Kent will unpack this further in his comments. Looking ahead, our priorities for 2023 and beyond remain the same. Operational excellence while strategically deploying 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 continue to target two to three new acquisitions per year that fit our clearly defined acquisition criteria and that will generate annualized EBITDA. in the range of $1.5 to $3 million each. I'll now turn the call over to Kent for a review of our financials. 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, which owns a medical clinic whose sole tenant is the U.S. Veterans Administration. 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 $797,000 for the third quarter of 2023 compared to income from continuing operations of $38.9 million last year. The third quarter of 2022 includes a one-time net gain of $37.9 million on the sale of PWSC. Consolidated adjusted EBITDA was $2.3 million for the third quarter of 2023 compared to $3.6 million last year. Combined operating income for extended warranty in KSX was $2.8 million for the third quarter of 2023 compared to $3.2 million in the prior year, while the combined pro forma adjusted EBITDA, which excludes the results of PWSC that was sold last year, was 3.2 million in the third quarter of 2023 and 4.6 million in the third quarter of last year. Now I'd like to break these down by reportable segment. In extended warranty, pro forma adjusted EBITDA was 2.1 million, or 12.3% of pro forma revenue in the third quarter of 2023 compared to 3.8 million or 21.1% of pro forma segment revenue in the third quarter of last year. This decline was attributable to decreases in revenues, an increase in VSA claims, and a decrease in realized investment gains, which were partially offset by lower operating expenses. First, let me go through the revenue decline. Revenues were down at both our VSA companies and Trinity. VSA revenues were down only 1.1% from prior year due to the continuing impact of payment pressures on end consumers resulting from higher interest rate environment and continued higher than expected price of used automobiles. While the price of a used automobile has fallen since the beginning of this year, the declines for the end consumer are not occurring as quickly as anticipated. It is difficult to predict when these macroeconomic trends will begin to ease. However, a bright spot is IWS, which sells through credit unions where the decline in IWS contracts sold is much lower than the overall market decline in loans placed. At Trinity, as JT discussed, lower revenue was due to decreases in equipment breakdown and maintenance support services as a result of mild weather conditions, which results in fewer service calls and as well as long lead times on parts and installations. However, we continue to have strong backlog of orders in the Trinity warranty business, and as the supply chain frees up and machines are shipped and installed, we expect that the associated revenues will revert to historical growth trends. Next, the increase in VSA claims is due to an increase in the cost per claim, or severity, while the number of claims, or frequency, was relatively stable. The increase in severity is a result of rising labor and parts costs which continue to increase at rates higher than the general market inflation. Claims in the third quarter were $600,000 higher than the prior year, but we're slightly down from Q2 2023 on both an absolute dollar basis and as a percentage of revenue. We continue to proactively assess our pricing to ensure that we are staying in front of any persistent claims severity increases. Operating expenses across all extended warranty companies were down about $600,000, excluding PWSC, which reflects initiatives put in place at Geminus and PWI since Brian Cosgrove took over both businesses about a year ago, as well as the continued scrutiny of all expense line items. Also contributing to extended warranty results is the investment income earned from our float and any gains or losses on other investments. As JT discussed, in the third quarter of 2022, IWS had very favorable realized gains from some of its investments, as well as a release of GAAP product reserves. That's G-A-P, product reserves. These totaled about $1.1 million, and we didn't realize similar results in 2023. As we've discussed before, we invest our float, which was about $45 million at September 30, 2023, in U.S. bonds, municipal securities, 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. This has resulted in TTM investment income as of 930.23 of 953,000 compared to just 369,000 for the year-ago period. We believe the long-term outlook for extended warranty remains healthy, and we continue to believe this is an attractive business to hold in our portfolio. At KSX, adjusted EBITDA was $1.1 million, or 14.5% of segment revenue in the third quarter of 2023, compared to $778,000, or 20.4% of segment revenue in the third quarter of last year. And as a reminder, last year included just Ravex. At Ravex, profitability was up slightly compared to the prior year, as the decline in revenue was essentially offset by higher gross margin of 34.7% in the third quarter of 2023 versus 28% in the year-ago quarter. The decline in revenue was due to a decrease in billable hours from lower than expected number of new clients that was partially offset by the increase in billing rates, the latter due to a shift in services mix as well as price increases. C-suite delivered gross margin of 35.6%, which was in line with our expectations, but on lower than expected revenues. C-suite continues to rebuild its pipeline, which was disrupted during the acquisition process, and has hired a business development team member to focus on its pipeline of opportunities. S&S delivered gross margin of 26.9%, which was higher than our expectations, but on lower than expected revenues. We continue to see a shift in mix from travel staffing to per diem staffing. Year-to-date, 58% of the shifts were per diem, which is the same year-to-date figure as the first six months of 2023. Also, the total number of shifts in Q3 2023 was down 20% to that in the year-ago quarter. As a reminder, when we purchased SNS, our purchase price was based on go-forward results being lower than recent historical results at the time of acquisition. as we believe that staffing rates and the number of shifts will revert to levels more in line with those experienced pre-pandemic. At SNS, near-term growth is expected to come from expanding its base of travel nurses, as well as an expansion into new geographic areas. SNS has more seasonality than our other businesses, and the number of travel shifts is expected to improve as travel demand increases during the upcoming cold and flu seasons. Given we acquired SPI in early September, its contribution to the current quarter results was minimal. We plan to discuss SPI more on future calls. Turning now to our balance sheet, at the end of the third quarter of 2023, we had cash and cash equivalents of $20.2 million, compared to $64.2 million at the end of 2022. Cash used in operating activities from continuing operations was $9.6 million for the nine months ended September 30, 2023, compared to cash provided by operations of $4.9 million in the first nine months of last year. Our cash balance has been impacted by the following items this year. $5 million payment of Trump's deferred interest in Q1 of 2023, $2 million for the release of the Mendota escrow in Q1, $1.8 million of management fees paid in Q1 and Q2 of this year related to the final sale of commercial real estate investments, lower operating income from the extended warranty segment, $16.7 million of cash received from holders exercising warrants, and $3.3 million from the sale of Limbock stock. 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 $40.9 million at the end of the third quarter of 2023, compared with $102.1 million at the end of last year. Net debt decreased to $20.8 million as of September 30, 2023, compared to $30.9 million at the end of last year. I'm sorry, 37.9 million at the end of last year. Earlier this year, the Board approved a one-year securities repurchase program. Through October 31, 2023, we have repurchased 1,093,861 of our warrants and repurchased just over 250,000 shares of our common stock. After considering both stock and warrant repurchases, 4.1 million of stock repurchases or securities repurchases could be made through March 22 of next year. The repurchased common stock is being held as Treasury stock at cost and has been removed from our common shares outstanding. As you may recall, the company had a number of outstanding $5 strike warrants that expired on September 15, 2023. After accounting for warrants repurchased by the company, All but 39,000 warrants were exercised prior to expiration. In 2023, just over 3.3 million of our warrants were exercised, resulting in 16.7 million of cash to the company. You can see a breakdown by quarter in today's earnings release. During Q3 2023, we completed the sale of all stock held in Lindbach Holdings, Inc., and recorded a realized gain of 600,000. Total cash proceeds from the sales were 3.3 million. I would like to close by discussing our trailing 12-month adjusted EBITDA run rate. As JT indicated, our range is now 19 million to 20 million. We often get questions from investors about this metric, so I would like to explain a few things. This metric is not intended to be guidance by management regarding the future earnings of the company. Rather, it is intended to capture the 12-month earnings of what the company currently owns or has recently acquired. As such, it includes the following. The actual operating results of our extended warranty businesses for the prior 12 months, which includes the recent declines. The investment income associated with our extended warranty float adjusted to reflect higher earnings associated with the current interest rate environment. we do not factor in any expectations on realized gains or losses, much like we had at IWS in Q3 of last year. It also includes Ravix 12 months actual results, as well as C-suite actual 12 months results, both pre and post acquisition. It includes 12 months of SNS results based on actual results since acquisition and adjusted results in order to reflect management's view that performance would revert to levels more in line with pre-pandemic results. And 12 months of results for SPI, DDI, and NICR based on adjusted results from our quality of earnings due diligence reports. In summary, while our extended warranty segment continued to experience some softness due to claims expense, It continued to perform and delivered the best quarterly results so far this year for the segment. We have added two companies to our KSX portfolios and hope to add a third early next year, which will enable us to deliver on our strategy of growth. Finally, 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 in front of us. I'll now turn the call back over to the operator to open the line for questions. Paul?