Q2 2022 I3 Verticals Inc Earnings Call
Good day, everyone and welcome to the I three verticals second quarter 2022 earnings conference call.
Today's call is being recorded and a replay will be available starting today through may 17th the number for the replay is 87734 475 to nine and the code is 3376015.
The replay may also be accessed for 30 days at the company's web site.
At this time for opening remarks, I would like to turn the call over to Jeff Smith VP of Finance. Please go ahead Sir.
Good morning, and welcome to the second quarter 2022 conference call for I three verticals. Joining me on this call are Greg Daily, our chairman and CEO Clay Whitson, our CFO and Rick Stanford our president.
Did you say any non-GAAP financial measure is discussed in today's call. You will also find a reconciliation to the most directly comparable GAAP financial measure.
Viewing yesterday's earnings release.
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 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. They are not statements of historical fact may be deemed to be forward looking statements.
I 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.
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.
Now I'll turn the call over to the company's chairman and CEO Greg Daily.
Thanks, Jeff and good morning, 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 and 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 six 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 is 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 fiscal year 2017, before our IPO a few short years ago.
Yeah.
We're extremely excited about our product offerings in both public sector and health care 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 fiscal year 'twenty two included.
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.
<unk> adds to our public sector vertical.
Our health care vertical continues to shape up.
And I am happy to announce another acquisition.
Which will be included in our results as of May one.
This business adds electronic health record platform.
Patient engagement suite, which is a 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 health care.
Now I'll turn the call over to clay and he'll provide you more details on our second quarter.
<unk> financial performance following Clay's comments, Rick will provide an M&A update and then we'll open up the call for questions.
Good morning, the following pertains to the second quarter of our fiscal 2022, which is the quarter ended March 31 2022. Please.
Please refer to the slide presentation titled supplemental information on our website for reference with this discussion.
We had a great quarter with record revenues adjusted EBITDA and pro forma adjusted diluted earnings per share.
Revenues for the second quarter increased 15, 9% to $78 1 million from $49 2 million for Q2, 'twenty, one reflecting continued double digit organic growth and acquisitions.
The key metrics, we track are headed in the right direction.
Integrated payments percentage improved to 62% for Q2 'twenty two from 59% for Q2 'twenty one.
Which helped our revenue yield improved to 146 basis points for the quarter from 115 basis points for Q2 'twenty one.
Organic growth for this quarter was 16%.
Software and related services revenue continued strong growth representing a record 50% of revenues for the quarter an important milestone in our evolution.
From here on out we expect to be a software and service company first with a complementary integrated payments platform that helps us add value for our customers.
Annual recurring revenues totaled $258.8 million in Q2, 22 compared to $173 3 million in Q2, 'twenty, one a growth rate of 47%.
Over 80% of our revenues in the quarter came from recurring sources.
Adjusted EBITDA increased 59% and $19 5 million for Q2, 'twenty two from $12 2 million for Q2 'twenty one.
We showed strength across the board with continued momentum in proprietary software and merchant services.
Adjusted EBITDA as a percentage of revenues increased to 25% for Q2 'twenty two from 24, 9% for Q2, 'twenty, one, reflecting lower corporate overhead as a percentage of revenues.
For the six months, the adjusted EBITDA margin expanded 50 basis points.
Pro forma adjusted diluted earnings per share increased 61% to <unk> 37 for Q2 'twenty two from.
23, <unk> for Q2 'twenty one.
Again, please refer to the press release for a full description and reconciliation.
Segment performance.
Revenues in our proprietary software and payments segment more than doubled to a record 49 million for Q2 'twenty two from $23 8 million for Q2, 'twenty, one principally reflecting growth in our two largest verticals public sector and health care.
Revenues in our education vertical continued a strong rebound increasing 43% Q to Q2.
Thanks to the reopening of existing customers and organic sales to new school districts.
The segments.
Adjusted EBITDA improved 95% to $16 3 million for Q2, 'twenty two from $8 4 million for Q2, 'twenty, one a new quarterly record.
The growth was principally be principally driven by our two largest verticals public sector and healthcare.
On a run rate basis public sector represents roughly half of our consolidated business, while health care as an estimated 20%.
Revenues for our merchant services segment increased 12% to $29 2 million for Q2, 'twenty two from $26 1 million for Q2, 'twenty, one reflecting broad based growth in hospitality and b to b.
Adjusted EBITDA for our merchant services segment increased to $8 1 million for Q2, 'twenty two from $7 6 million for Q2 'twenty one.
Our balance sheet.
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 our $275 million facility.
The face value of our convertible notes are $117 million.
As of March 31, our total leverage ratio was three nine times, while the current constraint is five point out times.
As mentioned by Greg We have subsequently completed a small health care acquisition, but we currently expect to remain below four <unk> 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.
Overtime, we expect our we expect to convert roughly two thirds of adjusted EBITDA into 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 cash interest and cash taxes.
Outlook looking forward, our strong first half gives us confidence in raising guidance for fiscal year 'twenty two.
It excludes acquisitions that have not yet closed and transaction related costs.
Revenues $300 million to $312 million.
Adjusted EBITDA of $75 million to $81 million.
Pro forma adjusted diluted EPS.
40 to $1 47.
From a seasonal standpoint, we have different verticals with different seasonal patterns, which generally counterbalance each other with our current mix of companies.
Our exception.
One exception is our education business, which slows down during the June quarter when school lets out.
As we become more software centric quarters might vary based upon perpetual license sales.
Even though our trend is generally toward more recurring revenue streams.
Now I'll turn the call over to Rick for company updates and M&A activity. Thank you clay good morning, everyone.
I'll discuss M&A I'll give an update on a few items, our public sector unified product offerings.
You need 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 solutions software sales in Georgia, Alabama, Tennessee, and Kentucky in other words, we are beginning to bring products into states aimed customers, where those products had not.
And utilized before.
We expanded our territorial reach by entering new states with contribution from four three public sector entities.
The 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.
We continue to implement on our recently announced Lacroix, Louisiana clerks remote access authority software contract, which is supported by statewide E filing this effort is going extremely well.
Our education and product offerings of unified under the three education brand with related marketing sales development and support our education businesses are coordinated and bringing a full and robust solution to K through 12 schools and to that end, we continue to make investments in our software.
Three education has been responsive to school needs by installing technology that lessens traditional lunch room interactions and Leverages staff given labor shortages, we have been pleased with the results in education, which are being driven by successful focus sales campaigns product line expansions cost consolidation.
And more relaxed cobot 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 our hosting environment and will bring significant enhancements to our products included rapid scaling increased geographic redundancy and improve 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 a need to modernize architecture low code platforms will give us better access to data across the organization as solutions become more integrated with <unk>.
<unk> training and are creating cross divisional teams to build a platform on which we can launch full suite solutions.
I'll now speak to M&A as Greg mentioned.
Gives me, we recently closed a tuck in acquisition within the health care vertical for nearly 20 years. This company has provided software solutions to a wide range of health care providers. The company was born out of a personal experience that the owner had with an antiquated health care system in the nineties. He realized that there were vast opportunities to approve improve.
<unk> operational efficiencies in the health care World.
This personal back story 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 patient portal revenue cycle management population health and data analytics and compliance program assistance.
Their flagship product as their EHR offering a solution that fills a much needed gap and our healthcare product offerings.
This EHR solution combined with our robust patient portal brings us to a complete unified product offering in the health care space the patient portal as a meaningful upgrade on our front end patient engagement side of the house and fits nicely with our existing backend solutions that our other healthcare businesses offer this.
Business is a natural strategic fit and <unk> healthcare vertical and in fact, they already do business with three of our existing health care companies.
I wanted to note at this point this acquisition fell within our standard range relative to multiples.
Our healthcare vertical is reimagining the delivery of software products by bringing together complementary businesses.
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 have built upon our invoicing systems to adapt best practices for our lab in 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 health care in that order and we look forward to sharing more on the acquisition front in the near term.
This concludes my comments, Matt at this time, we'll open the call up for Q&A. Please.
Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone.
We are using a speakerphone please pick up your handset before pressing the keys.
If at any time. Your question has been addressed and you would like to withdraw. Your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Our first question will come from John Davis with Raymond James. Please go ahead.
Hey, good morning, guys.
I wanted to start with organic growth, both if you'd give it for the quarter, but also maybe talk a little bit about longer term growth you have now 50% of software revenue.
Ali.
47%, so it seems like and.
Before long running be tipping over into the.
Low double digits on a sustainable basis, but just any comments on the organic growth would be helpful.
Well for the quarter it was 16%.
<unk>.
That follows 16 last quarter and 17 in the previous quarter.
The first half of the year.
Although December quarter had some COVID-19 rebound in 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.
Around the turn and having better visibility into the economy and what to expect from our various verticals.
Okay no.
Fair enough and then on the on the new deal.
I apologize if I missed it.
Size I know, Rick said historical multiples, but based off your leverage comments.
It's 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 will make the statement that.
Including the upfront purchase price and the earn outs, we expect to pay it all in that it'll be less than 10 million its a small deal.
Okay Super helpful. And then last one for me just on the margins I.
I think the implied margins in the guide are down about 50 basis points I'm, assuming that just has to do with business mix from all the acquisitions.
But you've done but I'm curious what are you doing anything else going on 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 mid points imply a lower percentage than the guidance that we gave last quarter reflects our experience of stronger topline revenues this quarter.
Okay.
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 shade of the composition of revenues sheet and.
Addendum.
You see that it was pretty strong on services this quarter.
<unk>.
Which leads to higher revenues for the six months, our adjusted EBITDA was ahead of the previous year by 50 basis points.
Okay.
Okay.
No. That's helpful. So basically no underlying changes is just business mix, if anything theres no youre not.
Investing more in the back half or anything like that it's just business mix.
Right. Okay. Thanks, guys.
Thanks Judy.
Our next question will come from Peter Heckmann with Davidson. Please go ahead.
Hey, good morning, everyone. Thanks for taking the question just wanted to see if you could talk a little bit about any early success.
More of the pure software companies, both on the public sector side with health care.
Any early success in cross selling payments or.
Little too early in those cases.
So Peter we are having successes cross selling payments into those businesses.
What.
What Scott our focus right now even more so as we're able to go in with multiple sub companies as one and compete.
Very well.
As one organization.
And winning deals from our competition.
<unk> is going as expected.
That's great that's great and then as regard just the.
It's called the American rescue plan, the federal stimulus program that was going to potentially stimulate a little bit of it spend.
You had noted this being 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 million available.
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 rollout those funds relative to new implementations, probably as a tailwind over the next couple of years.
Alright, thank you.
Our next question will come from George <unk> with Cowen. Please go ahead.
Good morning. This is Allison on for George Congrats on the results and thank you for taking my question I wanted to start on the guidance raise for the full year is that really just the flow through of the strong <unk> results or is there any contribution from the health care tuck in.
Understanding that it's small or better expectations embedded over QE tomorrow as well.
Okay.
Well it does flow through the beat.
But it also adds in.
The health care acquisition, we just made.
And the acquisition adds about a $1 million for the five months, we will have it this year.
Yes.
Five months.
And revenues.
Okay, great. Thank you that's super helpful. And then as a follow up to that can you remind us your expectation for interest expense.
Bedded within the outlook for the full year.
Yes, we have.
We've added.
A half point increase in May which has already happened another half point in June and then a third half point.
In July as our current assumption.
That should come to cash interest between eight five and $9 million for the entire year.
Okay, great. Thank you that's Super helpful. 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 <unk> wasn't a revenue driver there.
Is there anything else to call out there driving that performance and how should we think about segment margins over Q H. Thanks again.
Yes, the merchant margin sort of the last vertical to rebound out of Covid was our hospitality vertical.
Particularly on the West coast and Thats generally.
Thinner margin.
It also carries higher residual expense.
So.
And that's kind of the 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 in Hawaii as well.
So that's the biggest thing and then <unk> you rightly pointed out is as thin margin.
But we're very happy to see a resurgence in that as well.
Great. Thanks again.
Our next question will come from James Faucette with Morgan Stanley . Please go ahead.
Hey, guys. This is Jeff Goldstein on for James I was hoping for some more color on the M&A market. You had 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 hasnt been impacted by what's going on in the public markets right now.
Yes, there is.
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 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 are growing nicely.
We've kind of.
Argue alive about valuations.
Other companies they understand the market.
Fintech is down so.
They are.
Sympathetic to.
A lower <unk>.
Sure.
It's each 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 of than a conferences now that.
Covid Dover.
So it's.
Business as usual.
Kind of back to normal.
The pipeline is good.
We've been very picky with who on.
We kind of add to the team because we kind of like what we've got that 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 youre seeing in the competitive environment within your public sector and health care verticals. When it comes to kind of Rfps just anything notable to call out there that has maybe changed in recent quarters. Thanks.
Yeah.
I don't think it's really changed we see tie.
Tyler and public sector.
And Thats 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.
Got it.
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 hasnt changed.
Thanks for the color.
Thank you.
Again, if you have a question. Please press Star then one our next question will come from Chris Donat with Piper Sandler. Please go ahead.
Good morning, gentlemen, thanks for taking my question.
I'm, sorry, I forgot the right way to ask this in a way you can answer it but as <unk>.
Economic concerns have been rising in the last few weeks I'm trying to understand with your public sector and healthcare businesses.
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 health care.
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 discretionary versus non discretionary.
Our experience with healthcare during Covid was that it was one of our more resilient.
Verticals.
<unk>.
Health care is not something people can postpone for a very long I mean, they might be able to postpone a few months, but.
It's something that generally.
It needs to be kept up with insurance provides for so I do think of it as a very defensive vertical.
Okay, and just to be clear there it was resilient in the pandemic. So we've already had some example of people in it.
Challenging environment continuing to.
Your revenues remaining solid during that period.
Yes, and that's consistent with what we said on the conference call is during that period.
Okay Yep Yep.
Yes, I'm trying to think forward on how it might play out.
And then Lee.
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.
Or is there anything that.
Really drove it the last two quarters that was unique.
Well I think the big step up do you see.
Was in the <unk>.
December quarter and that reflects the healthcare acquisition, we made October one.
And so that's kind of a new level and you say it's stepped all the way from three point to $10 3 million and then this last quarter. It was 11, one so thats kind of a new level. We're at as a result of that.
Acquisition on that particular line item.
Okay.
But it was a two full quarters full quarter for the March 31st quarter full quarter for December 31, right. So.
Correct. It was October one was the acquisition.
Okay.
Okay and then.
Just one more on education I know, it's a smaller vertical for you, but where are we in the recovery of that.
And that vertical.
Well it's.
It's definitely outperformed our expectations this year.
The return to school was the biggest factor.
We still have free lunch switches.
Drag.
And if that goes away and there is a lot of to and fro over that right now, but if it goes away I think it will add.
$335 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 one is through more software sold two districts.
Which help alleviate their staffing shortages.
We have a number of things in the works, we're excited about which I won't say on this call because I.
We feel like we've got a lead on our competitors in that regard.
But we're very excited about the education vertical and it's been amazingly Brazilian.
In the face of.
Free lunch for everybody.
Okay got it so there is definitely some.
Areas, where that could improve if I mean.
You've got momentum and potential areas.
Improve.
Okay. Thanks very much.
This concludes our question and answer session I would like to turn the conference back over to Greg Daily for any closing remarks.
Thanks, everyone.
I hope we've got the message across that all parts all verticals of the company.
Doing very well.
I'd also like to thank our 1400 employees that we have.
What an incredible effort, they're doing every day.
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.