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 the 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 would 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 measure is discussed in today's call, you will 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 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 will now turn the call over to the company's Chairman and CEO, Greg Daily..

Thanks Scott and good morning to all of you. We are pleased with the performance of our fourth fiscal quarter of 2019 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 the prior year. We continue to execute on our software-driven payment strategy. We completed nine acquisitions this year and all nine acquisitions will focused on software-based payments.

During 2019, we made significant move into the public sector. Public sector now is our largest vertical 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 by our 44% increase in net revenue as net revenue increased to $40.6 million in Q4 of 2019 from $28.1 million in Q4 of 2018, 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 2019 from $7.8 million in Q4 2018. 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 continue to focus on public sector and education verticals 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 volume continues to grow.

54% of our payment volume was integrated during Q4, up from 45% during Q4 of 2018. Integrated payments results in lower attrition, higher margins and greater market growth potential. The increasing 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 a new role 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 this new role. Now I will 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 the three-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 2018, 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 2019 from $7.8 million for Q4 2018.

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 2019, up from 28% for Q4 2018, 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 one-time step-up in corporate expenses for fiscal 2019 with inflationary level growth in future years. The AVR acquisition did not contribute a material amount of EBITDA to the quarter, since we closed it this month, so we got 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 2019 from $4.5 million for Q4 2018, 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 2019 from 38% for Q4 2018, 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 2019 from $21.8 million for Q4 2018. 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 2019 from $8 million for Q4 2018.

The EBITDA margin improved to 35% for Q4 2019 from 34% for Q4 2018, showing operating leverage from revenue growth. Comments on the balance sheet. As of September 30, we had $160 million available under our revolving credit. Our leverage ratio as defined in our credit agreement was 3.25 times while our current constraint is 4.0.

Our interest rate is currently around 5.5%. Over time, we expect to convert roughly two-thirds of EBITDA into free cash flow which can either be used for acquisitions or debt repayments. Outlook for 2020. Before turning to that, I want to provide an update on i3's adoption of ASC Topic 606, the new revenue recognition accounting standard.

We are adopting ASC 606 as of October 1, 2019. So you will see the change beginning with our first quarter of fiscal year 2020. Under 606, we will report GAAP revenue, net of interchange and network fees. Our historical financials have reported gross revenue and included interchange and network fees as expense line items.

We have always supplied net revenues as supplemental information, so this will not fundamentally change anything. The reason I point it out is that 2019 periods on the face of our financials will report gross while 2020 periods will 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 will continue to provide the same supplemental net revenues for our 2019 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. It excludes future acquisitions and transaction related costs and adjusts for write-downs of deferred software revenues in connection with purchase accounting. For greater clarity, we are 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 to 29.5 million. 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.

One exception I should mention is our fiscal third quarter is generally a little below trend when schools are closed for the summer while our fiscal fourth quarter is a little above trend with back-to-school activity. I will now turn 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 wanted to first quickly touch on our continuing strategic integration efforts within our verticals and comment on the progress we have made with Pace Payment Systems, the acquisition we closed in June. Business and product integration demand 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 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 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 business.

Regarding M&A, last quarter, we mentioned we had a non-binding 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 install base.

We are 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 are also pleased to share that we have 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 two teams worked 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 are 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 four to five new deals per year. We look forward to sharing more information on acquisition activity as it becomes available.

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

[Operator Instructions]. We will take our first question from George Mihalos from Cowen and Company. Please go ahead..

Good morning. This is Allison, on for George. Thanks for taking my questions. Congrats on a strong quarter and also congratulations to Scott. I just wanted to start on the FY 2020 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 is 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 will 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. Thanks. That's very helpful.

And then just to follow-up, can you 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..

Okay. Great. Thanks. Thanks for taking my questions..

Thank you. We will next move to John Davis with Raymond James. Please go ahead..

Hi. Good morning guys. Clay, place to start off on organic growth in the quarter. Nice acceleration there. Anything to call out specific? I think you did that a little bit in easier comp.

But just curious if there is 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 2018, we had a bang up quarter in IPOS which led to last quarter been 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 and 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 was just a good quarter..

Okay. It also looks like the acquisitions, I guess, that 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.

But any of the acquisitions are performing above expectations that are worth calling out?.

Yes. 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 2019 having higher corporate costs as you transition to a public company. But I think guidance implies 85 basis points of margin expansion next year at the midpoint, like you did 30-ish this year.

Is there anything else going on 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 kind of 50 basis points on a run rate basis 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 the last one for me. Rick, I am not going to let you get 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 have been public have been in public sector. And I think Clay not mentioned that's the biggest vertical for you guys.

But just curious, what the pipeline breaks out as far verticals? And if there is any other outside those two that have come up are on the radar?.

Yes. JD, thanks for the question. We continue to look for healthcare and nonprofit. We would like to be in those verticals. We do have some contacts in those two 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. Thanks. And Scott, I want to add my congratulations..

Thank you..

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

Hi. Good morning guys. I just wanted to come back to the organic revenue growth topic as we think about fiscal 2020. 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 want to get a sense of kind of where you think the full year fiscal 2020 organic could land based on the guidance you have presented to us?.

We still think high single digit is the right number, if you layer in our 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 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 opportunity 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..

Okay. That's what I figured. Okay. Thanks for the comments, guys..

Thank you..

Thank you. We will next go to Josh Beck with KeyBanc..

Yes. Thanks for taking the questions. 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 from that?.

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

Okay. Great. And I think the visioning concept is pretty interesting. So what are the big milestones that you are looking for? I don't know what 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 are looking to achieve with that process?.

So number one would be coming up with the 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 bring the things together. We see an opportunity there.

Because we do so much in public sector, for example, we have duplicative code that we would like to sunset so 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 three..

And I would just 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 are all using more of our own software and more of our own technology..

Okay. Great. And maybe a little bit of a related question. It seems obviously that 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 payments.

And so I am just wondering when you think about the pipeline and M&A discussions 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 four, five, six times. Now that we are public, we are able to pay a little bit more. And we go up to the eight, nine, 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 are usually not in a competitive environment when we are dealing with these small software companies. So I don't think it's changed. The pipeline is deeper and better, but I am not seeing valuations that make me cringe and say, oh, this is out of control.

We have determined very quick, if we are going to be able to do something. So we don't want to waste their time or ours..

I would 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 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 am 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 yields 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 a high margin company..

Okay. That's all from me. Thanks, everybody..

[Operator Instructions]. We will next move to Peter Heckmann with Davidson. Please go ahead..

Hi. Thank you. Good morning. I missed your comments on the timeline, the final conversion of the back-end on Pace.

I think I heard on the integrated business, it should be in the next few weeks and final conversion would be when?.

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

Okay.

Any material level of drag in terms of duplicate expenses on your fiscal 2020 guidance that we should be thinking about picking up in next year?.

No. Their first earnout is a calendar 2020 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.

And then just, I didn't catch it if you said it, number of ISVs that you are currently live and working with as well as those in the pipeline as well as any commentary versus the pace of ISC sign up is changing at all?.

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

Great. That's helpful. I will get back in the queue..

Thank you. 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 have had after going public and we are really excited about the momentum that we have. And so with that, I will let everybody go. Thank you for joining us today..

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