Kingsway Corporation (KFS) Earnings Call Transcript & Summary

Welcome to the Kingsway Conference Call. [Operator Instructions]. 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 Image Solutions LLC. With me on the call are J.T. Fitzgerald, Chief Executive Officer; Kent Hansen, Chief Financial Officer; and Davide Zanchi, the incoming CEO of Image Solutions LLC. 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. 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 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.

Thanks, James, and welcome, everyone, to the call. As we disclosed in a press release, roughly 2 weeks ago, we purchased Image Solutions LLC for $19.5 million plus transaction expenses and a small working capital adjustment in an all-cash transaction, funded with cash and a $7.7 million debt facility. We will talk more about the transaction during this call and provide investors with an opportunity to ask questions about the transaction. We're in the process of closing our third quarter, and we will defer any questions about the financial results for the quarter to a subsequent conference call. So moving to the acquisition. We're excited to announce Image Solutions as our sixth acquisition in the growing Kingsway Search Xcelerator portfolio. As you know, the KSX segment is focused on acquiring service businesses with between $1 million and $3 million of EBITDA that satisfy our investment screening criteria specifically acquisitions must be within an industry with long-term secular growth trends with strong recurring customer relationships, high margins and an asset-light business model. Image Solutions demonstrates each of these characteristics. Since its founding in 2003, the business has grown through exceptional service to serve over 800 small and midsized businesses in the Southeast region. We are fortunate to partner in this acquisition with Davide Zanchi, who joined Kingsway last year as an Operator-in-Residence and has now transitioned to the role of CEO with Image Solutions. I'll now turn the call over to Kent for a review of the financial details, and then we'll ask Davide to share more about the business and the opportunities he sees. Ken?

Thanks, J.T., for the 12 months ended June 30, 2024, Image Solutions reported $9.8 million in unaudited revenue and approximately $3.1 million in unaudited adjusted EBITDA. Based on our purchase price of $19.5 million, the valuation represents approximately 2.3x revenue and approximately 6.3x adjusted EBITDA. The business has delivered EBITDA margins in excess of 30% in each of the last 2 years and demonstrates strong cash generation with limited capital expenditure or working capital needs. We acquired Image Solutions in an all-cash transaction comprised of $11.4 million in cash and $7.75 million in debt financing for a total of $19.5 million. The $11.4 million came primarily from the issuance of Class B preferred stock, proceeds from drawing on the existing KWH loan and cash on hand. On September 24, Kingsway issued and sold to accredited investors 330,000 shares of newly created Class B preferred stock with a liquidation preference of $25 per share for total proceeds of $8.25 million. The shares of Class B preferred stock were offered and sold without registration under the Securities Act of 1933. The issue had strong participation from members of our Board, management and the KSX Advisory Board. Key terms of the issuance include a fixed cumulative preferred cash dividend of 8%, conversion price of [ $9.50 ] per share, and redeemable by Kingsway on September 24, 2031, for the price of $25 per share. Refer to the 8-K we filed on September 27 with the Securities and Exchange Commission for further details of the issuance. Kingsway also chose to draw $4 million on its existing KWH loan, that's the loan secured by our extended warranty companies in mid-September, which consisted of $500,000 on the revolver and $3.5 million on the delayed draw term loan. The revolver is now fully drawn, and there's $500,000 unused on the delayed draw term loan. The $7.75 million of debt financing was provided by Avidbank in the form of a term loan priced at prime plus 50 basis points with a floor of 7.25%. The term of the loan is 6 years with a graduated amortization schedule and is nonrecourse to Kingsway. I'll now turn the call over to Davide for more details about the company and the industry.

Thank you, Kent. I'm pleased to have the opportunity to speak with you today and share additional context on how we sourced and evaluated Image Solutions. I'm happy to talk about the last 03 weeks since closing the transaction in the wake of the Hurricane Helene and also dive into the bright opportunity I see ahead for this great business. The company is headquartered in North Carolina, is a provider of IT managed services. It was founded in 2003 by a veteran in the IT equipment sales industry and initially served as a distributor of IT equipment to hospitals and small businesses in Western North Carolina. Since 2010, Image Solutions has expanded its offerings and now operates 3 business units: Equipment sales, service and helpdesk. Image Solutions is considered one of the largest IT service providers in Western North Carolina. They provide comprehensive IT services for both hardware and software to over 800 active accounts in the Southeast. But let me talk a little bit about the sourcing. In early 2024, I began an industry sprint focused on IT managed service providers. This highly fragmented and growing industry aligned well with Kingsway target investment criteria. It was supported by similar successful transactions in the search fund space can bolster my confidence in this thesis. During this time, I also engaged with many business owners and are operators to evaluate the MSP industry. Image Solutions was subsequently sourced through a sell-side broker process that involved multiple bidders. We believe that several factors contributed to our success. First, we recognized the strong fundamentals early in the process, specifically focusing on the rapidly growing MSP segment due to the company's legacy as hardware reseller. Second, Kingsway unique feature as a public company embracing an operator-driven approach enabled me to build a relationship directly with the seller and position ourselves as an attractive succession alternative. If we focus on the industry, Image Solutions operates in the rapidly expanding managed service provider and hardware-as-a-service sectors, both expected to see double-digit CAGR over the next decade. MSP services currently contribute about 30% of Image Solutions' revenue, with an impressive average growth rate of 25% year-over-year for the past 3 years. As companies increasingly outsource IT management to focus on core operations, MSPs are becoming essential for improving operational efficiency and remaining competitive. Image Solutions is well positioned to capitalize on this trend, offering not only MSP services but also comprehensive hardware-as-a-service solutions, which provide customers with both the equipment and the ongoing support they need. In the hardware-as-a-service model, Image Solutions integrates equipment sales and support into noncancelable 3- to 5-year contracts, driving steady growth with hardware sales increasing by about 10% year-over-year for the past 3 years. In combination of long-term service agreements and embedded equipment contracts create a reliable recurring revenue model, delivering both stability and predictability. In fact, Image Solutions has only 2% of revenue churn and has achieved high client retention, building a solid foundation for sustained growth and future expansion. In an increasingly competitive IT service provider industry, Image Solutions' ability to drive growth and maintain client loyalty positions it as a leader in the market, well equipped to capture future opportunities. So we talked a bit about the industry, let's focus on the diligence. The first thing that I did, I established credibility with the seller. It was supported by my own industry research in Kingsway support as an investor allowing us to transition to diligence, hence, allowed us to appreciate unique service mix and positioning that makes Image Solutions an ideal platform for the KSX portfolio. Image Solutions is a provider, as I said, of IT managed services with an impressive track record, enthusiastic client endorsement and growing pipeline of new business opportunities. Approximately 80% of Image Solutions' revenue is contractually recurring. I talked before about the low churn and strong margins with impressive historic organic growth. We're going to dive into this just in a few minutes. The business operates in a steady flourishing sector and geography. And we focus on growth and profitability, we focus on the most recent 3 years from 2021. The business has demonstrated a 3-year revenue CAGR of 12% and 20% annual growth rate in the past year. The company has consistently delivered 30% EBITDA margins. So multiple customer interviews and meeting with key suppliers, we were able to understand how Image Solutions helps build a platform into a critical component in their customer operations, consistently gaining wallet shares with new service expansion that further reinforces their profitability. The company historically focused on distributing IT equipment. However, as the needs of small business customers have evolved, we have implemented first, a hardware-as-a-service model, as I mentioned, supported by 3 to 5 years noncancelable and automatically renewable contracts with around 800 customers, but also, they offer an IT helpdesk service which is today the fastest-growing service line with about 25% year-over-year growth rate in the past 3 years. Image Solutions has grown their customers, demonstrating an exceptionally low churn rate. They were able to retain 98% of their revenue every year over the past 3 years and this gives us tremendous confidence in the ability to leverage this platform for future growth. I know that the closing corresponded with the 26 of September and the 27 of September, on Friday, North Carolina -- Western North Carolina was affected by the worst natural disaster in our lifetime. So I want to spend a few words on the impact that the Hurricane Helene had on the business. So let me start saying that fortunately, all 35 team members are safe, and no losses were incurred due to the damage from storm. The business is located on high ground adjacent to the Asheville Airport, it was able to maintain power throughout the storm and serve as a refuge for those in dangers. Just after a few days after the hurricane hit, Image Solutions was fully operational and ready to serve our customers. Looking ahead, we do not expect a significant impact on revenue, and we anticipate a full recovery by year-end, thanks to the contractual nature of our IT service and maintenance agreement. The only expected effect on revenue is a temporary deferral of installations. We have also seen some early wins because we were lucky, to be undamaged by the storm, we were able to outperform competitors in responding quickly and providing superior service, which has been key to securing new customers. Before I turn it back to J.T., I want to spend a few words on growth. While a few weeks have had some unexpected surprises, we remain excited when looking forward to the future of Image Solutions. As we look forward, we intend to leverage the Kingsway business system playbook by focusing on establishing processes, KPIs, and dedicated business development capabilities. Before doing that, however, I will spend time to learn about the business and to build the team so that we have the right people in the right place to then focus on medium and long-term goals. This will serve as the foundation for customer retention, new customer acquisition, and improving penetration of existing services into existing customers, and we will focus specifically on recurring revenue, MSP services. In the medium term, we see value creation opportunities through expansion of service lines within our customer base such as cybersecurity and cloud storage by focusing on scalable IT services, we can also expand the geographic serviceable area beyond our current geography. In the long term, we appreciate the highly fragmented nature of the IT service space and intend to evaluate additional opportunities for inorganic growth. I look forward to collaborating with the team to further advance the growth strategy and take Image Solutions to the next level. Now I'll turn it back to J.T. for closing comments.

Thank you, Davide. Great recap there. In search for acquisitions, we always expect 1 or 2 crises in the first year or so. You have stepped into a crisis on day 1 and have operated demonstrably well. So thank you for all of your tireless efforts around the clock in the last 3 weeks. Just some closing comments here. The acquisition of Image Solutions is yet another milestone in the evolution of our Xcelerator program, really excited about this sixth acquisition. Image Solutions is a very attractive business in a high-demand industry, and we're excited about the possibilities for the company under Davide's leadership and importantly, the value we believe it will return for our shareholders. With Davide transitioning out of his role as an Operator-in-Residence and into his new role as the CEO of Image Solutions, we now have 3 OIRs that continue to seek and evaluate additional M&A opportunities. We do plan to add additional OIRs to the team to backfill Davide and to support our acquisition and growth goals and are currently in active conversations with many more talented entrepreneurs who have an interest in joining the KSX program. More to come on that. As always, while there is no certainty around closing another deal or the timing, we remain encouraged by our OIR outreach efforts and the activity we are seeing in the market. And with that, we'll move into Q&A now. And if there are any questions afterward, please feel free to reach out directly to Kent or me or to James at Hayden Investor Relations to schedule a call. With that, operator, can you please open the phone lines for Q&A.

[Operator Instructions] There are currently no questions in queue. I'd like to turn the floor back to James Carbonara for any questions you may have via e-mail.

Thank you, operator. Yes, some questions did come in on e-mail. J.T., Kent and Davide. I'll try to avoid the ones that were already answered in the prepared remarks as some came in before the call and some during. Let's see, one of the questions is Image Solutions operates in the IT managed services market, what is the overall growth rate of this market? And has Image Solutions been gaining or losing market share?

Davide, do you want to take kind of the industry dynamic question here?

Yes. Yes, happy to. So Image Solutions is -- plays at the intersection between the managed service provider and the hardware-as-a-service industries. Both of those industries are expected to grow between 11% to 12% CAGR, so year-over-year in the next 10 years.