Kingsway Financial Services Inc. (NYSE:KFS) Q1 2024 Earnings Call Transcript

Kingsway Financial Services Inc. (NYSE:KFS) Q1 2024 Earnings Call Transcript May 10, 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 First Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. 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 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 would like to turn the call over to JT Fitzgerald, CEO of Kingsway. JT, please proceed.

JT Fitzgerald: Thank you, Holly. Good afternoon, everybody. And welcome to the Kingsway earnings call for the first quarter of 2024. It’s only been a short time since our last earnings call in March, so thank you all for joining us again today. We finished the first quarter of 2024 with financial results that are largely in line with our expectation expectations, particularly in light of current market conditions that are impacting certain of our operating entities. Most importantly, our strategy and investment thesis remain, the same execution at our operating businesses while growing through acquisitions to deliver sustainable long-term growth and cash flows and generating attractive returns for our shareholders. Let’s first look at the conduct consolidated financial results.

For the first quarter of 2024, consolidated revenue was $26.2 million, roughly in line with the prior year quarter and adjusted consolidated EBITDA was $2.1 million, compared to $2.4 million in the year ago quarter. For the Extended Warranty segment and the KSX segment combined adjusted EBITDA was $3.0 million, compared to $3.5 million for the year ago quarter. In our Extended Warranty segment, our vehicle service agreement or VSA companies were again impacted by an increase in average claims expense and persistent macroeconomic conditions, namely tighter credit conditions and lower loan volumes compared to the same period last year, making for a challenging year-over-year comparison. Despite the revenue headwinds facing the industry, we were able to sell more contracts in Q1 2024, and at a higher average revenue per contract than last year.

However, the claims severity we saw moderating as we exited 2023 ticked back up in Q1 with higher labor costs driving higher claims expenses in the quarter. I would note that we didn’t see claims inflation really pick up until Q2 and Q3 last year. So we expect more favorable comparisons in the quarters ahead. All-in-all, challenges faced by the businesses in our Extended Warranty segment are moderating, and importantly, we remain focused on controlling what we can, improve in contract production and managing our costs. We are seeing positive improvement thus far in 2024 with performance in March, better than when we started the year, and importantly, we continue to expect improving financial results in 2024 compared to last year. Moving to our Search Xcelerator or KFX segment, higher revenues were primarily driven by the recent acquisitions of SPI.

and DDI in the second half of 2023. Ravix mix has continued to perform ahead of our original investment thesis, and in the first quarter, adjusted EBITDA improved compared to last year despite a slight decrease in revenue. Strong utilization and higher gross margins, combined with tight expense management delivered improved EBITDA margins in the quarter. At CSuite revenue and adjusted EBITDA were lower than prior year. However, gross margins continue to be strong and expenses are down from prior year. Looking ahead, the private equity and M&A environment is showing signs of reinvigoration and the team is bolstering its pipeline of new deals. While it is early in the year, we have begun to see business activity improve and both Ravix and CSuite have added business development talent to accelerate revenue growth.

And SNS consistent with market trends, the per diem business continues to perform well, while market demand for travel nurses has continued to be challenging. This has resulted in much lower revenue and adjusted EBITDA in Q1 2024 than a year ago. However, our travel business is rebuilding and industry intelligence supports our view that travel demand is stabilizing and long-term demand for nurse staffing will be strong given the projected persistent shortage of registered nurses over the next several years. We remain bullish on this business for the long-term. At Systems Products International, or SPI, the team is developing and executing a strategy to grow annual recurring revenue or ARR. Since acquisition, the company has signed eight new clients who are at various stages of implementation.

Once onboarded, these customers should provide a nice lift to ARR. Additionally, SPI is executing several promising strategies to increase penetration and grow market share in its core market. The company is also expanding its high-value partnerships to bring innovative solutions to their new and longstanding customers. At Digital Diagnostics Imaging, or DDI, revenue continues to grow both month-over-month and year-over-year, with several new hospital customer ads in the quarter. Q1 revenue exceeded the prior year by over 20%. EBITDA trailed the prior year slightly as the company is investing to support the growth they are seeing. DDI is focused on building the internal infrastructure and processes to scale alongside the high level of demand they are seeing, while also ensuring continued excellent levels of quality and care.

Now turning to KSX search activities. Growth through acquisitions remains central to our corporate strategy, targeting opportunities that deliver predictably high returns on tangible capital in large and growing end markets. While the timing of completing a transaction is challenging to predict, we are encouraged by the strength of our pipeline and continue to target the completion of two to three deals over the next year that can each generate $1 million to $3 million in annualized EBITDA. Given the recent performance noted above, our 12-month run rate adjusted EBITDA for the operating companies is now $16 million to $17 million. As a reminder, run rate is intended to capture the last 12 months EBITDA of the businesses we currently own, including those we’ve recently acquired.

It is not intended to be forward-looking. As a reminder, we currently have four highly talented operators and residents who are actively searching for opportunities and evaluating a number of potential acquisition targets. Our deal pipeline is the most robust that I have seen it, reflecting both the hard work of our OIRs, as well as the systems and processes we have put in place for effective sourcing. That, combined with an improving overall M&A environment, gives us confidence in our ability to execute our plan. We are also actively recruiting our next cohort of OIRs. We received interest from over 60 qualified candidates in the first quarter alone. As always, we will remain highly selective about who we bring into the program. We are focused on delivering long-term results for you, our shareholders.

We continue to make great progress. With that, I’ll now turn the call over to Kent for a deeper 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 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. Since JT already covered the results of Extended Warranty and KSX, I won’t rehash those now. I’ll start with our balance sheet and cash flows. At the end of the first quarter of 2024, we had cash and cash equivalents of $12.1 million, compared to $9.1 million at the end of 2023.

In Q1 2024, we drew $3.5 million on our delayed draw term loan and a $0.5 million on our KWH revolver. Given the delayed draw term loan expired at the end of February, we felt it prudent to have some dry powder on our balance sheet. Cash provided by operating activities from continuing operations was $0.2 million for the first three months of 2024, compared to cash used in operating activities of $22.8 million in the year-ago period. A large portion of the cash used in operations in the prior year was related to payment of deferred interest on the trust preferred debt instruments that we repurchased during the first quarter of last year and payment of deferred interest on the remaining trust preferred debt instrument that we did not buy back.

We had total outstanding debt, which is comprised of bank loans and trust debt of $47.1 million at the end of the first quarter of 2024, compared to $44.4 million at the end of 2023. Net debt decreased to $34.9 million as of March 31, 2024, compared to $35.3 million at the end of 2023. In March of this year, our securities repurchase program was extended for one year through March of 2025. During 2024, we repurchased 8,000 shares of common stock for an aggregate purchase price of approximately $100,000. To-date, the company has repurchased securities at a total cost of $7.2 million. That’s total under the program. In summary, the first quarter financial results were largely in line with our expectations. Our balance sheet remains healthy and we are poised for improving results as we progress throughout 2024.

Our Annual General Meeting of Shareholders and Investor Day will be held at the New York Stock Exchange on Monday, May 20, 2024. The AGM will begin at 9 a.m. Eastern, and the Investor Day presentation will begin at 9.30 a.m. Eastern. Will Thorndyke has agreed to join us for a fireside chat to share his thoughts on capital allocation, the power of long holding periods and his experience as an original and long-term investor in the Search fund ecosystem. Anyone interested in attending the in-person Investor Day, as well as the off-site cocktail reception, may RSVP by emailing james@haydenir.com. His email is in today’s press release. We hope to see you there. I’ll now turn the call back over to Holly to open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question for today is from Adam Patinkin with David Capital Partners.

Adam Patinkin: Good afternoon, guys. How are you?

JT Fitzgerald: Hi, Adam. Great.

Kent Hansen: Hi, Adam.

Adam Patinkin: Hey. So I wanted to ask a few questions about your pipeline of new deals. I think that on the call today, you guys expressed a little bit more enthusiasm than we’ve heard in the past about what your deal pipeline looks like and how robust it is and I’m wondering if you could share a little bit more color about that. So, first, maybe if you could share maybe what kind of KPIs you look at when you judge how your platform — how your pipeline is coming along. And then maybe if you could share a little bit more about kind of what systems and processes you’ve put in place, which I think you also alluded to or mentioned outright on the call, to help us just get a better feel for how you’ve improved your sourcing funnel over time?

JT Fitzgerald: Yeah. Sure. Happy to chat about that a little bit. I mean, I think that we try to break down our KPIs between what we call lead measures, which are things that are both influenceable by our OIRs and predictive of what we call our lag metrics and so our lead measures would be a combination of industries identified and qualified. And then first instance of outreach to primary business owners. So that could be email campaign, LinkedIn email campaign, snail mail or phone call. And then the lag measures would be NDAs executed, SIMs received. That would be on like broker and intermediary channel. Indications of interest issued or conversations with owners, and then ultimately, letters of intent executed into closed deals, right? So which sort of track. It’s no different than a typical sort of sales pipeline, but sort of bifurcated between lead and lag measures. And so on…

Adam Patinkin: And you’re tracking all of those data points numerically?

JT Fitzgerald: Yeah. Weekly, monthly, quarterly. That’s right, by OIR. And in terms of the systems, right, so we track all of that in a CRM system. It’s called HubSpot, but we — our NDA execution, we have an electronic platform that allows us to outsource some of the legal and track all of our NDAs. And we have internal repositories for handling all of that. Standard forms for NDAs and indications of interest, all of those kinds of things. And so just like lots of activity. I think, in the first quarter, we probably sent, we spooled up a new outsourced sort of sales development resource. And we’ll dig into this in the Investor Day quite a bit more, Adam. But I think in terms of like outbound first instance of contact with business owners in the first quarter, somewhere like 15,000 contacts.

Conversion rate that that translates into conversations with owners is low single-digit percent. But then, dozens and dozens of NDAs executed and on down through the funnel. So a lot of activity.

Adam Patinkin: Got it. And you would say that this is more activity or the most activity that you’ve had?

JT Fitzgerald: Yeah. There’s just a lot of structure and rigor around both tracking and monitoring. I think what gets measured gets done and the guys are really leaning into maximizing on the lead measures that are then hopefully predictive of the lag measure.

Adam Patinkin: Got it. And then that’s really helpful and I look forward to hearing more at the Annual Meeting. On the same topic, so then when do you, so I saw that Kingsway recently posted applications for new OIRs to apply to the company and I think you mentioned that you’ve had over 60 applicants for one seat. I assume that you’re posting those only when you feel like you’re getting closer to transactions or maybe if you can speak to obviously without giving away or saying that you’re going to deliver a transaction at any point in time. But when do you make the decision, hey, we need to go out and start recruiting for the next rounds of OIRs?

JT Fitzgerald: Yeah. I mean, I think part of it is ongoing, right? I mean, I think that we firmly believe and have an expectation that each one of our current guys is going to get a deal done in the normal time frame and so we all we want to be thoughtful about knowing that we want to bring new people on as they move into a President, CEO role that we want to backfill and don’t want to be sort of behind the curve and so it’s a lot of it is an ongoing process. So I wouldn’t read too much into the timing, but just know that I think it’s indicative of our confidence, right, that we’re still recruiting. And so that — we post those job those job descriptions and profile descriptions sort of quarterly. And then there’s kind of ongoing, a little bit more organic development that comes through other channels as well and we’ll speak about that at the Investor Day, too. That’s a big part of our process is our talent recruitment pipeline and process as well.

Adam Patinkin: Got it. So then let me ask one last question, which is I saw that you guys added Tyler Gordy to your Advisory Board for KSX. Can you talk about how you utilize your Advisory Board? So you’ve got, Tom Joyce and you’ve got Tyler Gordy and you’ve got Will Thorndyke on there. How did they interact with your OIRs? Is it mostly before a deal gets done? Is it mostly after a deal gets done? Are there — is there a regular line of communication? Is it more structured or informal? Can you just maybe talk through how you utilize that Advisory Board?

JT Fitzgerald: Yeah. So the structured part is we meet in-person full day three times a year. We met in March and that is a fairly structured day. We start with identifying some critical kind of operating areas for new Presidents. This year we focused on talent and talent sort of development and coaching as the President of a small company and we focused on time management for a new CEO, and we focused on investment underwriting and key criteria in Search acquisitions. And so on those three topics, Will took one of them, Tom took one and Tyler took one. And they kind of did a workshop on that. So that was a big chunk of the day. The rest of the day was split between operating updates, key challenges and issues for each one of our KSX CEOs, a little bit more of like a Board meeting, if you will, for each one of those operating companies.