Kingsway Financial Services Inc (KFS) 2022 Q3 法說會逐字稿

Good day, and welcome to the Kingsway Third Quarter 2022 Earnings Call. (Operator Instructions) With 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. 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 risk factors detailed in the company's annual report, on Form 10-K, contained in the subsequent field reports on Form 10-Q, as well as in other reports that the company files from time to time with the Securities and Exchange Commission.

Please note, too, that today's call may include the use of non-GAAP numbers that management utilizes to analyze the company's performance. A reconciliation of such non-GAAP numbers to the most comparable GAAP measures is available in our most recent press release as well as in our periodic filings with the SEC.

Now I would like to turn the call over to J. T. Fitzgerald, CEO of Kingsway. J. T., please proceed.

Thank you, operator. Good day, everyone, and welcome to Kingsway Financial Services Q3 2022 Conference Call. This is our first quarterly call in many years. It's our aim to make these calls a permanent feature of our quarterly reporting going forward.

Today, I'd like to focus on a quick recap of our quarter, and then move on to what I hope will be a robust and engaging question-and-answer session. We had a lot of great activity during the quarter and subsequent to quarter end. So I expect there will be a lot to talk about.

Our results for the third quarter highlight the strength of our operating model and the progress we are making toward our stated organizational priorities. In each of my annual shareholder letters, I have reiterated the strategic priorities of the company.

In the past several months, we have made significant headway on advancing these goals. One key priority is a focus on strategic capital allocation to create long-term value for our shareholders.

There are 3 pillars to this objective. First, we aim to grow our portfolio of cash flow positive operating companies. During the quarter, we sold PWSC for $51.2 million in cash, with net proceeds to Kingsway of $37.2 million. While this may seem contradictory to our goal of growing our portfolio of great companies, we feel it was a prudent capital allocation exercise. We sold a great asset for a nice price. We can now redeploy that capital in the pursuit of acquiring other great businesses as well as reducing our debt, which we'll cover a little later on.

Subsequent to quarter end, we acquired CSuite Financial Partners in an all-cash transaction for $8.5 million. However, we believe we will be able to recapitalize the loan we took out for the Ravix acquisition in the near future in order to recoup some of that cash paid. CSuite is the second such acquisition completed under the Kingsway Search Xcelerator Program, and will be part of our KSX reportable segment.

The Kingsway Search Xcelerator is our entrepreneurial framework for growing through acquisitions by backing talented young managers. Timi Okah began as a searcher in the Xcelerator program and now run Ravix as its President and CEO. Under his leadership, Ravix has been highly successful in its first year, generating more than $2.9 million in operating income and more than $3 million in non-GAAP adjusted EBITDA, and achieving nearly 90% of the earn-out related to his gross profit targets, which we have accrued. Timi is further growing this business with our acquisition of CSuite Financial Partners.

CSuite fits our acquisition criteria as a business with recurring revenue, low working capital demands and impeccable reputation in its industry and a loyal customer base. Based in Manhattan Beach, California, CSuite is a national financial executive services firm providing financial management leadership to companies throughout the United States. Importantly, CSuite's offerings are highly complementary to Ravix and broaden the scope of services these entities can offer.

CSuite and Ravix can each go to market as a one-stop shop of services for clients.

For the 12 months ended July 31, 2022, CSuite had $9.4 million of unaudited revenue, $900,000 of unaudited U.S. GAAP income before income taxes and $1.8 million of unaudited non-GAAP adjusted EBITDA, making it immediately accretive to Kingsway.

Another pillar of our capital allocation focus is to improve our capital structure. We continue to strengthen our balance sheet through delevering. As previously announced in August, and then subsequently in September, we made substantial progress towards eliminating our trust preferred debt instruments or TruPs debt, as we call it, which is described as subordinated debt in our financial statements.

By entering into option agreements to repurchase 5 of the 6 TruPs for $59.4 million, which represents 83% of the total outstanding principal and accrued interest of our TruPs debt, those agreements give us the option to purchase 100% of the holder's principal and deferred interest for 63% to 63.75% of the outstanding principal and the deferred interest as of August 2.

The option to repurchase a meaningful portion of our outstanding TruPs at such a significant discount is highly accretive to Kingsway and our shareholders. We estimate that at current interest rates of repurchase of 100% of the amounts currently under agreement would yield an internal rate of return in excess of 20%.

The final pillar of our capital allocation focus is to monetize our portfolio of nonstrategic passive investments and redeploy the capital. Through the first 9 months of 2022, we have generated proceeds of approximately $7.4 million through the sale of nonstrategic assets. This includes the September 2022 sale of our investment in the Flower Portfolio of properties, which netted $5.8 million in cash to the company.

Due to a one quarter lag in reporting for this investment, we will fully record this transaction in our fourth quarter 2022 financial statements.

We still have a few legacy investments that we view to be noncore to our business. As we move forward, we expect to monetize these investments at a price that would be beneficial to our shareholders. Additionally, we've always viewed our rail yard and [VA] hospital holdings, which are part of our leased real estate segment as vehicles to monetize some of our net operating losses, which totaled approximately $792 million as of September 30, 2022.

We continue to work on strategies that will allow us to sell these assets at valuations that would be beneficial to our shareholders. If we are able to sell these assets, along with our nonstrategic real estate holdings, we expect that the debt associated with these assets would no longer be carried on our balance sheet.

Debt associated with our real estate holdings, which is nonrecourse to the company, totaled $199.6 million or 70% of the total debt on our balance sheet as of September 30, 2022. We believe this nonrecourse debt has created some confusion about our balance sheet, which, in turn, has been an overhang to our equity valuation. If we were able to sell these assets, we would generate cash while significantly delevering our balance sheet and making it easier to understand.

And finally, another stated priority we are highly focused on is attracting, developing and retaining world-class talent. During the quarter, we welcomed Drew Richard to the Kingsway Search Xcelerator program. Drew is a graduate of West Point and Harvard Business School, and prior to Kingsway served as a manager at Chevron.

With the addition of Drew, we currently have 3 very talented early career professionals that are actively searching for acquisition targets that fit our defined set of criteria, businesses that are capital-light, have recurring revenue streams and a sticky customer base.

Ideally, we are targeting 2 new acquisitions per year that will generate annualized non-GAAP adjusted EBITDA in the range of $1.5 million to $3 million apiece.

I'll now turn to Kent for a review of our financial results. Kent?

Thank you, J. T. As management, we focus on the following key metrics: net income, non-GAAP adjusted net income, operating income and non-GAAP adjusted EBITDA.

As you may know, the legacy investments and debt create complexity in our financial statements. Therefore, we use these non-GAAP metrics to help focus on the economic drivers of our business. Our net income was $37.6 million for the third quarter. This compares to a net loss of $226,000 in the year-ago quarter and a net loss of $2.4 million in the second quarter. Non-GAAP adjusted net income was $2.6 million for the third quarter compared to non-GAAP adjusted net income of $2.1 million in both the year-ago quarter and in the second quarter.

Significant items impacting the 2022 third quarter were the following: $26.4 million related to the sale of PWSC after taking into account transaction costs that are included in operating expenses and taxes arising from the sale; a $13.5 million unrealized gain on the value of our trust options, which we hold on our balance sheet as an asset of $15.8 million. These options are considered to be derivative instruments for accounting purposes, and we are required to mark these to fair value.

A $2.5 million loss on disposal of discontinued operations, net of taxes. When we sold Mendota in 2018, we provided certain indemnities for claims outstanding as of June 30, 2018. Based on new information provided during the third quarter, we concluded that the maximum amount under the indemnity was probable. Any cash required to be paid is currently held as restricted cash and no payments are due under the indemnity until late first quarter 2023. Also a $1.8 million loss on change in fair value of debt. We hold our TruPs debt at fair value on our balance sheet. Each quarter, we update the fair value, and the change that is not attributable to instrument-specific credit risk is recorded in our statement of operations.

And finally, a $1.5 million gain on change in fair value of real estate investments. As J. T. mentioned, in September, we sold the real estate underlying our Flower Portfolio. While we received the cash in the third quarter, given we report the results of Flower on a one-quarter lag, we recorded an unrealized gain in the quarter. This will be recorded as a realized gain in the fourth quarter.

For the third quarter, our combined operating income for extended warranty in KSX was $3.2 million compared to $1.4 million in the prior year quarter and $3.8 million in the second quarter of 2022. However, excluding the results of PWSC which we sold in July of this year, pro forma operating income was $3.3 million for the third quarter compared to $900,000 in the prior year and $3.1 million in the second quarter of 2022.

As a reminder, our 2021 third quarter results were impacted by a $1.9 million charge arising from our finalization of our PWI purchase accounting.

Pro forma non-GAAP adjusted EBITDA for our extended warranty segment was $2.8 million or 15.7% of segment revenue compared to $1 million or 6.4% of segment revenue in the year-ago quarter. IWS, one of our vehicle service agreement subsidiaries continues to perform well through its strong relationships with its credit union partners and continues to grow its volume of contracts sold.

For the quarter, IWS' cash sales, which is an indicator of current activity, grew by about 9% over the prior year. Our other vehicle service agreement subsidiaries, Geminus and PWI, continue to be impacted by the supply chain issues within the new and used automobile industry, However, their combined cash sales were only down about 2% from the prior year.

Earlier this year, we tapped [Brian Cosgrove,] the President of Geminus, to oversee both Geminus and PWI. He has already brought expense discipline to both businesses, is actively working on combining back-office functions and is overhauling our sales and go-to-market strategies. We have the utmost confidence in Brian's leadership, and we are excited about the future for both Geminus and PWI.

Non-GAAP adjusted EBITDA for KSX, which, as a reminder, is just our Ravix business as of September 30, 2022, was $800,000 or 20.4% of segment revenue in the third quarter of 2022. Timi continues to grow the business organically, and we've already seen referrals coming in from CSuite.

Now for a look at the balance sheet. At the end of the quarter, we had cash and cash equivalents of $48.6 million, an increase of nearly $36 million compared to the prior year-end. The increase in cash was largely driven by proceeds from the sale of PWSC and nonstrategic real estate holdings.

We ended the third quarter with outstanding debt of $283.6 million compared with $292.7 million as of December 31, 2021. We view our debt in 3 categories: bank loans, notes payable and subordinated debt. Bank loans were $21.8 million and $26.7 million as of September 30, 2022, and December 31, 2021, respectively. This is debt that is secured separately by either our extended warranty companies, or Ravix and the cash flows generated by those businesses is more than sufficient to service bad debt.

Notes payable were $199.6 million and $205 million as of September 30, 2022, and December 31, 2021, respectively. This debt relates to our various real estate holdings and is nonrecourse to Kingsway. The mortgage and additional mortgage, which totaled $177.2 million at September 30, 2022, relate to CMC, our rail yard in Texas.

The LA mortgage, $16.4 million at September 30, 2022, relates to our VA clinic in Lafayette, Louisiana. And the Flower Note, which was $6 million at September 30, 2022, relates to our Flower Portfolio that we sold in September and will no longer be outstanding beginning with our Q4 financials.

Finally, the subordinated debt was $62.3 million and $61 million as of September 30, 2022, and December 31, 2021, respectively. This is our TruPs debt for which we have options to repurchase 83% of the principal and deferred interest. This debt has carried at fair value on our balance sheet, and this also excludes the deferred interest that we continue to accrue on our balance sheet of $23.2 million as of September 30.

As J. T. mentioned, we are pursuing strategies to monetize the remaining assets that back the notes payable, and we have options to repurchase a significant majority of our subordinated debt. If we were able to successfully execute these then we would be able to reduce our September 30, 2022, outstanding debt by approximately $251 million or by 89% and our deferred interest by $19.2 million, all while retaining the operating income and adjusted EBITDA of our extended warranty and KSX segments.

Finally, cash from operations for the first 9 months of 2022 was $9.3 million compared to cash used in operations of $8 million in the comparable 2021 period. The 2021 period was impacted by a $10.6 million outflow related to the monetization of a CMC lease stream, but the corresponding inflow is shown in financing activities. Even after factoring this into the comparison, 2022 has been a strong operating cash year for the company as a result of our extended warranty and KSX businesses.

With that, I will turn the call back to the operator to open the call for questions.

(Operator Instructions) Our first comes from Adam Patinkin from David Capital Partners, LLC.

Well, first, I want to congratulate you guys on all the progress with Kingsway and especially in the simplification of the business. I think this is absolutely the right strategy. And I congratulate you on -- I know there's a lot more to go, but I congratulate you guys on all the progress so far.

And I also want to start off by congratulating you on your first earnings call. I think it's great that you're sharing the Kingsway story and -- for shareholders like myself, the transparency and the proactive communication is really appreciated. So I just wanted to start off by thanking you guys for that.

Thanks, Adam.

Thanks, Adam. Yes, you bet. Look, I'd like to say if the roles were reversed and you were the manager and I was the shareholder, I would expect the same. So I think having a consistent forum for our wonderful support of shareholders to come together and ask questions to management is really important.

Yes, that's great. And I agree 100%. So let's see, so I have 3 questions that I wanted to ask, and I'm going to ask them one at a time, if that's all right.

So my first question is on your business acquisition strategy. So when I speak with other shareholders about the company or prospective investors, oftentimes, the first question that I receive is what do these businesses have in common. You've got warranty businesses, you've got Ravix. Why do they go together?

So maybe as my first question, would you mind sharing what the commonalities are between the businesses that you're seeking to acquire and already have acquired, maybe what the business characteristics are that you're looking for and what your approach is in deciding which businesses to include in Kingsway's portfolio?

Yes, sure. Absolutely. Maybe a little bit of history. When I first came to Kingsway, I came because I was very interested in the extended warranty industry, not because I knew anything about extended warranty or had any experience in there, but I like the fundamental attributes of the businesses, the unit -- and the unit economics and the industry.

So that's -- I came with an opportunity to Kingsway, a business that we ended up acquiring. And I originally came to Kingsway to help build out the extended warranty segment. And what I liked about it and what we also like about the businesses that we're buying within the Search Xcelerator are kind of a handful of things. And I've outlined these in some of those shareholder letters in the past.

First, from an industry perspective, we're focused on companies in the industries that are large, sort of like greater than $1 billion or $2 billion of addressable market growing. And by that, we mean at sort of greater than 2x GDP and are fragmented.

And by fragmented, I think that we mean lots of competitive areas to hide lots of niches and potentially lots of acquisition targets. So -- and then within those industries, we're looking for companies that have a set of attributes. The first would be sort of strong profile of recurring or reoccurring revenue at high margin and low capital intensity, which is all of that sort of shorthand for saying businesses with what we deem to be sort of predictably high returns on tangible capital.

And so if you look at the acquisitions we've done in warranty, but also within the Search Xcelerator segment, we're looking for businesses in large and growing industries that meet those attributes, sticky customer base, low customer concentration, recurring revenue, high margins and low or no capital intensity.

That's great, and that's really helpful, and that makes sense in terms of maybe why some of these businesses would all fit in the portfolio.

So let's move to my next question, which is about how you think about Kingsway's profitability. So if I just take your adjusted pro forma EBITDA from warranty plus Ravix plus the CSuite acquisition, I'm kind of getting into the high teens millions per year, maybe somewhere between $16 million and $17 million. So you take the $3.6 million of pro forma adjusted EBITDA, you multiply that by 4, it's $14.4 million, you add CSuite to that with $1.8 million of EBITDA, and you're getting to kind of between that $16 million to $17 million range on an annualized basis. And then hopefully, there's opportunities for organic and inorganic growth from there.

Is that the right number to use or are there further adjustments that you think that I should be making? And just in general, how do you think about the run rate profitability of your operating businesses?

Yes, definitely, right? So EBITDA is sort of the internal metric that we use. Some people call EBITDA bull(expletive) metric. And I think that's true in businesses where there is some capital intensity. In our case, the depreciate -- there's very little depreciation, and the A is all amortization. It all comes from purchase accounting, it's not the wasting of an asset. So I think EBITDA is a very good proxy for pretax cash flow. In our case, because of our NOLs, also after-tax cash flow. So we use EBITDA as a proxy for cash flow.

In the warranty businesses, we use something internally called modified cash EBITDA. And it's a little different than what you would see in our financial statements, and we're not permitted to disclose it because it deviates from accepted revenue recognition rules under GAAP. But we think that it is a better proxy for economic value added in the period in a business where there is significant deferred revenue.

You can find the method for calculating that in our CIBC loan agreement, which was filed as an exhibit to our 2020 Form 10-K. And what I believe I can say, Adam, is that at warranty holdings, our total outstanding senior debt under the CIBC facility at quarter end was $16.7 million. And our senior leverage ratio under that loan agreement was 1.39x.

So you can do the math. That's sort of where we are on warranty. That's how we think about it, right? That's all I probably can say.

Ravix does not have deferred revenue, and so GAAP EBITDA works for our internal purposes, and the same will be true of CSuite.

Got it. That makes sense. If I'm doing the math, that's a little bit more than $12 million on the warranty side, plus, call it, 5 or 6 from Ravix, plus CSuite. So if I'm thinking about kind of this proxy for economic cash flow, maybe it's a little bit higher than I suggested, something like $17 million or $18 million and then hopefully, you'll be able to grow it from there. Is that fair?

I think that's fair, yes.

Okay. That makes sense. Great. And then my last question here is maybe more a qualitative question. So it really feels like you're building a flywheel where you're continuing to add these wonderful operating businesses, you're generating a lot of cash. That cash allows you to get more of the operating businesses and one leads into the other and the flywheel kind of runs faster and faster.

Can you maybe share a little bit about the opportunity that you have to deploy that capital. So maybe walk through what your strategy is for growing the operating profitability of your businesses which, again, I think is the key metric to look at. And maybe talk to a little bit of what the key competitive advantages are that allow you to continue executing on transactions like you have in the past, your warranty transactions, Ravix, CSuite? What allows you to do that where maybe sellers would find it more attractive to partner with you relative to others?

Yes. Okay. So I'll break that kind of into 2 parts. The first is the sort of the flywheel effect and what -- how can we -- what's the size of the opportunity set to continue to redeploy the capital.

So I agree there is a flywheel effect here, right? And as we grow -- obviously, right now, we're focused on getting out from under the TruPs debt and things. And -- but as we grow, a combination of the delevering of the businesses we own and the internal cash flow that they generate, ought to provide all of the capital that we need to continue to do more acquisitions, right?

And so that -- I think that's the flywheel that we were speaking to, right? So the business continues to grow organically and the acquisition without needing any additional capital. And so why do we think that we can -- or how can we differentiate to be successful with that?

So -- and what do we think the scale of that looks like?

So right now, we have 3 entrepreneurs in our Kingsway Search Xcelerator Program, actively looking for new acquisition opportunities. We hope to add to that. And I think kind of, at any given time, we would expect to probably have more like 4 or 5 people actively searching for new acquisitions. And that would probably translate into 2 to 3 acquisitions of lower middle market businesses that fit our criteria. That if history is to tell would sort of be generating in that $1.5 million to $3 million of EBITDA range.

And then I think like the final part is how do we differentiate, why do we think that we can be successful competing in what is a very competitive market for buying great businesses, right? And I think that comes back to Adam, just sort of some of the fundamental characteristics of what has made search or what's now more commonly referred to as ETA, entrepreneurship through acquisition, what made it successful?

And if you think about the universe of operating companies in the lower middle market, a large percentage of them are still founder-led owner operator. And a lot of those owner/operators are reaching the age where they're thinking about retirement and getting liquidity for what is often the largest asset that they have.

A lot of those founders are, one, very leery about selling to a strategic. They value their employees. They value their legacy, their brand, their products. And so they're a little nervous about selling to strategic acquirers for fear of what might happen to their employees and their -- and the thing that they build.

And then on the other hand, if you think about other players in the lower middle market, like private equity, typically private equity has to back an incumbent management team. And for a founder who wants to retire, it's not a perfect fit. And in small businesses, from private equities' perspective, it's also a pretty -- it's not a great return on time to buy a business and then have to go kind of reload the management team.

So that's where ETA, I think, is a very uniquely shaped key to solve the problem that a lot of founder-led businesses have, which is liquidity and management succession. So we like to think of it as, but we call it succession capital. We provide capital, and we provide management talent.

And I think that because of those 2 things, we can often differentiate and compete and win even in an auction process at a lower price because we have a really unique solution. When I say we, I mean, ETA broadly. And I think that's what's made it successful.

I think with -- specific to Kingsway, we bring an extra sort of level of confidence and in promoter of our entrepreneurs are backed by a publicly traded company. And so that just lends a lot of credibility in a deal process.

Our next question is Richard award from Freedom Capital Markets.

Firstly, Adam's actually -- Adam asked 3 questions, which touched on a number of topics that I wanted to bring up. So thank you for clarifying those things. And I do absolutely want to reiterate the transparency that you are showing in terms of having these earnings calls is very helpful and will ultimately, I think, grow the value of your enterprise over the long term. So I'm very glad to see that.

Just a couple of questions around the Xcelerator. And you highlighted that you have 3 entrepreneurs that are looking at opportunities. How are these opportunities coming to you? Are you guys proactively going out and looking for them or do you have small investment banks or individual business owners actually approaching you with these opportunities?

Yes. I mean, I guess the answer -- the quick answer is yes, but really both, right? And so we sort of run a two-pronged business development approach. So each one of the entrepreneurs has identified a handful of industries that meet our criteria. And then we use subscriptions to databases of private companies to mine for contacts -- high-level contacts at those companies, and we run a proprietary outbound search campaign in target industries, and that starts with outbound e-mails that show our criteria and our interest in the industry, snail-mail, follow-up phone call. So there's a very kind of time-consuming and robust effort to make direct contact with business owners in an industry, whether or not they're for sale in a way to try to engage with that owner in a non-process situation. But we also have a database of 3,000, maybe 4,000 intermediaries, everything from brokers and investment bankers to private wealth management, accountants, law firms that we do sort of a drip marketing campaign with that continue to stay on top of their radar if they have an opportunity that fits our criteria. So we kind of run it both ways.

Okay. And just a couple of questions on the retirement. Firstly, deleveraging the balance sheet, I think, is obviously -- I mean, saving the bleeding obvious, but that's key to success going forward for you guys. So you -- I just want to be clear. So you have effectively retired 5 of the 6 TruPs at an average cost of $0.65 on a dollar, including deferred interest. Is that accurate?

Generally accurate. Let me just -- maybe just kind of nitpick a little bit. We have options to retire the TruPs debt at -- on 5 of the 6 series for between 63% and 63.75% of the cumulative sort of outstanding principal and the interest that was deferred up until August 2, which is slightly less than what is showing as deferred on our balance sheet at 9/30.

Okay. And the -- in terms of the real estate assets have the nonrecourse debt on your balance sheet. Is there -- what is the process for executing a sale of those? Is that in process? Is that something you're thinking about? Is it something that you've engaged with potential buyers of?

I guess, Richard, maybe all I can say right now is that we're working on our strategies to achieve the best return we can, right?

Yes. All right. No, I understand that. And just finally, do you feel that you're in the position -- I mean I know that you guys are focused on running your business. But the fact that you guys are having the first conference call and discussing the results for the first time in quite a while, I think, can give you the opportunity to talk about your story more to investors. And you guys have a pretty narrow shareholder base.

Do you see that as a priority in terms of getting out and talking to your story, engaging with an IR firm? Or are you really just focused on growing the business first?

No. It's a great question, Richard. And I know we talked about this a little bit a month or so ago. We recently switched IR firms. James is on the call now. And so we are at the point now, in addition to doing these quarterly earnings calls, where -- like you said, we want to expand the group of high-quality shareholders at Kingsway. And by high quality, I mean, both long term, right, not focused on the short term, but really in it for the long haul and very engaged.

Do their work, understand the company, come to the call with great questions. And so we're in the process of developing a campaign, if you will, to try to get out and tell our story to what we believe would be a high-quality shareholder.

Yes, and Richard, I just wanted to clarify, we haven't repurchased any debt under the options yet. And those options expire May 2. So we have until that time to execute a repurchase.

Our next question comes from Christian Solberg from Sun Mountain Partners.

Kent, how are you?

Christian, Great.

Excellent. First question, churn is a really important metric. And obviously, it has many different definitions and ways to look at it. Are you able to provide any color on churn for your various businesses? The best way to look at it? What rough levels of churn are for those businesses?

Yes. So for everyone else listening, when you buy a recurring revenue business, one of the things that you want to focus on is how recurring is it? And do you have a leaky bucket or not? And so we think about churn a lot.

We don't publish it because there's a lot of different definitions for churn, right? And so we kind of look at it 3 ways. The first is just sort of logo churn. And by that, we mean like what's the number of your total customers that you lost in any given year as a percentage of the total number of customers you started the year with, right?

And we kind of look at this at the individual company level. But I'll kind of walk through that real quickly for you. A company like IWS, which has long-standing relations, like 15-year relationships with credit union customers that are both exclusive and contractual. They have basically no logo churn, like 1% a year. They might lose one credit union a year kind of thing where they switch or get acquired.

And kind of -- the result of that is kind of the next type of churn. We look at gross revenue churn, which is just sort of the revenue dollars that are lost from a lost customer as a percentage of the total revenue. And at IWS, we basically have -- even though they may lose 1% of customers, that customer is usually a small one. And so you have essentially no gross revenue churn.

And then I'll stick on IWS, just kind of walk through it. And then we look at net revenue churn, which is sort of the revenue from your -- the customers you maintained or kept as a percentage of their prior year revenue or -- yes, the prior year revenue, and to make sure that they are like continuing to -- you're growing those relationships. And so at IWS, we have negative net revenue churn, negative being a good thing. They're growing of like 8.7%.

PWI and Penn is a little bit different story, right? They have hundreds and hundreds of auto dealerships all over the country. And so their logo churn is actually pretty high. Dealers are always switching. These aren't exclusive relationships. They hop around to different product providers. And so the logo churn in those businesses is 30%, 35%. But a lot of the customers that they churn out are still the smaller ones. And so their gross revenue churn is anywhere from 8 to kind of high teens percent of gross revenue.

And then on a net churn basis, PWI actually has churned about 5% of its net revenue, which means its existing customers are doing less business this year. And I think we talked about that a little bit with some of the challenges in the used car market with inventory.

Penn, their net churn is basically 0. Their existing customers are doing about the same level of business that they did last year. And then at Trinity, which is our other sort of warranty business, and I'm talking just about the warranty side, which is where we focus on the churn metrics, logo churn is about 14%. Gross revenue churn is very small. The customers they lose, again, are small customers. So gross revenue churn about 2.5% to 3%. And then net revenue churn is negative, again, by about 8.5%. So their existing customers are growing this year.

So I think those dynamics really speak to the power of the attributes of extended warranty, this great recurring revenue profile with low to no gross and net churn.

That's great. That's really helpful for breaking it down like that. How about for businesses like Ravix and CSuite?

Yes, so Ravix, about 20% logo churn. Their gross revenue churn is about 6.8%. So I guess that just speaks to the logos that churn out are typically smaller. And then again, at Ravix, this year, the net revenue churn is actually negative 8.5% to 9%. So the customers that they retained are growing. I don't -- we haven't been able to do the full deep dive to dissect this the way that we like at CSuite, but I will report back.

Great. Well, it sounds like a similar type of business, so that would be...

I would expect similar.

Yes. Excellent. I've got 2 more quick ones. First is, how do you think about your internal hurdle rates when you're thinking about where to invest the incremental dollar of cash? So if you want to invest through the Search Xcelerator in a new deal or redeeming the TruPs or in share repurchases, how do you think about that hurdle rate?

Yes. Going all the way back to some of the first sort of goals we set internally, we set this sort of Big Hairy Audacious Goal of compounding capital at 20% per year for 20 years, right? That would be kind of a 50x type of thing.

That's not a forecast. That's an audacious goal. I think it informs how we think about our internal hurdle rate. And so when we're looking at investments, I like to think about an unlevered return on invested capital, and we use a 20% hurdle. And so not surprisingly, the calculated IRR on our TruPs repurchase, 20%, which is how -- one of the ways that we arrived at the percentage we were willing to pay as a discount, right?

And when we're buying operating businesses, just kind of quick math, if you're buying a business with no growth and we don't have leakage for tax, then we would be willing to pay 5x cash flow to hit that 20% unlevered target. We would be willing to pay more for a growing business, right?

And then within the Search Xcelerator, we also look at it kind of through an LBO model and look at a sort of a minimum 35% IRR target as well.

And so that the -- in the Search Xcelerator model, we're talking a 35% hurdle because those are levered returns?

I look at it both ways. I want a 20% unlevered, and that ought to equate to a 35% lever.

Yes. Okay. Great. And final one here, how did the buyer of PWSC look at the earnings in the business? Was it that modified cash EBITDA metric that you mentioned earlier?

Yes, and then they also -- so like PWSC, we sold it for $51.2 million, which you guys see coming through the income statement, kind of TTM at the time we sold it, it was probably around $2.2 million of EBITDA -- GAAP basis EBITDA. So it looks like we sold it for 25x kind of thing, right?

TTM to us modified cash was higher, about 3.3, 3.4. And then the buyer then -- so then -- so $51.2 million on $3.3 million trailing still a very juicy multiple. The buyer gave us credit pro forma for run rate, new business that we had acquired that we expected to come on, had already come on and then kind of annualize that. So I would say that they were thinking about paying 12x to 13x forward.

Yes, it's incredible. Are you seeing multiples in that arena with private transactions remaining that high in this environment? Or are you starting to see them comparable transactions starting to tick down?

I don't have any tangible evidence yet. I would -- and so -- and what I'm hearing is that there's a great sorting out going on. So deals that we're about to get closed or maybe on pause. And I don't know that things have reset yet, but I would say that there's going to be some movement.

That said, for really high-quality assets, like in the MGA space, like PWSC, there's still a lot of capital out there looking to be deployed. And so I don't -- obviously, as part of it's a function of the availability of leverage, but -- and the pricing of that leverage, but high-quality assets, I think, are still going to be pretty geared to people and there's still a lot of capital out looking for them.

So I hope they reset in warranty, right, so that we have some opportunities to buy good assets at prices we would be willing to pay, but I haven't seen it yet.

Got it. Very helpful. And it seems like it was a rational decision to sell PWSC and potentially -- hopefully, but put those proceeds into redeeming the TruPs. So Yes, great work, and thanks for putting together this call...

Yes, look, we were sad to see PWSC go. We had an amazing relationship with Tyler. He was really sort of the test case for the Search Xcelerator segment. He was our first sort of entrepreneur, young talented guy that we brought into a business that he didn't know to transition out management and run it and grow it.

And so our motivations were probably threefold. One was demonstrate the power of the model. Two, take advantage of some pretty aggressive inbound interests, and then three, we had an immediate use for that capital at returns in excess of our internal hurdle rate.

We now turn to James Carbonara, who has questions from e-mail.

So we did have some questions come in on e-mail. First one looks like a 2-parter. Can you talk about the synergies between Ravix and CSuite? And do you envision additional acquisitions over time for the Ravix team?

Yes, sure. So synergies, first of all, I hate that word, often paid for rarely materialize. So we definitely didn't go into the deal with synergies in mind. But that said, I think that they're very complementary businesses.

Maybe start with how they're different. As most of you know, Ravix provides outsourced accounting, HR services, including fractional CFOs. But a lot of additional accounting support at lower levels from controller, all the way down to bookkeeper. And their customers are predominantly portfolio companies of venture capital firms.

And Ravix often can't find CFO talent when a customer prospect is looking for an interim CFO or a permanent CFO resource. On the other hand, CSuite offers only interim CFO services and CFO placement. And they refer out all of the lower-level accounting from controller level on down and HR work at their clients to other firms and competitors of Ravix. And CSuite customers are often portfolio companies of private equity firms.

So the combination of these 2 businesses is very complementary and that each one of them can now provide a very comprehensive service offering across each one of their sort of industry verticals, venture capital and private equity.

And so any historical leakage from CSuite's lower-level accounting and HR referral work that they used to refer to other competitors will come to Ravix and then likewise, in return, the CFO placement opportunities that Ravix has been referring to other outside staffing firms can be referred to CSuite. So that's sort of the complementary service and sort of product and revenue opportunity.

On the cost side, Timi will be running both businesses. So I think that sort of eliminates one redundancy. But we don't really model cost synergies and approach the acquisition as if it was a stand-alone.

And then, James, I think Part 2 is additional acquisitions for Ravix. Did I get that right?

Yes. That's correct.

Okay. Yes. I think that's reasonable to expect. I mean, we don't have any view on timing. I think the first order of business here is to do a really good job of bringing CSuite into the Kingsway family of companies and making sure that transition goes very smoothly and Timi gets his arms around that group of folks and executes their growth plan.

And several months out to a year out after some delevering, we can look at other inorganic opportunities. I know Timi and Arthur, the former owner, have identified north of 200 potential acquisition targets. So it's certainly something they're thinking about. But in my experience, business is often -- more often than not die of indigestion, not starvation. So you got to get through the one that you just took down and then -- and be prudent and patient. So I'll leave it there.

Great. The next question is your press release mentioned how Ravix has achieved most of their earn-outs from this acquisition. Can you provide more color on how the earn-out works? And when the money is due to the seller, what targets do they have to meet?

Yes. So I think it's different -- I think it's important to distinguish between achieved and accrued, right? So the earn-out doesn't actually -- well, there was one -- there's two accelerated payment time lines where a portion of the earn-out can be actually achieved. The first one happened at the end of September. And we paid the first accelerated payment of $750,000 at the end of October.

And so -- but just coming back to a crude versus achieve, we have accrued through the third quarter about $4 million of a $4.5 million earn-out liability. And the earn-out is based upon the achievement of cumulative gross profit in excess of a hurdle over the 3 years after closing, with the maximum payout capped at $4.5 million. There's some math and a multiplier and things like that, but think about that.

So the gross profit that the company delivers in excess of a hurdle, and that hurdle was based on management's projections at the time of closing. So it'd just be paying for outsized growth in excess of what they were projecting.

Like I said, there are 2 intermediate accelerated payment dates. The first one was paid, $750,000. The next one is next October, and the sellers have an opportunity to earn an extra $375,000 if we're still in excess of the hurdle at that point. And then the final one is in October of 2024.

And at that time, whatever the maximum that we're able to earn would be $4.5 million minus whatever was paid in any accelerated payments. I don't know if I did -- if I fully answered the question there or not, James, you think you captured the e-mail question, I kind of lost the thread there.

Yes. No, it was a 3-parter. You hit them all. The next one says, Timi, the CEO of Ravix, was the first sort of CEO. How was the CSuite deal sourced? How did it end up with Ravix and not a stand-alone company?

That's an interesting question. Yes, that's -- it's actually sourced by another searcher on the Search Xcelerator platform, Charles Mokuolu, who I think we introduced at the Shareholder Day last year.

And I think maybe speaks to the power of the Search Xcelerator model to find new opportunities for portfolio of companies that we already have. Charles found this opportunity, developed a relationship with Arthur, the seller. And after digging in into CSuite, and the opportunity became pretty evident that this would be a really great fit for Ravix. And Charles handed that relationship with Arthur over to Timi. And Timi and Arthur hit it off and continue to progress towards the closing and now post-closing of working together. So -- but it was originally sourced through one of our other Search entrepreneurs. It's an interesting question.

Great. And the next one is as Kingsway grows, do you think the existing CEOs like Timi at Ravix will continue to make potential additional acquisitions in addition to the new search entrepreneurs?

Yes. I mean, obviously, the Ravix one is evidence of that. More broadly, I think that each one of the acquisitions we do under the Search Xcelerator has the potential to be a platform for follow-on acquisitions tuck-ins.

Again, right, that would have to be part of the original investment thesis. If it's a growth business that can use all of its capital to grow at really high rates of return, I think we would -- from a capital allocator standpoint, we would continue to allocate that capital to that business to maximize its organic growth.

But generally, there's often an inorganic growth thesis to a lot of these acquisitions. So yes, I think that's right. Like I said, in answer to an earlier question, our general feeling is that a new CEO should get into the business, learn the company and the industry, delever and also work on that organic growth before they start looking for new acquisitions.

And that might take a year or more, I mean, 2 years, and they hit that flywheel point where, through the combination of delevering and internally generated cash flow, they have now the resources to do a follow-on acquisition with no additional capital required. So that's kind of the model.

Got it. Okay. And then the next one is, can you talk about how Kingsway uses its NOLs against taxable income of the subsidiary companies?

No, this is like cash flow plumbing among all of our complicated structures. I'll flip that over to Kent. Do you want to...

Yes, I'll give...

How do we use our NOLs for our operating...

I give J.T. a break here, to have a sip of water or something. So, yes, so usually, when we talk about our NOLs, it's federal NOLs. We have just under 800 million available as of the end of September. And what we do is when we look at each of our individual companies that we own, we view each of those as sort of stand-alone entities for federal tax purposes. And so what we'll do is we'll calculate their federal tax to as if they were their own stand-alone company.

And so in that way, even though we do a consolidated return for Kingsway at the end of the day, we start with calculating tax at each of the subs. And so in that regard, we're much like IRS for our companies because if they owe money as a result of that, then they'll pay that up to the holding company.

But if they have some sort of tax benefit, then we'll remit that back. But by way of sort of remitting that capital up to hold co, it's sort of burning off those NOLs and monetizing those. And then as a side benefit is providing an additional cash flow stream for the holding company.

Great. And...

I would just add that those payments for the consumption of the NOLs and the cash back to Kingsway is allowed under our credit agreement. So it's a way to be "receiving distributions from our operating businesses, while being compliant with our bank agreement."

Because if they had been a stand-alone entity with a bank loan that they would have been paying that money to the IRS instead they're just paying it to the parent co.

Right.

Got it. Okay. And then the next one looks like a follow-up. Please remind us how long the NOLs left before they expire?

Yes. So much of the NOLs originated in the late 2000s and early 2010s. And so at that time, they had a 20-year life to them. So we actually have a schedule in our -- if you look at our last 10-K, we do schedule those out so people can see those. But I think it's -- it might be Note 15 or somewhere around there.

But they begin to expire in 2027. But 2029 is the big year where we almost -- where we have almost $500 million of NOLs expiring in that year. And then in 2030 and the following years, there's just various amounts that expire in each of those years through, I think it's about 2037, I believe.

Great. And it looks like there's just 3 more here. The first of the last 3 is the search entrepreneurs so far has very strong educational credentials. Can you talk about how you are identifying these candidates and what gives you confidence that you can continue to find qualified professionals?

Yes. Well, I hope we can continue to find them. Hope is not a strategy, obviously. I think the way that we source some is probably several different ways. First of all, the ETA entrepreneurship through acquisition, which I mentioned earlier, community and ecosystem is pretty close knit, right? And we remain active in that ecosystem, not only through the Search Xcelerator, but through Argo Partners, our sort of investment management firm that makes investments in search funds.

So we are sort of plugged in to that universe, so to speak. And there's a lot of word of mouth and information sharing there. We also actively recruit on the campuses of the top-tier business schools. So we recently did a lunch and learn at HBS, University Chicago, Northwestern, Wharton. And we've done that at Stanford and hope to do one here this spring. And we post the sort of the operator and residents job description on their internal job boards. So we get a lot of sort of inbound interests through those lunch and learns and presentations and through the job postings.

And then there's just a lot of overlap in people's personal networks. So we get a lot of referrals from our existing OIRs. So Drew came to us through Tyler. They both went to West Point. They both went to HBS. Prospective searchers, people that are interested in doing entrepreneurship through acquisition often reach out to people that have a shared background and have been successful in ETA to get the low down, and that often ends up in being a referral into our program. And I think we've got something that is a little bit differentiated within the broader universe of ETA.

It doesn't mean we're better, but I think we're unique. And for the right person, I think Kingsway is a really good model, and so people tend to gravitate towards it. And there's just a lot of interest in ETA on business school campuses these days. It's become kind of a real thing that people want to do postgraduate school in early in their career.

Great. And last 2 here, first of which is a multi-parter. Can you talk about the process for financing the search business? What multiple leverage do you hope to place? And what is the condition of those lenders? Are the lenders open for business and are they being competitive on their terms?

Okay. So 3-parter here. So generally, we're targeting a 50-50 debt-to-equity capital structure. And we feel like this is the right balance. On the one hand, you make your equity sweat, right, the discipline through debt. While on the other hand -- and also enhancing your equity returns through leverage, while on the other hand, not introducing the risk of insolvency.

And so we think that's the right balance of discipline through debt and enhancing equity returns without somehow adding capital structure risk to the equity, right? And so what that means is we're typically, given the multiples we're paying, looking for like 2.5 to 3 turns of leverage. And thus far, and up and through what we're working on with Ravix, we've been able to get those kind of terms from traditional senior lenders on pretty attractive terms and pricing, right?

We have -- in our sort of Rolodex, if you will, although no one uses it anymore, several lenders that work with are familiar with us and/or the ETA space more broadly. And so we've got a handful of firms that we go out to and solicit term sheets.

And so I guess the third part is open for business and being competitive. I think yes, I think they're open for business and I think the terms are competitive. The pricing is changing, obviously, with rising interest rate environment. But for now, anyway, I can't predict what the future will hold, but they seem to be open for business.

Great. And the final question here is, can you talk about your pipeline for potential additional acquisitions?

Maybe break that apart into extended warranty and then the Search Xcelerator. I think I've touched on this a couple of times here to the questions, but I'll be more -- a little bit more.

So within extended warranty, as I said before, the universe of attractive candidates is actually pretty small. It's a large and fragmented industry, lots of companies, but the number of high-quality companies, in my view, is actually quite small.

And we do see opportunities, including several this year that Kent and I really spent a lot of time on. But they've either been not a great fit for us in terms of distribution channel or the product set that they're providing, service contracts on or probably more importantly, they're selling for valuations that are just a lot higher than what we would be comfortable with.

So that said, I suspect, given some of the new macro backdrop that I was talking about, Christian, in the higher interest rate environment, that there may be a period of sorting out here and then things may sort of trade at better multiples, that would get us sort of interested and excited and be able to hit our internal IRR targets.

But in any event, given the smaller universe of high-quality assets, I think it will always be somewhat episodic. Contrast that with the Search Xcelerator, each one of our -- what we call them the searchers, we call them OIR, operators and residents. But so each one of our OIRs maintains a very active pipeline of opportunities, and we are, at any given time, at various stages with dozens of potential acquisitions.

It's sort of like the 100:1 principle where if you want to end up with one great acquisition, you need to start with 100 opportunities at the top of the funnel. And so when Richard was talking about how you do the outreach, we're constantly talking to business owners, constantly reaching out to brokers and bankers and other intermediaries and still in that pipeline. And at any given time, I don't know how many NDAs, Kent what do you think?

NDA with 30 companies at a time kind of thing, it feels like?

A lot. Yes.

With the goal of there are no called strikes in investing. We're going to be disciplined and wait for a fat pitch and -- but we got to see a lot of pitches in order to see if that works.

Excellent. Thank you so much. Operator?

There appear to be no further questions in the queue. Do you have any closing thoughts at this time?

No, I really appreciate everyone that took the time out of their day to come in and listen. And for those of you who asked questions, that was really great and really engaging. Hopefully, you learned more.

And like I said at the outset, we're really excited to make this a permanent feature of our quarterly investor communication going forward and really encourage a great dialogue with our support of shareholders.

If anyone wants to follow up with questions from either me or Kent directly, happy to answer those and just reach out to me via my e-mail, which I believe is on the website or in our filings.

So sometimes people a little shy about asking questions in front of a group. So if you want to talk to me directly, don't hesitate.

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