Good day, and welcome to the i3 Verticals Second Quarter 2024 Earnings Conference Call. Today's call is being recorded, and a replay will be available starting today through May 17. The number for the replay is 877-344-7529 and the code is 6854757. The replay may also be accessed for 30 days at the company's website. At this time, I would like to turn the conference call over to Mr. Geoff Smith, SVP of Finance. Please go ahead, sir.

Good morning. And welcome to the Second Quarter 2024 Conference Call for i3 Verticals. Joining me on this call are Greg Daily, our Chairman and CEO; Clay Whitson, our CFO; Rick Stanford, our President; and Paul Christians, our COO. To the extent any non-GAAP financial measure is discussed in today's call, you will also find a reconciliation to the most directly comparable GAAP financial measures reviewing yesterday's earnings release. It's 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 facts 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 reports that are furnished with 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 will now turn the call over to the company's Chairman and CEO, Greg Daily.

Thanks, Geoff, and good morning to everyone on the call. Before getting into the results of the second quarter of fiscal year '24, I'd like to provide a brief update on what we announced last quarter, namely the exploration of the sale of the Merchant Services Business. As previously announced in February, the company's Board of Directors has directed i3's management to explore the sale of certain discrete assets related to our Merchant Services Business. The process for considering this transaction is ongoing. We would intend to use the proceeds from the sale of this business to pay down debt. Any decision by the Board to engage in any transaction involving the Merchant Services Business will be aligned with the Board's objective to maximize long-term shareholders' value. I don't have any further updates on the process at this time. With that addressed, I am pleased to share with you some of our results from the second quarter of fiscal year '24. In a minute, Rick will elaborate on the realignment we began last year and how that has better positioned us for sustainable growth. Before he does, I'd like to reemphasize our commitment to highly recurring revenue streams. This quarter, several of our nonrecurring revenue lines are lower than last year, especially professional services and software licenses. Some of our revenue here has been impacted by delayed projects in our backlog, such as the Manitoba driver's license project we've discussed with you or the very large and exciting new utilities opportunity. The utilities opportunity has required us to build a complex new project. It is going great. However, we have not been able to recognize any revenue related to it. That's fine with us because we believe that, in the long term, this project is going to open up new markets and be highly accretive to our shareholders. In the interim, as we go through a period of lower professional services and license revenue, we benefit greatly from our excellent financial profile. ARR is well north of 80%. Our margins grew over 100 basis points despite lower higher-margin license revenue. We think that's fantastic results which we are proud of. Our future is very bright, and we are excited about the second half of our fiscal year. I'll now turn the call over to Clay, and he'll provide you more details on our financial performance.

Thanks, Greg. The following pertains to the second quarter of our fiscal year 2024, which is the quarter ended March 31, 2024. Please refer to the slide presentation titled supplemental information on our website for reference with this discussion. Revenues for the second quarter of fiscal 2024 increased 1% to $94.5 million from $93.9 million for Q2 '23, reflecting organic growth from recurring sources, partially offset by declines in nonrecurring sources. SaaS and transaction-based software revenues each grew 10%, while recurring software services grew 6%. Payments revenues also grew 6%. Nonrecurring sales of software licenses declined by over $2 million as expected, reflecting the ongoing shift to SaaS. Professional services revenues declined by $1.3 million, principally a result of the delay in Caltex implementation with Manitoba caused by the public workers' strike. We will discuss the outlook for both line items in our outlook section. ARR increased 6% to $322.5 million for Q2 '24, a new record compared to $305.7 million for Q2 '23. Over 80% of our revenues in the quarter continued to come from recurring sources. Software and related services represented 48% of total revenues for Q2 with payments at 47% and other at 5%. Payments revenues as a percentage of payments volume improved slightly to 71 basis points for Q2 '24 from 70 basis points for Q2 '23. Adjusted EBITDA increased 4% to $25.8 million for Q2 '24 from $24.7 million for Q2 '23. Adjusted EBITDA as a percentage of revenues improved to 27.3% from 26.3% for Q2 '23, reflecting improvement in our merchant services margin, along with lower corporate expenses. Both improvements resulted from the internal realignment discussed on previous quarterly calls. Pro forma adjusted diluted earnings per share was $0.34 for Q2 '24 compared to $0.38 for Q2 '23. The decline was driven by higher interest expense following the repurchase of our exchangeable notes in January. Again, please refer to the press release for a full description and reconciliation. Segment performance. Revenues in our Software and Services segment declined 2% to $59.5 million for Q2 '24 from $60.8 million for Q2 '23, principally reflecting lower one-time sales of software licenses and professional services as previously discussed. Payment revenues represented 25% of the Software and Services segment's revenues. The segment's adjusted EBITDA declined 5% to $20.9 million for Q2 '24 from $22.1 million for Q2 '23. Adjusted EBITDA as a percentage of revenues declined to 35.2% for Q2 '24 from 36.3% for Q2 '23. The biggest factor for the declines was lower one-time software license sales, which fall straight to the bottom line in the quarters they land. Revenues for our Merchant Services segment increased 6% to $35.1 million for Q2 '24 from $33.1 million for Q2 '23, reflecting broad-based growth in our ISO, ISV, B2B, and POS channels. Adjusted EBITDA for our Merchant Services segment increased 18% to $10.1 million for Q2 '24 from $8.6 million for Q2 '23, outpacing revenues. Our revenue yield increased slightly with continued expense control. Balance sheet. Our balance sheet remains strong and well positioned for '24. Following our repurchase of convertible notes in January, we have $26.2 million remaining. At quarter end, borrowings under the revolver, net of cash approximated $343.1 million, and our total leverage ratio was 3.5x. The current constraint is 5x under our $450 million revolving credit. The interest rate for the convertible notes is 1%, while the interest rate for the revolver is currently around 8.5%. We have remained disciplined in our approach to growth and acquisitions. We have approximately $4 million in earn-out payments remaining from past acquisitions. In the event we sell our Merchant Services Business, we would have very little, if any, remaining debt. This would free up even more resources to deploy towards the public sector, education, and healthcare verticals. Outlook. This is potentially a transitionary year, so I will first outline our revised outlook for fiscal year '24 assuming no divestitures or acquisitions. And I will touch on the financial profile for what could be called RemainCo in the event we sell the Merchant Services Business. For fiscal year '24, our revised outlook follows; Revenues, $380 million to $394 million; adjusted EBITDA, $107 million to $113 million; depreciation and internally developed software amortization, $11 million to $13 million; cash interest expense, $27 million to $29 million; and pro forma adjusted diluted EPS, $1.49 to $1.57. From a seasonal standpoint, historically, we have not had large step-ups from Q2 to Q3 organically. Although actual results on the one-time software line can vary significantly, our current expectations for software license sales remain $1 million for Q3 and $3 million for Q4. The bulk of the Q4 amount is an implementation for a large utility customer we have discussed on previous calls. In the event we sell our Merchant Services Business, we currently expect RemainCo would resume high single-digit revenue growth beginning in fiscal year '25. Some tailwinds that we have identified include the Manitoba project returning to a normal cadence, continued momentum in the utilities market, and the SaaS transition becoming less of a short-term drag. The education business will also lap the introduction of certain state subsidies for lunch, which began during the back-to-school season in '23. We would expect adjusted EBITDA as a percentage of revenues for RemainCo to improve annually by 50 to 100 basis points per year. We would also expect to resume acquisitions in the public sector, education, and healthcare verticals after using the proceeds from the sale to pay down debt.

Thank you, Clay. Good morning, everyone. Over the past 18 months, we've transitioned from a group of products in multiple verticals into a coordinated, efficient organization developing and selling software solutions in strategic vertical markets. Throughout the transition, we've adjusted our organizational structure to drive i3 forward. Initially, we capitalized on our expertise in the public sector by analyzing our products and processes to provide solutions across any government of any size with a single contract. Eventually, the initiative was called UPO or unified product offering. As a result of trust in i3, vendor fatigue, and our solutions and service, we quickly saw buy-in from our government customers. Because of the success in the public sector, our leadership team rolled out the initiative across the organization. We worked through changes, realigned the reporting structures, and captured market share. Now our focus is on achieving sustainable growth with enterprise software as we scale our strategic markets, public, healthcare, and education. Now that our company is unified and configured for sustainable growth, we are focusing on quality revenue expansion through sales of our enterprise software solutions. In addition, we plan to make additional strategic hires in product to lead and expand our ongoing investment in web-native configurable next-generation applications. This past quarter in the public sector, we secured long-term software contracts in California, Michigan, New Hampshire, and Tennessee. In education, we landed white space contracts in Georgia, North Carolina, South Carolina, and Texas, and in healthcare, a large health insurance carrier. Regarding M&A, we have looked at several opportunities over the last quarter. Most of them are in the public sector with a few in healthcare and education. Our dance card continues to be full of target companies largely in public sector and healthcare verticals. Some of the solutions include software solutions tailored towards mobile policing, utility management and property tax collection, case management and data intelligence solutions for justice and public safety industries, a school online enrollment solution, tax software and local government specializing in areas such as business license and tax, lodging tax, property tax, sales and use tax, and utility tax; and an RCM solution that automates a proportion of the back-office process. We hope to be able to share more details on the M&A front in the near future. This concludes my comments. At this time, we'll open the call for Q&A, please.

Sounds like the slightly softer revenue in the quarter was more or less kind of a push out of some revenue, but you did lower the full year guide by kind of a similar amount. So just curious if that's revenue that you're not expecting to get until next year, maybe conservatism, because you don't know when that's going to come? Or just any kind of comments on the lower outlook for the full year?

Revenue for the quarter is determined by our annual guidance, so it contributes to the full year's results. We do not anticipate any significant revenue from the Manitoba driver's license project this year, which ends in September '24; we expect to see that in '25. Therefore, that revenue has been deferred.

It was encouraging to see that, despite the reduced nonrecurring high-margin revenue, our margins still expanded nicely and aligned with our expectations. Clay, did this outcome exceed your expectations given the nonrecurring challenges? I know there are some cost initiatives in progress, but could you share any thoughts on the margins as we approach the end of the second quarter and look towards the latter half of the year?

No. We came into the year projecting margin improvement and continue to expect it. And it results from the internal realignment that began in earnest in the fourth quarter, but we're getting a full year effect this year.

Okay. And then lastly, I think ARR was up 6% in the quarter, you talked about RemainCo, kind of high single-digit growth profile going forward if you were to sell the Personal Services Business. So just help me bridge that gap. Was there anything that kind of weighed on ARR this quarter? Just how do we think about that acceleration from 6% to high single digits for RemainCo?

Well, four things. The Manitoba driver's license project will launch in 2025. Our major utility customer will have a significant year in 2025. We expect that most of the $3 million I mentioned for one-time license sales in the fourth quarter will come from this large utility customer, but it will lead into a more extensive project in 2025. Education concludes in August and September. Those were the main points.

I haven't seen the cash flow statement yet, but it looked as if cash flow was pretty good and looks like to me that you had a working capital inflow. Is that correct? Is that generally correct? I'm trying to just kind of back into some numbers here, but actually it looks like working capital is slightly negative, but it looked like free cash flow conversion was somewhere close to 50% for the quarter. Does that sound about all right?

Yes. I get 47%, Pete. CapEx was $1.5 million. Capitalized software is $6.1 million. Cash interest much higher at $14.1 million. When we paid off the convertible notes, we traded 1% debt for 8.5% debt. And then cash taxes were a pretty big number this quarter at $5.4 million. So I get 47%. And we came into the year expecting 50%, so it's pretty close.

Okay. Okay. Great. And then can you just talk a little bit about the attach rates on some of the software businesses that you had acquired over the last 3 years that, some of them hadn't even started marketing payments. But can you talk about where you've had some success there, either by vertical or even your sub-niche within the verticals?

Healthcare is still in its early stages and the progress will be gradual. We have thousands of billing customers who are currently using other providers, and most of these customers are small. Therefore, we will focus on acquiring them one by one. The education sector shows the highest attach rate, followed by the public sector which ranks second.

Pete, the other thing is we've talked about the realignment and bringing services to the enterprise level. We've created this past quarter a group that their specific directive is to sell into our three strategic verticals, and there's a support team behind that. So we look forward to seeing some advances from that group with a specific directive to go after those three verticals.

I understand. Okay. While I know you can't discuss the potential divestiture in detail, can you share if we might expect any news on that front in the next 90 days, should it occur?

I don't think we're able to provide an answer, Pete. We wish we could share more, but until something is finalized, we can't really comment on it.

This is Shefali Tamaskar, asking a question on behalf of James. I was wondering if you could provide an update on what the timing might look like for the continued transition from nonrecurring revenue sources like licenses to recurring revenue sources like SaaS and what that might look like going forward?

Well, our total software licenses sales for fiscal year '23 were $10.7 million, and we expect the total one-time sales this year to be $5 million. So at the end of fiscal '24, it will already be fairly de minimis. We do have some utility customers where we will continue to have some one-time software sales. So I'm viewing this year as the transition year and probably plateauing around the $5 million mark, although we could have some pleasant surprises in the future.

Okay. And just as a follow-up, could you provide an update on the current competitive environment you're seeing? And if you've seen any changes in competitive intensity as it pertains to winning deals or keeping current customers.

This is Paul Christians. That's been pretty steady state. We haven't seen that. Clay mentioned a couple of pushouts on projects, which are really tied to our customers having some personnel constraints of their own, which we're attempting to facilitate with additional support mechanisms to help them free up and get back on track. But the overall demand or competitive environment has been relatively constant.

Outside of the headwinds associated with the nonrecurring revenue sources, how would you describe the demand environment in the public sector, in particular, relative to the macroeconomic environment and other factors.

It's been relatively constant. We haven't seen any kind of extraction of RFPs beyond the norm or anything of that nature that would tell us we have more of a macro issue in that environment. I do think as we get to look at it and we switch more and more to SaaS delivery of product, that eases the pain for our customers because there's less capital requirements and their dollars go further on a near-term basis. So I think the SaaS transition as a natural extension will help mitigate that to a degree if that does surface, but we're not seeing any evidence of it.

Seems like there could be some seasonality.

Certainly.

Definitely. January and February were crazy this year, slowed down now. We think it's going to pick up this summer.

And fresh budgets are always impacted. Yes.

And one more, should we assume that the company is going to hold off on acquisitions until the Merchant Services sales process has been completed?

I hope not. We have an active pipeline and are negotiating with several parties, but we are not holding off. We continue discussions every day, and while Merchant Services is forthcoming, we have the ability to pursue deals in the meantime.

I guess when you look at the cost controls that have been put in place over the last several quarters, how should we think about that cost basis relative to where we're headed? Maybe more specifically in potential RemainCo, how do you feel like you're staffed? And overall, what headcount projections look like for the software side of the business for the next several quarters?

Well, I think there are just a little over 300. Okay. 300 people roughly associated with the Merchant Services Business, and the total company is some 1,700. So we are well-staffed, and we do believe we've been through realignment on the RemainCo's side, which will suit us well over the next few years. We're not feeling the need to cut more right now.

Okay. Helpful. And then you talked about additional internal development needed for the big utility customer. How much of that is sort of purely custom for their environment, their infrastructure versus development that can be leveraged for additional customers, especially if you can grow more in similar types of businesses?

One of the things that we're so excited about with this particular opportunity in all of our web-native development is that everything is being built in highly scalable, configurable native applications. So it really reduces the amount of customization we do for projects and it enhances speed to market, and it also reduces ongoing maintenance costs. So historically, if you look at that number, the new products, custom code that would be required is far less than the historic products. I noted that this remains consistent, and while there are slight variations in water, gas, and electric, it all follows the same fundamental model, just with different data attributes that need to be accounted for.

It looks like the commercial off-the-shelf application, the customized piece to it is vendor integrations by utility. That's the difference.

And then that gets augmented because we have standard methods of entry on our APIs that use that process as well.

I appreciate the color on the RemainCo outlook for '25. But just wanted to get a little more color around the linearity of revenue as we think about the quarterly cadence. So you had mentioned high single-digit growth. It sounds like there's some license revenue that's going to come through in the front half of the fiscal year. So that being said, I guess, first, is that high single-digit, I assume that's an average for the year? And secondly, are there any weightings towards any particular quarters that we should consider as we think about our model?

There will be seasonality, particularly on the one-time software line. I do believe Manitoba, we believe, is going to be more second half as opposed to the first half because we haven't received the requirements yet. When it comes to utility license sales, which are the big ones that we see for '25, it's hard at this stage to predict which quarter that falls into. I think that line item is just going to be a variable going forward.

Maybe I'll ask about Merchant Services from another angle. I guess, hard to not notice that you're seeing decent revenue growth in that business. You're now at $42 million of adjusted EBITDA over the last 12 months. That seems to be growing mid- to high teens. Do you think prospective buyers are seeing the value of these assets? And just curious if you've adjusted your view of the valuation through this process?

It's a good business, and we've never thought it was not a good business, and it's been really steady Eddie for us ever since going public and even before that. Do you want to comment on...

It's an amazing team with a strong pipeline that consistently delivers results. While I can't comment on the pricing of the transaction, it's a fantastic opportunity for the buyer. It enhances our narrative, transitions us into a software business, and helps us pay down our debt.

Okay. Fair enough. And then, I was wondering if you could help us quantify the size of the headwind you're facing from the subsidized launches?

In a normal year, we would expect education to grow by 10%. However, coming into this year, during our Q4 call in September, we adjusted that expectation down to 5% for fiscal year '24. Once we pass that threshold, we anticipate resuming a 10% growth rate in education.

The next question comes from Alex Markgraff with KeyBanc Capital Markets.

A couple, maybe one first. I think for Paul, just on some of the product level improvements, I think I heard you mention earlier speed to market, implementation timeline. Just curious if you could quantify some of those changes and some of the improvements as you work through some of these product initiatives.

Sure. In the public sector, there is significant demand and a diverse market with a range of enterprise solutions. Historically, projects in this area have been lengthy, as they often involve customizing established internal processes that have been in place for years. These processes are usually well-defined and consistent. Our team possesses extensive expertise in specific domains, which we leverage when developing products. Often, we collaborate with key customers to create solutions that function as ready-made components with standardized integrations, which is crucial for larger enterprise projects. Our expertise is organized by domain, focusing on areas such as ERP products, enterprise utilities, and tax considerations.

Okay. Great. And then just one quick one, Clay. Just the sort of confidence level on that license revenue in the fiscal fourth quarter.

It is in there. It has been delayed once from Q3 to Q4, but we still believe it will happen in Q4. If it doesn't, it would be our Q1, but we currently expect it in Q4.

And at this time, we are showing no further questioners in the queue, and this does conclude our question-and-answer session. I would now like to turn the conference back over to Greg Daily for any closing remarks.

Thank you. I'd like to thank my team, our team that are out there every day, killing it, thank you. And thanks, everybody on this call for your continued interest and call us if you need anything else. Thank you.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.