I3 Verticals, Inc. — Q1 FY2023 Form 10-Q
Reporting period: Three months ended December 31, 2022; comparisons are with the three months ended December 31, 2021. Unless stated otherwise, amounts are in millions. The company provides integrated payment and software solutions, primarily in Public Sector and Healthcare. Its reportable segments are Merchant Services and Software and Services.
Financial performance
| Metric | Q1 FY2023 | Q1 FY2022 | Change |
|---|---|---|---|
| Revenue | $86.0 | $73.9 | Up 16.4% |
| Operating income (loss) | $5.8 | $(0.8) | Improved $6.6 |
| Operating margin | 6.8% | (1.0%) | Improved |
| Consolidated net income (loss) | $0.2 | $(3.7) | Improved |
| Net loss attributable to i3 Verticals, Inc. | $(0.2) | $(2.5) | Improved $2.3 |
| Net loss per Class A share, basic and diluted | $(0.01) | $(0.11) | Improved |
| Net cash from operating activities | $18.2 | $21.9 | Down $3.7 |
| Net cash used in investing activities | $(94.5) | $(62.4) | Greater use of cash |
| Net cash from financing activities | $76.9 | $49.2 | Up $27.7 |
Revenue growth reflected acquisition contributions of approximately $6.1 million and growth in existing businesses, including Public Sector software and payment volume. Software and Services revenue rose 18.8% to $53.2 million; Merchant Services revenue rose 12.5% to $32.8 million. Company-reported annualized recurring revenue was $290.2 million, up 20.7%; payment volume was $5.9 billion, up 11.4%. Software and related services were 47.79% of revenue, versus 49.15% a year earlier.
Processing margin, the company’s operating measure defined as revenue less other costs of services plus residuals expense, was $77.3 million, versus $65.9 million, an increase of about 17.2%. This was approximately 89.8% of revenue, compared with 89.2% a year earlier. The filing does not present this ratio as a standardized GAAP margin.
Operating expenses increased 7.4% to $80.2 million. SG&A rose 10.0% to $51.0 million, primarily from higher employment costs, acquisition-related headcount and stock compensation. Depreciation and amortization increased 26.3% to $8.7 million, largely due to acquisitions. The contingent-consideration fair-value charge declined to $1.4 million from $4.9 million. Net interest expense rose 74.1% to $5.5 million, reflecting higher average debt and interest rates.
Cash, debt and liquidity
- Cash and cash equivalents were $3.6 million at December 31, 2022. The company also reported $8.9 million of restricted cash and $11.8 million of settlement assets; settlement assets are generally matched by settlement obligations and should not be viewed as freely available liquidity.
- Long-term debt, net of issuance costs, was $377.2 million, up from $287.0 million at September 30, 2022. It comprised $263.2 million outstanding under the revolving credit facility and $117.0 million principal on 1.0% Exchangeable Notes due February 2025.
- The $375 million revolving facility had $111.8 million available, subject to covenants, and matures May 9, 2024. The company reported covenant compliance; its interest coverage, total leverage and senior secured leverage ratios were 5.18x, 4.03x and 2.77x, respectively.
- Operating cash flow was positive but declined year over year. Investing outflows primarily reflected $89.5 million of acquisition spending. Financing included revolving-credit borrowings and repayments.
- Management stated that operating cash flow, cash and available borrowing capacity should be sufficient for operations, planned capital expenditures and debt service for at least the next 12 months. This outlook depends on cash generation and continued access to borrowing subject to covenants.
Material changes, outlook and risks
- Acquisitions: The company spent $89.5 million in cash on two acquisitions during the quarter, including Celtic, which expands Public Sector software offerings. Acquired businesses contributed $3.6 million of revenue and $1.0 million of net income during the quarter. A further Public Sector acquisition closed January 1, 2023 for $14.5 million of consideration, including $12.5 million cash, $2.0 million in Class A shares and contingent consideration still being valued.
- Debt and interest-rate exposure: Higher borrowings and rates materially increased interest expense. The facility’s stated rate was 7.69% on the outstanding balance at quarter-end; management estimated a 1 percentage-point rate change would affect results by $2.6 million. The facility is secured by substantially all company assets.
- Tax Receivable Agreement: The recorded obligation was approximately $40.8 million. The agreement generally requires payment to continuing equity owners of 85% of specified tax benefits; payments associated with exchanges through quarter-end were estimated at $0 to $3.3 million annually over the next 24 years. Future exchange-related amounts may add to this obligation.
- Legal contingency: Louisiana plaintiffs allege cybersecurity shortcomings associated with a third-party remote-access product and seek remediation costs, return of purchase prices and other damages. The filing cites $15 million purportedly spent by the State and $7 million by sheriffs, plus other requested relief. The company says the outcome is unpredictable and could affect results in the period resolved, though it does not currently expect a material adverse effect on business or financial condition. An appeal was pending, with oral argument expected in April 2023.
- Other potential obligation: A conditional third-party sales-organization buyout could be capped at $29 million, net of secured-loan repayment, plus up to $9 million of performance-based consideration. The company said the amount could not yet be estimated.
- Seasonality and operating risks: Management noted seasonal payment-volume patterns and education-calendar effects. Risks include inflation and rising rates, recessionary conditions, customer and transaction attrition, cybersecurity and service disruptions, third-party processor dependence, chargebacks, acquisition integration, and covenant or liquidity constraints. No new material risk-factor changes were reported.
- Accounting item: Adoption of ASU 2020-06 on October 1, 2022 changed the presentation of the Exchangeable Notes and reduced additional paid-in capital by $23.4 million, increased debt by $11.9 million and reduced accumulated deficit by $11.4 million; it had no impact on net income.
The filing provides no formal quantitative revenue or earnings guidance. Management’s stated liquidity outlook is not a guarantee of future results.
Important facts for investors to verify
- Whether acquired businesses deliver expected recurring revenue, growth and integration benefits, and how much of reported growth is organic versus acquisition-driven.
- Debt balances, borrowing availability, covenant headroom and refinancing plans ahead of the May 2024 revolving-facility maturity; sensitivity of earnings and cash flow to interest rates.
- Cash conversion and the drivers of lower operating cash flow, alongside continued acquisition spending and contingent-consideration payments.
- Developments, potential exposure and timing in the Louisiana cybersecurity litigation and the conditional sales-organization buyout.
- Actual tax savings and payment timing under the Tax Receivable Agreement, including any liabilities arising from future exchanges.