Kingsway Corporation (KFS) Earnings Call Transcript & Summary

Welcome to the Kingsway conference call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, James Carbonara with Hayden IR. You may begin.

Thank you, operator, and welcome once again to Kingsway conference call to discuss the acquisition of Digital Diagnostics Imaging, Inc., or DDI. With me on the call are J.T. Fitzgerald, Chief Executive Officer; Kent Hansen, Chief Financial Officer; and Peter Dausman, the incoming CEO of DDI. 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 differ materially from those contemplated by those forward-looking statements. 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 as well as 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 metrics that management utilizes to analyze the company's performance. A reconciliation of such non-GAAP metrics to the most comparable GAAP metrics is available in our periodic filings with the SEC. Now I'd like to turn the call over to J.T. Fitzgerald, CEO of Kingsway. J.T., please proceed.

Thank you, James, and welcome, everyone, to the call. We're pleased to announce today the acquisition of Digital Diagnostics Imaging, Inc., or DDI. DDI which is headquartered in New Jersey, is a provider of fully managed outsourced cardiac monitoring telemetry services to long-term acute care and inpatient rehabilitation hospitals throughout the United States. Their business enables remote access to client hospital telemetry systems from an outsourced monitoring station so that a patient's ECG is always under watch. The company has been operating for over 10 years and currently has a presence in 42 states. DDI has established itself as a trusted partner to its customers through its focus on a dependable, high-quality service offering, and our focus will be to support the company's growth while it continues to deliver exceptional value to its customers. We are delighted to welcome the DDI team to the Kingsway family. This is our fifth acquisition in the Kingsway Search Xcelerator Program, which, as a reminder, leverages the proven entrepreneurship through acquisition framework to partner with talented entrepreneurs and support them to acquire and build outstanding businesses within Kingsway. These acquisitions must satisfy a disciplined set of criteria. Specifically, we seek targets in growing industries with an established recurring customer base with low attrition, strong margins and proven business models with low capital needs to support their growth. Our ideal target as a founder operator who is looking to transition into retirement and generates between $1.5 million and $3 million in adjusted EBITDA. DDI fits these criteria to a tee. Peter Dausman is the Operator-in-Residence responsible for this transaction and has recently transitioned to the role of CEO of DDI. Tom Corney, the business founder of DDI, will support Peter in a transition period of up to 12 months. We'll hear from Peter in just a bit. We believe that Peter's background makes him uniquely well suited to run DDI as a graduate of the U.S. Naval Academy with a degree in Systems Engineering and as a graduate of the prestigious Navy Nuclear Power School. Peter spent the first 8 years of his professional career implementing safety and operational excellence programs in the military and in private industry. A central part of Peter's role in the nuclear industry involved using the Department of Energy's human performance manual to drive reductions in human error in critical nuclear safety environments. Importantly, this human performance manual is the exact same manual that the medical industry uses to reduce human error in hospitals. And so he will be able to directly rely upon this experience in managing high reliability telemetry services at DDI. A fun fact about Peter, in addition to his professional pursuits, he was also the concertmaster and first chair violinist for the U.S. Navy Academy Orchestra. We are very excited to announce this acquisition and look forward to continued growth at DDI under Peter's leadership. Importantly, DDI meets our predefined criteria as it operates in a stable and growing industry with solid demand. We're eager to bring the business into our portfolio and expect it will be immediately accretive. I'll turn the call over to Kent for a review of the financials, and then we'll ask Peter to share more about the business and its prospects.

Thanks, J.T. For the 12 months ended June 30, 2023, DDI reported $4.2 million in unaudited revenue and approximately $1.8 million in unaudited adjusted EBITDA. Based on our purchase price of $11 million, the valuation represents approximately 2.6x revenue and approximately 6.1x adjusted EBITDA. The business has delivered operating margins in excess of 40% in each of the last 2 years. DDI has a bit more fixed assets than our normal acquisition profile, having just under $1 million invested in patient monitors net of depreciation as of June 30, 2023. Future CapEx is expected to be used for monitor purchases for onboarding new customer hospitals or expanding capacity at current customer hospitals and is expected to be between $100,000 to $200,000 per year, depending on the pace of growth. The business was acquired in an all-cash transaction comprised of $5.4 million in cash on hand and borrowings of $5.6 million provided by Signature Bank of Illinois, for a total purchase price of $11 million. Terms of the loan included an interest rate of prime plus 0.5% with a floor of 5% and is amortized over 6 years with the first year being interest-only. And there is also a revolver for additional borrowings of up to $400,000. The long-term borrowings are nonrecourse to the Kingsway parent and are secured by the assets and cash flows of DDI. I'll turn the call over to Peter now for more details about the company and the industry. Peter?

Thank you, Kent. As J.T mentioned, Digital Diagnostics Imaging, Inc. is an outsourced cardiac monitoring service provider for hospitals. They provide 24/7 cardiac monitoring specifically for moderate-to-high acuity inpatient settings, and those are inpatient rehab hospitals and long-term acute care hospitals. Geographically, DDI's customers are spread across 42 states. They have a customer in Puerto Rico as well, and they provide these services from a single control center facility in New Jersey. The company has been operating in this unique niche for over 10 years. DDI is strategically headquartered in Wall, New Jersey. It leverages its proximity to the New York City Metro area for recruitment of ECG staff. It ensures a high level of quality in the service it provides by keeping shift lengths to no more than 8 hours. This is attractive to ECG techs who may be accustomed to longer 12-hour shifts in a traditional hospital setting. Currently, the company's operational space is at approximately 30% to 50% capacity, and that creates an opportunity to optimize the operating leverage and room for additional growth. There are approximately 1,500 long-term acute care and rehabilitation facilities in the U.S., and DDI currently services only a small fraction of that target market. Rehabilitation hospitals have not historically provided cardiac monitoring. So adding outsourced monitoring ensures continuity of care so that the patient does not have to be moved to a setting where they do require a monitor. DDI's monitoring services are viewed as an improvement, both in terms of standard of care and against ambulatory costs. In long-term acute care hospitals, almost all reimbursement codes require ECG monitoring. Without it, these hospitals are not reimbursed. The dynamics in both rehab facilities and hospitals create [indiscernible] for demand and provide attractive unit economics for DDI services. Furthermore, the industry backdrop and regulatory environment is stable with no clear disruptors on the horizon. ECG technology is expected to continue to be the sole method for predicting and diagnosing heart-related issues for DDI's core markets with no changes with biomarkers or any other alternative technology. DDI is the only qualified vendor in its core markets. Its commitment to customer service is evidenced by its high revenue retention rate and its low customer churn. As a result, the company has experienced impressive growth with revenues growing at greater than 20% CAGR and strong EBITDA and free cash flow margins. In summary, I'm extremely eager to lead DDI. DDI sets the standard in its market, the operational and financial fundamentals are solid, and there is tremendous opportunity for growth both in our niche and on a macro level. Our hospital customers continue to seek these outsourcing opportunities because of the immediate benefits that come from entrusting a dedicated service provider, the improved quality of care, higher continuity of care, higher diagnostic accuracy, significant cost savings, but most importantly, the unburdening of their medical staff. So the doctors and nurses on-site can focus on achieving the highest quality outcomes that make a real difference in people's lives, which is what this is all about. Now I'll turn it back to J.T for closing comments.

Thanks, Peter. The acquisition of DDI is yet another milestone in the evolution of our Xcelerator Program. We are extremely excited to partner with the DDI team and support them in our decentralized operating structure. DDI is a fast-growing company with attractive economics, and we believe it will further enhance the value of Kingsway for our shareholders. With Peter transitioning out of his role as Operator-in-Residence and into his new role as CEO of DDI, we still have two OIRs that are continuing to seek and evaluate additional M&A opportunities. We are also in active conversations with many more talented entrepreneurs who have an interest in joining the KSX program. While there is no certainty around closing another deal or the timing, we remain encouraged by our OIR's outreach efforts and the activity we are seeing in the market. We'll move into Q&A now. And if there are any questions afterwards, please feel free to reach out to James at Hayden Investor Relations to schedule a call. Operator, please open the lines for Q&A.

Absolutely. At this time, we will be conducting a question-and-answer session. [Operator Instructions] The first question comes from Adam Patinkin with David Capital.

Congratulations on this transaction. It's really exciting to see another deal.

Thanks, Adam.

So I have 3 questions that I wanted to ask. So let me jump in with the first one. So the first one is for Peter. I'm wondering if you could talk a little bit about how the deal was sourced? And alongside that, I think it would be helpful for me and other investors who are shareholders of Kingsway, if you could talk a little bit about your specific search process? Because I know you've been [indiscernible] I believe you joined in the middle of 2021. So it's been an almost 2.5 year search process. And I know, I think the goal that Kingsway has [indiscernible] a little bit shorter than that. And so I'm wondering if you could just talk through a little bit your experience within the Kingsway Search Xcelerator. Maybe were there other deals that you looked at, how you ended up coming to this one? And if you can just comment about any lessons learned in that process as well for ultimately achieving a good deal?

Absolutely. So just some background, a year into the search, we got pretty far down the line with the Fire Inspection deal, and we ended up backing out of that deal because it ended up not being what we originally thought, specifically in regard to its recurring revenue profile. We probably could have proceeded with that deal, but we made the decision to be disciplined investors and wait for something that's a better fit. And that's directly related to the advice that we give future searchers is when you start off to develop a rigid set of acquisition criteria that makes sense, sticking to that criteria, and it may be hard in the short run to turn down a lot of opportunities that may not be the best fit, but you'll be glad you waited for that ideal set. And this diligence took 7 months, and that was largely indicative of the diligence requirements, understanding the space and the business.

Got it. And can you maybe expand on that a little bit? So how did you come across the business? And how did you eventually decide that this one was the right one for you and get it over the line?

Absolutely. So this deal was actually a brokered opportunity. However, almost from the beginning, that relationship transitioned to a direct relationship with the seller CEO. And from the beginning, I worked with the CEO to understand the business. We also conducted a thorough customer and market diligence, interviewed over 20 industry participants, including cardiologists and hospitals to AI and wearable experts at software and hardware manufacturing companies. We also spoke to current customers of the business.

Got it. And in terms of, was it a competitive bid process? Or was it essentially you guys in there alone? Or how did you work that? Or how did that play out?

It was a competitive bid, and we believed at the beginning that it was very competitive just in terms of the amount of interest in the business. I think the seller saw an overall fit with Kingsway. Our long-term hold model, combined with our search-fund model is ideal for CEOs and founders who may want to transition, but still want to maintain the legacy of the business.

Got it. That makes a lot of sense. I guess that's the search model in action. Can you maybe then, moving to my second one, I'm sorry, I know there were a couple of add-on questions there. But can you maybe talk about what the competitive mode is to this business? Or any advantages that it may have that are important for investors on the outside to kind of understand what allows this business to be successful? And why aren't there or maybe there are other companies like this competing in the same space?

Absolutely. So just to reiterate, so DDI is the only qualified vendor in this niche, which is cardiac motoring for those 2 hospital business models, which are long-term acute care and inpatient rehab. And that competitive moat is comprised, I would say, put it into 4 categories: number one, established assets at the customer sites in the form of the actual cardiac monitors, and that creates a certain level of stickiness. Number two, I would say the 10-plus year experience and expertise of the company and its processes that have been developed over time. Number three, I would say the switching cost to switch to another vendor. And then four, the market position. They are the clear market leader, and that was very clear when we spoke to current and former customers.

Got it. That's really helpful. Thanks for sharing that. And then maybe can you just share a little bit about your value creation plan for the business? So like with other acquisitions, my assumption is that you see some opportunities to grow The Kingsway is there to invest in the business and to maybe build it further off the great foundation it already has. It sounds like it's a really nicely growing business. I think in your comments, you were saying that it was a 20% plus grower. But I'm wondering what opportunities do you see to really invest in this business and take it to the next level so that shareholders can expect a decent return? And maybe another way to phrase it is, where do you see this business in 3 years and 5 years and 10 years from now?

Absolutely. So just some background on the market opportunity. There's a lot of current pipeline just in current hospital system customers. If all we did was execute on that current requested pipeline from the 2 largest customers, we would see a 40% revenue growth in the 12 months following the transaction. So that is a great initial indicator. And past that, DDI is currently in 150 hospitals in the core market. We estimate there's another 450 that are potential customers. So after we want to expand from the core and after addressing the needs of our current customers, we would continue to roll out to the rest of the core market, execute that rollout of new customers that we've identified and then we'd execute a strategy to more fully develop the sales function to expand.

Got it. What's the sales function that you need to change? Or what are the processes you need to change there?

That would just be hiring some dedicated sales staff and account management staff to manage the demand that we're seeing.

Got it. And that's not something that's already there within the business?

Right now, that's just me.

Got it. Okay. And then maybe I'll ask a final question, and then I'll hop off the line and that simply, when you look at the kind of growth prospects for the business and where you can take it, it sounds like hiring a sales force might be important, and it sounds like you have a great pipeline. It also sounds like there aren't really any other companies that do a similar thing. And so I assume that the growth plan is entirely organic? Or is this the kind of business where down the line, maybe there would be inorganic opportunities to grow this a little bit quicker?

That's exactly right. We really feel strongly about the organic opportunity. And we will be open to additional opportunities down the line, but that's very clear that we should start with that.

[Operator Instructions] We have a question coming from Michael Demaray with Baird Associates.

Congratulations again. In your script, you mentioned the fact that a lot of these hospitals do not have monitoring and don't monitor, but they need it for coding. Can you talk about that a little bit more and help us understand the customer need a little bit better?

Yes. So the core market for DDI, it really comes down to 2 end customer hospital business models. 60% of DDI's revenue is for inpatient rehab hospitals, and the remaining 40% are for long-term acute care hospitals. They also have a small percentage in surgical centers. For inpatient rehab hospitals, they have not historically provided cardiac monitoring. And so adding outsourced monitoring ensures that they can keep additional patients and beds longer at their facility versus having to transfer them to another facility. So that's important as it ensures continuity of care for the patient, and that leads to better medical outcomes. But it's also a cost reduction for the inpatient rehabs, because it's a direct elimination of ambulatory costs to move the patient to and from other hospital businesses. And so the services are looked at as an improvement against ambulatory costs as well. And then for the second segment, the long-term acute care hospitals, which is 40% of revenue, hospitals are reimbursed per patient by diagnosis and all of the reimbursement codes for LTACHs, 99% of them require ECG monitoring. So without the monitoring, you're not reimbursed for the code. So for the LTACHs, both the reimbursement requirement and higher quality of service at lower costs. And then for all customers, and this is an important element of the outsourced cardiac monitoring industry, one of the benefits of this is that you're un-burdening the hospital staff, the nurses and doctors so that they can focus more on the task at hand.

Okay. Great. And so the LTACHs, I assume that they're doing this already themselves, but they're just going to outsource it? Is that a wrong assumption or is that correct? I mean or else they can't get reimbursed?

That's exactly right. So they have systems installed at their facility, and they have a staff sometimes in the form of on-site ECG techs, but oftentimes, the nurses are carrying that burden to do the ECG monitoring in addition to their normal load. And so by outsourcing that, you're unburdening the on-site hospital staff.

And from the businesses experienced in the past, have they been receptive to that sales proposition or that value prop? Or is this kind of a new market that you're looking at?

That, both the inpatient rehab and LTACH hospital markets are over 10 years old. The inpatient rehab in terms of current customer growth, that's growing at 20%. And the long-term acute care is growing at 100%.