i3 Verticals Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 10, 2024

There are 14 speakers on the call.

Operator

Good day, and welcome to the i3 Verticals Second Quarter 2024 Earnings Conference Call. Today, all participants will be in a listen only mode. Today's call is being recorded and a replay will be available starting today, May 17 or starting today through May 17. The number for the replay is 877344 7,529 and the code is 6,854,757. The replay also may be accessed for 30 days at the company's website.

Operator

At this time, I would like to turn the conference call over to Jeff Smith, SVP of Finance. Please go ahead, sir.

Speaker 1

Good morning, and welcome to the Q2 2024 conference call for I3 Verticals. Joining me on this call are Greg Daily, our Chairman and CEO Clay Woodson, our CFO Rick Stanford, our President and Paul Christians, our COO. To the extent 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 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.

Speaker 1

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 furnished with 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.

Speaker 1

I will now turn the call over to the company's Chairman and CEO, Greg Daley.

Speaker 2

Thanks, Jeff, and good morning to everyone on the call. Before getting into the results of Q2 fiscal year 'twenty four, I'd like to provide a brief update on what we announced last quarter, namely the exploration of the sale of the Merchant Services business. As previously announced in February, company's Board of Directors have directed I3 management to explore sale of certain discrete assets related to our merchant services business. This process for considering the process for considering this transaction is ongoing. We would intend to use the proceeds from the sale of this business to pay down debt.

Speaker 2

Any decision by the board to engage in any transaction involving the merchant services business will be aligned with the board's objective to maximize long term shareholders value. I don't have any further updates on the process at this time. With that addressed, I'm pleased to share with you some of our results from the Q2 of fiscal year 'twenty four. In a minute, Rick will elaborate on the realignment we began last year and how that has better positioned us for sustainable growth. Before he does, I'd like to reemphasize our commitment to highly recurring revenue streams.

Speaker 2

This quarter, several of our non recurring lines are lower than last year, especially professional services and software licenses. Some of our revenue here has been impacted by delayed projects in our backlog, such as the Manitoba driver's license project we've discussed with you, or the very large and exciting new utilities opportunity. The utilities opportunity has required us to build a complex new project. It is going great. However, we have not been able to recognize any revenue related to it.

Speaker 2

That's fine with us because we believe that in the long term this project is going to open up new markets and be highly accretive to our shareholders. In the interim, as we go through a period of lower professional services and license revenue, we benefit greatly from our excellent financial profile. ARR is well north of 80%. Our margins grew over 100 basis points despite lower higher margin license revenue. We think that's fantastic results that which we are proud of.

Speaker 2

Our future is very bright and we are excited about the second half of our fiscal year. I'll now turn the call over to Clay and he'll provide you more details on our financial performance. When he has finished, Rick will add commentary on the business and then we'll open up the call for questions.

Speaker 3

Thanks, Greg. The following pertains to the Q2 of our fiscal year 2024, which is the quarter ended March 31, 20 24. Please refer to the slide presentation titled Supplemental Information on our website for reference with this discussion. Revenues for the Q2 of fiscal 2024 increased 1% to $94,500,000 from $93,900,000 for Q2 'twenty three, reflecting organic growth from recurring sources, partially offset by declines in non recurring sources. SaaS and transaction based revenue software revenues each grew 10%, while recurring software services grew 6%.

Speaker 3

Payments revenues also grew 6%. Non recurring sales of software licenses declined by over $2,000,000 as expected, reflecting the ongoing shift to SaaS. Professional services revenues declined by $1,300,000 principally a result of the delay in Celtic's implementation with Manitoba caused by the public workers' strike. We will discuss the outlook for both line items in our outlook section. ARR increased 6% to $322,500,000 for Q2 'twenty four, a new record compared to $305,700,000 for Q2 'twenty three.

Speaker 3

Over 80% of our revenues in the quarter continued to come from recurring sources. Software and related services represented 48% of total revenues for Q2 with payments 47% and other 5%. Payments revenues as a percentage of payments volume improved slightly to 71 basis points for Q2 'twenty four from 70 basis points for Q2 'twenty three. Adjusted EBITDA increased 4% to $25,800,000 for Q2 'twenty four from $24,700,000 for Q2 'twenty three. Adjusted EBITDA as a percentage of revenues improved to 27.3% from 26.3% for Q2 'twenty three, reflecting improvement in our merchant services margin along with lower corporate expenses.

Speaker 3

Both improvements resulted from the internal realignment discussed on previous quarterly calls. Pro form a adjusted diluted earnings per share was $0.34 for Q2 'twenty four compared to $0.38 for Q2 'twenty three. The decline was driven by higher interest expense following the repurchase of our exchangeable notes in January. Again, please refer to the press release for a full description and reconciliation. Segment performance.

Speaker 3

Revenues in our software and services segment declined 2% to $59,500,000 for Q2 'twenty four from $60,800,000 for Q2 'twenty three, principally reflecting lower one time sales of software licenses and professional services as previously discussed. Payment revenues represented 25% of the Software and Services segment's revenues. The segment's adjusted EBITDA declined 5% to $20,900,000 for Q2 'twenty four from $22,100,000 for Q2 'twenty three. Adjusted EBITDA as a percentage of revenues declined to 35.2 percent for Q2 'twenty four from 36.3 percent for Q2 'twenty three. The biggest factor for the declines were lower one time software license sales, which fall straight to the bottom line in the quarters they land.

Speaker 3

Revenues for our Merchant Services segment increased 6 percent to $35,100,000 for Q2 'twenty four from $33,100,000 for Q2 'twenty three, reflecting broad based growth in our ISO, ISP, B2B and POS channels. Adjusted EBITDA for merchant services segment increased 18% to $10,100,000 for Q2 'twenty four from $8,600,000 for Q2 'twenty three, outpacing revenues. Our revenue yield increased slightly with continued expense control. Balance sheet. Our balance sheet remains strong and well positioned for 2024.

Speaker 3

Following our repurchase of convertible notes in January, we have $26,200,000 remaining. At quarter end, borrowings under the revolver net of cash approximated $343,100,000 Our total leverage ratio was 3.5x. The current constraint is 5 times under our $450,000,000 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 in our approach to growth and acquisitions.

Speaker 3

We have approximately $4,000,000 in earn out payments remaining from past acquisitions. In the event we sell our merchant services business, we would have very little, if any, remaining debt. This would free up even more resources to deploy towards education and healthcare verticals. Outlook. This is potentially a transitionary year, so I will first outline our revised outlook for fiscal year 'twenty four, assuming no divestitures or acquisitions.

Speaker 3

Then I will touch on the financial profile for what could be called RemainCo in the event we sell the Merchant Services business. For fiscal year 'twenty four, our revised outlook follows: revenues $380,000,000 to $394,000,000 adjusted EBITDA $107,000,000 to $113,000,000 depreciation and internally developed software amortization $11,000,000 to $13,000,000 cash interest expense $27,000,000 to $29,000,000 pro form a adjusted diluted EPS $1.49 to 1 $0.57 From a seasonal standpoint, historically, we have not had large step ups from Q2 to Q3 organically. Although actual results on the one time software line can vary significantly, our current expectations for software license sales remain $1,000,000 for Q333,000,000 for Q444. The bulk of the Q444 amount is an implementation for a large utility customer we have discussed on previous calls. In the event we sell our merchant services business, we currently expect RemainCo would resume high single digit revenue growth beginning in fiscal year 'twenty five.

Speaker 3

Some tailwinds that we have identified include the Manitoba project returning to a normal cadence, continued momentum in the utilities market and the SaaS transition becoming less of a short term drag. The education business will also lap the introduction of certain state subsidies for lunch, which began during the back to school season in 'twenty three. We would expect adjusted EBITDA as a percentage of revenues for RemainCo to improve annually by 50 to 100 basis points per year. We would also expect to resume acquisitions in the public sector education and healthcare verticals after using the proceeds from the sale to pay down debt. I will now turn the call over to Rick for company updates and M and A pipeline.

Speaker 4

Thank you, Clay. Good morning, everyone. Over the past 18 months, we've transitioned from a group of products in multiple verticals into a coordinated efficient organization developing and selling software solutions in strategic vertical markets. Throughout the transition, we've adjusted our organizational structure to drive I3 forward. Initially, we capitalize on our expertise in public sector by analyzing our products and processes to provide solutions across any government of any size with a single contract.

Speaker 4

Eventually, the initiative was called UPO or Unified Product Offering. As a result of trust in I3, vendor fatigue and our solutions and service, we quickly saw buy in from our government customers. Because of the success in public sector, our leadership team rolled out the initiative across the organization. We worked through changes, realigned reporting structures and captured strategic markets, public, healthcare and education. Now that our company is unified and configured for sustainable growth, we are focusing on quality revenue expansion through sales of our enterprise software solutions.

Speaker 4

In addition, we plan to make additional strategic hires in product to lead and expand our ongoing investment in web native configurable next generation applications. This past quarter in public sector, we secured long term software contracts in California, Michigan, New Hampshire and Tennessee. In education, we landed white space contracts in Georgia, North Carolina, South Carolina and Texas, and in healthcare, a large health insurance carrier. Regarding M and A, we have looked at several opportunities over the last quarter, most of them are in public sector with a few in healthcare and education. Our Dance Card continues to be full of target companies largely

Speaker 5

in public sector and healthcare verticals.

Speaker 4

Some of the solutions include software solutions tailored toward mobile policing, utility management and property tax collection, case management and data intelligence solutions for justice and public safety industries, a school online enrollment solution, tax software and local government specializing in areas such as business license and tax, lodging tax, property tax, sales and use tax and utility tax, and an RCM solution that automates a portion of the back office process. We hope to be able to share more details on the M and A front in the near future. This concludes my comments, Chris. At this time, we'll open the call for Q and A, please.

Operator

Thank you. And we'll now begin the question and answer And today's first question comes from John Davis with Raymond James. Please proceed.

Speaker 6

Hey, good morning guys. It sounds like the slightly softer revenue in the quarter was more or less kind of a push out of some revenue, but you did lower the full year guide by kind of a similar amount. So just curious if that's revenue that you're not expecting to get till next year, maybe conservatism because you don't know when that's going to come or just any kind of comments on the lower outlook for the full year?

Speaker 3

Well, revenue for the quarter, we give guidance annually, so revenue of the quarter would pass through to the full year. The Manitoba driver's license project, we don't expect to see any meaningful revenue this year in fiscal year 'twenty four, which ends in September. We'll get it in 'twenty five. So that is pushed out.

Speaker 6

Okay. That's helpful, Clay. And then it was encouraging to see despite kind of the lowered non recurring high margin revenue, margins still expanded nicely and kind of were in line with expectations. So Clay, was that better than you expected given the non recurring headwinds? Just any comments there.

Speaker 6

I know you guys have some cost initiatives underway, but any thoughts on the margin as we kind of exit 2Q ahead of the back half of the year?

Speaker 3

No, we came into the year projecting margin improvement and continue to expect it and it results from the internal realignment that began in earnest in the Q4, but we're getting a full year effect this year.

Speaker 6

Okay. And then lastly, I think ARR was up about 6% in the quarter. You talked about Remainco kind of high single digit growth profile going forward if you were to sell the services business. So just help me bridge that gap. Was there anything that kind of weighed on ARR this quarter?

Speaker 6

Just how do we think about that acceleration from 6 to high single digits for Mancos?

Speaker 3

Well, four things. One is the Manitoba driver's license project will come online in 'twenty five. The big utility customer we have will have a big 'twenty five. Dollars We actually expect most of the $3,000,000 I mentioned for the Q4 in one times license sales comes from that large utility customer also, but then it kicks up kicks into a bigger project in 2025. Education lapsed this August, September

Speaker 5

And

Speaker 3

I believe those were the and then, yeah, those were the major ones.

Operator

The next question comes from Peter Heckmann with D. A. Davidson. Please proceed.

Speaker 7

Hey, good morning, everyone. I haven't seen the cash flow statement yet, but it looked as if cash flow was pretty good and it looks like to me that you had a working capital inflow. Is that correct? Is it generally correct? I'm trying to just kind of back into some numbers here.

Speaker 7

But actually it looks like working capital is slightly negative, but it looks like free cash flow conversion was somewhere close to 50% for the quarter. Does that sound about right?

Speaker 3

Yes. I get 47%, Pete. CapEx was $1,500,000 capitalized software $6,100,000 cash interest much higher at $14,100,000 When we paid off the convertible notes, we traded 1% debt for 8.5% debt. And then cash taxes were a pretty big number this quarter at $5,400,000 So I get 47% and we came into the year expecting 50%, so it's pretty close.

Speaker 7

Okay, great. And then can you just talk a little bit about the attach rates on some of the software businesses that you had acquired over the last 3 years that some of them hadn't even started marketing payments. But can you talk about where you've had some success there either by vertical or even sub niche within the verticals?

Speaker 3

Well, healthcare is still in the infant stages. That's going to be a long slow roll. We have thousands of billing customers who currently use other providers and they're all small customers. Most of them are small customers. So we will be trying to attack those 1 by 1.

Speaker 3

Education is obviously the best and then attach rate and then public sector would be 2nd best.

Speaker 4

The other thing is we've talked about the realignment and bringing services to the enterprise level. We've created this past quarter a group that their specific directive is to sell into our 3 strategic verticals and there's a support team behind that. So we look forward to seeing some advances from that group with a specific directive to go after those 3 verticals.

Speaker 7

I see. Okay. And then I'm sure you can't comment too, too much on the potential divestiture, but just in terms of timing, is it to the extent that it did happen, would we expect to hear some news in the next 90 days?

Speaker 3

I don't think we're in a position to say Pete. We'd like to say more, but we really until something that is done, we can't really comment on it.

Speaker 8

I understand. Okay. I appreciate. I'll get back in the queue.

Operator

Our next question comes from James Faucette with Morgan Stanley. Please proceed.

Speaker 5

Hi. Thank you for taking my question. This is Shefali Tomaskar asking a question on behalf of James. I was wondering if you could provide an update on what the timing might look like for the continued transition from non recurring revenue sources like licenses to recurring revenue sources like SaaS and what that might like going forward?

Speaker 3

Well, our total software licenses sales for fiscal year 'twenty three were $10,700,000 dollars and we expect the total one time sales this year to be $5,000,000 So at the end of fiscal 'twenty four, it will already be fairly de minimis. We do have some utility customers where we will continue to have some one time software sales. So I'm viewing this year as the transition year and probably plateauing around the $5,000,000 mark, although we could have some pleasant surprises in the future.

Speaker 5

Okay. Thank you. And just as a follow-up, could you provide an update on the current competitive environment you're seeing and if you've seen any changes in competitive intensity as it pertains to winning deals or keeping current customers?

Speaker 8

This is Paul Christians. That's been pretty steady state. We haven't seen that. Clay mentioned a couple of push outs on projects, which are really tied to our customers having some personnel constraints of their own, which we're attempting to facilitate with additional support mechanisms to help them free up and get back on track. But the overall demand or competitive environment has been relatively constant.

Speaker 7

Okay. Thank you.

Operator

And the next question comes from Mark Palmer with Benchmark. Please proceed.

Speaker 9

Yes. Thank you for taking my question. Outside of the headwinds associated with the non recurring revenue sources, how would you how would you describe the demand environment in the public sector in particular, relative to the macroeconomic environment and other factors?

Speaker 8

It's been relatively constant. We haven't seen any kind of extraction of RFPs beyond the norm or anything of that nature that would tell that we have more of a macro issue in that environment. I do think as we get to look at it and we switch to more and more to SaaS delivery of product that eases the pain for our customers because there's less capital requirements and their dollars go further on a near term basis. So I think the SaaS transition is a natural extension will help mitigate that to a degree if that does surface, but we're not seeing any evidence of it.

Speaker 2

Seems like there could be some seasonality. Certainly, yes. January, February was crazy, busy. It slowed down now. We think it's going to pick up this summer.

Speaker 8

Right. And fresh budget is always impacted.

Speaker 9

And one more, should we assume that the company is going to hold off on acquisitions until the merchant services sales process has been completed?

Speaker 2

I hope not. We do have an active pipeline that we're negotiating with a handful of people, but the 2 are we're not holding off. We're still talking to people every day and merchant services, it'll happen, but we have the capacity to do deals while we wait for that to close.

Speaker 10

Very good. Thank you.

Operator

The next question is from Matt Van Dliet with BTIG. Please proceed.

Speaker 11

Yes, good morning. Thanks for taking the question. I guess when you look at the cost controls that have been put in place over the last several quarters, how should we think about that cost basis relative to where we're headed, maybe more specifically in potential RemainCo? How do you feel like you're staffed? And overall what headcount projections look like for the software side of the business for the next several quarters?

Speaker 3

Well, I think there are 300 and do you know the exact number?

Speaker 11

Just a little over. We're not

Speaker 6

over 300.

Speaker 3

Okay. 300 people roughly associated with the merchant services business and the total company is some 1700. So we are well staffed and we do believe we've been through the realignment on the RemainCo side, which will suit us well over the next few years. We're not feeling the need to cut more right now.

Speaker 11

Okay, helpful. And then, you talked about additional internal development needed for the big utility customer. How much of that is sort of purely custom for their environment, their infrastructure versus development that can be leveraged for additional customers, especially if you can grow more in a similar types of businesses?

Speaker 8

It's one of the things that we're so excited about with this particular opportunity in all of our web native development is that everything is being built in a highly scalable configurable native applications. So it really reduces the amount of customization we do projects and it enhances speed to market and it also reduces ongoing maintenance costs. So historically, if you look at that number, it will the new products, custom code that would be required is far less than the historic products.

Speaker 3

Great.

Speaker 8

Thank you. And then, Clay just made a note of that holds true and with some iterations of slight differences in water, gas, electric. It's all the same fundamental model, just some different data attributes that have to be picked up.

Speaker 4

And it looks like the commercial off the shelf application, the customized piece to it is vendor integrations by utility.

Speaker 7

Yes. And

Speaker 8

then that gets augmented because we have standard methods of entry on our APIs that ease that process as well.

Speaker 6

Okay, very helpful.

Operator

And Our next question is from Charles Neffan with Stephens. Please proceed.

Speaker 10

Hey guys, good morning and thank you for taking my questions. Appreciate the color on the RemainCo outlook for 'twenty five. But just wanted to get a little more color around the linearity of revenue as we think about the quarterly cadence. So you had mentioned high single digit growth. It sounds like there's some license revenue that's going to come through in the front half of the fiscal year.

Speaker 10

So that being said, I guess, first is that high single digit, I assume that's an average for the year. And secondly, are there any weightings towards any particular quarters that we should consider as we think about our model?

Speaker 3

It's there will be seasonality particularly on the one time software line. I do believe Manitoba, we believe is going to be more second half as opposed to first half because of the we haven't received the requirements yet. When it comes to utility license sales, which are the big ones that we see for 'twenty five, it's hard at this stage to predict which quarter that falls into. I think that line item is just going to be a variable going forward.

Operator

The next question is from Rufus Hone with BMO Capital Markets. Please proceed.

Speaker 12

Hey, guys. Thanks. Good morning. Maybe I'll ask about Motion Services from another angle. I guess, hard to not notice that you're seeing decent revenue growth in that business.

Speaker 12

You're now at $42,000,000 of adjusted EBITDA over the last 12 months. That seems to be growing mid to high teens. Do you think prospective buyers are seeing the value of these assets? And just curious if you've adjusted your view of the valuation through this process? Thanks.

Speaker 3

It's a good business and we've never thought it was not a good business and it's been really steady Eddie for us ever since going public and even before that. Do you want to comment?

Operator

It's an

Speaker 2

amazing team, nice pipeline. It constantly executed. I can't really comment about pricing on the transaction, but it's a great opportunity for the buyer. It cleans up our story, makes us a software business, pays off our debt.

Speaker 12

Okay, fair enough. And then I was wondering if you could help us quantify the size of the headwinds you're facing from the subsidized lunches? Thanks.

Speaker 3

We would in a normal year, we would expect education to grow 10% and coming into this year on our Q4 call, which was our September call, we adjusted that down to 5% for fiscal year 'twenty four. And I think once that anniversaries, we would expect to resume 10% growth in education.

Speaker 12

Got it. Thanks very much.

Operator

The next question comes from Alex Margraf with KeyBanc Capital Markets. Please proceed.

Speaker 13

Hi, everyone. Thanks for taking my questions. A couple, maybe one first, I think for Paul, just on some of product level improvements. I think I heard you mentioned earlier speed to market implementation timeline. Just curious if you could quantify some of those changes some of the improvements as you work through some of these product initiatives?

Speaker 10

Sure.

Speaker 8

When you're doing in the public sector in particular, there's significant pent up demand for such a large diverse market for a variety of enterprise solutions across the spectrum. And historically, when people have done that, it's been a very long elongated project where they're basically trying to customize existing internal processes that they've done over a decade. Those are pretty well set in place and pretty well configured and there's commonality amongst those. So as we and we have deep domain expertise in particular areas. Concert with core customers to give us the capability to meet that as a more of a commercial off the shelf component and also standardized integrations into the systems, which can be significant in large enterprise arrangements.

Speaker 8

It's really a domain by domain expertise and we're organized in a fashion that's domain specific around ERP products or enterprise utilities or cohorts as an example and tax considerations. We have in many cases 30 or 40 years worth of history and people who've been developing those over time. And so it's we find it easier to work with customers to show them something that's tangible and their optionality because they're able to do things in these systems that they didn't imagine they'd be able to do because of historic hardcoded constraints.

Speaker 13

Okay, great. Thank you.

Speaker 3

And then just one quick one, Clay. Just

Speaker 13

the sort of confidence level on that license revenue in the fiscal

Speaker 3

Q4? It is in there. It has been delayed once from Q3 to Q4, but we still believe it will happen in Q4. If it doesn't, it would be our Q1, but we currently expect it in Q4.

Speaker 13

Okay. Thank you.

Operator

And at this time, we are showing no further questioners in the queue. And this does conclude our question and answer session. I would now like to turn the conference back over to Greg Daley for any closing remarks.

Speaker 2

Thank you. I'd like to thank my team, our team that are out there every day. Killing it, thank you. And thanks everybody on this call for your continued interest and call us if you need anything else. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.

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