I3 Verticals Inc (IIIV) 2019 Q4 法說會逐字稿

Good day, everyone, and welcome to i3 Verticals Fourth Quarter 2019 Earnings Conference Call. Today's call is being recorded, and a replay will be available starting today through November 29. The number for replay is (719) 457-0820 and the code is 5577234. The replay may also be accessed for 30 days at the company's website.

At this time for opening remarks, I'd like to turn the call over to Scott Meriwether. Please go ahead, sir.

Good morning, and welcome to the Fourth 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 measures is discussed in today's call, you'll also find a 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 the reports that are filed or furnished to 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 company's Chairman and CEO, Greg Daily.

Thanks, Scott, and good morning to all of you. We're pleased with the performance of our fourth fiscal quarter of '19 and for the entire fiscal year. Fiscal year 2019 was an outstanding year for i3 Verticals in all facets of our business, from execution of our strategic plans operationally to execution of strategic M&A plans, to delivering strong financial results.

In fiscal 2019, our adjusted net revenue increased 26%, and our adjusted EBITDA increased 28%. And our adjusted EPS increased 45% from prior year.

We continued to execute on our software-driven payment strategy. We completed 9 acquisitions this year. And all 9 acquisitions were focused on software-based payments.

During 2019, we made significant move into the public sector. Public sector is now our largest particle, and we remain enthusiastic about our growth prospects. We continue to develop our proprietary software and our payment technology platforms. We are confident that these significant enhancements, we made this past year, will drive revenue going forward.

Turning to the fourth quarter. We had a strong finish to the fiscal year. This is demonstrated with our 44% increase in net revenue, as net revenue increased to $40.6 million in Q4 of '19 from $28.1 million in Q4 of '18, fueled by growth in our Public Sector vertical and strong back-to-school revenue within our Education vertical.

Adjusted EBITDA increased to $11.7 million in Q4 '19 from $7.8 million in Q4 '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 verticals markets. We continue to focus on Public Sector and Education vertical going forward, and we will also target acquisitions and other verticals that have attractive margin profiles and opportunities to provide software-driven payments.

Our integrated payments volumes continues to grow. 54% of our payment volume was integrated during Q4, up from 45% during Q4 of '18. Integrated payments results in lower attrition, higher margins, and greater market growth potential. The increase in proportion of our business coming from integrated payments give us confidence in achieving long-term margin improvement.

Finally, as mentioned in our earnings release, we have promoted Scott Meriwether into the new role of Chief Operating Officer. He has served the company well in his previous role as Senior VP of Finance, and I have no doubt that Scott will flourish in his new role.

Now I'll turn the call over to Clay. He will provide more detail on our Q4 financial performance and comments on 2020 outlook. And following Clay's comments, Rick will provide us an M&A update, and then we will take questions.

Thanks, Greg. The following pertains to the fourth quarter of fiscal 2019 which is a 3-month period ended September 30, 2019.

We finished the year with a strong quarter. Net revenues increased 44% to $40.6 million for Q4 2019 from $28.1 million for Q4 '18, driven by $11.7 million from acquisitions, principally in our Public Sector and Education verticals. The Pace acquisition led the group with double-digit growth, and we had it for a full quarter. Excluding the Purchased Portfolios and our IPOS business, net revenues grew 7% organically. If post-IPO acquisitions were included in both periods, organic growth would have been even higher.

Adjusted EBITDA grew 49%, outpacing net revenues to $11.7 million for Q4 '19 from $7.8 million for Q4 '18. Please see the press release for a reconciliation between net income and adjusted EBITDA. Adjusted EBITDA as a percentage of net revenues was 29% for Q4 '19, up from 28% for Q4 '18, despite a 61% increase in corporate expenses. The increase in corporate expenses was principally driven by public company costs.

As a reminder, we have expected a onetime step-up in corporate expenses for fiscal '19 with inflationary level growth in future years. The AVR acquisition did not contribute a material amount of EBITDA to the quarter, since we closed this mid-month, so we have half a month.

Adjusted diluted earnings per share was $0.24 for the quarter. 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 our Proprietary Software and Payments segment, net revenues grew 178% to $12.5 million for Q4 '19 from $4.5 million for Q4 '18, reflecting organic growth and acquisitions in our Public Sector and Education verticals. Adjusted EBITDA increased 188% to $4.9 million from $1.7 million, principally reflecting recent acquisitions in our Public Sector vertical. EBITDA, as a percentage of net revenues, improved to 39% for Q4 '19 from 38% for Q4 '18 due to a mix change of higher Public Sector, which carries a little higher margin than Education. Public Sector now represents the majority of net revenues and approximately 200 employees. These companies almost all acquired post IPO generally are strongest during our first half, our December and March quarters.

Net revenues for our Merchant Services segment excluding the Purchased Portfolios increased 23% to $26.7 million for Q4 '19 from $21.8 million for Q4 '18. This increase reflected growth in our direct sales channel, which includes B2B, ISO, and ISV channels, including Pace. While Pace mainly signs customers in the Public Sector and Education verticals, we include them in our Merchant Services segment because we do not own the software. We partner with ISVs. The Purchased Portfolios declined 30% to $1.3 million in line with expectations. In our IPOS business, the transition to SaaS that we communicated last quarter has begun, and the timing adjustments for net revenues are still baked into our 2020 guidance.

Adjusted EBITDA for our Merchant Services segment increased 22% to $9.7 million for Q4 '19 from $8 million for Q4 '18. The EBITDA margin improved to 35% for Q4 '19 from 34% for Q4 '18, showing operating leverage from revenue growth.

Comments on the balance sheet. As of September 30, we have $160 million available under our revolving credit. Our leverage ratio as defined in our credit agreement was 3.25x, while our current constraint is 4.0. Our interest rate is currently around 5.5%. Over time, we expect to convert roughly 2/3 of EBITDA into free cash flow, which can either be used for acquisitions or debt repayment.

Outlook for 2020. Before turning to that, I want to provide an update on i3's adoption of ASC Topic 606, the revenue recognition accounting standard. We're adopting ASC 606 as of October 1, 2019, so you'll see the change beginning with our first quarter of fiscal year '20. Under 606, we will report GAAP revenue and net of interchange of network fees. Our historical financials have reported gross revenue and included interchange and network fees as expense line items. We've always supplied net revenues as supplemental information, so this will not fundamentally change anything. The reason I point it out is that 2019 period on the face of our financial we'll report gross, while 2020 periods we'll report net. I think everyone on this call will understand that, but there are robo services that could report declining revenues while in fact revenues are actually increasing. We'll continue to provide the same supplemental net revenues for our '19 periods for an apples-to-apples comparison.

Looking forward, the strong finish to our fiscal year gives us confidence in the following guidance for fiscal year 2020, that excludes future acquisitions and transaction-related cost, and adjust for write-downs of deferred software revenues in connection with purchase accounting. For greater clarity, we're giving more line items this year.

Adjusted net revenues, $160 million to $164 million; adjusted EBITDA, $46 million to $48 million; depreciation and amortization of internally developed software, $3.75 million to $4.25 million; cash interest expense, $7 million to $7.5 million; pro forma adjusted diluted shares, 28 million to 29.5 million; pro forma diluted -- pro forma adjusted diluted EPS, $0.91 to $0.97.

From a seasonal standpoint, we have different verticals with different seasonal patterns. I mentioned government a little bit earlier. These generally counterbalance each other with our current mix of companies. The one exception I should mention is our fiscal third quarter is generally a little below trend when schools are at close for the summer, while our fiscal fourth quarter is a little above trend with back-to-school activity.

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

Thank you, Clay, good morning, everyone. Before I talk about our M&A outlook, I want to first quickly touch on our continuing strategic integration efforts within our of verticals and comment on the progress we've made with Pace Payment Systems, the acquisition which closed in June. Business and product integration remained our constant attention. Last quarter, we spoke about our vertical visioning process, which is shorthand for our goal of developing a unified product offering in each of our markets. In other words, we intend to provide a complete suite of products and services to our customers in each vertical. As noted in our last call, we began this visioning process in our Public Sector vertical, and that process is beginning to show results. During this fourth quarter, we began the same visioning process in our Education vertical. The working group includes business CEOs, sales, product and development teams. We believe this process will enable us to become more efficient in each vertical sector and to ultimately offer better and more targeted products and services to the market.

We were excited to announce the Pace Payments acquisition in June. Since then, the Pace team has settled in nicely with the rest of the i3 team and we see increased collaboration on a daily basis. As Clay mentioned earlier, we are seeing double-digit growth as a result of the increased harvesting efforts. On a related note, we estimate we will be approximately 85% complete with the conversion of Pace's integrated business within the next few weeks, and then we will begin the conversion of Pace's non-integrated businesses.

Regarding M&A, last quarter, we mentioned we had a nonbinding term sheet with a software company that offers utility billing and other software tools for gas, water and electric services. We also mentioned that the billing product is generating substantial customer interest in our installed base. We're happy to share this acquisition did close mid-September. This company is known in the market as AVR and is located in Houston, Texas. Aside from AVR's utility billing software, they also offer a public works product for work orders or system field management that is used to project and calculate work-related field expenses.

AVR has 44 employees and serves 650 municipal, utility districts and 85 privately owned utilities, independents and cities in multiple states across the U.S. We are extremely happy to have, Ren Nelson, the founder's granddaughter and COO and the entire AVR team as part of our Public Sector vertical and look forward to their future successes as part of the i3 family of companies. We're also pleased to share that we've already cross-sold AVR's billing product into one of our existing municipalities under our NET Data subsidiary. We couldn't be more excited how the 2 teams work together in an effort to gain a proof-of-concept for this new piece of software and its application within our existing customer cities. This is a concrete example of the cross-selling opportunities that are available to us within our verticals, which is exactly the reason we're engaged in the vertical visioning process that I mentioned a few minutes ago.

We are continuing to look at many deals and our pipeline continues to weigh heavily towards the Public Sector vertical. I do want to emphasize each target must be a good fit, and we are careful in that regard. We believe that we will remain successful in executing our M&A strategy, and still believe we can generate 4 to 5 new deals per year. We look forward to sharing more information on acquisition activity as it becomes available.

This concludes my comments. Derrek, at this point, we will open the call for Q&A, please.

(Operator Instructions) And we'll take our first question from Georgios Mihalos from Cowen and Company.

This is Allison on for George. Congrats on the strong quarter, and also congratulations to Scott. I just wanted to start on the FY '20 Outlook. Clay, you mentioned the revenue headwind due to the hardware transition to the SaaS offering is baked into the guidance. I was just curious, is that headwind still the $6 million to $7 million communicated on the last call? And then also, in relation to the 2020 guidance, what is embedded in both the revenue and EBITDA outlook from the recently closed Public Sector acquisition?

Allison, on the first question, you are right. It's the same guidance we gave on the last call that's baked into the 2020 plan. The Public Sector acquisition, we have not disclosed a purchase price. It was not a material acquisition. To give you some idea of the size, you'll be able to figure out from our cash flow statements that the purchase price was around the $10 million mark, and I think, you can apply our normal metrics to that to give you some idea.

Okay, great. That's very helpful. And then just a follow-up. Can help us think about the cadence of organic growth in 2020? Is it fair to think that should ramp throughout the year?

That is fair. Because as more and more of our post-IPO acquisitions enter the calculation, it will help our organic growth rate.

We'll next move to John Davis with Raymond James.

Clay, just wanted to start off on organic growth in the quarter, nice acceleration there. Anything to call out specific? I think, you did have a little bit of an easier comp, but just curious if there's any part of the business that reaccelerated to drive that?

Well your note mentioned an easier comp, and that's right that in the third quarter, which is our June quarter of '18, we had a bang-up quarter in IPOS, which led to last quarter being a challenging organic growth quarter. That wasn't the case this quarter. We have excluded IPOS anyway because going forward, we are transitioning to SaaS, so it won't be a good comparison. But we had strong growth across a number of areas, B2B came in very strong, our ISV business and, of course, the software-related businesses all had a strong quarter. So it's just a good quarter.

Okay. All right. It also looks like the acquisitions, I guess, you haven't lapped, are also outperforming. Any specific ones to call out there? I think you mentioned -- or Greg mentioned Pace on the call with any of the acquisitions that are kind of performing above expectations worth calling out?

Our Texas acquisition -- I mean our Louisiana acquisition and our Texas acquisition are both having good years. Pace, we both mentioned because its growth has accelerated like we had hoped it would.

Okay. And then just wanted to touch on margins. I think you called out '19 having higher corporate cost as you transition to a public company. But I think guidance implies 85 basis points of margin expansion next year at the midpoint. I think you did 30-ish this year. Is there anything else going on in there? Maybe future acquisitions aren't baked in that typically come on with a lower margin and ramp over time. Just curious if we still think about it as kind of a 50 basis points on a run rate basis, kind of going forward?

We do think that's still the guidance, 50 basis points improvement every year. Mix will help over time as we acquire more government and education properties. They generally carry higher margin than our Merchant Services segment.

Okay. And then last one for me, Rick, and I'm going to let you off the hook here. M&A pipeline, appreciate the commentary, is that still mostly Public Sector and Education deals? I think, the large majority of deals since you've been public have been in Public Sector. I think Clay mentioned that's the biggest vertical for you guys. But just curious what the pipeline breaks out as far as verticals? And if there's any other kind of outside those 2 that have come up on the radar?

Yes. JD, thanks for the question. We continue to look for healthcare nonprofit. We would like to be in those verticals. We do have some contacts in those 2 verticals, we are talking to. I would still say that greater than 50% of the pipeline active prospects are Public Sector with a little Education dabbled in.

Okay. Scott, I want to add my congratulation.

Thank you.

(Operator Instructions) Our next question comes from the line of Jason Kupferberg with Bank of America Merrill Lynch.

I just wanted to come back to the organic revenue growth topic as we think about fiscal '20. I know you talked about some incremental acceleration as we proceed through the year. So are we talking about kind of off of that 7% underlying number in Q4? Or are we saying that we kind of tick up from there gradually? I just wanted to get a sense of kind of where you think the full year fiscal '20 organic could land based on the guidance you presented to us.

We still think high-single-digit is the right number, if you layer in our acquisition -- post-IPO acquisitions every quarter, whether that's 6, 7, 8, 9, we don't have that much clarity or precision on that. But we think that range is a good range for the year.

Okay. And would you parse out a little bit further in terms of the Public Sector versus Education?

They are both double-digit growers. Education probably has a little more organic opportunity because government is more just population growth given the same suite of products. If you add a new product or a new customer, that changes. But the same customer probably doesn't have the growth opportunities that a school does.

Right. Okay, understood. And I know you grew payment volume in the quarter just about 30%. Obviously, that's inclusive of Pace. Is that a good proxy for the type of growth we should see, roughly until Pace anniversaries?

I have no reason not to believe that.

We'll next go to Josh Beck with KeyBanc.

Maybe just a high-level industry question for Greg. I mean there's been a ton of consolidation in 2019. Has that impacted your relationships or strategy in any way? Just wondering if there's any ripple effect to call out in that.

Not really, Josh. I've met with several of the new players now. They are still digesting it themselves. So we are reviewing it as maybe an opportunity. They are going to be on the sidelines for the next couple of years as they digest these large transactions are. But everything's pretty steady.

Okay, great. I think, the visioning concept is pretty interesting. So what are the big milestones that you're looking for? I don't know if the time frame is in the coming years or quarters, but just help us kind of understand what are some of the key mile markers that you're looking to achieve with that process?

So number one would be coming up with a unified product offering that I spoke to. We have competition in the market. People that have been acquisitive over the last few years, but they haven't seem to being the things together. We see an opportunity there. We -- because we do so much in Public Sector, for example, we have duplicative code that we'd like to sunset. So the management of the code base would be easier, and then partnering up resources amongst our Public Sector, for example, subsidiaries, allows us to get to the market on a more timely basis. So I would say those are the top 3.

And I would chime in, Josh, that one of our key things that we measure is percentage of integrated payments. And so going from 45% this time last year to 54% was a major step, and we will continue to do that, based on the acquisitions we have done lately, based on the strategy from our companies that we even had before the IPO. We're all using more of our own software, more of our own technology.

Great. Maybe a little bit of a related question. It seems obviously that's the best-in-class number, the 54%. It seems like there's a lot more interest just generically across the industry in this intersection of software and payment. So I'm just wondering when you think about the pipeline and M&A discussion that you are having, have you seen any change in the multiples that's notable? Or has that been about where it has been historically for you?

Well pre-IPO, we were very limited to what we could pay, 4, 5, 6x. Now that we're public, we're able to pay a little bit more, and we go up to the 8, 9, 10. But we are very disciplined. We walk away from transactions on a daily basis if the valuations get too high. We self-source our deals so that we're usually not in a competitive environment when we are dealing with these small software companies. So it -- I don't think it's changed. The pipeline is deeper and better, but I'm not seeing valuations that make me cringe and say, oh, this is out of control. We've determined very quick if we're going to be able to do something, so we want don't want to waste their time or ours.

I'd add to that and say our value prop is different when we do a deal. We want to bring the company on. We want to grow the business. When and if we have competition out there, they want to pay a little higher price than we are willing to pay and then they want to cut a half the staff post acquisition to justify the price, and that's not what the people we are doing deals with want to happen.

Okay. And then maybe for Clay. Just -- it seems like the gross margin has gone up very nicely in 2019. I'm guessing that is a little bit reflective of the integrated and the software mix. So anything to call out there? And is the success that we have seen in 2019 with that metric kind of sustainable as we look forward?

I think the main driver there is the revenue yield going up, and that's mostly a function of buying software companies because you get revenues without any associated volume. But what we have been buying is generally higher-margin, a pure software company can be high-margin company.

(Operator Instructions) We'll next move to Peter Heckmann with D.A. Davidson.

I missed your comments on the time line on the final conversion of the back-end on Pace. I think I heard on the integrated business should be in the next few weeks. And final conversion would be when?

Yes, Peter, the integrated business, we're about 85% complete in the next few weeks, and then we will start on the non-integrated piece right after that.

Okay, okay. And any material level of drag in terms of duplicative expenses on your fiscal '20 guidance that we should be thinking about, picking up in the next year?

No, their first earn-out is a calendar '20 time period, January 1, December 31, and we still think they are on track for the numbers we communicated at the time of the acquisition.

Okay, okay. And then just -- I didn't catch it if you've said it, number of ISVs that you're currently live and working with as well as those in the pipeline as well as any commentary of the -- whether the pace of ISV sign-up is changing at all?

Yes, Peter, I'm sorry, I didn't mention that today. We have 50 ISVs that are integrated with our technology platform, and 1 currently in the integration process as of yesterday.

And gentlemen, it does appear we have no further questions at this time. I would like to turn the conference back over to Greg Daily for any additional or closing remarks.

Thank you, everybody, for joining us this morning. I would, again, thank my team for an amazing year that we've had after going public, and we're really excited about the momentum that we have. And so with that, I'll let everybody go. Thank you for joining us today.

Thank you. And again, ladies and gentlemen, that does conclude today's call. We do thank you, again, for your participation. You may now disconnect.