I3 Verticals, Inc. — Q2 Fiscal 2024 Form 10-Q
Reporting period: Three and six months ended March 31, 2024. Unless noted otherwise, financial figures are in U.S. dollars; amounts below are in millions. The company provides integrated software and payment solutions, principally in Public Sector, Education and Healthcare markets. Its reportable segments are Software and Services and Merchant Services.
Financial performance
| Metric | Q2 FY2024 | Q2 FY2023 | Six months FY2024 | Six months FY2023 |
|---|---|---|---|---|
| Revenue | $94.5 | $93.9 | $186.5 | $179.9 |
| Operating income | $9.4 | $5.4 | $18.0 | $11.3 |
| Net income (loss) | $3.3 | $(0.2) | $4.9 | $(0.02) |
| Net income (loss) attributable to i3 Verticals, Inc. | $1.9 | $0.04 | $3.0 | $(0.2) |
| Class A diluted EPS | $0.08 | $0.00 | $0.13 | $(0.01) |
| Net cash provided by operating activities | Not separately shown in the provided text | $25.1 | $25.9 |
- Revenue mix and growth: Q2 revenue rose 0.7%. Software and Services revenue declined 2.2% to $59.5 million, while Merchant Services revenue increased 6.0% to $35.1 million. For the six months, revenue rose 3.7%; management attributed growth to recurring revenue, payment volume and a $1.5 million contribution from an acquisition, partly offset by lower non-recurring revenue.
- Operating performance: Q2 processing margin, the company’s segment performance measure, was $84.7 million versus $84.8 million. Software and Services processing margin declined to $55.3 million from $57.4 million; Merchant Services increased to $29.4 million from $27.4 million. Six-month processing margin increased to $167.3 million from $162.1 million.
- Costs and margins: Q2 other costs of services increased 6.3% to $21.2 million, while SG&A decreased 5.3% to $54.2 million. Depreciation and amortization rose 11.7% to $10.1 million. Operating margin was approximately 10.0%, compared with 5.8% in Q2 FY2023.
- Cash flow and investment: Six-month operating cash flow was $25.1 million. Investing used $12.4 million, substantially below the prior-period $111.1 million, which included much larger acquisition spending. Capitalized software spending was $6.1 million; purchases of merchant portfolios and residuals were $4.2 million.
- Debt and liquidity: At March 31, cash and cash equivalents were $3.1 million, with $103.8 million of revolver capacity available, subject to covenants. Revolver borrowings were $346.2 million; $26.2 million of 1.0% Exchangeable Notes due February 2025 remained. Reported debt, net of issuance costs, was $369.6 million, including the current portion, versus $385.1 million at September 30, 2023. The company reported covenant compliance: 4.1x interest coverage and 3.5x total leverage, against minimum and maximum requirements of 3.0x and 5.0x, respectively.
Material changes and unusual items
- In January 2024, the company repurchased $90.8 million principal amount of Exchangeable Notes for approximately $87.4 million, leaving $26.2 million outstanding. It recorded a $2.4 million gain on retirement of debt. Associated note hedge and warrant transactions also affected reported other income.
- Interest expense increased 25.0% in Q2 to $7.8 million and 23.7% for the six-month period to $14.5 million, reflecting higher average rates and debt balances.
- Q2 included a $0.3 million benefit from changes in the fair value of contingent consideration, compared with a $2.3 million expense in the prior-year quarter. The comparable six-month amounts were a $0.5 million benefit and a $3.7 million expense.
- The company changed the cash-flow presentation of settlement-obligation payments from operating to financing activities and reclassified comparative periods. This presentation change did not affect the balance sheet, income statement or equity.
- Management reported that recurring revenue and payment volumes grew, while software license and professional-services revenue declined. Q2 total payment volume increased 5.5% year over year to $6.3 billion; ARR increased 5.5% to $322.5 million. ARR is a company-defined measure, not a forecast. Software and related services were 48.3% of revenue, down from 50.4%.
Outlook, risks and contingencies
- Outlook: Management expects cash from operations, existing cash and available revolver capacity to fund operations, planned capital expenditures and debt service for at least the next 12 months. No numerical revenue or earnings guidance is provided in the filing text.
- Potential Merchant Services asset sale: The board is exploring a sale of certain Merchant Services assets, a process announced February 8, 2024. No transaction is assured. The company warns that the process could involve management distraction, transaction costs, disruption to personnel or business relationships, litigation, and stock-price volatility; the board may suspend or end the process.
- Interest-rate exposure: Revolver borrowings bear variable rates. The company estimates a 1 percentage-point rate change would affect results by approximately $3.5 million, based on March 31 borrowings.
- Litigation: Louisiana state and local plaintiffs seek remediation-related damages and other relief in litigation concerning alleged cybersecurity deficiencies involving a third-party remote-access product used by the acquired S&S business. The company says it cannot predict the outcome and does not currently expect a material effect on business or financial condition, but cannot rule out an effect on results or cash flows when resolved.
- Other obligations and risks: The company reports $40.3 million of Tax Receivable Agreement liabilities; payments related to exchanges through March 31 are estimated at $0 to $3.3 million annually over 24 years, with future exchanges potentially adding obligations. Management also highlights debt and covenant compliance, liquidity, cybersecurity, chargebacks, customer retention, acquisition integration, economic conditions and elevated interest rates as risks.
Important facts for investors to verify
- Whether the Merchant Services asset-sale review results in an agreement, and the assets, terms, proceeds and related costs if a transaction occurs.
- Current revolver utilization, borrowing availability after covenant restrictions, variable interest costs and headroom against leverage and interest-coverage covenants.
- The remaining Exchangeable Notes’ repayment or exchange requirements before their February 2025 maturity.
- Underlying recurring-revenue and segment trends, particularly the decline in Software and Services Q2 revenue and processing margin, and the company-defined ARR measure.
- Developments in the Louisiana litigation, including potential exposure; the filing does not provide a clear estimated loss range.
- Cash-flow comparability after the settlement-obligation reclassification and the effects of seasonality, including Education customer patterns.