Good day, everyone, and welcome to the i3 Verticals Second Quarter 2022 Earnings Conference Call. Today's call is being recorded, and a replay will be available starting today through May 17. The number for the replay is (877) 344-7529 and the code is 3376015. 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 Geoff Smith, VP of Finance. Please go ahead, sir..

Good morning, and welcome to the second quarter 2022 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 discussed in today's call, you will also find a reconciliation to the most directly comparable GAAP financial measure by reviewing yesterday's earnings release. It is the company's intent to provide non-GAAP financial information to enhance understanding of its consolidated GAAP financial information.

This non-GAAP financial information should be considered by each individual in addition to, not instead of the GAAP financial statements.

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 reports that are filed or furnished to the SEC. Consequently, actual operations and results may differ materially from those 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, Geoff, and good morning to all of you. We are happy with our second quarter 2022 results and have had a fantastic first half of our fiscal year. We're now confident that we will be able to deliver again in the second half.

This year, we set new records in revenue and EBITDA, which grew at 62% and 65% respectively for the 6 months ending March 31. Greater than 80% of our revenue comes from recurring sources. Last quarter, we highlighted software and related services had surpassed payments as our largest source of revenue.

And as of this quarter, it represents 50% of our revenue. For context how far we've come, software and related services represented 5% of our revenue in the fiscal year 2017 before our IPO, a few short years ago.

We're extremely excited about our product offerings in both public sector and healthcare verticals and we continue to make investments to improve our technology stack. We are seeing fruits of this investment in form of excellent sales momentum in the Public Sector vertical.

In the second quarter of the fiscal year '22 included a full quarter results from our December 31 public sector acquisitions. We are pleased how well this integration has gone and the addition state-level offerings that it adds to our Public Sector vertical.

Our Healthcare vertical continues to shape up and I'm happy to announce another acquisition, which were included in our results as of May 1. This business adds Electronic Health Record platform and patient engagement suite, which is perfect complement to our Revenue Cycle product offerings.

There are ample opportunities to cross-sell in both directions. The patient engagement software will help us further leverage our scale and expertise in Payments. When we find software businesses that are under-monetizing payments, we know we can unlock this value, thanks to our scale, expertise in that market, which is a real strategic advantage.

The success we've had and the lessons we've learned building out Public Sector vertical has helped us get off to a great start in Healthcare. Now I'll turn the call over to Clay, and he will provide you more details on our second-quarter financial performance.

Following Clay's comments, Rick will provide an M&A update and then we'll open up the call for questions..

Public Sector and Healthcare. On a run rate basis, public sector represents roughly half of our consolidated business, while Healthcare is an estimated 20%. Revenues for our Merchant Services segment increased 12% to $29.2 million for Q2 '22 from $26.1 million for Q2 '21, reflecting broad-based growth in hospitality and B2B.

Adjusted EBITDA for our Merchant Services segment increased to $8.1 million for Q2 '22 from $7.6 million for Q2 '21. Our strong balance sheet has allowed us to continue to execute our acquisition strategy. On March 31, we had $182 million borrowed under our revolver net of cash under a $275 million facility.

The face value of our convertible notes are $117 million. As of March 31, our total leverage ratio was 3.9x, while the current constraint is 5.0x. As mentioned by Greg, we have subsequently completed a small healthcare acquisition, but we currently expect to remain below 4x for Q3 the June quarter.

The interest rate for the convertible notes is 1%, while the interest rate for the revolver is currently around 4.25% but will increase as the Fed continues to raise rates. Over time, we expect to convert roughly 2/3 of adjusted EBITDA in the free cash flow, which can be used for debt repayment, acquisitions and earn-outs.

We define free cash flow as adjusted EBITDA minus CapEx, internally capitalized software, cashed interest and cash taxes. Outlook. Looking forward, our strong first half gives us confidence in raising guidance for fiscal year '22. It excludes acquisitions that have not yet closed and transaction related costs. Revenues $300 million to $312 million.

Adjusted EBITDA $75 million to $81 million. Pro forma adjusted diluted EPS of $1.40 to $1.47. From a seasonal standpoint, we have different verticals with different seasonal patterns, which generally counterbalance each other with the current mix of companies.

Our exception are -- one exception is our Education business which slows down during the June quarter when school lets out. As we've become more software-centric, quarters might vary based upon perpetual license sales, even though our trend is generally toward more recurring revenue streams.

I'll now turn the call over to Rick for company updates and M&A activity..

Thank you, Clay. Good morning, everyone. Before I discuss M&A, I'll give an update on a few items. Our public sector unified product offering software solutions continued to have strong results with success in local, municipal, county and state markets.

Over the last quarter, we've expanded our product reach by adding new solution software sales in Georgia, Alabama, Tennessee and Kentucky. In other words, we are beginning to bring products into states and customers where those products had not been utilized before.

We expanded our territorial reach by entering 4 new states with contribution from 4 i3 public sector entities. Expansion includes additional instances of our public safety, courts, payment processing, digital signature and certification, tax, records management and digital customer engagement software solutions.

We continue to implement on our recently announced LCRAA, Louisiana Clerks Remote Access Authority software contract, which is supported by statewide e-filing. This effort is going extremely well. Our education product offerings have unified under the i3 education brand with related marketing sales, development and support.

Our education businesses are coordinated in bringing a full and robust solution to K-12 schools and to that end, we continue to make investments in our software. I3 education has been responsive to school needs by installing technology that lessens traditional lunchroom interactions and leverages staff given labor shortages.

We've been pleased with the results in education, which are being driven by successful focus sales campaigns, product line expansions, cost consolidations and more relaxed COVID protocols.

From a technology perspective, we continue to focus on moving infrastructure into AWS, which allows us to centrally manage and support our products across the enterprise.

This effort is more than a change to a hosting environment and will bring significant enhancements to our products, including rapid scaling, increased geographic redundancy and improved security oversight.

In addition to modernizing infrastructure, we are investing in low-code application technologies that will allow us to rapidly deploy new products where we have gaps in our current offering or need to modernize architecture. Low-code platforms will give us better access to data across the organization as solutions become more integrated.

We've expanded training and are creating cross-divisional teams to build a platform on which we can launch full suite solution. I'll now speak M&A. As Greg mentioned, we recently closed the tuck-in acquisition within the healthcare vertical. For nearly 20 years, this company has provided software solutions to a wide range of healthcare providers.

The company was born out of a personal experience that the owner had with an antiquated healthcare system in the '90s. He realized that there were vast opportunities to improve operational efficiencies in the healthcare world. This personal backstory has allowed them to build products that do not lose sight of the patient first.

This business offers an array of services including electronic health records, electronic patient engagement or patient portal, revenue cycle management, population health and data analytics and compliance program assistance. Their flagship product is their EHR offering, a solution that fills a much-needed GAAP in our healthcare product offering.

This EHR solution combined with a robust patient portal brings us to a complete unified product offering in the healthcare space. The Patient Portal is a meaningful upgrade on our front-end patient engagement side of the house and fits nicely with our existing back-end solutions that our other healthcare businesses offer.

This business is a natural strategic fit in i3's healthcare vertical and in fact they already do business with 3 of our existing healthcare companies. I wanted to note at this point this acquisition fell within our standard range relative to multiples.

Our healthcare vertical is re-imagining the delivery of software products by bringing together complementary businesses. The current industry strains that came out of COVID required a commensurate pivot in the way we provide support services.

For example, in response to the pandemic, we've built upon our invoicing systems to adapt best practices for our lab and mobile healthcare delivery clients. And we continue to educate providers and staff on the ever-changing requirements of telemedicine. Our M&A pipeline has an emphasis on public sector and healthcare in that order.

And we look forward to sharing more on the acquisition front in the near term. This concludes my comments made at this time. We'll open the call up for Q&A, please..

[Operator Instructions] Our first question will come from John Davis with Raymond James..

Clay, I want to start with organic growth, both if you give it for the quarter, but also maybe talk a little bit about longer-term growth. You have now 50% software revenue, AR 47%. So it seems like -- and before long we're going to be tipping over into the low-double digits on sustainable basis.

But just any comments on an organic growth would be helpful..

Well, for the quarter it was 16%. That follows 16% last quarter and 17% the previous quarter. The first half of the year, although December quarter had some COVID rebound in it, this quarter much less so. And then the June quarter, I think it's gone altogether. But we committed to double-digit growth for this year.

I think we'll give guidance on that annually as we come around the turn and have better visibility into the economy and what to expect from our various verticals..

Okay. No, fair enough.

And then on the new deal, I apologize if I missed this, see its size and then Rick said historical multiples that based off your leverage comments, Clay, is fair to assume kind of $20 million to $30 million range?.

No, that's too high. We'll publish the 10-Q today and we'll make the statement that including the upfront purchase price and the earn-outs we expect to pay, all in it will be less than $10 million. It's a small deal..

Okay. No, super helpful. And then last one for me. Based on the margins, I think the implied margins in the guide are down about 50 basis points.

I'm assuming that just has to do with business make from all the acquisitions that you've done, but I'm curious anything else going on the margin we should be aware of?.

Well, there are ranges in the guidance for both revenues and adjusted EBITDA. We could reach the same EBITDA number with higher or lower revenues. The fact that the midpoints imply a lower percentage than the guidance that we gave last quarter reflects our experience of stronger top line revenues this quarter.

But we can't say with certainty what the composition of our revenues will be in the back half of the year. If you look at our annualized recurring revenue sheet or composition of revenues sheet in the addendum, you see that it was pretty strong on services this quarter which leads to higher revenues.

But for the 6 months, our adjusted EBITDA was ahead of the previous year by 50 basis points..

Okay. No, no, that's helpful. So basically no underlying changes, it's just business mix, if anything.

Basically, you're not investing more in the back half or anything like that, it's just business mix?.

Right. Yes..

Our next question will come from Peter Heckmann with Davidson..

Just wanted to see if you could talk a little bit about any early success on the more of the pure software companies, both on the public sector side and with healthcare? Any early success in cross-selling payments or a little too early in those cases?.

So, Peter, we are having successes cross-selling payments into those businesses. I think what got our focus right now even more so is we're able to go in with multiple sub companies as one and compete very well as 1 organization and winning deals from our competition. The payments is going as expected..

That's great. That's great. And then as regards just the -- just called the American Rescue Plan, the Federal Stimulus Program that was going to potentially stimulate a little bit of IT spend, I think you have noted it's seeing a little bit of procurement activity that may have been funded by that.

Any update in that regard? Are municipalities starting to get the word that those funds are available?.

Yes. So there is something like $350 billion available to state and local governments. We had pent-up demand that we saw during the heat of the pandemic, and that stuff starting to implement as we speak, but we are seeing an uptick in RFPs. It's hard to determine whether we can link those directly to those funds.

We know a lot of our customers are still discussing how that money is going to be spent. I would expect that we will see a roll out of those funds relative to new implementations probably as a tailwind over the next couple of years..

Our next question will come from George Mihalos with Cowen..

This is Allison on for George. Congrats on the results. I wanted to start on the guidance raised for the full year.

Is that really just a flow-through of the strong 2Q results, or is there any contribution from the healthcare tuck-in, understanding that it's small or better expectations embedded over 2H in there as well?.

Well, it does flow through the beat, but it also adds in the acquisition we just made. And the acquisition adds about $1 million for the 5 months we'll have at this year, or the -- yes, the 5 months, yes, in revenues..

Okay, great. That's super helpful. And then, Clay.

As a follow-up to that, can you remind us your expectations for interest expense embedded within the outlook for the full year?.

Yes. We've added 0.5 point increase in May, which is already happened, another 0.5 points in June and then a third 0.5 point in July is our current assumption. That should come to cash interest between 8.5 and $9 million for the entire year..

And then last one from me on the Merchant segment. Margins there came in below our expectations and were down year-over-year. I heard B2B was a revenue driver there. Just curious, is there anything else to call out there driving that performance? And how should we think about segment margins over 2H? Thanks again..

Yes. The Merchant margin, sort of the last vertical to rebound out of COVID was our hospitality vertical and particularly on the West Coast. And that's generally within our margin. It also carries higher residual expense. So that's kind of -- we saw a surge in that. In certain sectors we saw 100% surge in payment volumes.

California had remained shut down for much longer than the rest of the country and Hawaii as well. So that's the biggest thing. And then B2B, you rightly pointed out, is thin margin, but we're very happy to see a resurgence in that as well..

Our next question will come from James Faucette with Morgan Stanley..

This is Jeff Goldstein on for James. I was hoping for some more color on the M&A market.

You said in the past that your targets don't really track public valuations, but just curious if that's still the case? And if your pipeline still hasn't been impacted by what's going on in the public markets right now?.

Yes. The pipeline is still very good. Again, we self-source our deals and we go after people that weren't necessarily looking to sell, they want to be part of a larger team, but we haven't seen any impact. It's steady as it goes, as far as M&A for us in our pipeline..

It seems like each deal is different. If they're growing nicely, we've kind of argue a lot about valuations. Other companies, they understand the market, the FinTech is down, so they're sympathetic to a lower LOI. But each deal is different. We're getting a reputation, we've got lots of references for these old software owners to call.

We're seeing more and more than our conferences now that COVID is over. So it's business as usual. It's kind of back to normal. The pipeline is good. We've been very picky with who we kind of add to the team because we kind of like what we've got together today..

Got it. That's very helpful color.

And then I think you touched on this a little earlier, but can you update us on what you're seeing in the competitive environment within your public sector and healthcare verticals, when it comes to kind of RFPs, just anything notable to call out there that maybe change in recent quarters?.

I don't think it's really changed. We see Tyler in public sector and that's kind of the most notable person that we feel like we go up against. There is still lots of little guys, very fragmented.

In healthcare, no, it's so much larger than public sector, we like with the -- the offering that we put together with our team there is probably 600 people in that vertical. And it's still early compared to where we are with public sector though, but competition really hasn't changed..

[Operator Instructions] Our next question will come from Chris Donat with Piper Sandler..

And I'm trying to get the right way to ask this in a way you can answer it, but economic concerns have been rising in the last few weeks.

I'm trying to understand with your public sector and healthcare businesses, how likely they are to be resilient? I would imagine, public sector very much resilient, particularly with some of the government initiatives.

But on healthcare, is there any way to break healthcare down into discretionary and non-discretionary, or any way to think about healthcare and how that might perform in a more challenging economic environment..

Gosh, I don't know if I can, I don't have any statistics on the discretionary versus nondiscretionary. Our experience with healthcare during COVID was that it was one of our more resilient verticals. Healthcare is not something people can postpone for very long.

I mean they might be able to postpone a few months, but it's something that generally need to be kept up with, an insurance provides for. So I do think of it as a very defensive vertical..

Okay. And just to be clear that it was resilient in the pandemic, so we've already had sort of some example people in challenging environment continuing to -- your revenues remaining solid during that period.

Right?.

Yes, and that's consistent with what we said on the conference call during that period..

Okay. Yes, trying to think forward on how it might play out.

And then looking at the supplemental and the composition of revenue, the recurring software services revenue that's been growing, how should we think about that trajectory? Is that still likely to grow with some of the businesses, you've added on recently, or is there anything that really drove in the last 2 quarters that was unique?.

Well, I think the big step up you see was in the December quarter and that reflects the healthcare acquisition we made October first. And so that's kind of a new level. You see it step all the way from $3.2 million to $10.3 million and then this last quarter it was $11.1 million.

So that's kind of a new level we're at as a result of that acquisition on that particular line item..

Okay. And but it was a 2 full quarters, I mean full quarter for the March 31st quarter, full quarter for December 31st.

Right?.

Correct, October 1st was the acquisition..

Right, okay. Okay.

And then just one more on education, I know it's a smaller vertical for you, but where are we in a recovery of that vertical?.

Well, it's definitely outperformed our expectations this year. The return to school, it was the biggest factor. We still have free lunch, which is a drag. And if that goes away and there's a lot of to and fro over that right now, but if it goes away, I think it will add $3 million to $3.5 million to our bottom line on an annual basis.

But in the meantime, we've figured out a lot of ways to supplement our revenue streams there. One is through more software sold to districts which help alleviate their staffing shortages. We have a number of things in the works we're excited about.

We don't want to say on this call because we feel like we've got a lead on our competitors in that regard. But we are very excited about Education vertical, and it's been amazingly resilient in the face of free lunch for everybody..

Okay. Got it. So there's definitely some areas where that could improve if -- I mean you got momentum and potential areas to improve, okay..

This concludes our question-and-answer session. I would like to turn the conference back over to Greg Daily for any closing remarks..

All right. Thanks, everyone. I hope we've got the message across that all parts, all verticals of the company are doing very well. I'd also like to thank our 1400 employees that we have, what an incredible effort they're doing every day. And we look forward to updating you next quarter. So thank you again for your interest..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..