I3 Verticals Inc (IIIV) 2019 Q2 法說會逐字稿

Good day, everyone, and welcome to i3 Verticals Second Quarter 2019 Earnings Conference Call. Today's call is being recorded, and a replay will be available starting today through March 21 (sic - see press release, "May 21"). The number for the replay is (719) 457-0820, and the code is 3915262. The replay may also be accessed for 30 days at the company's website.

At this time, for the opening remarks, I would like to turn the call to Mr. Scott Meriwether, Senior Vice President, Finance. Please go ahead, sir.

Good morning, and welcome to the second quarter 2019 conference call for i3 Verticals. Joining me on this call are Greg Daily, our Chairman and CEO; Clay Whitson, our CFO; and Rick Stanford, our President.

To the extent any non-GAAP financial measure is discussed in today's call, you will also find the reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP by reviewing yesterday's earnings release. It is the company's intent to provide non-GAAP financial information to enhance understanding of its consolidated financial information as prepared in accordance with GAAP. This non-GAAP information should be considered by each individual in addition to but not instead of the financial statements prepared in accordance with GAAP.

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. And consequently, actual operations and results may differ materially from the results 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.

Thanks, Scott, and good morning to all of you. We're pleased with our performance of our second fiscal quarter of 2019, and we're excited about our accomplishments for the first 6 months of the fiscal year and how they will impact our ability to deliver strong future performance.

We had a great quarter. Net revenues increased to $31.4 million from $27.1 million in Q2 of '18, fueled by organic growth and several acquisitions. Pro forma adjusted EBITDA increased to $8.7 million in Q2 of '19 from $7.7 million in Q2 of '18. Clay will cover these numbers in more detail in his section.

We continue to achieve above-market growth rates by delivering seamless integrated payments and software solutions to SMBs and organizations in strategic vertical markets. We currently own software in 3 of these verticals, education, public sector and property management, and we partner with ISVs in the other verticals. We will continue to focus on verticals that are strategic to us and make selective acquisitions in these verticals.

We've been active in M&A. Since our last earnings call, we closed the 3 deals that we previously noted that were in due diligence. And in addition to these 3 acquisitions, we also are pleased to announce our recently completed acquisition within our government vertical. This makes 7 acquisitions since our IPO and 6 this fiscal year. 5 of these post acquisition -- 5 of the post-IPO acquisitions are in the Public Sector vertical. The Public Sector vertical is core to i3's strategy, and we will continue to focus on that space.

We remain committed to the same acquisition strategy we executed in the past and have plenty of debt capacity to support that strategy. Later, Clay will speak to the details of our new $300 million credit facility. This new facility enables us to pursue our acquisition strategy, and we appreciate the support of our bank group.

Integrated payments and proprietary software-embedded payments remain our focus. 49% of our payment volume was integrated during Q2, up from 39% during Q2 of '18. Integrated payments results in lower attrition, higher margins and greater market growth potential. The increase in the proportion of our business coming from integrated payments give us confidence in achieving long-term margin improvement. We believe our focus on organic growth, long-term margin improvement and strategic acquisitions position us well for success.

Clay, could you give us the financial overview?

Sure. The following pertains to the second quarter of fiscal '19, which is the 3-month period ended March 31, 2019. Net revenues increased 16% to $31.5 million for Q2 '19 from $27.1 million for Q2 '18, driven by internal growth and acquisitions.

Excluding acquisitions and the Purchased Portfolios, net revenues increased 6.4% organically. Acquisitions contributed an increase of $3.6 million in net revenues for Q2 '19. Net revenues from Purchased Portfolios declined to $1.5 million for Q2 '19 from $2.3 million for Q2 '18, a 33% decline.

Adjusted EBITDA grew 13% to $8.7 million for Q2 '19 from $7.7 million for Q2 '18. Please see the press release for a reconciliation between net income and adjusted EBITDA. It is essentially income from operations plus depreciation and amortization with the following exclusions: offering-related expenses, changes in earn-out estimates, equity-based compensation, acquisition-related expenses, state and local taxes not included in income taxes and deferred revenue write-downs associated with acquisitions of software companies.

Adjusted EBITDA as a percentage of net revenues remained 28% for Q2 '19 despite a 47% increase in corporate expenses. The increase in corporate expenses was principally associated with public company costs but also expanded costs for a sales conference and President's Club. As a reminder, we have expected a onetime step-up in corporate expenses for fiscal '19 with inflationary-level growth in future years.

Pro forma diluted earnings per share was $0.20 for the quarter. This measure starts with adjusted EBITDA, deducts depreciation and amortization of internally developed capitalized software but not amortization of purchased intangibles and deducts cash interest but not noncash amortization of deferred financing costs.

We apply a tax rate of 25%, which is an estimate of our go-forward blended federal, state and local tax rate, giving effect to the Tax Reform Act of 2018 and the Up-C reorganization in connection with the IPO. Again, please refer to the press release for a full description and reconciliation.

Segment performance. Please refer to the supplemental slide titled Segment Performance on our website for reference with this discussion. In Proprietary Software and Payments, net revenues grew 86% to $7.7 million for Q2 '19 from $4.1 million for Q2 '18. Revenues from software licensing in Louisiana were realized a little sooner than planned. These revenues helped the top line growth rate but did not impact internal growth because they came from a recent acquisition.

Adjusted EBITDA continued to grow and improve in margin. Adjusted EBITDA increased 98% to $3.6 million for Q2 '19 from $1.8 million for Q2 '18. The segment benefited both from continued expansion in our flagship Education vertical and healthy contributions from our acquisitions in our Public Sector vertical. The adjusted EBITDA margin for Proprietary Software and Payments improved to 46% for Q2 '19 from 43% for Q2 '18 with education margins driving the increase. Despite our success in education, we expect our Public Sector vertical to surpass education as the largest contributor in this segment in coming quarters.

Net revenues for Merchant Services increased 4% to $23.8 million for Q2 '19 from $22.9 million for Q2 '18. Adjusted EBITDA for Merchant Services increased 2% to $7.8 million for Q2 '19 from $7.7 million for Q2 '18. Excluding the Purchased Portfolios, net revenues in Merchant Services increased 8%.

Outlook. We affirm guidance for Q2 -- I'm sorry, for fiscal year '19, which was issued last month on April 8 in connection with the NET Data acquisition as follows: net revenues, $127 million to $133 million; adjusted EBITDA, $36.5 million to $39.5 million; and pro forma adjusted diluted EPS, $0.85 to $0.90. This guidance marks the third time the company has raised guidance for fiscal '19.

We will include expectations for the education acquisition we announced today as part of our fiscal 2020 guidance, but for the remaining months of fiscal '19 ending September 30, it will not move the needle. Like our other education companies, we expect the acquisition to lose money during June and July when school is out. These losses should largely offset profits we expect for the months of May, August and September. Over the course of the year, we expect the acquisition to conform to a purchase multiple of less than 10x EBITDA.

Our new credit facility. Greg referenced our strong acquisition pipeline. In order to take advantage of our opportunities, last week, we expanded our credit facility from $150 million to $300 million. The structure is 100% revolver so that we can borrow for an acquisition, pay down borrowings with free cash flow, rinse and repeat. We will benefit from a lower interest rate spread of approximately 0.5 percentage point.

The agreement contains a maximum leverage covenant of 3.75x EBITDA with a step down to 3.5x in 2.5 years. For further details on the credit facility, please see the agreement filed along with the press release yesterday afternoon.

Bank of America is again the lead arranger, and Fifth Third is joint bookrunner. Wells Fargo remains a strong -- a joint lead arranger while newcomers KeyBanc, Citizens and PNC joined as joint lead arrangers. Other banks that are new to the syndicate include Bank of Montréal, HSBC and First Financial Bank in Cincinnati. These banks all play important roles in our industry and have the capacity to help us grow for the foreseeable future. Our current leverage ratio, giving effect to the 2 acquisitions that have been completed after quarter end, is approximately 7.5x -- 2.75x.

We currently have approximately $113 million borrowed. Over time, we expect to convert roughly 2/3 of EBITDA into free cash flow, which can either be used for more acquisitions or debt repayment.

I'll now turn the call over to Rick for an update on M&A activity.

Thank you, Clay. Good morning, everyone. In our February 13 earnings release, we indicated that we had entered into 3 term sheets for potential acquisitions, 2 within our Public Sector vertical and 1 technology acquisition that would fold into Public Sector as well. We are pleased that all 3 of these deals closed. The first 2, we announced on March 4, and the third, we announced on April 8.

While we're excited about each of these deals, we're particularly excited about our acquisition of NET Data in Texas. This 35-year-old company offers a robust software platform for courts and municipalities that has widespread adoption throughout the state. It is led by an experienced management team and has a strong group of talented employees that have hit the ground running in the weeks following the closing. We look forward to good things from this business.

As Greg mentioned, we're very excited to have recently closed another acquisition within the Education vertical. This acquisition augments our existing business within this important vertical. It expands our footprint in various states where we currently operate but also creates a new foothold in many states where we do not reside today. We feel this acquisition will give us room to run in those new states in the future from a sales perspective.

We continue to work hard on integrating all of our prior acquisitions. Business integrations can be challenging, but we are encouraged at the early results of these efforts. And we are convinced that maintaining consistency in the leadership positions of each acquired business helps us streamline these integration efforts.

We work hard to find acquisition partners that have leadership groups who buy into the vision that Greg has laid out for us. This helps us both win deals and also make sure the deals are successful post-close. As we have said before, fit is extremely important to us.

We look forward to sharing more information on M&A activity as it becomes available. As you know, we stay very busy on the acquisition front, and we continue to see opportunities in the market.

This concludes my comments. Ranjita, at this point, we'll open the call to Q&A, please.

(Operator Instructions) We will now take our first question from George Mihalos from Cowen.

Nice to see the acceleration in the growth. I guess before getting into the quarter, just maybe, Greg and Rick, at a high level, now that you've got access to the $300 million, should we assume that you are potentially looking at larger acquisitions than what you have in the past?

And then Clay, to the extent you can ballpark for us, I know it's not going to matter for '19, but any sort of financial metrics around the education acquisition, revenue, EBITDA contribution on an annualized basis? Would love to hear that.

George, thanks for the question. I think we'll continue to stay between $2 million and $7 million in EBITDA. We're not looking for a deal that would be transformational at this point. We're looking for a perfect fit and smaller-type companies that we can grow.

George, so I think we mentioned we think education will -- or the education acquisition should roughly breakeven over the next few months. For a full year, we would anticipate -- we paid $10 million upfront. So staying within the 10x multiple, we'd expect at least $1 million of EBITDA and maybe 5x that for a revenue number.

Okay. That's very helpful.

A Gross revenue number.

Okay, okay. Understood. And then just looking at the performance in the quarter though, the Merchant Services line ex- the Purchased Portfolios, that accelerated. Can you speak a little bit to what you saw there? And I know that there's a hardware business there as well. How did that perform in the quarter relative to your expectations?

Hardware had a better quarter. I think we were 100,000 ahead this quarter versus the same quarter last year in gross profit. Fairway performed better. It was down 9% to 10% last quarter on a quarter-over-quarter basis, same quarter of the previous year. Second quarter of this year, it was down 5% versus second quarter last year. So about half of the impact from Fairway.

Okay. And then Greg, anything you can speak to as to your traction on the ISV front and partnerships that you are able to sort of forge there?

Yes, George. We mentioned that we had signed 7 ISVs on the last call. That brought our total enterprise-wide to 34. Two of those 7 have completed their integrations, and both have begun to board merchants with us. So total 34; 29 are active today with 5 that are currently integrating to our platform.

Okay. And just last question for me. Clay, I think you mentioned there were some items that elevated the corporate expense in 2Q. Should we expect that to come down modestly 2Q to 3Q?

No, that's more infrastructure spending that we signaled at the IPO that our first year, our fiscal '19 would have higher corporate expenses, a onetime step-up. And then in future years, fiscal 2020 and beyond, we would expect inflationary growth. But it's just a little more HR, a little more legal, a little more accounting, that sort of thing.

Okay. So this is a good run rate to think of for the rest of the year?

Yes. I think we'll have modest growth over time, yes.

We'll take the next question from John Davis from Raymond James.

I just want to follow up a little bit on George's question around organic growth and the Fairway acquisition specifically. Clay, what drove kind of the modest improved performance? Any update on, I think you guys bought a gateway and were integrating that into the Fairway business. Basically, how has that gone so far? Is that what's driving the improvement in results there?

I think we've lapped some of the attrition we noted on the last call. And over time, the comparisons eased from the prior quarters. The new business -- I don't know if you want to comment on that at all, Rick, but they are bidding on a lot of new business now. I do know we've won a large -- or for us, a large equipment order, which is an encouraging sign. But it's not so much new business now as the comparison easing up from the prior quarters.

Okay. And then -- so along those lines, we could expect organic growth to kind of continue to step up, all else equal, given you've lapped the tougher compares at Fairway?

At Fairway, I believe so.

Okay. And then Rick, maybe I just want to touch on the education acquisition. Appreciate, Clay, the detail on revenue and EBITDA, but I was more interested in what software -- what it adds to the software offering. Is it something you can roll out nationwide? It seems like this may be a little bit more of a platform acquisition than a tuck-in. So just any comments there would be helpful.

Sure. I would compare this to a platform deal, similar products to PaySchools, lunch program being the biggest. I think what attracted us to this particular organization was we had talked about in the road show that this is one of the verticals that we'd have to acquire our way into other states. It's very difficult to get in there where we don't have a footprint today. And this brings us into multiple states that we're not in today. So comparatively, we're very excited about this software and the modules it has to offer. And we think we'll do well growing this organization.

Greg, would you...

I'll jump in, John. So I was with this team yesterday. They're amazing, 15 employees, 15-year-old business, which is a young business for us nowadays. And they're excited. They needed just a little bit of our resources to go to the next level. We've known them very well for 4 years, had followed them. They followed us. We have meetings going starting Monday with how we work together.

But education is something that we know very well. It's our first software company that we got involved with 5 years ago. It's a pay [faq]. It's on Worldpay. So it should be a natural company that helps us drive organic growth a year from now when it anniversaries. But what it -- I mean, I was very impressed with how excited the team is, younger, and couldn't be prouder about this one. It's a little bit smaller than some of them that we do, but it's one that has probably more opportunities going forward than we're accustomed to.

Okay. Great. And last one for me. Clay, just operating cash flow ticked up quite a bit this quarter. I think it was up 60% year-over-year. EBITDA was up, I think, 13% by my math. So anything to call out there from an operating cash flow standpoint?

The only thing I can think of are software revenues fall straight to the bottom line. So when we have a quarter where software revenues are higher than planned, it drops straight down. Scott, would you have any further color on that? Okay. We'll look at it, JD, and see if anything else comes to mind.

(Operator Instructions) We will take the next question from Josh Beck from KeyBanc.

I was just wondering if you could maybe help us kind of get a sense of where the public sector and education sector are in terms of contribution to the business. It sounds like there could be a potential kind of overlap there where one is going to pass the other. So just trying to get our arms around how big of a contributor they are to the business.

About a year ago, education might have been 80% of that segment. And today, it's a little bit over half. Now we've just purchased a business in education and also one in government, but I think government is going to be the lion's share from here on out.

Okay. And Greg, it sounded like you were pretty excited about really what you could do with this most recent acquisition. Should we be thinking about it as you're expanding the footprint into new states and you see yourself as gaining share within that state and that's where some of the synergy comes from? Just would like to understand that comment a bit better.

Yes. It's a great piece of software. It's a great platform that needed -- that just needs maybe half of a developer, another person in marketing, another person in sales, attending more conferences, just more blocking and tackling.

So they have a nice presence in the West Coast and in Florida. And those are areas that we're not involved with at all. But I think we'll be able to give you even more clarity next quarter after we have all met together and compared notes. But my sales teams told me, PaySchools, that they need references to be able to effectively open up a new state, and now they have them.

Okay. That's very helpful. And when we think about maybe some of the other verticals that we haven't touched on quite as much, B2B, health care, property management, anything notable to call out about either the trends that you're seeing within the business or maybe opportunities down the road within some of those verticals?

So we are actively looking for, I think as we broadcast regularly, in health care and nonprofit, a platform. We have looked at a few more this past quarter. They haven't -- we haven't been able to close a deal. They're performing well. The whole team is. There's probably 10 or 12 of our key platform companies that drive our revenue. They're all doing very well. B2B is always at the top of the leaderboard when it comes to growth. The hospitality vertical is doing very well.

It's just the public sector flurry, Rick's kind of been in the zone, has just kept us crazy busy of getting into these other verticals, but we're still interested. We're still engaged. But because of public sector being 5 out of the last 6 deals, we only have so much -- we can only do so many. And so we're comfortable doing 4 or 5 a year. This has been an unusual year of doing 7, but we're still involved in the other verticals.

Well, property management grows at 50% a year. It's just so small is the reason we never talk about it, but it is gaining a little bit of traction.

(Operator Instructions) We will take our next question from Peter Heckmann.

In terms of the public sector, some interesting capabilities there. My impression is that the marketplace there is still pretty fragmented, especially at the Tier 3 and Tier 4 municipalities.

What areas do you think you're going to focus on initially, from court payments, traffic violations, things like licensing and permitting? Are there specific areas where you feel like you have proprietary capabilities that really stand out and can drive organic growth?

So Pete, I would say the areas that you mentioned are focused. We are taking the opportunity to bring all of our public sector leaders in for what I call a summit in a couple of weeks. And the specific design of that meeting is to look at cross-pollinating products amongst those different entities. So I think that's a big step in the right direction.

We -- it is continuing to be fragmented. I think -- I don't know that I would say that anything is necessarily proprietary because there's others out there that may offer the product. But I would tell you the ones that we've picked and done a deal with do it very well compared to their competitors.

In some ways, I would say the guys that we're buying do it a lot better than the bigger guys that we pass on because they're close to the customer. They're high touch. We're very high on public sector. And I think you'll see some more deals, and you'll like what you see.

That's great. And is there -- from a sales perspective, is there a little bit of a synergy from -- between K-12 schools and small municipalities or at least like governing school districts? Would that be a little bit of the same sales process?

There's not that much overlap. We have done a couple of public sector acquisitions, and they had maybe 10% of their business in education. And so -- but it's not doing lunch money or activities. It's something else that they're doing for the local K-12 school. From a sales perspective, government or public sector gets us into states that we haven't been in educationally. So I wouldn't call it overlap. It's just big -- more opportunities.

Got it, got it. Okay. And then Clay, just one more. Could you help us -- with the acquisition that you did outside of the public sector last quarter with the wireless providers, can you talk about just sizing that a little bit in terms of their relative size to what you think is the market is there?

Oh, they're mainly in the Midwest. They're, I'd probably say, less than 5% of the market would...?

Yes, maybe more. I mean there's only 4,000 of them. We probably have 400. We're...

They're very small.

We like to think that all of our companies and verticals and acquisitions could grow at 10% or more.

That concludes today's question-and-answer session. Mr. Greg, at this time, I would turn the conference back to you for any additional or closing remarks.

Again, everyone, thank you for joining us on our second quarter fiscal year '19. We look forward to further updates as Rick continues to do more deals and give you updates on a quarterly basis. So thank you again.

This concludes today's conference call. Thank you for your participation. You may now disconnect your lines.