Kingsway Financial Services Inc. (NYSE:KFS) Q4 2023 Earnings Call Transcript

Kingsway Financial Services Inc. (NYSE:KFS) Q4 2023 Earnings Call Transcript March 5, 2024

Kingsway Financial Services Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Kingsway Full Year 2023 Earnings Call. [Operator Instructions] With me on the call are JT 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 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 and subsequent Form 10-Qs and Form 8-Ks filed with 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 JT Fitzgerald, CEO of Kingsway. JT, please proceed.

JT Fitzgerald: Thank you, John. Good afternoon, everybody, and welcome to the Kingsway earnings call for full year 2023. Thank you for joining us. I’d also like to quickly apologize. I know that the earnings release just dropped. We had some technical difficulties with our service provider and then a fairly large queue to get those things out. Apologize on the short timing here. So, let’s get started. First let me start by saying that 2023 was a year of significant accomplishments. We delivered financial results that are largely in line with our expectations given the current market conditions. And we completed two great acquisitions, which is in line with our previously described internal target of two to three acquisitions per year.

Also, during the year, we repurchased a substantial amount of our warrants in common stock, and we completed the repurchase of a substantial portion of our subordinated debt that resulted in a much more simplified and stronger balance sheet. All in all, 2023 was a great year here at Kingsway. Equally important, over the course of the year, we built a firm foundation to advance our strategy of growth through acquisitions and are really energized by the opportunities ahead of us. So we’ll start with the financial results. Our first year or rather, our full year financial results include consolidated revenue of 103.2 million, up 11% from a year ago, and consolidated adjusted EBITDA of 9.1 million. Combined adjusted EBITDA for the extended warranty segment and the KSX segment was 14.1 million for the year.

If we break this down, our extended warranty segment reported 68.2 million of revenue in 2023 compared to pro forma revenue of 74 million in 2022. Adjusted EBITDA for 2023 was 8.4 million compared to pro forma adjusted EBITDA of 10.7 the year prior. As a reminder, pro forma results exclude those of PWSC, which was sold in July of 2022. Throughout most of the year, as we discussed on the quarterly earnings calls, our Vehicle Service Agreement or VSA companies were impacted by an increase in average claims expense or severity and persistent macro level revenue headwinds that impact consumers primarily tighter credit conditions and high used car prices. In the fourth quarter, claims severity began to moderate as the rate of inflation related to parts and labor began to recede compared to earlier quarters, we’ve been able to reduce the impact of these headwinds through our tight focus on managing operating expenses.

We’ve implemented price increases to reflect the higher claims environment and expect those to begin rolling through the book this year. IWS, Gemini and PWI have also been very active on the business development front. IWS added several new credit union partners during the year, and Gemini and PWI have executed a significant reboot of their sales teams and the corresponding goals and incentives, which are starting to yield results. At Trinity, maintenance support business revenues were negatively impacted by decreases in its equipment breakdown and maintenance support services due to both smaller, average job sizes and generally mild weather condition, which resulted in fewer service calls. Equipment warranty sales were negatively impacted by softer demand and long lead times on equipment availability and installations with some equipment lead times approaching as much as a year.

As a reminder, our revenue from warranty equipment sales is not recognized until the underlying equipment is installed. Thankfully, these backlogs are starting to free up, and the Trinity team has also done a nice job adding new distribution partners over the past 12 months to offset these challenges, we expect positive momentum in 2024. In summary, for the extended warranty segment, while it’s difficult to predict macroeconomic trends and the resulting impact to our business going forward, our companies remain focused on improving Salesforce production, strategically adjusting pricing and managing our costs. We have seen significant positive progress thus far in 2024 and expect a better year ahead. Switching now to our Search Xclerator or KSX segment, which reported revenue of $35 million in 2023 compared to revenue of $19.2 million in 2022.

Adjusted EBITDA for 2023 was $5.7 million compared to $3.8 million in 2022. These increases were driven by the acquisitions of CSuite and SNS, which were completed in November 2022, as well as the acquisitions of SPI in September and DDI in October. Within the segment, Ravix performed better-than-expected from a profitability perspective, especially in Q4 as higher operating margins more than offset lower-than-expected revenues. Since our acquisition, Ravix has performed very well ahead of our original underwriting thesis. CSuite experienced fewer interim engagements and inconsistent search placements amidst the challenging private equity and M&A environment. The team has bolstered its pipeline and is advancing new business opportunities to reignite growth.

While it is early in the year, we have begun to see the M&A environment thaw a bit and both Ravix and CSuite have added business development talent to accelerate revenue growth. For SNS, the per diem business is performing quite well, partially offsetting an industry-wide decline in the use of travel nurses, which are typically billable at a higher margin. To address the industry headwinds, the team recently added new recruiting talent and completed upgrades to its technology and operations to better support its clinician recruiting efforts. The team has done a nice job of building a tech-enabled platform to support its anticipated growth. Importantly, we believe long-term demand for nurse staffing will be strong with the projected persistent shortage of registered nurses over the next decade.

Secular demand for per diem and travel nurses is expected to remain robust. Growth through acquisitions is central to our corporate strategy. We have developed and follow an underwriting framework that evaluates opportunities based on a pre-defined set of performance criteria that reinforce the thoughtful and disciplined allocation of capital and enable us to acquire high return cash flow generating operating companies at reasonable valuations. In short, we are targeting opportunities that deliver predictably high returns on tangible capital in large and growing end markets. In September, we acquired Systems Products International or SPI, a privately held vertical market software company. It was the fourth acquisition completed under our Search Xclerator and a great fit to our portfolio with contractual recurring revenue, low customer churn, strong margins and low capital demands.

It operates in a growing industry and as we expected was immediately accretive upon consolidation into KSX. In October, we acquired Digital Diagnostics Imaging or DDI, a provider of fully-managed, outsourced, cardiac monitoring telemetry services. DDI is the industry standard bearer for outsourced cardiac monitoring in the long-term acute care and rehab hospital space and has established itself as a trusted partner to its customers through its focus on dependable, high-quality service. This business has a high level of recurring revenue with high customer retention and operates in a fast growing and underpenetrated market. DDI has demonstrated an opportunity to grow at a very fast clip with revenues growing in excess of 30% year over year in our first few months of ownership.

The team at DDI is focused on building the internal infrastructure and processes to scale alongside this high level of demand, while ensuring continued excellent levels of service and care. We held separate conference calls to discuss each of the SPI and DDI acquisitions. If you miss the original calls, I encourage you to listen to the replays for a more in-depth discussion of those transactions. We are eager to expand our KSX business, but we are also committed to discipline decision making. The M&A environment is more favorable than it was 12 months ago, and we continue to believe this will translate into the completion of two to three deals over the next year. With the addition of Paul Vidal at the start of 2024, we currently have four fantastic operators and residents who are actively scouring the market and evaluating potential target opportunities.

We remain encouraged by the quality of our pipeline and hold a high degree of confidence in our ORs. We continue to believe that the future is extremely bright for our search accelerator platform given the talent we have on our team, the quality of the opportunities they are pursuing, and the rigorous framework through which we evaluate acquisition candidates. Inclusive of our recent acquisitions, our trailing 12 month adjusted EBITDA run rate is 17 million to 18 million. This includes the extended warranty companies, the existing KSX companies, as well as pro forma results for SPI in DDI. As a reminder, this metric is intended to capture the 12 month earnings businesses of the company that we currently own and is not intended to be forward-looking guidance.

Looking ahead, our priorities for 2024 and beyond remain the same. Operational excellence at our companies, while strategically deploying the excess cash flows, they generate to grow our portfolio of wonderful businesses. Our goal is to deliver sustainable long-term growth in cash flow from operations and provide an excellent return to our shareholders. We continue to target two to three new acquisitions per year that fit our clearly defined acquisition criteria and we’ll generate annualized EBITDA in the range of $1 million to $3 million each. And as we build our acquisition engine and our cash flows, we believe we are building the flywheel to scale our acquisition pace even further. I’ll now turn the call over to Kent for a review of our financials.

Kent Hansen : Thank you, JT. 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 US Veterans Administration. As part of our strategic shift away from the lease 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. Given that JT covered operating results, I would like to focus on holding company expenses, cash flows, and some balance sheet highlights. Our ongoing holding company expenses, which exclude our KSX search expenses consist mainly of employee costs of our 10 corporate employees and costs associated with being a publicly traded company.

Total expense excluding interest from our last remaining TruPS with 7.7 million in 2023 compared to 7.3 million in 2022. However, 2023 includes the following items: $1 million of stock-based compensation expense, which is non-cash, $1.1 million of expense related to acquisitions and non-recurring items and about $600,000 in IBNR expense as our employee medical plan was self-insured in 2023. We have since moved to a fully insured plan in 2024 and at a lower total cost. We continually challenge our holding company expenses, which has resulted in significant savings over the past few years. We believe our holding company will be able to scale as our underlying businesses expand and grow. Our ongoing KSX search expenses consist of employee costs for our active searchers as well as the tools to support their searches.

Total expense was $1.3 million in 2023 compared to about $600,000 in 2022. The increase was mainly due to the average number of OIRs in 2023 increasing over 2022. The addition of our VP of Business Development in 2023, and due to having a full year of the Strategic Advisory Board in 2023, as well as expanding it by one member this year. We would expect KSX search expenses to fluctuate as we hire new OIRs and existing OIRs close deals and move into the newly-acquired businesses. We view these expenses as a long-term investment that will fuel the growth of the entire Kingsway organization. Turning to our balance sheet and cash flows. At the end of 2023, we had cash and cash equivalents of $9.1 million compared to $64.2 million at the end of 2022.

Cash used in operating activities from continuing operations was $26.8 million for the 12 months ended December 31, 2023, compared to $2.6 million a year ago. Our cash balance was impacted by the following significant items in 2023. First, the repurchase of a majority of our trust preferred debt for $56.5 million, which retired $96.7 million in principal and deferred interest that was done in the first quarter. $5 million payment of trust’s deferred interest also in the first quarter. $2 million for the release of the Mendota escrow in Q1, $1.8 million of management fees paid in Q1 and Q2 related to the final sale of commercial real estate investments, $7.2 million paid for the repurchase of our warrants in common stock, principal debt payments of $9.1 million in 2023, excluding the stocks repurchase and then also we have $16.7 million of cash received from holders exercising warrens and $3.3 million from the sale of — stock.

We had total outstanding debt, which is comprised of bank loans and trust debt, of $44.4 million at the end of 2023, compared to $102.1 million at the end of 2022. Net debt decreased to $35.3 million as of December 31, 2023, compared to $37.9 million at the end of 2022. As we’ve mentioned before, in March 2023, the Board approved a one year securities repurchase program. Through February 29, 2024, we repurchased nearly $1.1 million of our warrants and repurchased just over 400,000 shares of our common stock under this plan. The repurchase of common stock is being held as treasury stock at cost and has been removed from our common shares outstanding. In summary, we continue to make progress reducing our net debt. We have shed most of the remaining non-core assets and we’re able to repurchase a meaningful amount of our securities, all of which we believe will provide more flexibility in pursuing our strategic objectives.

I’ll now turn the call back over to John, the operator to open the line for questions. John?

Operator: [Operator Instructions] The first question comes from Adam Patinkin with David Capital.

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Q&A Session

Adam Patinkin: So let’s see. I’ve got a few questions that I wanted to go into and granted I didn’t have a ton of time to read through the results, but first I wanted to ask, just about the VA Lafayette process. I know that that asset has been for sale for a little bit and has been held as a under discontinued operations. Can you maybe provide an update on where things stand there?

Kent Hansen: We currently have the VA under an LOI, and so we’re progressing through the process at this point.

Adam Patinkin: The second question I had is just I’m trying to understand the run rate EBITDA metric. So I guess my question on that is, when you do the calculation for run rate EBITDA for the operating businesses, are you taking the 12 months trailing operating profit? In other words, does the 17 18 million, is that essentially including the depressed warranty results from 2023? Or are you normalizing that to say, Hey, in a normal year, once we put through some of the different things that you mentioned on the call already to improve the profitability of that business, are you taking those into account that the improvements you’re making? Or is it literally just, hey, here’s the 12 months trailing, so you’re including kind of a depressed warranty EBITDA number?

JT Fitzgerald: So run rate EBITDA, the way we define, it’s probably a little bit of a misnomer, right? It is truly the last 12 months of earnings power of the businesses we currently own. So it is the trailing 12 month of all of the warranty businesses, plus the trailing 12 months of CSuite, Ravix and SNS. And then the last 12 months of operating performance of DDI and SPI as if we had owned them for the whole 12 months. The only normalizing adjustment Adam we make is to make an estimate of the increase in investment income we would receive on the warranty float. If we reinvest all of that at current market yields, that normalizing adjustment has compressed over time as we have rolled over a lot of those securities.

Adam Patinkin: If, I’m trying to think about it, and I think the way that most investors think about the companies that they invest in is thinking about what are the perspective cash flows of the business? In other words, what’s the earnings power today and going forward? So if I’m going to think about what kind of a normalized earnings power is here. It actually should be a good bit higher than that number that you’ve provided just because I think the hope or expectation would be that the warranty business is going to recover from, kind of this depressed year for all the reasons you outlined. And then obviously each of your businesses, you’re continuing to grow them and improve them. You just got SPI and DDI under your umbrella, et cetera. Is that a fair comment to make?

JT Fitzgerald: I think that’s a very fair comment. I think that you heard in my prepared remarks that, we feel pretty good about where we stand today, certainly vis-a-vis with several months ago and there are nice things happening. We believe we have momentum and therefore I think that’s a fair comment.

Adam Patinkin: Okay, great. I appreciate that and the clarity around that. Just one last question, which is in your press release, in your commentary, you noted that the transition has gone smoothly for SPI and DDI and you said some positive things about those businesses. Would you mind just providing a little extra color on SPI and DDI, how those transitions have gone with the OIRs taking over and how those deals have been performing so far, just a little bit more granularity so we can get a feel for those two kind of new businesses under the KSX umbrella?

Kent Hansen : Yes, great. I’ll start with SPI. That is led by Drew Richard, really talented young guy. If you recall, this was a sort of a family-owned small software business. We really like the fundamentals of it. The business as is often the case in these small founder-led businesses probably had a lot of unlocked opportunity and particularly around organic growth. And so, obviously, first 100 days, Drew has to transition in, establish sort of the new regime and get to know all of the folks there and build rapport and then talk to customers and based on that sort of start to begin articulating a vision for the business and the strategy to achieve that vision. Drew’s thesis is that, there is ample opportunity to grow this company organically through new customer acquisition in its existing market segment.

We’ve got a wonderful new Head of Sales there that had only been on Board at the company for a couple of months prior to our closing and they’ve been building out their sales process sort of top of the funnel all the way down through and have had some early success on adding new customers onto the software platform. That will probably take some time, as they kind of starting from scratch to build this sales team and processes. But so far things are going really well and we’re very pleased with the company we bought. Turning to DDI, again, Founder-led business. The Founder has largely transitioned out. Peter Dousman is our President there. This is sort of a unique situation where DDI has been growing pretty rapidly. As I mentioned in the prepared remarks, in our first couple of months of ownership in 2023, year-over-year revenues were up over 30%.

And that’s through inbound existing customers trying to expand their business in new rehab and LTAC hospitals and more recently some inbound interest from other hospital systems. Peter is very busy creating the internal processes, structure and team to be able to support really wonderful opportunity to grow, but do it in a very thoughtful way so that we most importantly ensure a very high-quality level of service and quality of care for the patients that we’re monitoring. And so that’s the dynamic he’s balancing, but I think that he’s got a really nice growth runway ahead of him.