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i3 Verticals Inc (NASDAQ:IIIV)
Q1 2020 Earnings Call
Feb 11, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the i3 Verticals First Quarter 2020 Earnings Conference Call. Today's call is being recorded, and a replay will be available starting today through February 18. The number for the replay is (719) 457-0820, and the code is 8962025. 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, Chief Operating Officer. Please go ahead, sir.

Scott Meriwether -- Chief Operating Officer

Good morning, and welcome to the first quarter 2020 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 refusing -- by reviewing yesterday's earnings release. It is the Company's intent to provide non-GAAP financial information to enhance understanding of its consolidated financial information as prepared in accordance with GAAP. This non-GAAP information should be considered by each individual in addition to, but not instead of the financial statements prepared in accordance with GAAP.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding the Company's expected financial and operating performance. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. You are hereby cautioned that these forward-looking statements may be affected by the important factors, among others, set forth in the Company's earnings release, and in reports that are filed or furnished to the SEC. And consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements.

Finally, the information shared on this call is valid as of today's date, and the Company undertakes no obligation to update it except as maybe required under applicable law.

I'll now turn the call over to the Company's Chairman and CEO, Greg Daily.

Greg Daily -- Chief Executive Officer

Thanks, Scott, and good morning to all of you. We are pleased with our first fiscal quarter of 2020, and look forward to delivering strong performances throughout 2020.

Our first quarter is a strong start to the fiscal year. Clay will cover the financial results in a little more detail later. One highlight was a 41% increase in net revenue, as net revenue increased to $41.6 million in Q1 of 2020 from $29.6 million in Q1 of '19, primarily driven by our Public Sector vertical and strong internal growth throughout the Company. Pro forma adjusted EBITDA increased to $11.9 million in Q1 of 2020 from $8.6 million in Q1 of '19. We continued to achieve above-market growth rates by delivering seamless integrated payment and software solutions to SMBs and organizations in strategic vertical markets.

Our integrated payments volume continues to grow. 55% of our payment volume was integrated during Q1 of 2020, up from 46% in Q1 of '19. Integrated payments results in lower attrition, higher margin, and greater market growth potential. We continue to focus on deploying new technology, and streamlining our existing technology, particularly within Public Sector and Education verticals as well as our payment platform. Our sales teams are experiencing increased momentum from these technology offerings, and we anticipate it will help drive our future growth.

We believe, we can continue to leverage our distribution channels for our software offering, and that we have further opportunities to leverage our payment platform within our technology assets. Rick will speak to M&A momentarily, but I will note that our pipeline is very strong. Our focus remains primarily in Public Sector and Education verticals. In addition, we will continue to target strategic acquisitions in other verticals that have opportunities to provide software-driven payments.

Clay, would you please provide a financial overview?

Clay Whitson -- Chief Financial Officer

Sure. The following pertains to the first quarter of fiscal year 2020, which is the three-month period ended December 31, 2019. We started the year with a strong quarter. Net revenues increased 41% to $41.6 million for Q1 2020, from $29.6 million for Q1 2019, driven by strong organic growth and acquisitions principally in our Public Sector and Education verticals.

As discussed on the call last quarter, the face of the income statement shows a decline in revenue, as a result of adopting ASC 606. Q1 2019 presents revenues gross of interchange and network fees, while Q1 2020 presents revenues net of interchange and network fees. For an apples-to-apples comparison, please refer to the supplemental segment presentation contained in yesterday's 8-K filing. You can also access it on our website, under Events and Presentations.

Excluding the Purchased Portfolios and our IPOS business, net revenues grew 9% organically. We benefited from strong growth in Education, Public Sector, B2B, and ISO. Acquisitions contributed $11.5 million to net revenue growth for the quarter. Adjusted EBITDA grew 38% to $11.9 million for Q1 2020, from $8.6 million for Q1 2019. Please see the press release for a reconciliation between net income and adjusted EBITDA.

Adjusted EBITDA as a percentage of net revenues was 28.5% for Q1 2020, down from 29% for Q1 '19. The decline resulted from a lower margin in our proprietary software segment, which I will unpack in the segment discussion. Partially offsetting this decline, corporate expenses as a percentage of net revenues improved to 6.2% for Q1 2020, from 7.2% for Q1 2019. The improvement was expected following the step-up in public company costs in the first year following our IPO. Adjusted diluted earnings per share were $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 134% to $14.6 million for Q1 2020, from $6.2 million for Q1 2019, reflecting an organic growth and acquisitions in our Public Sector and Education verticals.

Adjusted EBITDA increased 90% to $5.4 million, from $2.9 million, principally reflecting recent acquisitions in our Public Sector vertical. EBITDA as a percentage of net revenues was 37% for Q1 2020 versus 46% for Q1 '19. This segment is double the size it was a year-ago, and margins will continue to fluctuate based on the mix of companies, seasonal factors, and revenue streams. Payments revenues and SaaS revenues are steady, while perpetual software license sales and custom builds can vary significantly quarter to quarter.

Within the Public Sector, some products such as traffic tickets might carry 8% net revenue yields, while our utility bill might be 1% to 2%. On the flip side, utility bills happen every month, while traffic tickets are infrequent. So we love the volume and consistency with utility bills. Our latest acquisition AVR is a utility billing company with proprietary software. Its margins are currently in the 20% range, but will grow over time as its retooled web-based product grows.

Net revenues for our Merchant Services segment, excluding the Purchased Portfolios increased 23% to $26.1 million for Q1 2020, from $21.3 million for Q1 '19. This increase reflected growth in our direct sales channel, which includes B2B, and ISO and ISV channels, including continued double-digit growth from 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 other ISVs.

The Purchased Portfolios declined 35% to $1.3 million, in line with expectations. In our IPOS business, the transition to SaaS, that we communicated last quarter, is taking hold and the timing adjustments for net revenues are still baked into our 2020 guidance. Adjusted EBITDA for our Merchant Services segment increased 15% to $9 million for Q1 2020, from $7.9 million for Q1 2019. The EBITDA margin was 33% for Q1 2020, versus 34% for Q1 2019, reflecting conversion costs at Pace, which should be finished by the end of the June quarter.

Balance sheet. As of December 31, we had $166 million available under our revolving credit. Our leverage ratio, as defined in our credit agreement, was 2.85 times, while our current constraint is 4.0 times. Our interest rate is currently around 5.5%. Over time, we expect to convert roughly two-thirds of our EBITDA into free cash flow, which can either be used for more acquisitions or debt repayment.

Outlook. Looking forward, the strong start to our fiscal year, gives us confidence in the following guidance for fiscal 2020. It excludes future acquisitions and transaction-related costs, and adjusts for writedowns of deferred software revenues in connection with purchase accounting.

Adjusted revenues $162 million to $166 million, adjusted EBITDA $46 million to $48 million, and pro forma diluted EPS $0.91 to $0.97. We have raised the range for adjusted net revenues by $2 million, recognizing that the transition to SaaS and our IPOS business will take time to fully implement. We maintain our previously issued guidance for adjusted EBITDA and pro forma diluted EPS. We do not intend to update our guidance during the year for depreciation and amortization, cash interest expense, or fully diluted shares outstanding, unless material changes occur.

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

Rick Stanford -- President

Thank you, Clay. Good morning, everyone. Before I talk about our M&A outlook, I want to first quickly give you a few updates relative to the information provided on the last call.

First, we are continuing to pursue a unified product offering in each of our Public Sector and Education verticals. That process is going extremely well, and we are moving rapidly toward offering our customers in those verticals a more robust and comprehensive suite of products.

Second, relative to the Pace acquisition, we have now completed the conversion of the integrated ISV business, and we have begun the conversion process for the non-integrated business. We hope to have a non-integrated piece completed by the end of summer. We continue to be impressed with the people at Pace, and the opportunities they bring to the table. The decision to merge both the i3 and the Pace ISV teams, is proving to be a winner for us at the enterprise level and allowing us to engage salespeople throughout the Company in other acquisition subs, and year-to-date had little to no access to this type of offer.

Third, on the ISV front, our total number of signed and integrated ISVs at the end of our first fiscal quarter is 52.

Lastly, regarding M&A, our team is hitting their stride. This team includes M&A, finance, operations, legal, and IT, functioning as one cohesive group, each having a part in our overall success, from nurturing new potential deals to diligence to closing and post-close support. I'm very pleased to say that the pipeline for potential acquisitions is stronger today than it's been since our IPO. While the acquisition process has a natural ebb and flow, the last two quarters have been especially busy for us, and we are optimistic with regard to M&A activity.

To that point, we currently have four executed term sheets in process. To be clear, all of these term sheets are non-binding, and we are in various stages of due diligence with each of them, and there is no assurance that we will ultimately close these deals. Each of these deals is in our sweet spot, from public sector to education, with a sprinkling of ISVs and B2B, and we like the opportunities that each of them presents. In addition to these potential deals, our general pipeline is populated with a heavy emphasis on Public Sector, with a little Education and some others mixed in.

While we saw last year as an anomaly, where we closed nine acquisitions, we believe that we will remain successful in executing our M&A strategy, and still believe we can generate five or more new deals this year.

This concludes my comments, Rochelle. At this time, we'll open it up for Q&A, please.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And our first question today, we'll hear from John Davis with Raymond James.

John Davis -- Raymond James -- Analyst

Hey, good morning, guys.

Greg Daily -- Chief Executive Officer

Good morning.

John Davis -- Raymond James -- Analyst

Clay, just wanted to start off on organic growth, glad to hear 9%, I think you accelerated 200 basis points sequentially ex-IPOS. So, anything to call out there? Any specific business that performed well? Just any commentary there. And I assume you still have kind of a high-single-digit number baked in the full-year guide, but just wanted to confirm that.

Clay Whitson -- Chief Financial Officer

Well, I can't confirm, we expect high-single-digits for the remainder of the year, maybe not in every single quarter, but on average for the year. It was strong across the board, really from B2B, to government, to education, our ISV channel, even our ISO channel.

John Davis -- Raymond James -- Analyst

Okay. And then also the yield improved 8 basis point sequentially. I think the net revenue yield is 108 basis points versus 100 basis points a year ago. Is that more integrated? Is that more proprietary software? Just how should we think about that as we kind of model out the rest of the year?

Clay Whitson -- Chief Financial Officer

Well, the proprietary software segment has doubled in size, and with that come more software revenues. And I think our software revenues as a percentage of our total revenues this quarter was in the range of 22%. That's up from maybe half of that at the IPO. So as that blends happens, it takes our revenue yield higher. And what was the second part of your question?

John Davis -- Raymond James -- Analyst

No. Just how to think about it for the rest of the year? Any reason that that was specifically high in the first quarter, and an anomaly, just kind of thinking about it as we go through the rest of the year?

Clay Whitson -- Chief Financial Officer

No, I don't think. There was no anomaly.

John Davis -- Raymond James -- Analyst

Okay. And then, Rick, anything you can give us in terms of combined size of the four deals, just anything to kind of help us frame? I think my math suggests you had nearly $100 million of capacity based on the leverage into the year. So, I think that's an issue. But I think, very glad to hear four deals, but just trying to think about how to size those.

Rick Stanford -- President

Yeah. That's a fair question, John. Unfortunately, we are at various stages, but we're early -- in the early stages, and we don't have enough definitive data to give us an accurate measurement on any of these deals yet to give you a good measurement of size. As far as timing, it's also too early. There's multiple factors that go into timing, size, total lines of code that have to be reviewed, consents from third parties. So, I can't tell you at this point either when those deals are going to close. I think we have the capacity. So, hopefully I'll be able to give you more detailed information sooner than later. But right now, we don't know, what we don't know.

John Davis -- Raymond James -- Analyst

Okay. Fair enough. Thanks, guys.

Operator

Next, we'll move to George Mihalos with Cowen.

George Mihalos -- Cowen -- Analyst

Hey guys, good morning. Congrats on the accelerated growth. So, maybe just to kind of start off on that point, you're starting the year off higher certainly than what we were looking for. I know you've said in the past that the growth rates could be a little bit choppy going quarter-over-quarter and the like. But as we go through the remainder of the year, and more of these faster-growing inorganic revenue streams go to organic, is there the possibility where we could have a double-digit growth quarter based on the trends that you're seeing across the entire business?

Clay Whitson -- Chief Financial Officer

Possibility is always there, but I think our expectation remains high-single-digit.

George Mihalos -- Cowen -- Analyst

Okay. And that's what's embedded in the outlook, just to be clear?

Clay Whitson -- Chief Financial Officer

Yes.

George Mihalos -- Cowen -- Analyst

Was there any impact on the point-of-sale side in the first quarter, I know you had said $6 million to $7 million of potential headwind for the year. Was there any impact in the first quarter?

Clay Whitson -- Chief Financial Officer

There was, but it wasn't a huge impact. The Essentials product, which is the SaaS-based product from NCR, has -- is in pretty full swing now. In January, 50% of our new deals were Essentials. And so, that's for -- this took a lot longer to get started than we thought it would, but now that it's started, we are very pleased with how it's selling. We think it's a good competitive product, and we're getting excited about it.

George Mihalos -- Cowen -- Analyst

Got it. That's helpful. And just the last question from me. As we look at the margins going forward, is the right way to think about it that on a year-over-year basis we could have some continued compression on the software side, and there is a little bit of an offset, if you will, on the corporate expense line year-over-year?

Clay Whitson -- Chief Financial Officer

I think it depends on where in the range of guidance we fall, George. But we do hope that we can continue to improve margins. AVR is a mix issue for us because they're lower margin, but they have 40 people, because they were a stand-alone company. And so with double-digit growth, I think a lot of our Public Sector companies can grow into better margins over time.

George Mihalos -- Cowen -- Analyst

Okay, great. Thanks for the color, guys.

Clay Whitson -- Chief Financial Officer

Thanks.

Operator

Next, we'll move on to Peter Heckmann with D.A. Davidson.

Alexis Huseby -- D.A. Davidson -- Analyst

Hi guys, this is Alexis on for Pete. Congratulations on a great quarter.

Greg Daily -- Chief Executive Officer

Thank you.

Alexis Huseby -- D.A. Davidson -- Analyst

So, just touching back on the IPOS transition. Could you quantify for us how that affected organic growth in the quarter?

Clay Whitson -- Chief Financial Officer

Well, organic growth would have been -- if we include it in the calculation, organic growth would have been smaller, but not by a great amount. I think we gave $6 million to $7 million of revenue impact at the beginning of the year, and that was assuming it all started October 1, which clearly has not happened. So that $6 million to $7 million original estimate is proving to be a conservative estimate, and we carry $2 million of revenue excess into the guidance. A good portion of that is from IPOS, but not all of it.

Alexis Huseby -- D.A. Davidson -- Analyst

Okay. Thanks, Clay. That's really helpful. And then could you give us an update on how we should be thinking about any shifts in seasonality on a quarter-over-quarter basis, due to this mix shift in Public Sector?

Clay Whitson -- Chief Financial Officer

Well, in Public Sector specifically, this coming quarter is usually a good quarter for us. In Q3, Education is quite weak because of the June, July shutdowns, and that's a bigger impact now that we have SchoolPay. Before it was just PaySchools, but now it's also SchoolPay. But collections are strong in government in the coming quarter.

Alexis Huseby -- D.A. Davidson -- Analyst

Okay. So if you have to combine together the impacts on seasonality from Public Sector and Education, which quarters would you say are relatively stronger versus weaker with the new acquisitions?

Clay Whitson -- Chief Financial Officer

I'd say, all three of our quarters are relatively strong other than the third quarter. The impact on Education is the one we feel on a consolidated basis, because we still got all of the people and virtually no revenues for two months. But in the non-integrated business, January, February is weak and that's always been the case from the other payments companies you know. So, it helps to have government counterbalancing that overall weakness in January, February.

Alexis Huseby -- D.A. Davidson -- Analyst

Okay. Thank you. And then could you just give us an update in growth in the direct sales force?

Greg Daily -- Chief Executive Officer

We're consistent with between 120%, 125% [Phonetic] today. It hasn't changed much.

Alexis Huseby -- D.A. Davidson -- Analyst

Okay, great. Thanks, guys.

Clay Whitson -- Chief Financial Officer

Thank you.

Operator

[Operator Instructions] Next, we'll move to Josh Beck with KeyBanc.

Josh Beck -- KeyBanc -- Analyst

Thanks for taking the question, team. I wanted to ask about Pace. It certainly seems like you've been pretty happy with the team there. Anything to call out in terms of synergy opportunities as you've had a little bit more time to work with them?

Greg Daily -- Chief Executive Officer

I feel like they taught us a lot about ISVs, how to sell to them, how to harvest their accounts. They have been -- really upgraded us when it comes to that. It's crazy productive when it comes to being able to for new sales, and now we're trying to roll that out in more of our distribution channels. So, we're very pleased. I think I made note when we did the deal that, I was hoping by mid-year 2020 to say it's the best deal we've ever done. And I think we're on track to say that. But we're not -- we're still learning a lot about each other.

Josh Beck -- KeyBanc -- Analyst

Okay, great. I think Rick, you talked a little bit about the unified platform that you're building within the Education and Public Sector verticals. Maybe just help us understand some of the changes that you're making behind the scenes? And then ultimately what you are hoping for in terms of either a business benefit or customer benefit as those platforms build out?

Rick Stanford -- President

Yes. Good question, Josh. So, we brought together the CEOs and salespeople and the IT folks from let's take Public Sector, for example. In an acquisitive business like ours, we have overlapping products, some are good, some are not so good. We took that group and we did a gap analysis on all products under our Public Sector vertical, and then we determined which products we wanted to move forward with, and what is the total product suite that we need to bring to market. Once we decided on that product suite, we're focused on the back end. How do we get this in the salespeople's hands and how do we price it, and how do we sell it, and how do we communicate with each other? So, all of those discussions are under way. We are seeing some cross-pollination of product sales in other subs now, which is our ultimate goal. And we look at our competition, what do we need to provide that they're not providing? So, this unified product offering is something that's got our people really excited. They're working as a team across multiple subs. So to go out with one best-of-breed product suite within Public Sector that our people are excited about, I can't imagine things being better than that for us.

Josh Beck -- KeyBanc -- Analyst

Okay. That's great to hear. I noticed that you had called out B2B a couple of times. Maybe you could just remind us of your exposure there? And is that an area of maybe growing opportunity when you look out to the future, when you either think about organic or M&A opportunity?

Clay Whitson -- Chief Financial Officer

Organically, it's a strong grower. I think from an M&A standpoint, valuations are high in the B2B space. The private equity, the market are in love with B2B. And so, I'm not all that hopeful about a B2B acquisition, but we love the one we got and it continues to -- it's large, it might be order of magnitude 10% of our business, and it continues to grow. So, that helps our organic growth when a large company has good growth.

Rick Stanford -- President

And Josh, I'll add to that and say that I mentioned it this morning as one of the companies under the four term sheets. They started in a B2B mode, and then moved into Education and that's their core focus. And I also -- I feel compelled to bring it up since it's a place that we operate today. But we weren't going after a B2B-type acquisition when we found this group.

Josh Beck -- KeyBanc -- Analyst

Okay. Okay. And that's helpful. Maybe just an industry question, and I'm not sure if it's too early, but certainly there is some more coverage of Visa and some of the interchange changes that they plan to make. So I'm wondering if there is any read on -- any early read on the potential impact from that? Or if it's one of those things that's just maybe too early to discuss?

Greg Daily -- Chief Executive Officer

We've looked at it Companywide, and we think net it's a slight positive to us. So it will be -- it is not a negative. So it's not that big of a deal, but it is positive.

Josh Beck -- KeyBanc -- Analyst

Okay. That's helpful. Thanks, everybody.

Operator

And that will conclude the question-and-answer session. At this time, I would like to turn the call back over to Greg Daily for any additional or closing remarks.

Greg Daily -- Chief Executive Officer

Thank you, everybody. I feel like we had a great start to our 2020. Love the growth. Thanks to the team, wow. They have come together amazing in the last year. And encourage all of you to stay tuned, we've got a lot of exciting things that we're working on, and hopefully we'll be able to update you very soon. Thank you.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Scott Meriwether -- Chief Operating Officer

Greg Daily -- Chief Executive Officer

Clay Whitson -- Chief Financial Officer

Rick Stanford -- President

John Davis -- Raymond James -- Analyst

George Mihalos -- Cowen -- Analyst

Alexis Huseby -- D.A. Davidson -- Analyst

Josh Beck -- KeyBanc -- Analyst

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