i3 Verticals, Inc.

today 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 17th or starting today through May 17th. The number for the replay is -344-7529 and the code is 685-4757. The replay also may be accessed for 30 days at the company's website. At this time I would like to turn the conference call over to Mr. Jeff Smith, SVP of Finance. Please go ahead, sir.

Good morning and welcome to the Second Quarter 2024 conference call for i3 Verticals. Joining me on this call are Greg Daley, our Chairman and CEO, Clay Whitson, 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. 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 at 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 Daley. Thanks, Jeff.

And good morning to everyone on the call. Before getting into the results of the second quarter of fiscal year 2024, I would 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, the company's Board of Directors have directed I-3 management to explore the sale of certain discrete assets related to our merchant services business. This process for considering this transaction is ongoing. We would intend to use the proceeds from the sale of this business to pay down debt. Any decision by the board to engage in any transaction involving the merchant services business would 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 second quarter of fiscal year 24. 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. 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 Drivers 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. 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. Our future is very bright and we are excited about the second half of our fiscal year. For fiscal year, I'll now turn the call over to Clay. He'll provide you more details on our financial performance. When he is finished Rick will add commentary on the business. And then we'll open up the call for questions.

Thanks, Greg. The following pertains to the second quarter of our fiscal year 2024. Which is the quarter ended March 31, 2024. Please refer to the slide presentation titled Supplemental Information on our website for reference with this discussion. Revenues for the second quarter of fiscal 2024 increased 1% to $94.5 million from $93.9 million for Q-223, reflecting organic growth from recurring sources partially offset by declines in non-recurring sources. SAS and transaction-based software revenues each grew 10% while recurring software services grew 6%. Payments revenues also grew 6%. Non-recurring sales of software licenses declined by over $2 million as expected, reflecting the ongoing shift to SAS. Professional services revenues declined by $1.3 million, principally a result of the delay in Celtics implementation with Manitoba caused by the public worker strike. We will discuss the outlook for both line items in our outlook section. ARR increased 6% to $322.5 million for Q-224, a new record, compared to $305.7 million for Q-223. Over 80% of our revenues in the quarter continued to come from recurring sources. Software and related services represented 48% of total revenues for Q-2, with payments 47% and other 5%. Payments revenues as a percentage of payments volume improved slightly to 71 basis points for Q-224 from 70 basis points for Q-223. Adjusted EBITDA increased 4% to $25.8 million for Q-224 from $24.7 million for Q-223. Adjusted EBITDA as a percentage of revenues improved to .3% from .3% for Q-223, reflecting improvement in our merchant services margin along with lower corporate expenses. Both improvements resulted from the internal realignment discussed on previous quarterly calls. Proforma adjusted diluted earnings for share was $0.34 for Q-224 compared to $0.38 for Q-223. 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 full description and reconciliation. Segment performance revenues in our software and services segment declined 2% to $59.5 million for Q-224 from $60.8 million for Q-223, 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 $20.9 million for Q-224 from $22.1 million for Q-223. Adjusted EBITDA's percentage of revenues declined to .2% for Q-224 from .3% for Q-223. 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. Revenues for our merchant services segment increased 6% to $35.1 million for Q-224 from $33.1 million for Q-223, reflecting broad-based growth in our ISO, ISV, B2B, and POS channels. Adjusted EBITDA for our merchant services segment increased 18% to $10.1 million for Q-224 from $8.6 million for Q-223, outpacing revenues. Our revenue yield increased slightly with continued expense control. Balance Sheet Our balance sheet remains strong and well positioned for Q-24. Following our repurchase of convertible notes in January, we have $26.2 million remaining. At quarter-end, borrowings under the revolver net of cash approximated $343.1 million. Our total leverage ratio was three and a half 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 in our approach to growth and acquisitions. We have approximately $4 million 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 the public sector, education, and healthcare verticals. Outlook This is potentially a transitionary year, so I will first outline our revised outlook for fiscal year 24, assuming no divestitures or acquisitions. 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 24, our revised outlook follows. Revenues, $380-394 million. Adjusted EBITDA, $107-113 million. Depreciation and internally developed software amortization, $11-13 million. Cash interest expense, $27-29 million. Proforma adjusted diluted EPS, $1.57. 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 million for Q3 and $3 million for Q4. The bulk of the Q4 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 25. Some tailwinds that we have identified include the Manitoba project returning to a normal cadence, continued momentum in the utilities market, and the SAS 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 -to-school season in 23. We would expect adjusted EBITDA as a percentage of revenues for RemainCo to improve annually by 50-100 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 sales to pay down debt. I will now turn the call over to Rick for company updates and M&A pipeline.

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. 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 the public sector, our leadership team rolled out the initiative across the organization. We worked through changes, realigned reporting structures, and captured market share. Now our focus is on achieving sustainable growth with enterprise software as we scale our 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. In addition, we plan to make additional strategic hires and product to lead and expand our ongoing investment in web-native, configurable, next-generation applications. This past quarter in the 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 insurance carrier. Regarding M&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 in public sector and healthcare verticals. 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&A front in the near future. This concludes my comments, Chris. At this time, we'll open the call for Q&A, please.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw it, please press star, then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from John Davis with Raymond James. Please proceed.

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 that you're not expecting to get until next year, maybe conservatism, because you don't know when that's going to come. Are there any kind of comments on the lower outlook for the full year?

Well, revenue for the quarter, you know, 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 and fiscal year 24, which ends in September, we'll get it in 25. So that is pushed out.

Okay, no, that's helpful, Clay. And then, you know, encouraging to see despite kind of the lower kind of 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? I know you guys have some cost initiatives underway. But any thoughts on the margin as we kind of exit to Q headed in the back half of the year?

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 fourth quarter, but we're getting a full year effect this year.

Okay, and then lastly, I think ARR was about 6%. In the quarter, you talked about for main co kind of high single digit growth, the profile going forward, if you were to sell the person services business, so just help me bridge that gap. You know, was there anything that kind of weighed on ARR this quarter? Just, you know, how do we think about that acceleration from, you know, six to high single digits for main co?

Well, four things. One is the Manitoba Drivers License Project will come online in 25. The big utility customer we have will have a big 25. We actually expect most of the three million I mentioned for the fourth quarter in one time's license sales comes from that large utility customer also, but then it kicks up, kicks into a bigger project in 25. Education laps this August, September, and I believe those were the, and then yeah, those were the major ones.

Okay, appreciate it. Thanks,

guys. Thanks. The next question comes from Peter Heckman with DA Davidson. Please proceed.

Hey, good morning, everyone. I haven't seen the cash flow statement yet, but it looked as if cash flow was pretty good and looked 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, but actually it looks like we're getting slightly negative, but it looked like pre-cash flow conversion was somewhere close to 50% for the quarter. Does that sound about right?

Yeah, I get 47%, Pete. CapEx was one and a half million. Capitalized software is 6.1 million. Cash interest much higher at 14.1 million. You know, when we paid off the convertible notes, we traded 1% debt per .5% debt. And then cash taxes were a pretty big number this quarter at 5.4 million. So I get 47%, and we came into the year expecting 50%, so it's pretty close.

Okay, 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 in the last three years that, yeah, 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 your sub niche within the verticals?

Well, healthcare is still in the infant stages. That's going to be a long, slow role. We have thousands of billing customers who currently use other providers, and they're all small, most of them are small customers, so we will be trying to attack those one by one. Education is obviously the best, and then a path rate, and then public sector would be second best.

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 three strategic verticals, and there's a support team behind that. So we look forward to some advances from that group with a specific directive to go after those three verticals.

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, to the extent that it did happen, would we expect to to hear some news in the next 90 days?

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

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

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

Hi, thank you for taking my question. This is Shefali Tamaskar 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 SAS and what that might look like going forward?

Well, our total software license sales for fiscal year 23 were 10.7 million, and we expect the total one-time sales this year to be 5 million. So at the end of fiscal 24, 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 viewing this year as the transition year and probably plateauing around the 5 million mark, although we could have some pleasant surprises in the future.

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?

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.

Okay, thank you.

The next question comes from Mark Palmer with Benchmark. Please proceed.

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

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 sales and sales and sales 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.

It seems like there could be some seasonality. Certainly,

yes. Definitely.

January, February was crazy, busy. It slowed down now. We think it's going to pick up this summer.

And fresh budgets always impacted.

One more. Should we assume that the company is going to hold off on acquisitions until the merchant services sales process has been completed?

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

Very good. Thank you.

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

Yeah, 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 Romain Co.? How do you feel like you're staffed and overall, what would headcount projections look like for the software side of the business for the next several quarters?

Well, I think there are 300 and, you know, the exact number. A little over. 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 Romain Co. side, which will suit us well over the next few years. We're not feeling the need to more right now.

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?

It's one of the things that we're so excited about with this particular opportunity and all of our Web Native development is that everything's being built in a, you know, highly scalable, configurable native applications. So it really reduces the amount of customization we do for projects and enhances speed to market and it also reduces ongoing maintenance costs. So, you know, 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.

Very great. Thank you.

And then I just made a note of, you know, 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.

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

Yes. That's the difference. And then that gets augmented because we have standard methods of entry on our APIs that ease that process as well.

Okay. Very helpful.

And our next question is from Charles Nepon with Stevens. Please proceed.

Hey, guys. Good morning and thank you for taking my question. I appreciate the color on the main outlook for 25 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 licensed revenue that's going to come through in the front half of the fiscal year. So, you know, 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?

It's, there will be seasonally, 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 25, 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. Got it. Okay.

Appreciate the caller. Thank you.

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

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. You're now at 42 million 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 I'm curious if you've adjusted your view of the valuation through this process. Thanks.

It's a good business and we've never thought it was not a good business. And it's been really steady for us ever since going public and even before that.

Do you want

to comment?

It's an amazing team, nice pipeline. They constantly executed. You know, can't really comment about pricing on the transaction, but you know, it's a great opportunity for the buyer. You know, it cleans up our story, makes us a

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

Thanks. 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 24. And I think once that anniversary is, we would expect to resume 10% growth in education.

Got it. Thanks very much.

As a reminder, if you do have a question, please press star, then one. The next question comes from Alex Markgraf with KeyBank Capital Markets. Please proceed.

Hi, everyone. Thanks for taking my questions. A couple, maybe one first, I think for Paul, just on some of the 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 and some of the improvements as you work through some of these product initiatives?

Sure. When you're doing, in the public sector in particular, there's significant pent-up demand for, because it's 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 decades. 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, so as we are working to develop product, we are doing it with that domain expertise and in many times, concert with customers to give us the capability to meet that as a, you know, more of a commercial off the shelf component and also standardized integrations into the systems, which can be significant in large enterprise arrangements. 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 courts, as an example, and tax considerations. You know, we have in many cases 30 or 40 years worth of history and people who have 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 hard coded constraints.

Okay, great. Thank you. And then just one quick one, Clay. Just a sort of confidence level in that license revenue in the fiscal fourth quarter.

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

Okay, thank you.

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.

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

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