I3 Verticals, Inc. — Q1 FY2020 Form 10-Q
Reporting period: Three months ended December 31, 2019; comparative period ended December 31, 2018. Amounts are in U.S. dollars; financial statement amounts are in thousands unless stated otherwise.
Business context and financial performance
The company provides integrated payment and software solutions to small and midsize businesses and organizations, including in education, public sector, property management, nonprofit and healthcare markets. It reports Merchant Services and Proprietary Software and Payments segments.
- Revenue: Reported revenue was $41.1 million, down 51.6% year over year. This decline is not a like-for-like measure: adoption of ASC 606 moved interchange and network fees from operating expenses to a reduction of revenue. On a presentation excluding that change, revenue was $110.2 million, up 29.9% from $84.9 million.
- Growth drivers: Management attributed the increase on the comparable presentation primarily to acquisitions completed in fiscal 2019 and higher payment volume. Payment volume rose 30.4% to $3.8 billion. Integrated payments were 55% of volume versus 46% a year earlier.
- Profit: Operating income was $4.1 million, up 16.1%; net income was $1.9 million versus $2.4 million. Net loss attributable to i3 Verticals, Inc. was $149,000, or $0.01 per Class A share, compared with attributable income of $178,000, or $0.02 per share. The allocation to non-controlling interests resulted in attributable loss despite consolidated net income.
- Processing margin: $33.5 million versus $23.1 million, an increase of approximately 45%. The company defines this measure as revenue less interchange and network fees and other costs of services, with specified residual expense add-backs. It is a company-defined operating metric, not a GAAP margin.
- Costs and interest: SG&A increased 54.1% to $19.3 million, primarily due to higher employment costs, stock compensation and acquisition-related headcount. Depreciation and amortization rose 31.1% to $4.7 million. Net interest expense increased 120.4% to $2.0 million.
- Cash flow: Operating cash flow was $7.5 million, versus $6.1 million. Investing used $1.8 million, versus $22.0 million, including $21.0 million of acquisition spending in the prior-year quarter. Financing used $6.6 million, versus $16.3 million provided.
- Liquidity and debt: Cash and cash equivalents were $0.3 million; restricted cash was $1.9 million. Revolver borrowings were $134.0 million gross ($132.3 million net of issuance costs), with $166.0 million available under the $300 million facility. The facility matures May 9, 2024. The company reported compliance with its covenants.
Material changes and accounting comparability
- The company adopted ASC 606 on October 1, 2019 using the modified retrospective method. Interchange and network fees of $69.1 million were presented net against revenue in the current quarter; the prior-year $55.8 million remained in operating expenses. The presentation change did not affect operating income or materially affect net income, but makes reported revenue and expense comparisons misleading without adjustment.
- ASC 606 adoption produced a $1.3 million cumulative equity increase, including $705,000 to accumulated earnings and $640,000 to non-controlling interest, principally reflecting contract acquisition costs amortized over expected customer lives.
- No business acquisitions were completed in the quarter. The company purchased $545,000 of residual buyouts, treated as asset acquisitions.
- Goodwill was $166.4 million and intangible assets, net, were $104.9 million at December 31, 2019. Preliminary purchase-price adjustments reduced goodwill by $1.9 million during the quarter.
- Equity-based compensation expense increased to $2.1 million from $1.0 million.
Outlook, risks and contingencies
- No specific revenue, earnings or other numerical guidance was provided. Management expects operating cash flow, cash and available revolver capacity to be sufficient for operations, planned capital expenditures and debt service for at least the next 12 months.
- Management noted seasonal variation in payments and education-related revenue. The company reported approximately 1% net payment-volume attrition per month during the quarter.
- Key risks identified include competition, reliance on distribution partners and third parties, data security and service disruptions, regulation, client retention, acquisition execution, economic conditions, debt and credit-facility restrictions.
- The $23.2 million Tax Receivable Agreement liability reflects an obligation to pay continuing equity owners 85% of certain realized or deemed tax benefits. Estimated payments related to prior exchanges range from $0 to $2.1 million annually over 24 years; future exchanges could add obligations.
- Recorded contingent consideration was $18.4 million, including $12.1 million classified as current. The quarter included a $154,000 expense from a fair-value increase, which management associated primarily with some acquired businesses exceeding expectations.
- Contractual commitments include $9.0 million of processing minimums and $10.4 million of operating lease payments. Management said ordinary-course legal matters and specified indemnification obligations were not expected to have a material impact. The filing reported no material changes to the prior Form 10-K risk factors and no off-balance-sheet financing arrangements.
Important facts for investors to verify
- Reconcile the reported 51.6% revenue decline with ASC 606’s gross-to-net presentation change; compare growth using the filing’s $110.2 million comparable-presentation revenue figure.
- Assess whether payment-volume growth and the increase in integrated payments can offset the disclosed client attrition and weaker Purchased Portfolio trends.
- Review debt repayment capacity, variable-rate exposure, facility covenants and the distinction between low cash on hand and substantial undrawn borrowing capacity.
- Track acquisition-related costs, contingent consideration, goodwill and intangible asset balances, and the sustainability of operating cash flow.
- Evaluate future Tax Receivable Agreement payments and the effect of continuing equity owners’ unit redemption or exchange rights.