Q4 2022 I3 Verticals Inc Earnings Call
Good day, everyone and welcome to the I think what it goes fourth quarter 2022 earnings conference call.
Today's call is being recorded and a replay will be available starting today through November 20.
The number for the replay is 87734 475 to nine and the code is 90 785901.
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 or where does Jeff Smith SVP of finance. Please go ahead Sir.
Good morning, and welcome to the fourth quarter 2022 conference call for <unk> 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'll 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 but 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 our 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.
Yes.
Thanks, Jeff and good morning to all of you.
I'm pleased to report report a strong finish to fiscal year 'twenty, two and we're excited about what's coming in fiscal year 'twenty three.
We said sequential records for revenue and adjusted EBITDA every quarter this year.
Year to date revenue and adjusted EBITDA grew 42%.
44%, respectively from fiscal year, 'twenty, one to fiscal year 'twenty two.
Our entity as a vertical market software company is more fully realized than ever.
Software and related services are our largest source of revenue comprising 49% of total revenue in fiscal year 'twenty two.
From 40% a year before and 26% a year before that.
We love the recurring nature of software and related services.
But we also value payments as the platform because it provides another recurring revenue growth engine.
More than 80% of our revenue in fiscal year 'twenty two came from a RIN Curry sources and sections of that section of our P&L continue to outgrow all others.
We look for acquisition targets that have untapped recurring revenue sources, and we continue to find great opportunities.
One such opportunity.
As we previously announced our second largest acquisition to date Celtic systems.
Rick will share more the Celtic is a perfect fit with our 2021.
D I S acquisition, Celtic and B I S. Each have complementary best of class products for transportation departments at the state level.
The cross selling opportunities are compelling enough.
So we are better positioned to respond to Rfps, we can't wait to see how Celtic grows and landing. This deal was an ideal start.
For fiscal year 'twenty three.
Now I'll turn the call over to clay. He will provide you more details on our financial quarter performance. Following Clay's comments, Rick will provide an update on some rule changes and address the M&A and then we'll open up the call for questions.
Thanks, Greg.
The following pertains to the fourth quarter of our fiscal year 2022 which is the quarter ended September 30th 2022. Please refer to the slide presentation titled supplemental information on our website for reference with this discussion.
We had another great quarter with record revenues and adjusted EBITDA revenues for the fourth quarter increased 27% to $85 3 million from $67 2 million for Q4 'twenty one.
Reflecting strong organic growth and acquisitions.
Our revenue yield improved to 140 basis points for the quarter from 120 basis points for Q4 'twenty one.
Organic growth for this quarter was approximately 12%.
Annual recurring revenues totaled 281.2 million for Q2, 'twenty, two compared to $210 8 million for Q4 'twenty one.
The growth rate of 33%.
Organic or our growth generally runs a few percentage points above our total organic revenue growth.
Over 80% of our revenues in the quarter came from recurring sources software and related services remains the largest portion of our revenues representing 49% for fiscal 'twenty two payments.
Payments represented 45%.
Other just 6%.
Adjusted EBITDA increased 27% to $21 7 million for Q4, 'twenty two from $17 1 million for Q4, 'twenty one where.
Collecting continued momentum in our software and services segment adjusted.
EBITDA as a percentage of revenues increased to 25, 5% for Q4 'twenty two from 25, 4% for Q4, 'twenty, one reflecting margin improvement in our software <unk> services segment.
For the fiscal year, the adjusted EBITDA margin expanded 30 basis points to 25%.
Pro forma adjusted diluted earnings per share increased to 39 cents for Q4 'twenty two from 33 for Q4 'twenty one.
For the fiscal year 'twenty to pro forma adjusted diluted earnings per share increased to one to $1 48 from $1 five for fiscal 'twenty one.
Again, please refer to the press release for a full description and reconciliation.
Segment performance.
Revenues in our software and services segment increased 40% to 51 8 million for Q4 'twenty two from $36 9 million for Q4, 'twenty, one principally reflecting growth in our two largest verticals public sector and health care.
Revenues in our education vertical with continued a strong rebound increasing 35% Q4 to Q4, thanks to organic sales to new school districts and higher lunch and activity fees that existing districts.
Federal and state subsidies for lunch have decreased significantly since the pandemic.
Software license revenue increased 47% to $3 5 million for Q4, 'twenty two from $2 4 million for Q4 'twenty one.
The largest was an $800000 image soft sale to a department of transportation and the Midwestern state for an enterprise document management system and workflow system.
This line item made up only three 5% of our total revenue in the quarter, but it has a 95% gross margin and can be lumpy and hard to predict as you can see from the variation between quarters.
While we are focused on SaaS and other recurring sources of revenue license sales will not go away completely some customers, particularly in the public sector still prefer them.
Yes.
The segment's adjusted EBITDA improved 55% to $17 1 million for Q4, 'twenty two from $11 1 million for Q4, 'twenty one outpacing revenues.
The growth was principally driven by our two largest verticals public sector and health care.
On a run rate basis public sector represents over half of our consolidated business, while health care as an estimated 20%.
At EBITDA as a percentage of revenues improved to 32, 4% for Q4 'twenty two from 31, 1% for Q4 'twenty one.
Collecting margin improvements in public sector and education.
Revenues for our merchant services segment increased 9% to $33 4 million for Q4, 'twenty two from $30 7 million for Q4, 'twenty one principally.
Reflecting growth in our b to B and ISO channels.
Adjusted EBITDA for our merchant services segment increased slightly to $9 1 million for Q4, 'twenty two with higher revenues, partially offset by higher residual expenses.
In keeping with our strategy since the IPO, we have steadily redirected acquisition and internal resources from traditional merchant services into higher growth and higher margin software and services coupled with integrated payments.
Our balance sheet has allowed us to continue to execute our acquisition strategy on September 30th we had 181 5 million borrowed under our revolver net of cash.
Under our $275 million facility.
The face value of our convertible notes of $117 million.
As of September 30th our total leverage ratio was approximately three seven times, while the current constraint is five and a quarter times.
In conjunction with the <unk> systems acquisition, we increase the size of our existing revolving credit facility from 275 million to $375 million.
In October we borrowed $85 million for the purchase of Celtic systems, but we currently expect total leverage to be close to four times on December 31 2022.
The interest rate for the convertible notes is 1% while the interest rate for the revolver is currently around 7%.
But will increase as the fed continues to raise rates.
Over time, 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 capital expenditures internally capitalized software cash interest and cash taxes.
Looking forward the strong finish to our fiscal year gives us confidence in the following guidance for fiscal 'twenty three.
It excludes acquisitions that have not yet closed and transaction related costs.
Revenues $360 million to $380 million adjusted EBITDA 94 to 102 million cash interest expense 19 to 22 million pro forma adjusted diluted EPS of $1 50 to $1 62.
From a seasonal standpoint, the Celtic systems acquisition gives us a good start to the year like the October 1st Health care acquisition did last year.
Acquisition activity could prove different this year, but we currently expect the quarters of fiscal 'twenty three.
To follow a similar pattern to those of fiscal 'twenty two.
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.
I'll now turn the call over to Rick for a company updates and M&A activity.
Thank you clay good morning, everyone.
First I want to speak a moment about our two new executive team members Paul Christians in Crystal Asia. Since 2019 acquisition, Paul has been leading the pace payment business for us and also leading our public sector unified product offering for U P. O process with great success, we are proud to announce his promotion to chief operating off.
<unk> three verticals in this new position Paul will continue to oversee our public sector <unk> strategy and he will expand that successful effort to include leadership of <unk> in health care.
I have no doubt that Paul will replicate the public sector successes within our health care vertical.
<unk> is critical to our overall company strategy as we integrate products within our existing vertical businesses to provide comprehensive solutions to our customers. Paul is a perfect fit for this role.
Chris Leisure joined US as part of our <unk> acquisition in early 2021, and his CEO role to be eyes, Chris has led that business to impressive growth and has proven his deep understanding of the public sector vertical. He is now going to draw on that experience and will become the president of public sector, which is our largest vertical and is it.
Responsible for 50% of our revenues, Chris understands the ongoing needs of public sector customers across the country and will no doubt lead us to even more growth within that vertical.
Paul and Kris or intelligent seasoned and effective leaders, perhaps more importantly, they are quality individuals who will help encourage our high integrity collaborative and entrepreneurial culture, we look forward to their many contributions.
Before I discuss M&A I want to make note of developments within our education businesses is K through 12 education market begins to shift to post pandemic environment prices on school lunches have increased across the board. While currently all federal and most state subsidies for lunches have decreased in most states district.
We're also seeing an uptick in other transactions as traditional activities resume which adds to the daily students spend.
These developments have contributed to increased revenues that we've seen in these businesses.
I'll now speak to M&A.
We continue to pursue grows by performing acquisitions of companies that fit with our strategy an emphasis on companies in our public sector and health care verticals on October 4th we announced our latest acquisition the acquired business Celtic Cross Holdings, Inc, and Celtic systems private limited together known as Celtic.
Fits extremely well with B I S. Both companies have products for transportation departments at the state level, but their products, mostly complement each other so we see many opportunities to expand the addressable market and cross sell within existing customers. Celtic also offers a greater geographic reach with customers and 18 U S States.
Four Canadian provinces.
Celtic software it can be broken down into two parts part one is motor carrier software late.
Late group fleet vehicles and distance management capabilities are built ins in conjunction with their integrated inventory management module. It streamlines carrier Prudential, Inc, and increases operational efficiencies through automated issuance. It also has built in tools for selecting carriers to audit based on specific auditor crowd.
Syria, notifying carriers and conducting both current and previous year carrier audience with India and tracking capabilities.
There are product gathers carrier and fuels specific information, including miles traveled gallons used in taxes pay it streamlines the oversized overweight vehicles permitting process and automatically generates safe travel routes by evaluating and selecting the most appropriate route for specific vehicle and low dimensions.
Taking regulations restrictions and roadway bridge hazards into account and provides turn by turn directions to the carrier.
All of this resulting information provides the international rate plan I R. P and international fuel tax Association EFTA offices with critical information that can be leveraged by carriers for registering renewing in the issuing credentials to carriers and vehicles. It also provides roadside law enforcement assisted.
To quickly ascertain if a carrier <unk> vehicle is in compliance with safety and Credentialing rules, helping to keep onsite vehicles off the road.
They are supporting products include document management for electronic filing management and retrieval of required documents.
The software also allows for processing of mandatory quarterly tax retards tax liability, including penalty interest fees and credits and tax payment cutoff dates for various fuel types, such as special fuels and died diesel fuels.
It also provides for intrastate registrations for carrier fleets and other fleet types operating wholly within the jurisdiction, while maintaining applicable insurance filings.
Part two is motor vehicle software. Some of the features include title transactions like original title title transfer titled Correction et cetera. This software also provides for instruction permits commercial and noncommercial driver's license and identity card issuance.
The software generates and tracks various types of driver credentials after analyzing driver records in history and collecting all the required document and fees at <unk>.
Captures and tracks all driver records, including convictions points accidents and based on business rules will automatically initiate the desired necessary actions such as sending a warning generating suspension records or reinstatement on suspension.
It calculates and collect payments based on various business rules and distributes funds to appropriate general ledger accounts is required.
It manages dealer inventory and dealer licensing, which helps motor vehicle departments manage dealer permitting dealer records replications audits and reporting.
In summary, Celtic is a perfect fit in our public sector vertical it aligns nicely with a combined <unk> product suite and further enhances our presence in state and provincial level markets in the U S and Canada in the past 30 days, both Celtic and be ice had been jointly responding to new Rfps currently in the market as well.
As joint marketing at state shows that have a card.
I want to specifically note that this deal fell within our normal range of multiples our pipeline remains robust with opportunities for acquisitions in public sector and health care that are similar in size to many of our acquisitions today.
This concludes my comments operator at this time, we'll open the call for Q&A. Please.
Yeah.
Thank you we will now begin the question and answer session.
You asked a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone please pick up your handset before pressing the key.
But anytime Youre question has been answered and you would like to withdraw your question. Please press Star then two.
At this time, we will pause momentarily with Nomura.
Okay.
Our first question comes from John Davis with Raymond James. Please go ahead.
Hey, good morning, guys.
Rick it's good to hear you talk about education.
Pockets of strength, but maybe could you just remind us roughly what percentage of the business either adds or EBITDA.
Education today, and kind of where those absolute kind of run rate levels versus pre pandemic are we back ahead of pre pandemic education, but just size of that business would be helpful.
J D I'll take that.
In fiscal year, 'twenty, two education contributed $15 million of revenues and $7 million of EBITDA.
That's where we were in 2019 pre pandemic.
School lunch Hasnt come all the way back.
But we've added a lot more school. So that's why we're even from where we were.
For fiscal 'twenty three.
It will improve.
From 'twenty two.
Because we just had a very well get four quarters of strong school lunch.
Okay.
That's helpful and then another one for you clay.
No I think based off of the guide you gave me a lot.
Our math suggests kind of roughly 10% organic growth.
Slide.
You know versus kind of mid single digit I'm, sorry high single digits. Historically is that is that fair. You know obviously I think you said you did 12% organic growth in the fourth quarter.
But it is call it roughly 10% organic growth is that fair for for 'twenty three.
Yeah, I feel like we're right on the edge.
The past two quarters have been 10% and 12%.
Q4 had a good software license quarter.
With healthy organic growth.
We don't know the macro environment for 'twenty three yet.
So it's hard for us to predict whether organic growth registers, 9% or 11% for 2003.
Double digit is certainly our goal.
But long term I think we have to continue to guide in a high single digit in.
And we'd like to beat it like like we just stay at these this year.
All right last one for me nice to see you know good margin expansion I think 150 basis points at the midpoint of the guide.
I think a good portion of that's driven by.
Some of these higher margin acquisitions.
Celtic specifically, but.
Maybe just talk a little bit recur or Greg about the pipeline. How do you guys think about the margin profile of the businesses and the pipeline is this something that we should continue to see as far as M&A coming on at a higher than corporate average margin. So it's got to do some of that margin expansion going forward. Thanks guys.
Yeah, that's a great question.
Do I think internally have.
A bigger focus.
On acquisitions that have higher margin.
We're very happy with.
The previous deals we've done we feel like we have.
Great.
Platforms in place.
And when we do additional acquisitions.
They I think they will look more like a traditional software business with.
EBITDA.
Margins being 50% so.
Not promising that but that is the goal that's the targets.
Pipeline looks great.
You know doing four or five deals a year is kind of our mission.
Okay I appreciate all the color thanks, guys.
Thank you.
Our next question comes from Peter Heckmann with D. A Davidson. Please go ahead.
Good morning, everyone. Thanks for taking the question and congratulations on the <unk> deal.
I wanted to ask so with Celtic.
Where are they in their progression from a license model to a software as a service and end with some of those things you were talking about in terms of permitting driver history Records.
Transaction revenue a part of it or is it primarily.
Software.
Pete I'll start on that.
Celtic does have around a 50% margin and so.
That is part of what you see in our guidance for Q3.
They are not currently a SaaS model, maybe 40% of their revenues are recurring in some form or fashion, but they really haven't begun.
To design, a SaaS offering, but we will begin to do that now but it's.
It's baby steps right now.
What was your second question.
It sounds like there's no there would be really no transaction based revenue in terms of no. Yeah. No. They have currently have none, but again, we plan to try to introduce that particularly on new business.
Got it got it and then as a follow up Celtic looks like.
I think in the press release, you said four Canadian provinces, but looking at it looks like there's a couple of those they won a number of years ago. So fairly established in Canada. How do you think about Canada, expanding the Tam for your for your public sector business is there a way or is there a way to think about that.
Well, it's exciting for us.
We currently.
Have several Canadian customers.
The contracts are denominated in U S dollars.
No.
The FX wont be very challenging for us.
But yes, it's a whole new Tam as you put it to to explore and expand and add payments to and we're very excited about that.
Great I appreciate it I'll get back in the queue.
Okay.
Our next question comes from James Fawcett.
Morgan Stanley . Please go ahead.
Great. Thank you very much first.
Your 23 margin guide I think implies around 150 basis points of year over year expansion and we've seen some margin pressures crop up and and other both competitors and Comparables. How are you thinking about the puts and takes around your margins in and where are you targeting for fiscal year 'twenty three.
Well Celtic adds about.
As almost as much as 100 basis points, just layering it in at 50%.
Corporate should contribute.
50 basis points. It contributed 40 basis points this year and a challenging inflationary environment.
TNA and trade shows have been a pretty big deal this year in fiscal 'twenty two.
That was $3 million higher than in 'twenty one.
As normal travel and in person sales activities resumed trade shows started taking place again, so we don't have that drag coming into 2023.
Now there is general inflation so.
We're not promising 150, but we have a pretty clear sight to margin improvement in 'twenty three.
Okay.
Got it got it and then on the M&A front.
You indicated that <unk> was kind of within your historical range of evaluations that you paid.
Given the environment and kind of your pipeline of deals what's the opportunity for you to even find things that you can do a better valuations than you've done.
Historically in.
And just wondering how we should think about that as a as a potential, especially given the overall environment right now.
We do.
Yes.
Self source our deals from beginning to end.
And we do explain to our targets that.
The market's down.
Valuations are lower.
They tend to understand that we lean more on.
We're building a team will take care of your key employees.
Here's 20 references for you to talk to.
We just don't get involved in auctions.
Auction processes.
And the story is very well received.
Like what we've built they like our reputation.
Our culture.
So you know being able to pay seven or eight times versus we were paying.
We paid up to 10.
I think going forward.
Till the market changes.
Page seven or eight is probably more the model.
Going forward, what do you anything to that Rick Yeah, I would just say you know.
We've been very successful in taking our business and growing it over time, so that overall multiple goes down over time. So if we start in that range and again, we're being very selective at this point, we're not at a breakneck breakneck pace as we've done in previous years, four or five deals a year of high growth companies really.
Good structured and strategic software companies within our our verticals.
I don't I don't think our mind paying the six to eight times knowing that over time, we can grow that business and drive the multiple down overall.
That's great to hear thank you so much.
Okay.
Yeah.
Good morning.
Operator, do you have any more questions.
Yeah.
Yes.
I apologize my line was on mute Accidently I, just I just Aneel Mark Palmer Lane from BPI. Please go ahead Sir.
Yes. Thank you good morning, and thanks for taking my question.
And so far as software has been a growing portion of.
The company's overall revenue how should we be thinking about the gross margins for software compared to gross margins for payments.
And how.
Do you expect consolidated gross margins to evolve over time, given that changing mix.
Mark I'll refer you to page two of our supplemental information revenue composition.
And payments revenues, probably averaged 60% gross margins.
The top three line items in our software and services revenue.
Mix are probably 90% gross margin.
Recurring software services and professional services.
We aim for.
One third margins, but maybe count on 30% there.
And then software licenses.
The bottom number that's probably 95% margin.
And so as software and services become a bigger portion of our whole it'll it'll.
Our gross margin consolidated gross margin over time.
Thank you just one follow up to that what is the implied mix.
Software and payments.
In your 2023 guidance.
I don't have that number in front of me, but I'm confident software and services will.
Go over 50% this year, because Celtic today is 100% software and services.
Yeah.
Very good thank you very much.
Okay.
The question and answer session I'll turn the call back over to Greg Daily for closing comments.
Thank you everybody.
Thank you our team what an amazing.
Year, we had in 'twenty, two and we're very excited about the momentum that we've got going into 'twenty three so with that said.
Thank you for your interest.
The conference has now concluded. Thank you for attending today's presentation you may all now disconnect.