i3 Verticals, Inc. (NASDAQ:IIIV) Q2 2023 Earnings Call Transcript May 13, 2023

Operator: Good day, everyone, and welcome to the i3 Verticals Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Today’s call is being recorded, and a replay will be available starting today through May 17. The number for the replay is 877-344-7529, and the code is 1617435. The replay may also be accessed for 30 days at the company’s website. At this time, for opening remarks, I would like to turn the call over to Geoff Smith, SVP of Finance. Please go ahead, sir.

Geoff Smith: Good morning and welcome to the second quarter 2023 conference call for i3 Verticals. Joining me on this call are Greg Daily, our Chairman and CEO; Clay Whitson, our CFO; Rick Stanford, our President; and Paul Christians, our COO. To the extent any non-GAAP financial measures 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. It 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. 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’ll now turn the call over to the company’s Chairman and CEO, Greg Daily.

Greg Daily: Thanks, Geoff, and good morning to everyone on the call. We’re excited to present our results for the second quarter of fiscal year ‘23. This quarter, we set another record for revenue and adjusted EBITDA, which were up 20% and 27% over the same quarter last year, which reflected our improving margins. We have been highlighting our transformation to the vertical market software business that uses payments to optimize the great businesses we acquire, unlocking improved recurring revenue growth. This quarter’s software and related services revenue overtook all other sources and accounted for more than 50% of total revenue. Annualized recurring revenue grew over 20% compared to the same period last year, driven by strong SaaS, software maintenance and payments revenue growth.

This quarter includes the first results of operation for AccuFund. Their integration into the rest of our public sector has been seamless, and we continue to be excited about the cross-sell opportunities they unlock. The last time when we refreshed our senior secured credit facility was 4 years ago in May of 2019. Since that time, we have grown tremendously, and the quality of our credit has never been better. Thanks to that and the excellent service from our bank group that we are pleased to announce the closing of our new senior secured credit facility. It has been interesting times in the credit markets to say the least. But against that backdrop, we were able to achieve a fantastic result. First, we upsized our revolving line of credit capacity to $450 million, which sets the table for future M&A over the next 5 years.

Next, we added flexibility in our financial covenants about our confidence on our credit and execution from our bank group. And finally, improved pricing in our interest rate spread by 0.25 point. We are grateful to all of our banks who participated in the facilities, including JPMorgan Chase, Fifth Third, Regions, TD Bank, KeyBanc, Pinnacle, First Bank, Raymond James, First Horizon and Bank of America. Now I’ll turn the call over to Clay, and he will provide you more details on our second quarter financial performance. Following Clay’s comments, Rick will provide an update on some business-related items and address M&A and then we’ll open up the call for questions.

Clay Whitson: Good morning. The following pertains to the second quarter of our fiscal year 2023, which is the quarter ended March 31, 2023. Please refer to the slide presentation titled supplemental information on our website for reference with this discussion. We had another great quarter with record revenues and adjusted EBITDA. Revenues for the second quarter increased 20% to $93.9 million from $78.1 million for Q2 ‘22, reflecting organic growth and acquisitions. Our revenue yield improved to 158 basis points for the quarter from 146 basis points for Q2 ‘22. Organic growth for this quarter was approximately 12%, benefiting from a strong quarter for sales of software licenses, which totaled $3.5 million. Although small in the scheme of things, we keep highlighting this line because it’s an outlier from our otherwise highly predictable revenue and explains many of the variations between quarters.

Annual recurring revenues totaled $305.7 million for Q2 ‘23 compared to $254.5 million for Q2 ‘22, a growth rate of 20%. Organic ARR growth generally runs a few percentage points above our total organic revenue growth. Over 80% of our revenues in the quarter continued to come from recurring sources. Software and related services remains the largest portion of our revenues, representing 50% for Q2. Payments represented 45%, other 5%. Adjusted EBITDA increased 27%, outpacing revenues to $24.7 million for Q2 ‘23 from $19.5 million for Q2 ‘22, reflecting continued momentum in our Software & Services segment. Adjusted EBITDA as a percentage of revenues increased to 26.3% for Q2 ‘23 from 25% for Q2 ‘22, reflecting margin improvement in our Software and Services segment.

Pro forma adjusted diluted earnings per share increased to $0.38 for Q2 ‘23 from $0.37 for Q2 ‘22. Again, please refer to the press release for a full description and reconciliation. Segment performance. Revenues in our Software & Services segment increased 24% to $60.8 million for Q2 ‘23 from $49 million for Q2 ‘22, principally reflecting growth in our flagship public sector vertical, which represents over half of our consolidated business. Public sector includes the education sub-vertical, which deserves special mention. Revenues in our education sub vertical continued a strong rebound, thanks to organic sales to new school districts and higher lunch and activity fees at existing districts. Federal and state lunch subsidies have decreased significantly since the pandemic.

Benefiting from strong license sales, the segment’s adjusted EBITDA improved 35% to $22.1 million for Q2 ‘23 from $16.3 million for Q2 ‘22, outpacing revenues. Adjusted EBITDA as a percentage of revenues improved to 36.3% for Q2 ‘23 from 33.4% for Q2 ‘22, reflecting high-margin software and services acquisitions such as Celtic over the past year and a return to traditional high margins in education. The AccuFund acquisition effective January 1 was high margin as well. Revenues for our Merchant Services segment increased 13% to $33.1 million for Q2 ‘23 from $29.2 million for Q2 ‘22, principally reflecting growth in our ISO, ISV and B2B channels. Adjusted EBITDA for our Merchant Services segment increased 6% to $8.6 million for Q2 ‘23 from $8.1 million for Q2 ‘22, with higher revenues partially offset by higher residual expenses.

In keeping with our strategy since the IPO, we have steadily redirected acquisition and internal resources from traditional Merchant Services into higher growth and higher margin Software and Services, coupled with integrated payments. The balance sheet, Greg mentioned the completion of our new revolving credit facility. I just want to reiterate that we were able to improve several aspects of the agreement. First, we expanded to $450 million from $375 million that had been upsized $100 million on October 1 of last year. Second, we achieved a 25 basis point improvement in our spread, and we went from 2 leverage covenants to 1 covenant for total leverage, dropping the senior secured leverage covenant, which gives us greater flexibility as we think about our capital structure over the next 5 years.

Our strong balance sheet has allowed us to continue to execute our acquisition strategy. On March 31, we had $267.1 million borrowed under our revolver, net of cash. The face value of our convertible notes, are $117 million. As of March 31, our total leverage ratio remained approximately 4x. The interest rate for the convertible notes is 1%, while the interest rate for the revolver is currently around 8.1%. Over time, we expect to convert roughly two-thirds of adjusted EBITDA into free cash flow, which can be used for debt repayment, acquisitions, and earn-outs. We define free cash flow as adjusted EBITDA minus CapEx, internally capitalized software, cash interest and cash taxes. Outlook. Looking forward, the strong first half to our fiscal year gives us confidence in the following guidance for fiscal year ‘23, which excludes acquisitions that have not yet closed and transaction-related costs, revenues $360 million to $380 million, no change there, adjusted EBITDA, $97 million to $103 million, that’s a $1 million increase at the midpoint.

Depreciation and internally developed software amortization, $8 million to $9 million. We have not given specific previous guidance on that number. Cash interest expense net $22 million to $23 million. This represents a $2 million increase from the midpoint given last November. The main drivers include the AccuFund purchase. Fees associated with the new revolving creditability facility and higher unused fees with the larger $450 million credit limit. Pro forma adjusted diluted EPS, $1.46 to $1.56. That’s $0.05 lower due to the higher interest expense. From a seasonal standpoint, in the absence of new acquisitions, we currently expect Q3 revenues and EBITDA to look pretty similar to Q2 with a customary step up in Q4, coinciding with back-to-school activity.

Quarters might vary based upon software license sales, even though our trend is generally toward more recurring revenue streams. I’ll now turn the call over to Rick for company updates and pipeline.

Rick Stanford: Thank you, Clay. Good morning, everyone. Before I discuss M&A, I want to comment on a few developments within the business. A couple of quarters ago, we announced the promotions of Paul Christians to Chief Operating Officer; and Chris Laisure to President of Public sector. They have been doing an amazing job in these new roles and are far exceeding our expectations. We now have another important promotion I’d like to share. Tom DeBord, formerly the CEO of our B2B business, Infintech, has been promoted to President of Merchant Solutions for i3. Tom is a veteran in the payment space and is highly respected by his peers. His long and successful history and his significant contributions to the success of i3 Merchant Solutions, making him a natural fit for this job.

The i3 Merchant Solutions division develops and implements enterprise payment technology for the i3 Verticals family of companies and the broader financial technology market. We are looking forward to seeing Tom’s many successes across the enterprise with Merchant Solutions. As a result of the unified product offering success in public sector, we are replicating similar processes and structure across all primary verticals at i3. One example of this structure is a unified enterprise level RFP team, which includes RFP management, technical writers, product personnel, finance, and cloud team members. Benefits of the new team include improved response time, enhanced response quality, industry prowess and command of the RFP technology and process.

These teams are comprised of individuals across the organization to maintain market sensitivity and domain expertise. The next generation of UPO discipline is being deployed in public education and healthcare sectors with enhanced infrastructure and development resources being pulled from within the vertical sub-companies to strengthen sales, product development, operations, implementations and deployment. These internal customer-facing market services are being bolstered by our three teams focused on enterprise level infrastructure, security, cloud services, development and project management. The next evolution of public sector focuses on four primary sub-verticals, including justice technology or Justice Tech, utilities, ERP and transportation.

Justice Tech is modernizing online court systems with fully integrated digital solutions, including e-filing, CMS and digital evidence management and attendant reporting for full-scope state court systems. The utility sub-vertical serves large utility clients and local utilities with unmatched data delivery, IVR, digital customer engagement and CIS solutions. The transportation sub-vertical does motor vehicle, motor carrier and driver service solutions; and the ERP sub-vertical includes GFA, land records, permits, licensing and business tax solutions. As the education sector continues to expand, we deliver a fully integrated seamless user experience to our clients with school activities reaching a post-pandemic high. Our focus is on three primary sub-verticals: Nutrition Services, Ticketing & Events and Payments.

The combination of BIS and Celtic and i3 Transportation delivers a needed solution to meet the demands of the transportation market. Two new state contracts and transportation sub-vertical prove the market recognizes the depth and breadth of our solution suites. In addition, the application of AccuFund across the public sector and the i3 Verticals family has proved to be a very well-received addition. And i3 Healthcare Solutions executes its UPO strategy with unified sales, marketing, product and software engineering teams, the sector is accelerating its strategy to monetize payments across the revenue spectrum. Throughout the portfolio, subsidiaries are advancing their technology platforms to connect with patients through in-app payments, text-to-pay, e-statements and payment portals.

Additionally, i3 Healthcare Solutions continues to see the results of the UPO disciplines through the synergies of our practice management and EHR platforms targeted as geographic expansion. i3 Healthcare Solutions continues to recognize – been recognized as a market leader for delivering revenue cycle management services, evidenced by a recent award of a state-level contract to provide RCM technology and services at the agency, clinic and laboratory levels. Demonstrating the sector’s breadth across the healthcare ecosystem, i3 healthcare solutions also secured a contract to deliver software and consulting services to one of the top 5 U.S. healthcare payers. It goes without saying but an additional result of many of these structural changes that I’ve just mentioned will also allow us to prioritize our product investment opportunities.

I’ll now speak to M&A. While we didn’t have a closing this past quarter, we continue to have discussions with multiple targets. The number of opportunities we look at each quarter has not changed. As you all know, acquisition timing can tend to be lumpy. This is driven by three dynamics: one, we are reorienting our pipeline and are looking for larger deals than we have historically. Two, we are searching for targets in new states and looking to take out potential competition in those new geographies and are dealing with a very fragmented market; and three, the trickle down of lower valuations in the current environment has not been realized by many prospects. We remain disciplined when it comes to multiples. And as usual, we continue to self-source our acquisition targets.

We still believe we will be able to continue to complete 4 to 5 deals per year, and our pipeline remains healthy with opportunities for acquisitions in public sector and healthcare. This concludes my comments, operator. At this time, we will open the call for Q&A, please.

Q&A Session

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

Operator: The next question comes from James Faucette with Morgan Stanley. Please go ahead.

Operator: The next question comes from Charles Nabhan with Stephens. Please go ahead.

Operator: [Operator Instructions] Our next question comes from Matt VanVliet with BTIG. Please go ahead. Matt, is your line on mute? Matt, as a reminder, is your line on mute? We’re not able to hear you. Can I move on to the next question? I can’t hear him.

Operator: Alright. Our next question comes from Peter Heckmann with D.A. Davidson. Please go ahead.

Operator: The next question comes from Matt VanVliet with BTIG. Please go ahead.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Greg Daily for any closing remarks.

Greg Daily: Well, it’s nice to have another quarter behind us. We’re excited about the second half of ‘23 and into ‘24. So I appreciate everybody being on the call this morning. Thank you.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may all disconnect.