Greg Daily - Chairman, CEO Clay Whitson - CFO Rick Stanford - President Scott Meriwether - Senior Vice President Finance.

John Davis - Raymond James George Mihalos - Cowen Peter Heckman - Davidson Josh Beck - KeyBanc.

Good day everyone, and welcome to the i3 Verticals, Fourth Quarter 2018 Earnings Conference Call. Today’s call is being recorded and a replay will be available starting today through December 6. The number for the replay is 719-457-0820 and the code for this is 3349103. The replay may also be accessed through December 6 at the company’s website.

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

Good morning and welcome the fourth quarter 2018 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 a reconciliation of that measure 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 the 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 then 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. .

lower attrition, higher margins, and market growth potential. The increase in the proportion of our business coming from integrated payments give us the confidence in achieving long-term margin improvement. Following the IPO, we have a strong balance sheet with plenty of debt capacity.

Our leverage ratio on a pro forma basis for our recently completed acquisitions was less than 2x as of September 30, 2018. After the financial section, Rick will spend some time on our recently completed acquisitions. Our acquisition pipeline has been very active since we completed the IPO in June.

We remain committed to the same type of acquisition strategy we have executed in the past with the evidence of our REV -- our recently completed acquisitions. The combination of strong organic growth, long-term margin improvement, and strategic acquisition position us well for the future years. Clay, could you give us the financial overview..

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. That’s our prospective item.

Adjusted EBITDA as a percentage of net revenues held steady at 38% for Q4, 2018 despite a 42% increase in corporate expenses, principally associated with becoming a public company. Q4 was our first full quarter as a public company. Our IPO was at the end of June. Fees costs were anticipated and factored into our previous guidance.

Pro forma diluted and earnings per share were $0.19 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 the non-cash 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. Net revenues for merchant services increased 37% to $23.6 million for Q4, 2018 from $17.2 million for Q4, 2017.

Net revenues for proprietary software and payments grew at an even higher rate, 43% to $4.5 million for Q4 ‘18 from $3.2 million for Q4 ‘17. Adjusted EBITDA for merchant services increased 25% to $8 million for Q4, 2018 from $6.4 million for Q4 2017.

In proprietary software and payments, adjusted EBITDA continued the transformative trend we’ve seen all year, increasing 153% to $1.7 million for Q4 ‘18 from $676,000 for Q4, 2017.

The principal reason for the improvement has been sustained organic net revenue growth in our flagship education vertical along with some operational improvements which have contained growth and cost. The public sector acquisition completed in September contributed approximately $100,000 to EBITDA.

The adjusted EBITDA margin for proprietary software and payments improved to 38% for Q4, 2018 from 21% for Q4, 2017. The improvement in the software and payments more than offset the step-up in corporate expenses associated with being public. Outlook; our guidance for fiscal year 2019 net revenues was $122 million to $128 million.

Adjusted EBITDA for fiscal ‘19 is $35 million to $36 million and pro forma adjusted diluted EPS $0.84 to $0.87%. We expect the three recently completed acquisitions to collectively contribute over $8 million in net revenues for fiscal ‘19 and over $3 million in adjusted EBITDA high margin businesses.

Excluding contingent consideration, we paid $27.1 million mainly in cash. From a balance sheet perspective, Greg mentioned our leverage ratio less than 2x, that is pro forma for recently competed acquisitions. On September 30 our term facility stood at $35 million and we currently have $88 million available under our resolver.

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

Thanks Clay. As we told you in June, prior to our IPO acquisitions are an important part of our overall growth strategy. To that end we regularly consider potential acquisition partners for both platform and tuck-in deals. In addition to price, we carefully assess how they would fit with our business goals and how we would integrate with our culture.

Fit is very important to us. As a result of the recent acquisitions, we’ve grown our employee base from 334 to 397 strong in the last few months. These acquisitions are not two person deals, but not 100 either.

While the acquisition process has a natural ebb and flow, the last 120 days have been especially busy for us and we are excited about three acquisitions we closed during this timeframe. On our Q3 call I mentioned that we had signed a non-binding term sheet for a tuck-in opportunity. That deal eventually closed in September.

It’s in our public sector vertical and service courts and municipalities with proprietary software and payments. It’s important to note that this business has already been merged into our technology platform as well. The second acquisition we closed in November is a platform acquisition within the public sector vertical.

This business provides payment capabilities to courts and municipalities like the others we have purchased, but this one also provides accounting software that their customers utilize.

This additional software capability gives us a good end-to-end solution, allows us to provide a more comprehensive product suite and offers additional opportunities to extend our payment solutions. Last, we believe it gives us a scale to move into other states.

Both public sector deals offer fully integrated payment solutions, which is squarely within our long term business strategy. Integration significantly reduces attrition and makes the sales stickier. The third acquisition we closed in November as well is the technology play in the payment space.

This is a leading technology company and offers cutting edge solutions that will augment our Burton Platform and accelerate the time to market for the full suite of tools that we plan to offer within that platform.

The three acquisitions I’ve spoken to have shared characteristics being small but growing, lower attraction and profitable, including the technology deal we completed for the Burton Platform.

We will continue to focus on finding potential acquisition partners with an emphasis on deals that would accelerate our vertical strategy, and we’re extremely excited about our progress and look forward to sharing even more news about closed deals with you in the coming quarters. This concludes my comments Kaylee.

At this point we’ll open the call for Q&A please. .

[Operator Instructions] We will now take our first question from John Davis of Raymond James. Please go ahead sir..

Hey, good morning guys. Clay, good to hear the organic growth is still 9%, still healthy, but it looks like it did decelerate a little bit and it looks like the yield came down but margin beat. So my assumption is the little bit weaker revenue was related to hardware sales.

Is that true and if not, just kind of give any color you can on what drove what was a little bit weaker topline but much better margin?.

Yes, that’s exactly right John. We had about $1 million less in hardware sales going from Q3 to Q4. That impacts net revenue inordinately, because the cost of the hardware is not factored in to the net revenue; it’s in other cost of services.

The other thing was payment systems, the purchase portfolios declined at a 34% rate that’s higher than we’ve experienced over the first nine months, and that probably cost us $400,000 or so. .

Okay, and then as you look out to 2019, I think guidance increased a little bit less than the acquisition detail you gave.

Is that similar lower hardware sales expected, you know any color you can give on kind of the implied organic growth rate in the updated 2019 guidance?.

Yeah, I think it’s been influenced by this quarter, and the hardware business has had some market pressures to transition to more of a SaaS monthly model as opposed to big upfront expenditures. We got a lid on that environment and so I’ve taken a more cautious view of equipment for 2019.

Also, the purchase portfolios, that attrition I’ve assumed will continue until I’d say otherwise. .

Okay, and last one for me, maybe for Rick. Just detail on the acquisitions, just trying to figure out from a – were they all equal, roughly equally sized, was one really big and then maybe Clay just where is your pro forma debt level now. I know we closed one in the quarter, and so that’s included in that debt balance in the quarter.

Just trying to figure out kind of what pro forma debt looks like today?.

Yeah, so two of the deals are in the public sector. One was about an average size comparable to the deals we’ve done before, one was a little larger. The addition of the accounting software and the end to end solution give us a lot of confidence to be able to expand into other states, which we hadn’t had to-date.

We are positive about all of these acquisitions. The technology play that I mentioned is going to make time to market with what we had envisioned for the Burton Platform, a reality sooner than later, and we are excited about that as well. .

So, we have about $57 million borrowed today, $88 million of availability under our revolver, but the $57 million includes the term facility. .

Okay, and then just Rick, any commentary on the geographic expansion area, like within public sector, remind us where you are geographically today? Where these acquisitions were planned to expand that beyond those geographies? Do you need to do more acquisitions or can you just take the technology now and kind of expand that throughout the rest of the U.S.

.

You know I think, we’ll do both. I have additional public sector deals in my pipeline that I continue to court. These deals were in the South East, similar to the ones we’ve done before. I see upwards North East and Mid-West expansion, Mid-West being the primary. .

Okay, alright thanks guys. .

Thanks John. .

We will now take our next question form George Mihalos of Cowen. Please go ahead sir..

Hey, good morning guys. Just to follow-up on John’s question, Clay, can you remind us the percentage of revenue that has been coming from hardware in ‘18 and maybe where you see that or where your guidance implies that will go in 2019.

And then as it relates to the purchase portfolios, you know I think those declined a little bit more than what we had expected this quarter.

Should we still be thinking of an attrition rate though, sort of in the mid-20s as we think about 2019?.

Well, I’ll start with the purchase portfolios. Volume attrited 27%, but net revenues attrited 34% and it’s a lot of smaller account closures that were very fee dependent as opposed to larger merchants with a lot of processing volume. So yes, I’m assuming that continues that revenue attrition into 2019.

Your question regarding our Aloha business, it’s about 7% of net revenues, and I’m taking that cautious approach for 2019 as well. .

Okay, and that’s related to – is that mostly San Diego Cash Register, is that the business that we’re talking about or…?.

That is, but we also have another one named EMS up in Seattle. .

Okay, that’s helpful. And then just wanted to ask on the software acquisitions that were recently consummated. It looks like they are kind of coming in and call it about a 38% you know margin.

Is there room to even improve upon that going forward or should we be thinking of that as kind of the run rate for you know the intermediate term?.

Well, these are very high margin businesses. Two of the three are over 50% margins, but it’s lumpy. They get – you know they are selling software. So, they sell a large customer and it can be very lumpy. So, it’s hard to know how much of that to project, but I can say they’ve had very good years in the last two years..

Okay, and is there any reason why we shouldn’t see the revenue yield continue to increase going forward, especially given maybe some of the puts and takes around hardware, and the new software revenue coming in or the software acquisitions excuse me. .

Well hardware helps the revenue yield, because there’s no volume associated with it, and so a decline in hardware doesn’t help the revenue yield.

The software companies do help the revenue yield, but in general a long term we do expect the revenue yield to increase, because we plan to make our acquisitions and our verticals and they carry higher revenue yields. .

Okay, thank you. .

We will now take our next question from Peter Heckman of Davidson. Please go ahead sir..

Good morning, thanks for taking my question.

Can you talk a little bit about the new ISV partners and if some of those are helping you identify new verticals that you might want to enter?.

Yeah, so as Greg had mentioned we’ve signed five new ISV partners. I can’t speak to the specific vertical. Typically we are looking for a new ISV partners in the non-profit and healthcare space. These were signed and are currently integrating. I believe there’s one that’s actually actively placing merchants today.

We’ll continue to focus on non-profit and healthcare though Peter. .

Okay, that’s helpful.

And then, did you give an overall attrition number for the consolidated quarter?.

We’re still tracking at 1% a month, blend-in. .

Got it. Okay, that’s helpful. And then last question, was there anything notable on a trend basis within the three primary areas of proprietary software, education, I think had been the most rapidly growing. But anything to call out there in terms of changes, acceleration, deceleration among those verticals. .

We had another great quarter in education, August and September are big months for us. So that’s continued right along. We are getting more and more excited about the public sector vertical now. We now have three acquisitions as Rick outlined and a full product suite to roll out to new states.

So our vision is for our public sector business to follow the trajectory that education once did. .

Great. Alright, thanks for taking my questions..

[Operator Instructions] We will now take our next question from Josh Beck of KeyBanc. Please go ahead sir. .

Thank you. My first question is probably for Greg or Rick. And you’ve been really active obviously in the public sector over the last year having done three deals.

But just kind of wondering what was so attractive about that vertical, and then when you think about the pipeline, are you finding other verticals where maybe you want to concentrate the M&A efforts and kind of do several in one vertical or do you kind of see opportunities across the board..

Well, I’ll jump in first Rick. In the government space Josh, we did one a year ago and we loved the people, their growth and found that they were still you know under penetrated in that particular vertical.

The guy that runs the vertical for us made several quick introductions to us, the people that he liked that think that would fit and we acquired them. But you know going through the IPO process really made us sharpen our focus on maybe the higher margin verticals such as education and government or what we call it, public sector.

You know we don’t have attrition there. They are smaller deals than we would like to – I mean I’d like to do bigger ones. They take just as long, but they were available. We went there and told them our story. They agreed to join the team and we couldn’t be more elated about that. .

And I think one other thing that you kind of left out Rick in kind of telling, you know these three deals, we’ve talked to all three of them about you know, who else fits in your vertical, whether it’s a tuck-in or whether it’s a product or whether it’s a competitor and so we’re kind of excited about starting on that after the first of the year. .

Yeah Josh, Greg makes a good point that to your first question we are going to follow the margin where it’s greatest. It’s not secret we like non-profit and public sector. Also, typically my best leads come from deal from CEOs of deals that we’ve previously done. So we have two new deals and they have contacts in this space.

So I’ll continue to run those strings out to see what is out there. Now that we have a platform deal in the public sector you can assume that we are going to look for tuck-ins around that software to make it a more complete solution. But we do continue to call into multiple verticals.

As I mentioned on the roadshow, B2B is an assortment of small verticals and some of them are really cool. So we are learning as we speak about some of these new verticals and testing the market and having conversations with people for potential additional verticals. .

Okay, really helpful. And then when I look at the implied EBITDA multiple, at least for fiscal 2019, it looks like it’s about 9x. So when you think about that multiple, is that pretty representative of what you are seeing out there in the market.

Were there any unusual things that we should be thinking about when we assess the multiple of these deals?.

Well, I wish you hadn’t asked that question, because that’s uncomfortably high. I’m sure some of our targets are listening and we’re trying to get 7x. But I think you know they are smaller companies, high growth, software, their technology is good, their culture was fantastic.

So we paid-up a little bit more than what we normally do, but I do think that within a couple of years the multiple looks more like 4x or 5x..

Okay, that’s helpful and then what about – Clay, I don’t know if you could share this or give us any rough detail, but the mix of software revenue versus payments revenue for these companies that you’ve acquire and maybe how that compares to some of the other verticals that you are in?.

Well, the one public sector we closed in September is virtually all payments.

The technology company we bought is virtually all software, and for the platform public sector business, do you have an estimate Scott?.

They are 20% payments and the rest software. .

Did you hear that? 20% payments and 80% software for the other, the third company..

Okay, that’s helpful and then this is my last question on you know the outlook for 2019. If you were to exclude that hardware revenue, which is obviously I think not up, right up, a really integral part of the business long term and exclude the purchase portfolios.

Any sense of kind of what the underlying growth is? I mean does it compare to the high single to low double digit organic growth that we’ve seen in the second half of this year.

Obviously that’s not directly comparable if you back out purchased portfolios, but just trying to get a sense of what the underlying growth is that you are thinking about next year excluding some of those factors?.

I’m thinking high single digits. 9% this quarter is probably representative, that’s excluding the purchase portfolios. We do want to get to double digit, but I’m not – I don’t think we are there quite yet. .

Okay, that’s all I have. Thank you so much. .

[Operator Instructions] We will not take our next question from [Inaudible]. Please go ahead sir. .

Hi Greg, hey guys. Thanks for taking my question.

I just wanted to get a quick update on the purchase portfolio and is it continuing to wind down as expected?.

Well the attrition did accelerate this quarter and so that was not as expected. It had been running 23% for the first nine months, and so I guess that was not expected, but we are assuming that in our guidance going forward. .

Okay, and then just one more question just in terms of capital allocation.

Could you just remind me kind of what levels you guys are comfortable with in terms of debt as you kind of continue to do these acquisitions going forward?.

Well, our current credit agreement allows us to go to 3.75x for senior debt and we do have the ability to layer in subordinated to get a little bit higher, but where we are today, I think long term we are very comfortable with 3.5x and we would be comfortable flexing-up temporarily though for 4.5x with a view towards coming back to 3.5x as cash flow pays down the debt..

Okay, great. Thanks guys. .

Thank you. .

It appears we have no further questions at this time. I’d now like to hand the call back over for any additional or closing remarks. .

So again, thanks everybody for joining us this morning. We are excited about our prospects, our team, Rick’s pipeline and we look forward to talking to you again on our next quarterly call. .

This concludes today’s call. You may now disconnect..