Good day, and welcome to the Kingsway Third Quarter 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 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 JT Fitzgerald, CEO of Kingsway. JT, please proceed.

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 with 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 continue 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 Xclerator platform. And in October, we signed a definitive agreement to purchase 95% 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…

Thank you, JT. Before I get started, as a reminder, during the fourth quarter of 2022, we began executing a plan to sell 1 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 and 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…

[Operator Instructions] And there were currently no questions from the lines. I would like to hand the call to James Carbonara for any questions submitted via e-mail.

Sure. We did have a few questions come in on the e-mail. The first one is a 2-part question. It says, what is run rate EBITDA pro forma for the recent acquisitions? What is pro forma debt at KFS? And what is the run rate interest expense for the acquisitions and current base rates? I can re-read any of that, if necessary.

Okay. Yes, I think I got it. So first, run rate EBITDA pro forma for the recent acquisitions, I think Kent just walked through that. We have increased that to $19 million to $20 million range, and that's sort of the TTM EBITDA of the things we own, plus the things that we expect to own. Pro forma debt, net debt at 9/30 was roughly $20.8 million. And then pro forma, I guess, would include the new acquisitions. We borrowed an additional $5.6 million to help finance the DDI transaction. And we anticipate borrowing another roughly $3 million or so to finance the NICR acquisition. We didn't use any debt to help finance the SPI acquisition. So, I guess, if you add all of that up, $5.6 million plus $3 million plus $20.9 million would get you $29.5 million of net debt. And then, James, sorry, what was the final question -- part of the question?

Sure. It concluded with, what is the run rate interest rate expense for the acquisitions and current base rates?

Yes, I'll take that in reverse order. So current base rates, the DDI acquisition debt has an interest rate of prime plus 50 basis points. So prime is at 8.5% today, I think. So that would be 9%. And we would expect similar pricing on the NICR acquisition debt. So base plus spread. And that translates into an additional $500,000 of interest expense, give or take, at DDI. And somewhere around $270,000 or so of interest expense at NICR.

Great. And I do see we have a live question in the queue. Operator, can we take that before reverting back to these e-mail questions?

[Operator Instructions] And we have a question coming from Adam Patinkin from David Capital.

Congratulations on a nice quarter and all of the progress along the way. Great. So I have a few questions that I wanted to jump through. And I'm sorry, they're a little bit disjointed. So they're kind of unrelated to one another. So my first question is, I guess, the way that I think about the value of the company is based on what, I guess, you would call normalized earnings would be or what go-forward earnings would be. And so, I guess, what I'm trying to do is to track the trailing 12 months adjusted EBITDA number of $19 million to $20 million, which is a really helpful number to know. But then to try to look forward. And obviously, there's no guidance and you're not predicting. But I can do some of that math where I say, "Hey, this is where I think the growth might be in some of the acquisitions that you've made through the KSX Xclerator". The one that I'm a little less clear on is warranty. So you've talked about how maybe warranty has been going through a tougher period, but there is an opportunity for it to maybe revert to the mean, which I think is partly underway with the improvement in profits this quarter versus last quarter. You mentioned on the call like a $600,000 reduction. And so, if I annualize that, I get to between $2 million and 3 million of EBITDA above where you currently are, maybe in a more normal environment. So I'm not talking about a peak environment, but I'm also not talking about a poor environment. Is that the right way to think about it? Or how do you think about what kind of a normalized earnings power would be for the warranty business compared to where you have it over the last 12 months?

Yes, that's a great question. A lot of ways to sort of attack that. First and foremost, I would say, TTM is our sort of best predictor of the future in a more normal environment. Obviously, warranty isn't there right now, Adam. And so, yes, they have been very focused on cost rationalization and maintaining sort of very lean operating environment in what is a challenging both sales and claims environment. And so, the way I think about it is that, the cost reductions have essentially offset the reduction in revenue and that claims are in the quarter were sort of $600,000 higher than prior quarter. And as we move forward, we're going through a pretty comprehensive pricing exercise, both moving vehicles, mileage bands into different rate classes and things, and also taking price kind of across the entire book. And so, if those -- just kind of to play on your question here, as those price increases work their way through the book, and we're talking sort of mid- to high single-digit price increases, that would offset the claim severity. And if the operating expense improvements are sustained, then you get back to that sort of $2 million in improved profitability, right? That isn't guidance, but that's just me kind of working through the math the way I think about it.

Got it. That's super helpful. I mean, that's -- essentially that's what I'm trying to get at is to say, okay, in a more normal environment, and I'm confident the car market will head back towards that. Obviously, you can see the declines in car prices that are coming through with I think more to come. But in a more normal environment that I'm confident the business will do maybe what it's done in the past. And that's really helpful to know that maybe normalized warranty means that adjusted EBITDA number might be more like $22 million or $23 million or whatever it whatever it would end up being. Let's see, my next question is on the VA Lafayette. Can you give any update on that sales process?

Yes, Adam, this is Kent. So we continue to have it being marketed by a national broker. We've had a number of interests in that. And we just continue to -- the commercial real estate market has been a little bit challenging this year, but we continue to market it towards targeted people or companies that we think would be interested in that particular profile. It does have some debt on it that some people find attractive. Some buyers need some depreciation recapture before the end of the year. So it's still a very active market right now.

Got it. Great. That's helpful. And then my next question is just on your searchers. You've got 2 searchers going right now. And I know your goal is to bring on a couple more searchers. Can you maybe speak to both of those? How's it going with the current searchers? And how are they progressing in their searches? And then also, can you speak to your confidence level about attracting high-quality candidates to join as your next 2 searchers?

Yes, sure. Happy to talk about it. So Peter Hearne joined us in early May and then Miles just joined us at the end of the summer, mid to late August. And now as we've launched both Drew and Peter Dausman and soon to launch Davide, we've been actively recruiting and fielding inbound interest through concentric circles of networks of our current CEOs and OIRs talk to dozens and dozens, 60-plus candidates, really high-quality group of folks that we've been talking to. We're in pretty advanced stages with a handful of them. And the goal would always be to have 4 to 5 people actively looking for acquisitions in support of that 2 to 3 acquisitions a year. And so, yes, we're making great progress. Again, we want to maintain our discipline and really target folks that have that set of attributes that we think will make them both effective searchers, but more importantly, great CEOs and small businesses. And so, that work is ongoing. And with respect to Miles and both at Peter, early days, we've built a really nice set of processes around proprietary search, as well as intermediated search. They've got a handful of industries that they're very interested in and they're running that playbook. But I would always go back to sort of average time to close a transaction is probably 17 or 18 months. We've seen that here at Kingsway, right? Some searchers close very quickly, like Davide. Peter Dausman took him over 2 years to finally close a transaction. And so, we're going to support them, focus on what we say is, we derive our margin of safety from business quality. And so, really making sure that we maintain our discipline around the types of acquisitions we're pursuing. And so, they're doing all the right things and we're very optimistic about their prospects, but we also want to maintain discipline.

Got it. That makes a lot of sense. And then maybe this is a question I'm just going to ask 1 last question, which is maybe you haven't gotten there on this, but I just wanted to ask you. So as you acquire more businesses through the Kingsway Search Xclerator, your business is kind of mix shifting away from warranty, which is a wonderful business. But maybe a little lower growth business and towards some of these higher growth businesses and you think about something like the last 2 acquisitions that you've made here as being really growthier businesses. And that's going to be more and more of the Kingsway portfolio over time, which I think should be positive when you think about the business quality and positive about the earnings growth ahead of the company, just the mix in a way is a little bit growthier. How do you guys think about disclosures over time? In terms of disclosing where each of the businesses are in terms of their EBITDA or whether you prefer to kind of lump them all together or maybe get snapshots every now and then? I don't know if you guys have had settled on an approach there, but hopefully, there will be a lot more acquisitions to come. And I'm just trying to understand how you are thinking about sharing that information with the market. And I'll step off. That's my last question.

Yes, it's a great question, Adam. And right now we have a reportable segment that means certain things to under GAAP and things about how we manage those businesses. We think of them within KSX is all fitting a very similar profile and we're focused on the same types of things. And so, that becomes its own reportable segment. And then like today, we sort of unpacked within that segment the performance of each one of the individual businesses. And I would expect that we would continue to do that. Certainly also as we update our investor deck for Q3, break out that performance. And that would be something that we intend to do quarterly going forward. So people can see under the hood how each one of these businesses are doing within that Search Xclerator segment. And the same is true at warranty, maybe a different growth profile. We really like those businesses, combination of diversified contractual prepaid revenue and the investable float. Just maybe a slightly more mature market. So, I don't know if that fully answered your question, Adam, but we would certainly -- I don't think we'll have separate reportable segments within KSX, but we'll break them out and talk about the underlying performance of each one of our businesses every quarter and in the investor deck.

Yes, this is Kent. So I'll just add, the U.S. GAAP rules sort of are complicated when it comes to determining your reportable segments. And it's hard to determine if we'd be required in our filings to sort of break apart KSX that will depend on the profile of future acquisitions and how closely they are sort of related to each other. But internally, right now, we sort of look at KSX as a segment internally and the Board looks at it that way. And -- but we'll continue to try to give as much color as we can without also perhaps disclosing too much information that a competitor might pick up as well.

And there were no other questions from the lines. Back to you, James.

Yes, we have three more questions from the e-mails, actually 1 that just came in live. And if you do have a question, you're listening on the webcast, feel free to shoot it over to james@haydenir.com. Happy to get the question teed up. The most recent question that came in was on CSuite. It says, why was CSuite's pipeline disrupted during the acquisition process? Yes, that's all the questions for JT or Kent.

Yes, great question. So, Arthur, the seller, was the primary business development person at his company. And so, as he got deeply involved in the sale of his business, his pipeline of new business suffered a bit, I would say, just through distraction. And so, Timi has internally promoted someone at the company to transition Arthur out. He is now no longer with the company. He satisfied his 1-year consulting agreement. And Timi is now focused on rebuilding that pipeline and has been most of the year as well. But I would say, that the pipeline of new business activity took a backseat during the sales process because Arthur was selling his business and not focused on business development.

Got it. And the next one was, how does management feel about levered acquisitions given the current interest rate environment? What spreads are they able to get on acquisition debt currently?

Yes, I think we talked about the spreads on acquisition debt. Acquisition debt is sort of 50 basis points over prime on our most recent deal. And that's been pretty consistent in all of our acquisitions. And then levered acquisitions, given the current interest rate environment, I think it's important to point out that we have and will continue to use what we believe to be a relatively conservative amount of leverage in support of these transactions. So 3x senior funded debt-to-EBITDA or less at closing. And so, obviously, the cost of capital, the debt capital is higher. But interestingly, if you sort of model that out in our acquisition models, then because of the amortization of the debt and things, the impact on our modeled IRRs, if you go from sort of 6% debt cost of capital to 9%, only decreases by 100 basis points or so over 6 years. So, the higher cost of debt doesn't really have a big impact on the modeled returns. But as I've said before, we want to use a modest amount of debt to enhance those equity returns, but we're probably more focused on striking the appropriate balance on returns to our invested capital with adequate covenant headroom, right? And so, we want to give these operators plenty of cushion out of the gate. So we don't take on a ton of debt so that we're not in senior funded debt-to-EBITDA [PICLs] or fixed charge coverage ratio challenges. And so, the current rate environment at our level of leverage hasn't really impacted things.

Great. And the last question we have here is, does management have a lower bound for interest coverage, i.e., would they pull back on the acquisition pipeline if interest coverage fell below 1x or a different threshold? You may have just answered that, but just sharing that last one that came in.

Yes. Certainly, if interest coverage was below 1x, that would be not good. So we would absolutely pull back. But it is a good question. I think that it's important to point out that each one of our acquisitions is financed independently. And so, for instance, the DDI debt that we just used to support that acquisition is non-recourse to Kingsway, the parent company, and it is secured only by the cash flows and assets of DDI. And that loan facility has financial covenants that include that sort of maximum senior leverage ratio and a fixed charge coverage ratio of like 1.2x, which includes both principal and interest. And so, we would never get anywhere close to 1x interest coverage at the sort of lower bound. And we're kind of bound to a fixed charge coverage, which includes, again, both principal and interest of 1.2x. And when we model these things out, they have plenty of cash flow coverage on fixed charge.

Got it. Yes, I think that's it. I'm looking at the e-mail and I'm not seeing any additional questions in there. JT, had you finished answering the question?

Yes, that's great. I think if there are no more questions, we'll hand it back to the operator. Thank you, everybody, for participating on the call.

Thank you. This does conclude today's conference, and you may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.