Quisitive Technology Solutions Inc.

Good morning and welcome to Quisitive's first quarter 2023 earnings conference call. Joining us for today's call are Quisitive Chief Executive Officer Mike Reinhart and Chief Financial Officer Scott Merriweather. Following the remarks, we will open the call for your questions. Before we begin today, I'd like to remind everyone that during the conference call, management will be making statements that contain forward-looking statements within the meaning of applicable Canadian securities litigation. Please refer to the company's forward-looking information disclaimer statement, which can be found on the notice for this call, our website, and the first quarter 2023 earnings release. Now, I would like to turn the call over to Mike Reinhart. Sir, please proceed.

Thank you, operator, and good morning, everyone. We appreciate you taking the time to join our Q1 2023 earnings call. The first quarter showcased progressive growth in our overall revenue with a significant contribution coming from our global payment solutions business. We were able to sustain operational momentum across various internal initiatives, and we are steadily advancing toward our long-term financial objectives. First, we will discuss our cloud solutions business. Given the overarching economic landscape we persist in staying flexible and responsive to the ever-changing market environment. In the first quarter, our recurring revenues from cloud solutions, encompassing managed services, licensing, and software sales, demonstrated an increase both on a quarter-over-quarter and year-over-year basis. This uptick showcases the positive inherent growth of our organization. We are unwavering in our commitment to invest in these solutions. as they not only offer crucial buffers against unpredictable market situations, but also provide a reliable and enduring value to our clientele. The growth we are witnessing is encouraging, suggesting sustainable stability and scalability for the future. While our managed services and software solutions performed well in Q1, we underwent a few operational pivots in reaction to changes in the professional services market, Beginning in 2020, we saw a drastic shift in demand for professional services, where there was a marked increase in cloud services demand, with a particular emphasis on the tooling and infrastructure needed to support distributed workforces. This year, we are starting to see new trends settle in, with a departure from a focus on digital workplace services and a higher emphasis on custom solutions, data and AI, while foundation solutions like security and infrastructure persist. In light of these adjustments to the marketplace and consistent with other IT services and technology firms, we have made corresponding adjustments in our cloud professional services groups to align our operational capacity to market demand. At the end of April, we removed over $4.5 million in annualized costs to support this adjustment, peeling back investment from lower demand areas. These adjustments will increase our short-term quarter-over-quarter growth profit and adjusted EBITDA outlook. This refocusing within our professional services organization, together with the customer delays mentioned during our last call, resulted in a slight year-over-year decline in our cloud business. However, the operational adjustments implemented at the end of April, along with the continued strength in our sales pipeline, have enabled us to better align our operations with the market, mitigate future disruptions, and set the stage for a return to growth. We are intensifying our sales efforts to help customers finalize contracts promptly and continue investing in recurring revenue streams to alleviate the burden on the professional services sales engine as customers navigate through challenges. We remain committed to our successful cross and upselling strategies, aim to expand monthly recurring revenue for increased stability, and will continue to focus on key areas of innovation, including generative AI. AI remains a prominent focus within the industry. This is illustrated by key announcements from Microsoft regarding their co-pilot solutions, which opens up opportunities for innovation and increases demand from our existing customers for guidance on leveraging generative AI, including but not limited to ChatGVT. We will soon provide more details about our investment in generative AI and its specific applications within our industry solution suite. It's worth noting that while large language model-enabled generative AI is creating a buzz in the industry, Quisitive has been utilizing AI in customer solutions for quite some time. As demonstrated in a recently published case study with Green Tweet, we successfully integrated AI into their smart factory, which uses AI, machine learning, and advanced predictive analytics for decision-making based on real-time data and predictive modeling. The system negated the need for manual part inspection, thereby saving costs for the customer while improving quality. AI has already started to make a difference for customers. We're excited about how this new wave of generative AI will further enhance companies' technology landscapes by improving efficiency and accuracy. We are confident that the genuine worth for our customers is found in initiatives like these, incorporating AI into their existing systems. This approach aligns perfectly with our aspiration to provide all-encompassing technology solutions that assist in achieving business objectives and provide value throughout the technology ecosystem. We are actively collaborating with Microsoft to spearhead efforts in activating Copilot for customers, broadening inquisitive solutions to incorporate Azure OpenAI services, and assisting customers in assessing and implementing generative AI solutions within their business. In conclusion regarding AI, we are excited to participate in the upcoming Innovate Theory to Commerciality Conference organized by A Capital in Montreal. We will be discussing the potential impacts of Microsoft Co-Pilot and other AI tools on SaaS solutions. This emphasizes our commitment to staying in tune with advancements in AI, exploring how to integrate them into our current solutions, and delivering their value to our clients. We eagerly anticipate sharing updates on these initiatives with the market. As we look forward to Q2 in the cloud segment, we anticipate steady growth in a robust sales pipeline, as previously mentioned. These ongoing shifts within the industry are to be expected, and we will persist in our adaptability to address customer requirements and achieve our long-term objectives. Transitioning to our payment solutions business, as we previously mentioned, our payment segment was a major contributor to the total revenue growth for the quarter. This reaffirms that our diversified approach spanning both payments and cloud continues to be a valuable asset to our business. As expected from our seasonal trends, we experienced a surge in volume growth from our direct portfolio and third-party portfolio, particularly in March, which set new records, aligning with the performance of other major players in the industry. We are making steady progress with PayIQ. In April, I accompanied our payments leadership team to the ETA Transact Payments Conference in Atlanta, where we had the chance to interact with leaders from all the major payment card networks. These discussions reinforced our confidence in our future roadmap and strategy, with industry leaders expressing their belief in PayIQ's robust infrastructure and the progress made so far. At present, we anticipate commercialization around the middle to end of Q3, with expansion and expect merchant activity to begin in July as we onboard early merchants onto the platform and concurrently advance our relationships and complete the Amex and Discover certifications. Furthermore, as we announced in a press release last week, we plan to host a live demonstration of the PayIQ platform during our investor day in June. This demonstration will showcase live customer transactions processed through PayIQ and its distinctive merchant platform. During this event, we aim to exhibit the unique technology and opportunity that PayIQ offers to Quisitive and our partner merchants. PayIQ aspires to provide a comprehensive value add from merchant to the end customer, and we are excited to present this to the market. Our partnership with Microsoft continues to flourish and provide new opportunities for our organization. As it is the Q4 for Microsoft, we are taking extra care to support joint sales and market motions with our partner Quisitive. team to close out the year well and align for a strong start to their new fiscal. We are collaborating with Microsoft in several ways to drive growth in their upcoming fiscal year. We are working closely with the Microsoft sales and marketing teams to jointly create and execute initiatives that target potential customers. This collaboration allows us to leverage each other's strengths and networks to increase our reach and efficiency. As Microsoft continues to innovate and expand its suite of products and services, we are staying in lockstep. We are investing in the training and resources needed to offer these new services to our customers, ensuring we can meet their evolving needs. In alignment with Microsoft's strategic focus, we are prioritizing areas like AI, managed services, security, and industry solutions in healthcare, manufacturing, and the public sector. By doing so, we are positioning ourselves to tap into high-growth markets and offer solutions that are in high demand. Our team is continually updating their skills and gaining certifications in Microsoft technologies. This allows us to provide the most up-to-date and efficient solutions to our customers, keeping us competitive and enabling growth. By focusing on these areas, we believe we can continue to strengthen our partnership with Microsoft and drive significant growth in their new year. In line with our previous communication, Quisitive is vigilantly monitoring the market for valuations and opportunities that align with our M&A strategy. We have seen the value our past acquisitions have added, enhancing our sales capabilities, broadening our geographic footprint, and enriching our solutions portfolio. We regard these endeavors as crucial and value-adding to our future strategy, and we will continue to scout for promising prospects. As we progress, we anticipate gradual sequential growth throughout the year, having positioned the company to capitalize on emerging market opportunities. These initiatives will require time to mature, and we remain committed to strategically maintaining and extending our reach. Our focus will be on delivering the complete acquisitive experience to every customer, offering our comprehensive range of services an exceptional customer service to promote customer retention and expansion. We aim to address immediate business challenges while also realizing our vision of becoming the foremost end-to-end digital transformation partner in both cloud and payments. We are grateful to have you all as shareholders and supporters. Now I'll hand it over to our CFO, Scott Merriweather, to discuss our Q1 2023 financial results. Scott?

Thanks, Mike, and thank you to all who are joining us for today's call. The first quarter of 2023 delivered continued growth requisitive, as revenue increased 8% to $48.3 million from $44.9 million for Q1 of 22, driven by the performance of our payment segment. All of our acquisitions have fully annualized, so the quarterly comparisons are clean. Gross margin increased 1% to $18.2 million in Q1 of 23, over $17.9 million in Q1 of 22. Gross margin as a percentage of revenue decreased at 37.6% from 39.9% in Q1 of 22. The gross margin decrease was driven by our cloud segment. As Mike referenced earlier, the cloud segment had expected softness in Q1, and I'll cover more on that later. Adjusted EBITDA increased 10% to $7 million for Q1 of 23 from $6.4 million for Q1 of 22. Adjusted EBITDA as percentage of revenues was 14.6% for Q1 of 23, an increase from 14.3% in Q1 of 22. We'll now move to discussing the specific performance of our segments. Revenue in our global cloud solution segment decreased 5.7% to $31.8 million for Q1 of 23, from $33.7 million for Q1 of 22. In line with the revenue decrease, the cloud segment suggested EBITDA decrease 7% to $3.9 million for Q1 of 23 from $4.2 million for Q1 of 22. EBITDA margin decreased to 12.3% in Q1 of 23 from 12.5% in Q1 of 22. The decrease in cloud segment experience was consistent with our expectations and consistent with trends we have seen across the IT services industry. Our professional services revenue within the first quarter was weaker as customers pushed large contracts out of Q1, primarily due to macroeconomic concerns and a desire to not commit to large projects until they had more visibility to their own projections. We have a strong sales pipeline, and we maintained extra capacity so we could serve those customers when they were ready to start. As we had better visibility of the timing of our own pipeline, we ultimately made adjustments to our cost structure. Mike previously mentioned the cost reductions that we made in early QT that equate to approximately 4.5 million in annualized cost savings. The significant majority of this expense was allocated to the cloud segment. One trend we do want to highlight within our cloud business is the growth within our recurring revenue within the cloud segment. Our cloud recurring revenue was 11.9 million in Q1 of 23, an 18% growth rate, up from 10.2 million in Q1 of 22, and also up sequentially from the 10.8 million we recognized in Q4 of 22. One of our stated goals has been to increase our recurring revenue, which will be driven by our first-party IP and our managed service offerings. We are proud of our growth to date in these areas and will continue to focus on increasing these recurring revenue streams. Given the strength of our pipeline, we anticipate that the gross margins within cloud will return to their historic levels and our EBITDA margins will increase from the current level, especially as our recurring revenue streams continue to increase. Pivoting to the global payment segment, revenue once again set a quarterly record, increasing to $16.5 million for Q1 of 23 from $11.2 million for Q1 of 22 and delivering organic growth of 48%. All of the Q1 revenue is from our bank card acquisition. Charge volume grew 3% year over year. Revenue growth significantly outpaced the charge volume growth as we added new revenue to third-party revenue streams for which we do not control or count the charge volume. These third-party revenue streams are more seasonal in nature than our historic base portfolio revenue. The third-party portfolios increased their Q4 and hit their peak in Q1 of 23. We do not expect that these revenue streams will contribute a similar proportion throughout all of fiscal 23. While we're definitely happy with the revenue and EBITDA impact in Q1, a 48% revenue growth rate is not expected for future quarters. These seasonal revenue streams also have a higher residual and commission split with our sales between our historical averages, which also drives down our gross margin percentage for payments from historical averages. Adjusted EBITDA for our payment segment increased to $3.1 million in Q1 of 2023, an increase of 42% from the $2.2 million recognized in Q1 of 2022. Bankart contributed a strong quarter of EBITDA with $5.2 million in Q1 of 23 before allocation of corporate costs. This is a $1.6 million or 43% increase over Q1 of 22. The EBITDA for the payments division also includes spending on the PIQ platform, which reduced payments EBITDA by $1.5 million in Q1 of 23 compared to $1 million in Q1 of 22. We have noted on our previous calls that operating costs related to PayIQ are expected to increase throughout fiscal year 23 as we reach market readiness and the launch of the platform. We expect our quarterly EBITDA losses from PayIQ will increase for the remainder of the year before reducing ultimately throughout fiscal year 24 as increased revenue will begin to offset the existing spend throughout fiscal year 24. Moving to the balance sheet, on March 31st, we had $75.8 million of term loans outstanding and $5.9 million of cash on hand. As of March 31st, our total leverage ratio was just below 2.5 times. Our quarterly debt paydowns are 2.4 million. On our previous earnings call, we noted that we amended our credit facility with BMO as of March 31st to lower our fixed charge coverage ratio from a ratio of 1.25 to 1 to 1.10 to 1 for fiscal year 23. Our fixed charge coverage ratio is more than interest coverage as it includes adjustments for interest, CapEx, and other items. This covenant change gives us more flexibility to deliver our strategy during a time of rising interest rates. For the last three years, Q1 has been our weakest quarter for cash flows from operations. We experienced our expected seasonal trend this past quarter as cash flows from operations were 2.2 million. However, the results from Q1 to 23 display the company's growth as the $2.2 million in Q1 of 23 is an improvement from zero cash flows from operations in Q1 of 22 and negative $0.6 million in Q1 of 21. We did not make any earn-out payments in the first quarter. We have $11.2 million of projected earn-out payments and short-term liabilities in the balance sheet at March 31st related to the bank card and MNLO earn-outs. That $11.2 million includes $5.6 million of earn-outs that will ultimately be paid with equity for the contractual terms of the purchase agreements. There's another $2 million in accrued liabilities related to the MAZIC earn-out, and Quizzip has discretion in how it will make that payment in cash and equity. As a result, our working capital deficit at March 31st of $6.9 million is overstated, as it includes earn-out amounts expected to be paid with equity. The final earn-out payment for Menlo will be paid in Q2, and the final earn-out payment for Bancorp will be paid in Q3. The second earn-out for MAZIC will be paid in Q3, and after those payments, we will only have the year three earn-out for MAZIC remaining. and it will be our only remaining earn out for all these prior acquisitions. Our cash flow used in investing activities was $1.7 million. This run rate is a good baseline for fiscal year 23. We expect our capex spending to increase slightly from this run rate in Q2 and Q3 as pay IQ nears market readiness. The current weighted average interest rate on our term loans is approximately 8.13%. Going forward, we expect to convert roughly half of our adjusted EBITDA into free cash flow, which can either be used for acquisitions or for debt repayment. We find three cash flows adjusted EBITDA minus CapEx, internally capitalized software, cash interest, and cash taxes. Using Q1 as our baseline, we are confident in our ability to deliver growth in both the cloud and payment segment throughout fiscal year 23. We expect our payment segment to continue its strong performance, though at more historical growth rates than 48% demonstrated this past quarter. The PIQ platform remains on target to launch in the second half of fiscal year 23. Our cloud pipeline is strong, and our growing recurring revenue base will help drive increased profitability. This concludes our prepared remarks. Thank you all for your time this morning, and we're now ready to open the call for your questions. Operator?