Good day, everyone, welcome to the i3 Verticals fourth quarter 2022 earnings conference call. Today's call is being recorded and a replay will be available starting today through November 28. The number for the replay is 877-344-7529, and the code is 9785901. The replay may also be accessed for 30 days at the company's website. At this time, for opening remarks, I would like to turn the call over to Geoff Smith, SVP of Finance. Please go ahead, sir.
Good morning and welcome to the fourth quarter of 2022 conference call for i3 Verticals. Joining me on this call are Greg Daily, our Chairman and CEO, Clay Whitson, our CFO, and Rick Stanford, our President. To the extent any
Non-GAAP financial measure is discussed in today's call, you'll also find a reconciliation to the most directly comparable GAAP financial measure by reviewing yesterday's earnings release. It is 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 fact 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 filed or furnished to 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 now turn the call over to the Company's Chairman and CEO, Greg Daily.
Thanks, Geoff, and good morning to all of you. I'm pleased to report a strong finish to fiscal year 2022, and we are excited by what's coming in fiscal year 2023. We set sequential records for revenue and adjusted EBITDA every quarter this year. Year-To-Date revenue and adjusted EBITDA grew 42% and 44% respectively from fiscal year 2021 to fiscal year 2022. Our identity as a vertical market software company is more fully realized than ever.
Software and related services are our largest source of revenue, comprising 49% of total revenue in fiscal year 2022, up from 40% a year before and 26% a year before that. We love the recurring nature of software and related services. We also value payments as a platform because it provides another recurring revenue growth engine.
More than 80% of our revenue in fiscal year 2022 came from recurring sources, and that section of our P&L continue to outgrow all others. We look for acquisition targets that have untapped recurring revenue sources, and we continue to find great opportunities. One such opportunity, as we previously announced, our second-largest acquisition to date, Celtic Systems.
Rick will share more, but Celtic is a perfect fit with our 2021 BIS acquisition. Celtic and BIS each have complementary Best-Of-Class products for transportation departments at the state level. The Cross-Selling opportunities are compelling enough that we are better positioned to respond to RFPs. We can't wait to see how Celtic grows, and landing this deal was an ideal start to fiscal year 2023. Now I'll turn the call over to Clay.
He will provide you more details on our financial quarter performance. Following Clay's comments, Rick will provide an update on some role changes and address M&A, and then we'll open up the call for questions.
Thanks, Greg. The following pertains to the fourth quarter of our fiscal year 2022, which is the quarter ended September 30th, 2022. Please refer to the slide presentation titled Supplemental Information on our website for reference with this discussion. We had another great quarter with record revenues and adjusted EBITDA.
Revenues for the fourth quarter increased 27% to $85.3 million, from $67.2 million for Q4 2021, reflecting strong organic growth and acquisitions. Our revenue yield improved to 140 basis points for the quarter from 120 basis points for Q4 2021. Organic growth for this quarter was approximately 12%. Annual recurring revenues totaled $281.2 million for Q4 2022, compared to $210.8 million for Q4 2021, a growth rate of 33%.
Organic ARR growth generally runs a few percentage points above our total organic revenue growth.
Over 80% of our revenues in the quarter came from recurring sources. Software and related services remained the largest portion of our revenues, representing 49% for fiscal 2022. Payments represented 45% and other just 6%. Adjusted EBITDA increased 27% to $21.7 million for Q4 2022 from $17.1 million for Q4 2021, reflecting continued momentum in our software and services segment.
Adjusted EBITDA as a percentage of revenues increased to 25.5% for Q4 2022 from 25.4% for Q4 2021, reflecting margin improvement in our software and services segment. For the fiscal year, the adjusted EBITDA margin expanded 30 basis points to 25%. Pro forma adjusted diluted earnings per share increased to $0.39 for Q4 2022 from $0.33 for Q4 2021.
For the fiscal year 2022, pro forma adjusted diluted earnings per share increased to $1.48 from $1.05 for fiscal 2021. Again, please refer to the press release for a full description and reconciliation. Segment performance.
Revenues in our software and services segment increased 40% to $51.8 million for Q4 2022 from $36.9 million for Q4 2021, principally reflecting growth in our 2 largest verticals, public sector and healthcare. Revenues in our education vertical continued a strong rebound, increasing 35% Q4 to Q4, thanks to organic sales to new school districts and higher lunch and activity fees at existing districts. Federal and state subsidies for lunch have decreased significantly since the pandemic.
Software license revenue increased 47% to $3.5 million for Q4 2022 from $2.4 million for Q4 2021. The largest was an $800,000 ImageSoft sale to a Department of Transportation in a Midwestern state for an enterprise document management system and workflow system.
This line item made up only 3.5% of our total revenue in the quarter, but it has a 95% gross margin and can be lumpy and hard to predict, as you can see from the variation between quarters.
While we are focused on SaaS and other recurring sources of revenue, license sales will not go away completely. Some customers, particularly in the public sector, still prefer them. The segment's adjusted EBITDA improved 55% to $17.1 million for Q4 2022 from $11.1 million for Q4 2021, outpacing revenues.
The growth was principally driven by our 2 largest verticals, public sector and healthcare. On a run rate basis, public sector represents over 1/2 of our consolidated business, while healthcare is an estimated 20%. Adjusted EBITDA as a percentage of revenues improved to 32.4% for Q4 2022 from 31.1% for Q4 2021, reflecting margin improvements in public sector and education.
Revenues for our merchant services segment increased 9% to $33.4 million for Q4 2022 from $30.7 million for Q4 2021, principally reflecting growth in our B2B and ISO channels. Adjusted EBITDA for our merchant services segment increased slightly to $9.1 million for Q4 2022, with higher revenues partially offset by higher residual expenses.
In keeping with our strategy since the IPO, we have steadily redirected acquisition and internal resources from traditional merchant services into higher growth and higher margin software and services, coupled with integrated payments. Our balance sheet has allowed us to continue to execute our acquisition strategy.
On September 30th, we had $181.5 million borrowed under our revolver, net of cash, under a $275 million facility. The face value of our convertible notes are $117 million. As of September 30th, our total leverage ratio was approximately 3.7x, while the current constraint is 5.25x. In conjunction with the Celtic Systems acquisition, we increased the size of our existing revolving credit facility from $275 million-$375 million.
In October, we borrowed $85 million for the purchase of Celtic Systems, but we currently expect total leverage to be close to 4x on December 31st, 2022. The interest rate for the convertible notes is 1%, while the interest rate for the revolver is currently around 7%, but will increase as the Fed continues to raise rates.
Over time, we expect to convert roughly 2/3 of adjusted EBITDA into free cash flow, which can be used for debt repayment, acquisitions, and earnouts. We define free cash flow as adjusted EBITDA minus capital expenditures, internally capitalized software, cash interest, and cash taxes. Looking forward, the strong finish to our fiscal year gives us confidence in the following guidance for fiscal 2023.
It excludes acquisitions that have not yet closed and transaction-related costs. Revenues $360 million-$380 million.
Adjusted EBITDA, $94 million-$102 million. Cash interest expense, $19 million-$22 million. Pro forma adjusted diluted EPS, $1.50-$1.62. From a seasonal standpoint, the Celtic Systems acquisition gives us a good start to the year, like the October first healthcare acquisition did last year.
Acquisition activity could prove different this year, but we currently expect the quarters of fiscal 2023 to follow a similar pattern to those of fiscal 2022. As we become more software-centric, quarters might vary based upon perpetual license sales, even though our trend is generally toward more recurring revenue streams. I'll now turn the call over to Rick for company updates and M&A activity.
Thank you, Clay. Good morning, everyone. First, I wanna speak a moment about our 2 new executive team members, Paul Christians and Chris Laisure. Since 2019 acquisition, Paul has been leading the Pace Payment business for us and also leading our public sector unified product offering or UPO process with great success.
We are proud to announce his promotion to Chief Operating Officer at i3 Verticals. In this new position, Paul will continue to oversee our public sector UPO strategy, and he will expand that successful effort to include leadership of UPO and healthcare.
I have no doubt that Paul will replicate the public sector successes within our healthcare vertical. UPO is critical to our overall company strategy as we integrate products within our existing vertical businesses to provide comprehensive solutions to our customers. Paul is a perfect fit for this role.
Chris Laisure joined us as part of our BIS acquisition in early 2021. In his CEO role at BIS, Chris has led that business to impressive growth and has proven his deep understanding of the public sector vertical. He is now going to draw on that experience and will become the President of Public Sector, which is our largest vertical and is responsible for 50% of our revenues.
Chris understands the ongoing needs of public sector customers across the country and will no doubt lead us to even more growth within that vertical. Paul and Chris are intelligent, seasoned, and effective leaders.
Perhaps more importantly, they are quality individuals who will help encourage our high integrity, collaborative, and entrepreneurial culture. We look forward to their many contributions. Before I discuss M&A, I wanna make note of developments within our education businesses.
As K-12 education market begins to shift to Post-Pandemic environment, prices on school lunches have increased across the board, while currently all federal and most state subsidies for lunches have decreased in most states. Districts are also seeing an uptick in other transactions as traditional activities resume, which adds to the daily student spend.
These developments have contributed to increased revenues that we have seen in these businesses. I'll now speak to M&A. We continue to pursue growth by performing acquisitions of companies that fit with our strategy and emphasis on companies in our public sector and healthcare verticals. On October 4th, we announced our latest acquisition, the acquired business, Celtic Cross Holdings, Inc. and Celtic Systems Private Limited, together known as Celtic, fits extremely well with BIS.
Both companies have products for transportation departments at the state level, but their products mostly complement each other, so we see many opportunities to expand the addressable market and cross-sell within existing customers.
Celtic also offers a greater geographic reach with customers in 18 U.S. states and four Canadian provinces. Celtic software could be broken down into 2 parts. Part one is motor carrier software.
Rate group, fleet, vehicle, and distance management capabilities are built in. In conjunction with their integrated inventory management module, it streamlines carrier credentialing and increases operational efficiencies through automated issuance.
It also has Built-In tools for selecting carriers to audit based on specific auditor criteria, notifying carriers, and conducting both current and previous year carrier audits with End-To-End tracking capabilities. Their product gathers carrier and fuel-specific information, including miles traveled, gallons used, and taxes paid.
It streamlines the oversize, overweight vehicle permitting process and automatically generates safe travel routes by evaluating and selecting the most appropriate route for specific vehicle and load dimensions, taking regulations, restrictions, and roadway bridge hazards into account, and provides Turn-By-Turn directions to the carrier. All of this resulting information provides the International
Registration Plan, IRP, and International Fuel Tax Agreement, IFTA, offices with critical information that can be leveraged by carriers for registering, renewing, and issuing credentials to carriers and vehicles. It also provides roadside law enforcement assistance to quickly ascertain if a carrier and/or vehicle is in compliance with safety and credentialing rules, helping to keep unsafe vehicles off the road.
Their supporting products include document management for electronic filing, management and retrieval of required documents.
The software also allows for processing of mandatory quarterly tax returns, tax liability, including penalty interest fees and credits, and tax payment cutoff dates for various fuel types, such as special fuels and dyed diesel fuels. It also provides for intrastate registrations for carrier fleets and other fleet types operating wholly within the jurisdiction while maintaining applicable insurance filings.
Part 2 is motor vehicle software. Some of the features include title transactions like original title transfer, title correction, et cetera. The software also provides for instruction permits, commercial and non-commercial driver's license, and identity card issuance. The software generates and tracks various types of driver credentials after analyzing driver records and history and collecting all the required document and fees.
It captures and tracks all driver records, including convictions, points, accidents, and based on business rules, will automatically initiate the desired necessary actions, such as sending a warning, generating suspension records, or reinstatement on suspension.
It calculates and collects payments based on various business rules and distributes funds to appropriate general ledger accounts as required. It manages dealer inventory and dealer licensing, which helps motor vehicle departments manage dealer permitting, dealer records, revocations, audits, and reporting. In summary, Celtic Systems is a perfect fit in our public sector vertical.
It aligns nicely with the combined BIS product suite and further enhances our presence in state and provincial-level markets in the U.S. and Canada. In the past 30 days, both Celtic and BIS have been jointly responding to new RFPs currently in the market, as well as joint marketing at state shows that have occurred.
I wanna specifically note that this deal fell within our normal range of multiples. Our pipeline remains robust with opportunities for acquisitions in public sector and healthcare that are similar in size to many of our acquisitions to date. This concludes my comments, operator. At this time, we'll open the call for Q&A, please.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star then one on your Touch-Tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys.
If at any time your question has been addressed, and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from John Davis with Raymond James. Please go ahead.
Hey, good morning, guys. Rick, it's good to hear you talk about education as a pocket of strength. Maybe could you guys just remind us, you know, roughly what % of the business, either revs or EBITDA, is education today, and kind of where are those absolute kind of run rate levels versus pre-pandemic? Are we back ahead of Pre-Pandemic education? Just sizing that business would be helpful.
J.D., I'll take that. In fiscal year 2022, education contributed $15 million of revenues and $7 million of EBITDA. That's where we were in 2019, Pre-Pandemic. School lunch hasn't come all the way back, but we've added a lot more schools, so that's why we're even from where we were. For fiscal 2023, we think it'll improve from 2022, because we'll get four quarters of strong school lunch.
Okay. No, that's helpful. Another one for you, Clay. You know, I think based off of the guide you gave, you know, our math suggests kinda roughly 10% organic growth implied, you know, versus kinda high single digits historically. Is that fair? You know, obviously, I think you said you did 12% organic growth in the fourth quarter. It's caught roughly 10% organic growth. Is that fair for 2023?
Yeah. I feel like we're right on the edge. The past 2 quarters have been 10% and 12%. Q4 had a good software license quarter, which helped the organic growth. We don't know the macro environment for 2023 yet, so it's hard for us to predict whether organic growth registers 9% or 11% for 2023. Double digit is certainly our goal. At long term, I think we have to continue to guide in high single digit and, you know, we'd like to beat it like we just did this year.
All right. Last one from me. Nice to see, you know, good margin expansion, I think 150 basis points at the midpoint of the guide. You know, I think a good portion of that's driven by some of these higher margin acquisitions, in Celtic specifically. Maybe just talk a little bit, Rick or Greg, about the pipeline, how you guys think about the margin profile of businesses in the pipeline.
Is this something we should continue to see as far as M&A coming on at a higher than corporate average margin to kinda juice some of that margin expansion going forward? Thanks, guys.
Yeah, that's a great question. We do, I think, internally have a bigger focus on acquisitions that have higher margin. We're very happy with the previous deals we've done. We feel like we have a great couple platforms in place.
When we do additional acquisitions, I think they'll look more like a traditional software business with, you know, EBITDA margins being 50%. Not promising that, but that is the goal. That's the targets. Pipeline looks great. You know, doing four or 5 deals a year is kind of our mission.
Okay. Appreciate all the color. Thanks, guys.
Thank you.
Our next question comes from Peter Heckman with D.A. Davidson. Please go ahead.
Morning, everyone. Thanks for taking the question and congratulations on the Celtic deal. I wanted to ask, with Celtic, where are they in their progression from a license model to software as a service? With some of those things you were talking about in terms of permitting, driver history records, is transaction revenue a part of it or is it primarily software?
Pete, I'll start on that. Celtic does have around a 50% margin. That is part of what you see in our guidance for 2023. They are not currently a SaaS model. Maybe 40% of their revenues are recurring in some form or fashion, but they really haven't begun to design a SaaS offering. We'll begin to do that now. It's baby steps right now. What was your second question, Pete?
There would be really no transaction-based revenue.
Oh, no. Yeah.
Okay.
No, they currently have none. Again, we plan to try to introduce that, particularly on new business.
Got it. As a Follow-Up, I think in the press release you said four Canadian provinces. It looks like, you know, a couple of those they won, you know, a number of years ago, so fairly established in Canada. You know, how do you think about Canada expanding the TAM for your Public Sector business? Is there a way to think about that?
Well, it's exciting for us. We currently have several Canadian customers. The contracts are denominated in U.S. dollars. You know, the F.X. won't be very challenging for us. Yeah, it's a whole new TAM, as you put it, to explore and expand and add payments to. We're very excited about that.
Great. I appreciate it. I'll get back in the queue.
Our next question comes from James Faucette with Morgan Stanley. Please go ahead.
Great. Thank you very much. First, your 2023 margin guide, I think implies around 150 basis points of year-over-year expansion. We've seen some margin pressures crop up in other both competitors and comparables. How are you thinking about the puts and takes around your margins and where you're targeting for fiscal year 2023?
Well, Celtic adds about almost as much as 100 basis points, just layering it in at 50%. Corporate should contribute 50 basis points. It contributed 40 basis points this year in a challenging inflationary environment. You know, T&E and trade shows have been a pretty big deal this year in fiscal 2022. That was $3 million higher than in 2021.
You know, as normal travel and In-Person sales activities resumed, trade shows started taking place again. We don't have that drag coming in 2023. Now there is general inflation, so we're not promising 150, but we have a pretty clear sight to margin improvement in 2023.
Got it. Got it. And then on the M&A front, um, you know, you indicated that Keltic was kind of within your historical range of valuations that you paid. Given the environment and kinda your pipeline of deals, what's the opportunity for, um, you to even find things that you can do at better valuations than you've done, um, historically? And, and just wondering how we should think about that as a, as a potential, especially given the overall environment right now.
We do self-source our deals from beginning to end. You know, we do explain to our targets that, you know, the market's down, valuations are lower. They tend to understand that we lean more on, you know, we're building a team, we'll take care of your key employees. Here's 20 references for you to talk to. You know, we just don't get involved in auction processes.
The story is very well received. You know, they like what we've built, they like our reputation, our culture. You know, being able to pay 7x or 8x versus we were paying, you know, we've paid up to 10x. I think going forward, you know, until the market changes, you know, paying 7x or 8x is probably more the model.
Going forward, do you add anything into that, Rick?
Yeah, I would just say, you know, we've been very successful in taking a business and growing it over time, so that overall multiple goes down over time. If we start in that range, and again, we're being very selective at this point.
We're not at a breakneck pace that we've done in previous years, four or 5 deals a year, high growth companies, really good structured and strategic software companies within our verticals. I don't think I mind paying the 6x-8x, knowing that over time we can grow that business and drive the multiple down overall.
That's great to hear. Thank you so much.
Operator, do you have any more questions?
Yes. I apologize. My line was on mute accidentally. I just unmuted Mark Palmer's line from BTIG. Please go ahead, sir.
Yes, thank you. Good morning, and thanks for taking my question. Insofar as software has been a growing portion of the company's overall revenue, how should we be thinking about the gross margins for software compared to gross margins for payments? How do you expect consolidated gross margins to evolve over time given that changing mix?
Mark, I'll refer you to page 2 of our supplemental information revenue composition. Payments revenues probably average 60% gross margins. The top 3 line items in our software and services revenue mix are probably 90% gross margin.
Recurring software services and professional services, you know, we aim for, you know, 1/3 margins, but maybe count on 30% there. Software licenses, the bottom number, that's probably 95% margin. As software and services become a bigger portion of our whole, it'll lift our gross margin, consolidated gross margin over time.
Thank you. Just one follow-up to that. What is the implied mix of software and payments in your 2023 guidance?
I don't have that number in front of me, but I'm confident software and services will go over 50% this year because Celtic today is 100% software and services.
Very good. Thank you very much.
That concludes our question and answer session. I'll turn the call back over to Greg Daily for closing comments.
Thank you, everybody. Thank you, our team. What an amazing year we had in 2022, and we're very excited about the momentum that we've got going into 2023. With that said, thank you for your interest.
The conference has now concluded. Thank you for attending today's presentation. You may all now disconnect.