Business context and reporting period
i3 Verticals, Inc. provides integrated payment processing and software solutions to small and midsize businesses and organizations in vertical markets including education, public sector, property management, nonprofit and healthcare. This Form 10-Q covers the three months ended December 31, 2018, the company’s fiscal first quarter of 2019. Financial amounts below are in millions unless stated otherwise; the filing presents most financial statements in thousands.
Financial performance and liquidity
| Metric | Quarter ended Dec. 31, 2018 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $84.9 | $77.2 | Up 9.9% |
| Processing margin | $23.1 | $18.8 | Up 23.1% |
| Income from operations | $3.5 | $3.3 | Up 5.5% |
| Consolidated net income (loss) | $2.4 | $(0.3) | Improved $2.7 |
| Net income attributable to i3 Verticals, Inc. | $0.2 | $(0.3) | Improved $0.5 |
| Operating cash flow | $6.1 | $5.9 | Up $0.2 |
| Cash used in investing activities | $(22.0) | $(22.0) | Broadly unchanged |
| Cash provided by financing activities | $16.3 | $16.6 | Down $0.3 |
- Operating margin was approximately 4.2%, compared with 4.3% in the prior-year quarter. The filing does not report a conventional gross margin; processing margin is revenue less interchange/network fees and other service costs.
- Payment volume was $2.9 billion, up 4.1%. Integrated payments increased to 46% of volume from 42%. The company reported approximately 1% net payment-volume attrition per month.
- At December 31, cash and cash equivalents were $0.9 million and restricted cash was $0.7 million. Total debt outstanding was $55.3 million before debt issuance costs ($33.8 million term loans and $21.5 million revolving borrowings); the balance-sheet carrying amount, net of issuance costs and current portion, was $49.0 million. Available revolver capacity was $88.5 million.
- Net investing outflow principally reflected $21.0 million spent on acquisitions. Cash increased by $0.3 million during the quarter to $0.9 million, excluding restricted cash.
Material changes versus the prior comparable period
- Revenue increased $7.6 million. Management attributed $5.5 million of the increase to acquisitions and the remaining $2.1 million primarily to higher payment volume. Excluding purchased portfolios with elevated attrition, revenue grew 12.7%.
- Merchant Services revenue rose 6.9% to $77.7 million; Proprietary Software and Payments revenue rose 57.7% to $7.2 million. Acquisitions contributed to growth in both segments.
- Selling, general and administrative expense increased 41.5% to $12.5 million, primarily from higher employment costs, including stock compensation and acquisition-related headcount, as well as increased technology, insurance and professional-services costs.
- Interest expense declined 61.7% to $0.9 million, reflecting lower debt and interest rates and repayment of prior notes. The prior-year quarter included a $1.7 million warrant-liability fair-value charge; the warrants were exercised in June 2018.
- Goodwill increased from $84.0 million to $98.5 million, primarily due to $14.5 million of acquisition goodwill. Capitalized software increased from $3.4 million to $6.5 million.
Outlook, commentary, risks and unusual items
- Management said operating cash flow, cash on hand and available revolver capacity should be sufficient to fund operations, planned capital expenditures and debt service for at least the next 12 months. The filing provides no numerical revenue or earnings guidance.
- The company acquired two businesses that expanded public-sector software offerings and enhanced its Burton Platform. Consideration was $25.0 million, including $21.0 million funded with revolver proceeds and $4.0 million of contingent consideration. The agreements permit up to an additional $14.0 million based on performance targets through October 2020.
- Reported contingent consideration liabilities totaled $8.1 million at quarter-end. The company also recorded a $0.3 million fair-value benefit, primarily related to acquisition performance below expectations.
- The senior secured credit facility matures October 30, 2022, is secured by substantially all company assets, includes financial and other covenants, and restricts distributions. The company reported compliance with covenants at quarter-end. A 1 percentage-point change in the applicable rate was estimated to affect results by $0.6 million.
- Management notes seasonality in payment activity, including lower same-store revenue in the first calendar quarter and variation in education revenue with school schedules. Other stated risks include competition, reliance on distribution and processing partners, technology and data-security risks, client retention, acquisition integration, indebtedness and regulatory requirements.
- The tax receivable agreement generally entitles continuing equity owners to 85% of certain tax benefits actually realized or deemed realized. The recorded liability was $0.8 million; management expects future payments to be substantial, with timing and amount dependent on future exchanges, taxable income and other factors.
- A $1.0 million settlement of the Expert Auto class action received final court approval in January 2019; the company expected to fund it in April 2019. A related insurer coverage dispute remained pending, with trial set for November 2019. The filing does not provide a clear estimate of potential additional exposure in that dispute.
- The company made a $1.0 million investment in a hospitality software and payments company on January 14, 2019. It also prospectively changed the amortization rate for certain merchant-contract intangibles in the quarter to reflect expected future cash flows.
Most important facts for investors to verify
- How much of future revenue and processing-margin growth is organic versus acquisition-driven, and whether payment-volume growth can offset reported attrition.
- Whether higher SG&A, stock-based compensation and amortization continue to pressure operating profitability.
- Acquisition integration and performance against earn-out targets, including potential contingent payments of up to $14.0 million in addition to amounts already accrued.
- Debt levels, interest-rate exposure, covenant headroom and the company’s dependence on revolver capacity to fund acquisitions and other cash needs.
- Potential future Tax Receivable Agreement payments, the resolution and insurance coverage of the Expert Auto matter, and any developments in other legal or indemnification contingencies.