i3 Verticals, Inc. (NASDAQ:IIIV) Q1 2024 Earnings Call Transcript

i3 Verticals, Inc. (NASDAQ:IIIV) Q1 2024 Earnings Call Transcript February 9, 2024

i3 Verticals, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, everyone, and welcome to the i3 Verticals First Quarter 2024 Earnings Conference Call. Today’s call is being recorded, and a replay will be available starting today through February 16. The number of the replay is 877-344-7529, and the code is 418-4683. The replay may also be accessed for 30 days at the company’s website. At this time for opening remarks, I’d like to turn the floor over to Jeff Smith, Senior Vice President of Finance. Please go ahead, sir.

Geoff Smith: Good morning, and welcome to the First Quarter 2024 Conference Call for i3 Verticals. Joining me on this call are Greg Daily are our Chairman and CEO, Clay Whitson, our CFO, Rick Stanford, our President, and Paul Christian’s, our COO. If any non-GAAP financial measure is discussed in today’s call, you will also find a reconciliation to the most directly comparable GAAP financial measure by reviewing yesterday’s earnings release is the company’s intent to provide non-GAAP financial information to enhance understanding of its consolidated GAAP financial information. This non-GAAP financial information should be considered by each individual in addition to, but not instead of the GAAP financial statements. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements among others.

Regarding the Company’s expected financial and operating performance. For this purpose. Any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. You are hereby cautioned that these forward-looking statements may be affected by the important factors, among others set forth in the company’s earnings release and in reports that are filed or furnished to the SEC Consequently, actual operations and results may differ materially from those discussed in the forward-looking statements. Or finally, the information shared on this call is valid as of today’s date and the Company undertakes no obligation to update it, except as may be required under applicable law. I will now turn the call over to the Company’s Chairman and CEO, Greg Daily.

Greg Daily: Thanks, Jeff, and good morning to all of you on the call. We have some big and exciting things to discuss with you this morning. But first, I’d like to highlight the results of our first quarter of fiscal year 20 for revenue and EBITDA were both 7% higher in Q1 over the same quarter last year, and ARR. grew at 9%. We’re laser focused on nurturing recurring revenue streams such as SaaS and transaction-based revenue. Sometimes these comments, the expense of life license revenue, which you will notice is much lower this quarter. I’m sure many of you saw our disclosure yesterday as we are well along in the process to sell certain assets related to our merchant services business. Richard, Rick is going to give you a full rundown of the process.

And first, I will first I want to make a few points. First, our roots by deep and merchant services. We started this company and we knew the business well, we understood the power of consistent recurring revenue that could be unlocked when we add value to our customers and take care of them. We have built and acquired best in class technologies, attracted amazing customers and most importantly, assembled an incredible team. I’m extremely proud of the I. three merchant services business and what we’ve accomplished together. Second our merchant services capabilities have set the stage for us to build something very special in vertical market software. We’ve always believed in our scale and our expertise in payments gave us an edge. We’re not just looking for any buyer of our merchant services business that a long-term partner who wants to help us continue to unlock payment opportunities within our current software businesses.

Third, we’d like the opportunity of the sale because we believe it is beneficial to our customers, our employees and our shareholders. If we focus this narrowing of our focus to our core markets of public sector, healthcare and education. We will be better poised to capitalize on the expansive opportunities within Asia. Now I’ll turn the call over to Rick and he’ll provide you more details on the ongoing process. And then he’ll when he finishes, Clay will discuss our financial performance, and then we’ll open up the call for questions.

Rick Stanford: Thank you, Greg. Good morning, everyone. I’ll start by talking briefly about the process mentioned in last night’s press release and then cover M&A has previously announced. The Company’s Board of Directors has directed R3 management to explore the sale of certain assets related to our merchant services business. This decision was made after careful consideration by our Board with input from management and the company’s financial adviser and is consistent with the Company’s strategic focus on vertical market software. Consistent with this strategy, the Board believes that the sale of this discrete portion of our business and no other part of the business or R3 as a whole is in the best interest of the Company and its shareholders.

Merchant Services business includes all payment related assets, not tethered to proprietary vertical market software, including the associated payments technology. This is a leader in the market and we believe it has tremendous potential with increased attention and resources of external ownership is led by a highly respected industry veterans with decades of experience and their sales and technology teams are formidable and top-notch. This business has appropriate leadership, sales and support to operate on a stand-alone basis, and we are confident that it will attract be attractive to many potential buyers. The sale of the merchant services business would generate capital that the Company would expect to deploy to pay down debt and can be used with additional strategic application towards M&A in our three target verticals, our focus will continue to be growing our industry leading software businesses and public sector, health care and education, which we believe are the optimal platforms to deliver enhanced shareholder value over the long term.

Each of these verticals includes a large addressable market, a decentralized competitive landscape and is underserved by technology. We believe these businesses have significant opportunities for growth. Our Board has the benefit of input from management on our financial advisor has directed us to initiate this process solely to explore the sale of our merchant services business as the best path to create value for our shareholders as we explore the potential sale of the merchant services business. We will continue to fully support current payments clients and the payments technology platforms. Our clients should not be affected by this decision. And if the sale transaction does occur, it would be a seamless transition for them further, as part of any transaction, we would expect to execute an agreement for ongoing payment partnership with the potential buyer so that we continue to offer this value added integrated payment service that our customers expect from us after this call, three does not intend to make any further disclosure concerning these matters unless or until a definitive transaction agreement is reached or until three determines that additional disclosure is appropriate and warranted.

All the inquiries from potential third party purchasers. Concerning our merchant services business should be directed to Raymond James and Associates. Regarding M&A, we continue to look at opportunities over the last quarter for potential targets for acquisition. Most of them were in public sector with a few in health care and education. Our pipeline continues to be robust with Target Companies largely in public sector and health care verticals. I’ll now turn the call over to Clay, and he’ll provide more details on first-quarter financial performance.

Clay Whitson: Thanks, Rick. The following pertains to the first quarter of our fiscal year 2024, which is the quarter ended December 31, 2023. Please refer to the slide presentation titled Supplemental Information on our website for reference with this discussion. Revenues for the first quarter of fiscal ’24 increased 7% to $92 million from $86 million for Q1 in 2023, reflecting organic growth and acquisitions. Organic revenue growth for this quarter was a little above 5%. Revenues from software licenses fell to just $0.7 million for Q1 2024 from $1.2 million for Q1 2023, and an average of $2.7 million per quarter in fiscal ’23. As we have communicated in the past, software license sales are the most variable and difficult revenue stream for us to forecast.

It can be feast or famine on this line depending on customer schedules, particularly in the public sector. We have been deliberately replacing one-time software sales with recurring revenues such as SaaS and currently expect one-time software sales to be $5 million lower in fiscal ’24 compared with fiscal ’23. The transition is happening a little faster than expected. Saas grew 13% for Q1 ’24 versus Q1 ’23. ARR increased 9% to $317 million for Q1 ’24, a new record, compared to $290 million for Q1 ’23. Over 80% of our revenues in the quarter continued to come from recurring sources. Our revenue yield improved modestly to 148 basis points for the quarter from 145 basis points for Q1 ’23. Software and related services represented 47% of total revenues for Q1 with payments 48% and other 5%.

Adjusted EBITDA increased 7% to $25.2 million for Q1 ’24 from $23.6 million for Q1 ’23. Adjusted EBITDA as a percentage of revenues remains steady at 27.4% for Q1 ’24 and 2023. The adjusted EBITDA margins in both the software and services segment and merchant services segment improved but were offset by an increase in our corporate expenses, principally healthcare insurance costs and duplicative hosting costs as we transition from our private cloud with Rackspace to AWS and Microsoft Azure. Pro forma adjusted diluted earnings per share was $0.36 for Q1 ’24 compared to $0.37 for Q1 ’23. Again, please refer to the press release for full description and reconciliation. Segment performance. Revenues in our software and services segment increased 6% to $56.6 million for Q1 ’24 from $53.2 million for Q1 ’23, reflecting growth in healthcare and public sector, including education.

Celtic acquisition anniversary this quarter and declined by $1 million Q1 to Q1, reflecting the strike in Manitoba, which we discussed on our Q4 conference call. While the strike has ended, our projects have not yet resumed. Payment revenues represented 25% of the software and services segment’s revenues. The segment’s adjusted EBITDA improved 7% to $20.2 million for Q1 2024 from $18.9 million for Q1 2023. Adjusted EBITDA as a percentage of revenues improved to 35.6% for Q1 ’24 from 35.4% for Q1 ’23, reflecting cost efficiencies gained from an internal realignment within verticals we discussed on the Q4 call. Revenues for our merchant services segment increased 8% to $35.4 million for Q1 ’24 from $32.8 million for Q1 ’23, reflecting broad-based growth in our ISOISV.

B-to-B and POS channels. Adjusted EBITDA for our merchant services segment increased 14% to $10.7 million for Q1 ’24 from $9.4 million for Q1 ’23, outpacing revenues. Our revenue yield moved up a few basis points with continued expense control. Balance sheet. Our balance sheet remained strong and well positioned for ’24. During January, we repurchased 90.8 million face value of convertible notes utilizing the revolver for a discounted amount of approximately $86.6 million. There are 26.2 million of notes remaining, 19% of the original 138 million issued which addresses a springing maturity clause in our revolving credit agreement. We currently expect to allow the remaining notes remain outstanding until maturity. While we saved roughly 4 million from the repurchase, we will have a similar amount of additional interest expense for fiscal ’24 associated with the higher interest rate from the revolver.

As of December 31, borrowings under the revolver, net of cash and pro forma for the repurchases in January approximated $348 million. Our total leverage ratio pro forma for the note repurchase was 3.6 times. The current constraint is five times under our $450 million revolving credit. The interest rate for the convertible notes is 1%, while the interest rate for the revolver is currently around 8.5%. We have remained disciplined on our approach to growth and acquisitions. Our estimate for earn-out payments for the remainder of fiscal 2024 is approximately $5 million in the absence of acquisitions. We currently expect to finish fiscal ’24 with the leverage ratio around 3 times. We want to be clear on our rationale for the proposed merchant services sale.

Once the sale is completed, we should have very little if any, remaining debt. This will free up even more resources to deploy towards the public sector, education and healthcare verticals. We believe that the remaining public company should trade at a higher EBITDA multiple as a pure play software and services company outlook. Looking forward, our Q1 results gives us confidence in the following guidance for fiscal year ’24. It excludes acquisitions that have not yet closed, transaction-related costs, and the potential asset sale discussed on this call. Revenues, $385 million to $400 million, adjusted EBITDA, $109 million to $115 million, depreciation and internally developed software amortization $11 million to $13 million, cash interest expense $26 million to $29 million, pro forma adjusted diluted EPS dollar $1.52 to $1.64.

From a seasonal standpoint, we currently expect the quarters of fiscal year ’24 to follow a similar pattern to those of fiscal year ’23. Although actual results on this one-time software line can vary significantly, our current expectations for software license sales are $800,000 for Q2, $1 million for Q3, and $3 million for Q4. We currently expect to resume high single-digit organic revenue growth in fiscal ’25 as Manitoba gets back to a normal cadence, our opportunities in the utilities market progresses, and the SaaS transition becomes less of a short-term drag. This concludes my comments, Marlise. At this time, we will open the call for Q&A, please.

Operator: [Operator Instructions]. Our first question comes from John Davis from Raymond James.

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Q&A Session

John Davis: Hey, morning, guys. Maybe first, Clay, just on the lower revenue outlook. It sounds like it’s just $5 million less of license revenue this year. Anything else to call out on the kind of the reduced our outlook for the top line?

Clay Whitson: No, I think you if you’ve that’s the correct point, just to do some math around that, what would have been $5 million of one-time license revenue might turn into 800,000 of SaaS revenue because let’s assume a three year contract and maybe it comes in halfway through the year. So it’s quite a short term headwind, although in the long term, it’s a much better model.

John Davis: No, that’s helpful. And then as we think about the margin guide, I think it’s about for about 150 basis points of expansion year over year. Margins were roughly flat in the first quarter. So how should we think about kind of the cadence of the margin expansion throughout the rest of the year and kind of what gives you confidence and what’s driving the higher margins in the back three quarters here in 24?

Clay Whitson: Well, onetime revenues have is a big factor when when looking at a quarter’s margin, it’s 90% of that and maybe even 95% of that revenue drops to the bottom line. So in a quarter like on onetime revenues, it’s remarkable we could keep the margin as we did flat on the internal realignment is ongoing and continues. And so we’ll get the full effect of that as the quarters progress in 24.

John Davis: And then last one me for me quickly, just on the EPS guide, it looks like the majority of that is just higher interest expense you’re eight or $0.09 and a few pennies for slightly lower EBITDA. Just curious if that’s the right way to think about everything else is going on on the on the EPS side?

Clay Whitson: That’s correct. It’s about 4 million more than $4 million of interest expense for the 8.5 months from mid January. We did get a $4 million discount approximately on our bond repurchase, one hits the balance sheet and the other hits the P&L.

Operator: Our next question comes from Peter Heckmann from D.A. Davidson. Peter, please go ahead.

Peter Heckmann: A very early morning this morning. He wanted to see if you could maybe provide a little bit finer detail in terms of the portion of the merchant services business that is being considered for divestiture, if I heard correctly, it’s those portions that either are not integrated with software or are not integrated with i-Series proprietary software. Can you confirm that. And then just maybe give a little bit of better idea of what we’re talking about in terms of percent of revenue and potentially for percent of EBITDA for us for 2023 or 2024 appeal.

Clay Whitson: It corresponds pretty closely to the merchant services segment, and we don’t know exactly what assets will be included depending on a buyer for example, they might not want the PayFac platform if they already have one, and we’d love to keep the PayFac platform. So there’s a little bit of play, but for planning purposes, I would just use the segment’s revenues and EBITDA.

Peter Heckmann: Okay. Okay, great. And then and then in terms of the kind of the determination of whether or not you proceed, I certainly valuation is a part of that. But how do you think about then kind of that long-term partnership and how that might work in terms of servicing current clients? Is that significant parallel decision-making process?

Greg Daily: Yes.

Clay Whitson: I mean, our customers still want bundled payments and integrated software, and we intend to continue to provide that. And our Software and Services segment 25% of our revenues or payment revenues. We just don’t feel like we have to own the payments capabilities. So we would like to partner with whoever we sell the business to continue to provide that to our customers.

Peter Heckmann: Got it. Got it. And so just and then just Kirby, I heard this right, but you believe this divestiture could eliminate the majority or all of the companies that had divestment probably modestly dilutive or somewhat dilutive to earnings, but a eliminating the debt could really provide the company with a lot of flexibility going forward. In terms of thinking about alternatives? Primarily M&A, right?

Clay Whitson: Yes.

Greg Daily: I mean, we number one goal. We want to be a software business. Number two, we are fixed our balance sheet to your point in that free, if not close. And then not we’ve been public six years, we have to make a change and this we’re very excited about it is this should put us on and a good spot over the next three or four years.

Clay Whitson: Great.

Peter Heckmann: Thanks for the additional color.

Operator: And now we will proceed with the question from Matt Van Fleet from BTIG. Matt, you may proceed.

Unidentified Analyst: Yes, thanks for taking my question. I guess when you look at the public sector software market out there and given given the backdrop of the quarter’s performance, how are you, I guess, assessing the demand environment out there, which which areas or some verticals of public sector are still driving the results here? And maybe where are you seeing either elongated sales cycles or just sort of in decisiveness on behalf of customers is a lot of exciting stuff going on utilities and education.

Greg Daily: Healthcare is great. But the public sector dealing with counties, municipalities, states, that seems to be a a lower is a slower process. We’ve got a huge pipeline. There’s been a lot of delays it seems like things have pushed back and most of it is at this date or county level.

Clay Whitson: And I think courts are a big opportunity on top of utilities going forward.

Greg Daily: And yes, that can be huge.

Clay Whitson: Okay.

Unidentified Analyst: Very helpful. And then maybe just one more on the potential sale of the merchant services. I guess it seems like over the last couple of years being able to go in with a combination offering of know powerful software with embedded payments into a would run a little counter to then being looking to sell off the business. So I guess what type of stipulations or contractual obligations might you include in terms of keeping that the payments side of the business? It’s sold to a third party involved in kind of what you’re doing, maybe more importantly on the growth pipeline ahead? And then how does that change your go-to-market strategy if it’s not an internally owned merchant services attached to the software.

Peter Heckmann: Okay.

Clay Whitson: Great question.

Greg Daily: I’m glad it’s so let’s make it clear. We’re still in the payments business. We’re still selling payments every day through our software and public sector government on utilities, education and health care, we are selling everything else. So we’re keeping payments in our own software within public sector.

Rick Stanford: But if there was business that’s not in those verticals where that’s what we’re selling that a good way to think about it is we’re going to continue to sell the payments in our primary verticals once the sale is complete, then we’ll flip it over the fence for onboarding and support thereafter with the volume.

Clay Whitson: Okay.

Rick Stanford: But you’re right, we think our plans are prepared.

Greg Daily: Our plan is to go to market buying software companies and then cream on top is being able to sell payments into their installed base and new customers.

Unidentified Analyst: Okay.

Greg Daily: Thank you.

Operator: And now we have a question from Charles Nabhan from Steve and Charles. Please go ahead.

Peter Heckmann: Good morning and thank you for taking my question.

Clay Whitson: I wanted to follow up Pete’s earlier question around a potential deal and could appreciate that there’s a range of possible outcomes, but curious how we should think about the breakout of corporate across the and across the segments, as you know, corporate annual corporate expenses in the low 20 millions, we think 20% of that might be reduced with the sale of the merchant services segment roughly.

Rick Stanford: And that’s what we’ve had.

Clay Whitson: And that’s what we’ve identified so far, that number will likely in guidance over time as we examine it a little more closely.

Peter Heckmann: Got it. Okay, Bob, and good to see the strike in Manitoba has been resolved, but curious if you could quantify the impact that’s had on the financials thus far this year, speak to your expectations in terms of like getting things up and running again there as well as what that could mean for what that could mean for growth?

Geoff Smith: Yes, this is Jeff. So while the strike is over, the project has continued to push out as they kind of had to ramp back up and get people back to actually the table of stakeholders that reengage.

Greg Daily: So there’s three phases to it.

Geoff Smith: The second phase will go live later this year has been raised for the better part of the last year, but strength delayed all of that. And then the requirements for the third phase will begin built-out later this year. There won’t be a lot of revenue from that down until the following year, and they’ll trail out from there. It’s a meaningful amount of revenue that has pushed back out of this year from when we guided back in the fall? Yes, ballpark, just with that, what have you.

Peter Heckmann: Okay. And if I could speak, I could sneak in one more on any comments you could make on the vertical or channel exposure within Merchant Services? I know a chunk of it is restaurant, but any any color you could provide on based on previous disclosures would be, I think, would be helpful.

Clay Whitson: Well, we have what we think of as partners ISO.s and IS. V’s POS is a good portion of the business. We are a reseller of Aloha and we have our own proprietary POS system. I see that the is a good category, but those would be the biggest portions of it.

Operator: And our next question comes from Alex Mark Graf from KeyBank Capital Markets. Alex, you may proceed.

Unidentified Analyst: Thank you, and thanks for taking my questions here. Greg, just wanted to follow up on your earlier comment on kind of the the go to market thought process in the event of the sale of the merchant services business. It sounds like the kind of bottom line is little to no change. I’m just curious, categorically, are there any sort of dissynergies associated with that potential sale? I mean it again, it sounds like no, but just wanted to maybe put a finer point on that topic of synergies.

Greg Daily: There’s not I mean, obviously, 100% of our footprint focus on being on public sector, education and health care. And I think is a primary goal also. So a better balance sheet. I’m 100% focused on our software businesses, the merchant service, that’s been a great business, steady and plastic team, they’ve always kind of been separate from our software business.

Peter Heckmann: Okay.

Unidentified Analyst: That’s great. And then just one more quick one on the exploration and the sale. I mean, it it sounds like you have shared this morning. I’m just more narrow and focused on certain aspects of software I guess is there is there any way that the your MO around M&A might change in the event of a sale? I mean, or is it simply just kind of accelerating and pushing further into the pipeline than you maybe could have with the merchant services business onboard?

Unidentified Analyst: Yes.

Greg Daily: I mean, since going public, we’ve always done as software businesses on that will continue. Most of them will be public sector, but we do have some things in our pipeline of education and health care.

Unidentified Analyst: Uhm-hmm, I don’t think any change now, so nothing that I mean, I guess is not addressable today having the merchant services business model its margins now pushing further into that pipeline. Is that a fair characterization?

Clay Whitson: Yes, that’s correct, right.

Unidentified Analyst: Okay.

Peter Heckmann: Thank you.

Operator: So let me remind remind you that if you still have a question to Paul’s, please press star one and we’ll proceed with a question from Rob Stone from BMO Capital Markets. Please go ahead.

Peter Heckmann: Hey, guys, good morning. Thanks for the question. Just two quick ones. You mentioned using the proceeds of any sale mostly going to paying down debt. I don’t know if you could give us a sense of the leverage ratio you’re potentially going to be targeting as a pure software and services business. And then the second question is really around the size of target acquisitions you’re expecting to complete this year? I know in the past you’ve talked about sort of 1 to 5 million of EBITDA being your sweet spot to see if there’s any update to that?

Clay Whitson: Thanks. Well, our leverage will start off at near zero. I think we haven’t put a number on it, but I don’t think we will run quite as high in the future, and that’s a big driver for doing this. As far as acquisition size, I don’t think much changes. It’s still our sweet spot one to 5 million, but we’ve done larger deals. We’ve done $10 million. I really don’t think that changes in the future.

Operator: And we have a follow-up question from Peter Heckmann from D.A. Davidson. Peter either. Go ahead.

Peter Heckmann: Thank you. So just to put a little bit of a finer point on it, and I know that the any sale is going to be contingent on the buyer and what assets they want don’t want. But if we look at fiscal 23 under your kind of alternative revenue breakdown, rent payments was 45% of revenue last year and then merchant services was 37. And so if you consider divesting majority of Merchant Services, then kind of on a pro forma basis a payments would go from being 45% of the revenue stream to kind of maybe like 15% to 20% with the vast majority of the rest being software either maintenance or SaaS? Is that the way to think about it?

Clay Whitson: Well, that’s very close paid in the last quarter. Payments were 25% of the software and services segment. So that’s probably a better number to use.

Peter Heckmann: Okay.

Unidentified Analyst: Okay.

Peter Heckmann: 25, right. Banks are right, we will. And do you have any time line for this type of transaction? Would you should we expect to hear something in the next three to four months or could it take longer?

Greg Daily: Hopefully it’s sooner.

Clay Whitson: Right.

Operator: Okay.

Peter Heckmann: We’ll look forward to hearing more details.

Greg Daily: Thank you, Pete.

Operator: And we have a question now from James Faucette from Morgan Stanley. James, please go ahead.

Peter Heckmann: Hey, good morning. Thanks a lot. I’m just wanted to ask just from a A. like you guys and you’ve highlighted multiple times is that you’ve been focused on building out the software on part of your business and that kind of thing. And from a strategic focus especially the direction you’d like to go on. I think that’s consistent. I’m just wondering how you’re thinking about the proceeds and capital allocation and if you’re able to execute a sale to expect at that pace of acquisition can accelerate? Or are you feeling like this is something that makes sense given what you’re seeing in the from a valuation perspective in the market. Just wondering if there’s on pricing and capital related considerations in the timing or is this truly just you’ve reached the stage of mix and strategic focus that now is the right time trying to tease out that nuance.

Greg Daily: So I think our timing is a good. We do plan to spend around 100 million a year as it feels about right and that’s what we’re able to digest. We’re not going to do the stock to maximize back buybacks. It’s going to be our capital is going to be deployed toward M&A in our software verticals.

Peter Heckmann: Got it. Got it. Got it.

John Davis: All right. That’s that’s really helpful.

Peter Heckmann: Thank you so much.

Unidentified Analyst: Good luck.

Greg Daily: Thanks, Jim.

Operator: And this concludes our question and answer session. I would like to turn the conference back over to Greg Daily for some closing remarks.

Greg Daily: Well, thanks, guys. This has been a very interesting three or four months to be able to get to this point. We’re excited about the next couple of months, and I appreciate everybody’s time this morning. Paul, is the genius. Thank you.

Operator: And the conference has now concluded. Thank you very much for attending today’s presentation. You may now disconnect and have a great day.