Earnings Call Transcript - KFS Q1 2023

Operator, Operator

Good day and welcome to Kingsway's First Quarter 2023 Earnings Call. All participants are in listen-only mode and the floor will open for questions and comments after the presentation. Joining 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 concerning the future, including expected revenue, operating margins, expenses, and business outlook. Actual results could materially differ from those anticipated in these forward-looking statements. For a discussion of risks and uncertainties that could cause actual results to differ, please refer to the risk factors outlined in the Company's annual report on Form 10-K and other reports filed with the Securities and Exchange Commission. Additionally, today's call may include non-GAAP metrics that management uses to evaluate the Company's performance. A reconciliation of these non-GAAP metrics to the most comparable GAAP metrics is available in our latest press release and in our periodic SEC filings. Now, I will turn the call over to J.T. Fitzgerald, CEO of Kingsway. J.T., please proceed.

J.T. Fitzgerald, CEO

Thank you, Tom. Good afternoon and welcome to the Kingsway first quarter 2023 earnings call. Thank you for joining us. Let me begin by saying we were very pleased with our start to 2023 with solid financial performance and operating results that generally met our expectations, despite an environment of macro uncertainty regarding interest rates and inflation. Importantly, we further simplified and strengthened our balance sheet with the repurchase of nearly all our trust preferred debt and recorded a nice gain. With a cleaned-up balance sheet and the liquidity and capital resources we have available, we are poised to execute on our strategy for future growth. As of March 31, 2023, our trailing 12 months consolidated adjusted EBITDA was 11.5 million, an increase of nearly 80% over the comparable year-ago period. Our trailing 12 months adjusted EBITDA run rate of our operating businesses continues to be in the 18 million to 19 million range. Turning first to our extended warranty segment. On a pro forma basis, first quarter warranty revenues increased 3% over last year, and pro forma adjusted EBITDA increased by 17%. Please note that our pro forma results exclude PWSC, which was sold in Q3 of 2022. And our auto-focused warranty businesses' higher used car prices and increasing financing costs continue to have a modest impact on industry-wide demand. Despite these macro conditions, our warranty businesses continue to execute and find opportunities for growth. As used car prices begin to normalize, particularly at the older end of the spectrum where our products are most relevant, we continue to expect that declining used car prices will offset some of the impact of higher borrowing costs. And our mechanical and HVAC-focused warranty business' ongoing supply chain backlogs for new equipment continue to pose challenges. As the supply chain freeze up and those machines are shipped and installed, we expect that the associated warranty revenues will revert to historical growth trends. In our search accelerator or KSX segment, revenues grew by 131% compared to the first quarter of last year and adjusted EBITDA of $1.7 million was up 93%. This segment of our businesses currently comprises three operating entities, Ravix, CSuite, and Secure Nursing Services or SNS. As you may recall, in November 2023, we acquired CSuite, a national financial executive services firm to provide financial management leadership in the U.S.; and SNS, a staffing agency for the nursing and healthcare vertical. Q1 2023 is the first quarter that includes a full period of results for these two entities. Kent will provide more details later in the call, but we are encouraged by the early performance of these acquired businesses. Turning to the balance sheet, during the quarter we repurchased nearly all of our trust preferred debt, or TruPs debt, as we call it, that was under option using available funds from working capital. We paid $56.5 million for five of the six remaining TruPs tranches. With this transaction, we recognize the gain on extinguishment of debt of 31.6 million. As of the end of the first quarter, we had a carrying value of 11.8 million related to the remaining TruPs debt instrument. In March, the board approved a one-year share repurchase program and authorized the repurchase of up to $10 million of our stock through March 21, 2024. We believe it is a good corporate practice to have a plan in place and the flexibility to allocate capital towards repurchasing shares. We are acutely focused on maximizing intrinsic value per share. And if market conditions provide opportunities, we will allocate capital to creative repurchases of our stock. 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 from operations, and provides an attractive return for our shareholders. We are targeting two to three new acquisitions per year that fit our clearly defined acquisition criteria and will generate annualized adjusted EBITDA in the range of $1.5 million to $3 million each. We aim to do this by, in part, attracting, developing, and retaining world-class talent within our KSX platform. We have a great team of talented professionals who are actively searching for acquisition targets that fit our defined set of criteria, and our acquisition pipeline is strong. Subsequent to the end of the first quarter, we added a new Operator-in-Residence or OIR, Mr. Peter Hearne to the KSX platform. Peter joins us from Centerview Partners where he advises companies across a broad range of industries on key strategic and financial matters, including mergers and acquisitions. We welcome Peter to the team and look forward to supporting him in his search for a great company to acquire and run. Also, subsequent to quarter end, we announced that we welcome Charles Joyce to Kingsway, as Vice President of Business Development for our KSX platform. This is a new position at the Company. Charlie joins us from 4 Circle LLC, a search investment firm where he was responsible for sourcing and evaluating investment opportunities. We are delighted to welcome Charlie to the team as we build out our deal sourcing engine for future acquisitions. And finally, before I turn the call over to Kent for a more in-depth discussion of the numbers, I'd like to remind everyone that we are hosting our Annual General Meeting of Shareholders along with an Investor Day at the New York Stock Exchange next Tuesday, May 16th. The AGM will begin at 9 A.M. Eastern Time, and the Investor Day presentation will follow immediately thereafter.

Kent Hansen, CFO

Thank you, J.T. 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, as part of our strategic shift away from leased real estate assets and to simplify our capital structure. The 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. Income from continuing operations was $27.7 million for the first quarter of 2023, compared to a loss from continuing operations of $4 million in the first quarter of 2022. The current period includes a $31.6 million gain on the extinguishment of debt related to the repurchase of our TruPs, as well as interest expense on all six tranches through the date of repurchase. Consolidated adjusted EBITDA was $2.4 million for the first quarter of 2023, a $1.4 million or 135% increase compared to consolidated adjusted EBITDA of $1 million in the first quarter of last year. Combined operating income for extended warranty and KSX was $3 million for the first quarter of 2023, compared to $2.5 million in the prior year. Combined pro forma adjusted EBITDA, which excludes the results of PWSC that we sold in July of 2022 was $3.5 million in the first quarter of 2023 and $2.4 million in the first quarter of last year, or an increase of 44%. Breaking this down by reportable segment. In extended warranty, first quarter 2023 pro forma adjusted EBITDA was $1.8 million, or 10.9% of pro forma extended warranty revenue, compared to $1.6 million, or 9.6% of pro forma revenue in the first quarter of last year. The first quarter of 2023 was impacted by the following items. First at Trinity, lower revenue was due to an unseasonably mild winter and parts availability issues, due to the overall supply chain, as J.T. mentioned, which was partially offset by lower cost of goods sold due to the variable cost nature of those expenses. Trinity leadership has focused 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. The next slightly higher revenue PWI and lowered general and administrative expenses were partially offset by higher commission expenses. As mentioned on prior calls, Brian Cosgrove took over the leadership of PWI in the second half of 2022 and continues to implement strict cost discipline while bringing in new leadership to the sales organization. And finally, higher revenue IWS was partially offset by an increase in commission expenses and claims expenses, attributed to a decrease in the number of claims that was more than offset by an increase in the average cost of a claim. For extended warranty on a trailing 12-month basis, pro forma adjusted EBITDA was $10 million or 14.3% of pro forma revenue, compared to $7.7 million or 11.5% of pro forma revenue in the previous trailing 12-month period. Turning to KSX, adjusted EBITDA was $1.7 million or 17.1% of segment revenue in the first quarter of 2023, compared to $861,000, or 28.7% of segment revenue in the first quarter of last year. The first quarter of 2023 was impacted by the following items. First at Ravix, lower revenue due to a decline in billable hours that was partially offset by an increase in billing rates, a shift and mix to higher level positions, and lower general administrative expenses. The decline in billable hours is mainly attributable to the decline in general M&A activity and venture capital funding. However, gross margins improved to 33% in the first quarter of 2023 compared to 29% a year ago. For the quarter, Ravix had adjusted EBITDA of $900,000, as Timi Okah will cover more at our Investor Day next week. Since Kingsway acquired Ravix in October of 2021, TTM revenue has increased 21%. TTM adjusted EBITDA has increased 40%, and the number of clients has increased 18%, all without increasing headcount. KSX also benefited from a full quarter of financial results from CSuite and SNS. Timi, who also leads Ravix, took over the leadership at CSuite upon its acquisition. CSuite's revenue is being impacted by similar factors as Ravix as well as a higher mix of revenue from search, which is generally lower margin. Gross margin was 30% for the first quarter of 2023. For the quarter, CSuite had adjusted EBITDA of 135,000. At SNS, we have seen a shift in mix from travel staffing to per diem staffing, resulting in a nearly 50/50 split for Q1 of 2023. While the total number of shifts is down slightly from the prior year, the average billing rates are holding at a higher level than anticipated. Charles is doing a nice job transitioning the business from the former owner and is already looking to expand into other geographic markets. Gross margin was 26% in the first quarter of 2023, and SNS had adjusted EBITDA of about $650,000. Turning now to our balance sheet, at the end of the first quarter of 2023, we had cash and cash equivalents of $8.3 million compared to $64.2 million at the end of 2022. This decrease was largely driven by the TruPs repurchase of approximately $56.5 million. We also received $6.2 million in cash proceeds from holders of our warrants exercising during the quarter. As of March 31, 2023, $3.2 million of our $5 strike warrants remain outstanding. Our total outstanding debt is comprised of bank loans and the remaining TruPs. Debt associated with VA Lafayette is reported as a separate line item on our balance sheet as liabilities held for sale. As a result, we had total outstanding debt of $42.8 million at the end of the first quarter of 2023 compared with $102.1 million at the end of 2022. And an originally reported amount of $292.7 million at the end of 2021. So since the end of 2021, we have reduced our total debt by 85%. And as of March 31, 2023, our deferred interest was zero. I would also like to note that all but 30,000 of our Class A preferred shares elected to convert during the first quarter, and the remaining 30,000 are expected to convert during the second quarter. As a reminder, conversion requires zero cash outlay by the Company. On a quick side note, our VA Clinic is listed for sale and is actively being marketed by a national broker. We have received a lot of serious interest and hope to have the VA Clinic sold during 2023. As J.T. mentioned, the board approved a one-year share repurchase program, and authorized the repurchase of our stock. No shares were repurchased during the three months ended March 31, 2023. In summary, our business performed well in the first quarter. We have substantially delivered and simplified our financials and we have the financial flexibility to be selective and opportunistic as we deploy capital. With that, I look forward to seeing you at our upcoming Investor Day. And now, I'll turn the call back over to the operator to open the line for questions.

Operator, Operator

We have a question from Adam Patinkin. Adam, your line is live. Please proceed.

Adam Patinkin, Analyst

So I guess, I've just a few quick questions. So my first one is, I was interested in the hiring of Charlie Joyce. Can you expand on his role and what you expect him to bring to the team? And what that might mean for your ability to maybe attract additional OIRs and to conclude purchases of businesses in the KSX segment?

J.T. Fitzgerald, CEO

So Charlie has a great background and was doing a self-funded search. He understands the ETA community very broadly. The thought process here is to really lean into our sourcing process here at KSX to allow our OIRs to focus on more direct sourcing in specific industries of interest. So Charlie will be predominantly focused on building out our database of intermediaries, brokers, and investment bankers, and enhancing our outreach process to describe the search accelerator, our acquisition criteria, and the solution that we provide to lots of business owners who are looking to transition into retirement. The hope is that we will be able to see a lot more opportunities that are coming through traditional broker and intermediary channels with a single point of contact at the search accelerator. That will also provide continuity in that sourcing engine as new OIRs come onto the platform and other OIRs leave when they get an acquisition done. He'll also spend some time focused on our recruiting efforts. He's very plugged in in the ETA community. He will be a point of presence for the search accelerator at ETA conferences, on business school campuses, etc. I think it really enhances our product offering for OIRs to come on board, if they can step into a very vibrant and powerful pipeline of ongoing deal flow through that channel. I believe it also helps that he's out getting the word out in the community.

Adam Patinkin, Analyst

That’s great. That's a really exciting person to bring on board and it sounds like a really nice fit. Maybe to kind of transition to something you touched on there. Now you have four OIRs and I know you reiterated during your prepared remarks that you're still targeting two to three acquisitions per year. Can you maybe talk about what you're seeing out there in the market, how your pipeline looks maybe compared to last quarter a few months ago? Just would love any update on the progress around the OIR and making business acquisitions?

J.T. Fitzgerald, CEO

Yes, look, I think broadly, the general M&A environment was a little slow. In the first quarter, we certainly saw that at CSuite and Ravix, and I think you've probably read about it. At the lower end of the lower middle market, I think that it remained pretty solid. Credit conditions tightened up a bit, and valuation expectations probably are a little mismatched between sort of buyers' cost of capital and sellers' expectations. But I fully expect that to kind of revert and the broader sort of M&A environment to unthaw here as we head into the summer. Our pipeline looks pretty strong. Peter and Drew are up to full speed and cranking along. We have Peter Hearne just joined us, so we expect to get him up and going. And then obviously, the things that Charlie is doing will only enhance that. We did part ways with one OIR subsequent to the quarter end, so we're still at a total of three OIRs with the addition of Peter.

Adam Patinkin, Analyst

That's helpful to know. And then maybe just one final question on a slightly different topic, which is, I was just scanning through the 10-Q, after you guys released it, and noticed that you had a $1.1 million unrealized gain, and it looks like it's related to Limbach shares. And I noticed that the Limbach stock price was up a whole bunch today. Can you maybe comment on what that is? And what you plan to do with that? And obviously, anytime you see a million dollar gain that seems like a positive thing. But we'd love to understand a little bit more about what's going on there?

J.T. Fitzgerald, CEO

Yes, so that gain is related to warrants that we received in Limbach, as part of this back sponsorship that Kingsway sponsored way back in 2016 when Limbach went public via a reverse merger. There are $400,015 strike warrants in Limbach. They are available for cashless exercise and they expire in July. So, provided the stock price is higher than the strike price, we will cashless exercise for Limbach shares. Those shares will be restricted for six months, I believe. After that, we would be able to monetize that asset.

Adam Patinkin, Analyst

So have you already exercised that or how does that work in terms of, so I guess that's a really good thing that the stock was up 17% today? But yes, maybe if you could give a little bit more color on whether you've exercised it or not, or what your plans are?

J.T. Fitzgerald, CEO

We went through a process to test the cashless exercise to make sure that we had all of the processes understood and could do it timely. So we exercised a small portion of them in the last week or so. The thinking was we would wait to get through earnings and the potential that they would get added to the Russell and see what the momentum in the stock is heading into the expiration, so we will continue to monitor that with a view to maximizing the value. You get a little leverage by not exercising them if the stock price continues to go up, so we're keeping an eye on it.

Operator, Operator

And there are no further questions at this time. I would now like to turn the floor back to management for closing remarks.

J.T. Fitzgerald, CEO

James, did you have any questions that were sent via email? I want to make sure that if people submitted questions via email, that we had an opportunity to address those.

James Carbonara, Analyst

Absolutely. Yes, three did come in. The first question that came in was. Is there a targeted hold exit period for investments in the accelerator segment? Are these investments entered into with the expectation of holding indefinitely unless for a compelling external bid?

J.T. Fitzgerald, CEO

I think that what I would say is that our general preference would be to hold a great asset indefinitely. We don't go into an investment with a preconceived idea of an exit. That said, if we got a compelling external bid that allowed us to realize a return and redeploy that capital at a higher rate of return, we would certainly do that. But I think that our goal here is to build and compound with the great businesses that we're buying with sort of an indefinite horizon.

James Carbonara, Analyst

And the second question that came in was. Can J.T. or Kent comment on the run rate operating costs of the Holdco? What are those currently, and what level of consolidated EBITDA is required for KFS to cash flow?

Kent Hansen, CFO

Yes, thanks James. This is Kent. So, I think I'll talk about the Holdco runway run rate expenses. When I say Holdco, it means that the corporate team as well as the KSX team, and that hasn't migrated to one of the operations yet. If we look at sort of like the cash-only spend and not taking into account interest expense, because that's variable, and it's only a small part of our TruPs that are left. So, we're targeting the runway cash expenses, say $1 million to $1.2 million per quarter.

James Carbonara, Analyst

And the third and final question that came in online was. What would the management team need to see to engage in buybacks? What are the targets that would trigger them? It does close with saying looking forward to discussion and next week's investor day?

J.T. Fitzgerald, CEO

I think I touched a little bit on that in my presentation. Our goal would be to do buybacks in a way that is accretive to our view of intrinsic value per share. Any buybacks we do would be at a discount to that view. That is where we would be looking to repurchase shares.

James Carbonara, Analyst

That does conclude the questions that came in online. J.T., to throw it back to you for any closing comments.

J.T. Fitzgerald, CEO

Thanks, everyone for participating in the call this afternoon. I really appreciate your attendance. I look forward to seeing all of you next week in New York for our Investor Day. Thanks and have a great afternoon.

Operator, Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.