i3 Verticals, Inc. (IIIV) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations together with our audited financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. Certain amounts in this section may not foot due to rounding.
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Executive Overview
Recognizing the convergence of software and payments, i3 Verticals was founded in 2012 with the purpose of delivering seamlessly integrated payment and software solutions to SMBs and organizations in strategic vertical markets. Since commencing operations, we have built a broad suite of payment and software solutions that address the specific needs of SMBs and other organizations in our strategic vertical markets, and we believe our suite of solutions differentiates us from our competition. Our primary strategic vertical markets include education, non-profit, public sector and healthcare.
COVID-19
In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic, which continues to spread throughout the United States and other parts of the world. The spread of COVID-19 and its variant strains brought about many precautions at the state and local government levels to mitigate the spread of the virus, including the closure of local government facilities and parks, schools, restaurants, many businesses and other locations of public assembly. Throughout fiscal 2020 and 2021 governments have imposed and reimposed restrictions in response to increased transmission rates of COVID-19 and eased such restrictions once the transmission rates declined across multiple cycles.
The COVID-19 pandemic significantly affected overall economic conditions in the United States. The economic impact of these conditions materially impacted our business. Our payment volume fluctuated as a result of the impact of the COVID-19 pandemic. Despite positive developments, such as the availability of vaccines, there are no reliable estimates of how long the pandemic will continue, how many people are likely to be affected by it or the duration or types of restrictions that will be imposed. For that reason, we are unable to predict the long-term impact of COVID-19 and its variant strains on our business at this time.
Acquisitions
A core component of our growth strategy includes a disciplined approach to acquisitions of companies and technology, evidenced by numerous platform acquisitions and tuck-in acquisitions since our inception in 2012. Our acquisitions have opened new strategic vertical markets, increased the number of businesses and organizations to whom we provide solutions and augmented our existing payment and software solutions and capabilities.
Acquisitions subsequent to September 30, 2021
Subsequent to September 30, 2021, we completed the acquisition of one business within the Company’s Healthcare vertical that provides comprehensive revenue cycle management and related administrative and consulting services for hospitals, including academic teaching institutions with residents, practice groups and healthcare providers primarily in the southeast. Total purchase consideration included 60,000 in cash and revolving line of credit proceeds, and an amount of contingent consideration, which is still being valued.
Acquisitions during the year ended September 30, 2021
On November 17, 2020, we completed the acquisition of substantially all of the assets of ImageSoft, Inc. to expand our software offerings, primarily in the public sector vertical. Total purchase consideration was $46.3 million, including $40.0 million in cash consideration, funded by proceeds from our revolving credit facility, and $6.3 million in contingent consideration
On February 1, 2021, we completed the acquisition of substantially all the assets of Business Information Systems, GP, a Tennessee general partnership and Business Information Systems, Inc., a Tennessee corporation (collectively “BIS”) to expand our software offerings, primarily in the Public Sector vertical. Total purchase consideration was $95.5 million, including $52.5 million in cash on hand and proceeds from the Company's revolving credit facility, 1,202,914 shares of the Company's Class A Common Stock, and $7.8 million in contingent consideration.
During the year ended September 30, 2021, we also completed the acquisitions of six unrelated businesses, to expand the Company’s software offerings in the public sector and healthcare vertical markets, and to add proprietary technology that will augment the Company’s existing platform across several verticals. Total purchase consideration was $65.5 million, including $57.0 million in revolving credit facility proceeds, and $8.5 million of contingent consideration.
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Acquisitions during the year ended September 30, 2020
During the year ended September 30, 2020, we completed the acquisitions of three unrelated businesses. Two expanded our geographic reach and software capabilities in the public sector vertical. The other added text-to-pay capabilities and other software solutions in our non-profit vertical. Total purchase consideration was $32.6 million, including $27.9 million in revolving credit facility proceeds and $4.7 million of contingent consideration.
The results of operations of these acquired businesses have been included in our financial statements since the applicable acquisition date. For additional information, see Note 4 to our consolidated financial statements.
Our Revenue and Expenses
Revenues
We generate revenue from software licenses and subscriptions, other software related services, and volume-based payment processing fees (“discount fees”), and to a lesser extent, software licensing subscriptions, ongoing support and other POS-related solutions that we provide to our clients directly and through our distribution partners. Volume-based fees represent a percentage of the dollar amount of each credit or debit transaction processed. Revenues are also derived from a variety of fixed transaction or service fees, including authorization fees, convenience fees, statement fees, annual fees and fees for other miscellaneous services, such as handling chargebacks.
Interchange and network fees. Interchange and network fees consist primarily of pass-through fees that make up a portion of discount fee revenue. These include assessment fees payable to card associations, which are a percentage of the processing volume we generate from Visa and Mastercard. Upon our adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”) on October 1, 2019, these fees are presented net within revenue.
Expenses
Other costs of services. Other costs of services include costs directly attributable to processing and bank sponsorship costs. These also include related costs such as residual payments to our distribution partners, which are based on a percentage of the net revenues (revenue less interchange and network fees) generated from client referrals. Losses resulting from excessive chargebacks against a client are included in other cost of services. The cost of equipment sold is also included in cost of services. Interchange and other costs of services are recognized at the time the client’s transactions are processed.
Selling, general and administrative. Selling, general and administrative expenses include salaries and other employment costs, professional services, rent and utilities and other operating costs.
Depreciation and amortization. Depreciation expense consists of depreciation on our investments in property, equipment and computer hardware and software. Depreciation expense is recognized on a straight-line basis over the estimated useful life of the asset. Amortization expense for acquired intangible assets and internally developed software is recognized using a proportional cash flow method. Amortization expense for internally developed software is recognized over the estimated useful life of the asset. The useful lives of contract-based intangible assets are equal to the terms of the agreement.
Interest expense, net. Our interest expense consists of interest on our outstanding indebtedness under our Senior Secured Credit Facility and Exchangeable Notes, and amortization of debt discount and issuance costs.
How We Assess Our Business
Merchant Services
Our Merchant Services segment provides comprehensive payment solutions to businesses and organizations. Our Merchant Services segment includes third-party integrated payment solutions as well as merchant of record payment services across our strategic vertical markets.
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Proprietary Software and Payments
Our Proprietary Software and Payments segment delivers embedded payments solutions to our clients through proprietary software. Payments are delivered through both the payment facilitator model and the traditional merchant processing model. We have Proprietary Software and Payments clients across all of our strategic vertical markets.
Other
Our Other category includes corporate overhead expenses, when presenting reportable segment information.
Effective July 1, 2020, we realigned one component from the Proprietary Software and Payments segment to the Merchant Services segment. Prior periods have been retroactively adjusted to reflect the Company's current segment presentation. For additional information on our segments, see Note 17 to our consolidated financial statements.
Key Operating Metrics
We evaluate our performance through key operating metrics, including:
•the dollar volume of payments our clients process through us (“payment volume”);
•the portion of our payment volume that is produced by integrated transactions; and
•period-to-period payment volume attrition.
Our payment volume for the years ended September 30, 2021 and 2020 was $18.8 billion and $14.4 billion, respectively, representing a period-to-period growth rate of 31%. We focus on volume because it is a reflection of the scale and economic activity of our client base and because a significant part of our revenue is derived as a percentage of our clients’ dollar volume receipts. Payment volume reflects the addition of new clients and same store payment volume growth of existing clients, partially offset by client attrition during the period.
Integrated payments represents payment transactions that are generated in situations where payment technology is embedded within our own proprietary software, a client’s software or critical business process. We evaluate the portion of our payment volume that is produced by integrated transactions because we believe the convergence of software and payments is a significant trend impacting our industry. We believe integrated payments create stronger client relationships with higher payment volume retention and growth. Integrated payments grew to 60% of our payment volume for the year ended September 30, 2021 from 55% for the year ended September 30, 2020.
We measure period-to-period payment volume attrition as the change in card-based payment volume for all clients that were processing with us for the same period in the prior year. We exclude from our calculations payment volume from new clients added during the period. We experience attrition in payment volume as a result of several factors, including business closures, transfers of clients’ accounts to our competitors and account closures that we initiate due to heightened credit risks. During the year ended September 30, 2021, our average net volume attrition per month remained below 1%.
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Results of Operations
Year Ended September 30, 2021 Compared to Year Ended September 30, 2020
The following table presents our historical results of operations for the periods indicated:
| Year ended September 30, | Change | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | 2021 | 2020 | Amount | % | |||||||||||
| Revenue | $ | 224,124 | $ | 150,134 | $ | 73,990 | 49.3 | % | |||||||
| Operating expenses | |||||||||||||||
| Other costs of services | 57,706 | 47,230 | 10,476 | 22.2 | % | ||||||||||
| Selling general and administrative | 134,872 | 78,323 | 56,549 | 72.2 | % | ||||||||||
| Depreciation and amortization | 24,418 | 18,217 | 6,201 | 34.0 | % | ||||||||||
| Change in fair value of contingent consideration | 7,140 | (1,409) | 8,549 | n/m | |||||||||||
| Total operating expenses | 224,136 | 142,361 | 81,775 | 57.4 | % | ||||||||||
| (Loss) income from operations | (12) | 7,773 | (7,785) | n/m | |||||||||||
| Other expenses | |||||||||||||||
| Interest expense, net | 9,799 | 8,926 | 873 | 9.8 | % | ||||||||||
| Other (income) expense | (2,595) | 2,621 | (5,216) | n/m | |||||||||||
| Total other expenses | 7,204 | 11,547 | (4,343) | (37.6) | % | ||||||||||
| Loss before income taxes | (7,216) | (3,774) | (3,442) | 91.2 | % | ||||||||||
| Provision for (benefit from) income taxes | 623 | (2,795) | 3,418 | n/m | |||||||||||
| Net loss | (7,839) | (979) | (6,860) | 700.7 | % | ||||||||||
| Net loss attributable to non-controlling interest | (3,382) | (560) | (2,822) | 503.9 | % | ||||||||||
| Net loss attributable to i3 Verticals, Inc. | $ | (4,457) | $ | (419) | $ | (4,038) | 963.7 | % |
n/m = not meaningful
Revenue
Revenue increased $74.0 million, or 49.3%, to $224.1 million for the year ended September 30, 2021 from $150.1 million for the year ended September 30, 2020. This increase was driven by an increase in revenue from existing businesses of $10.4 million, primarily due to an overall increase in consumer spending as a result of recovery from the COVID-19 pandemic. Acquisitions completed during the 2021 and 2020 fiscal years contributed an incremental $63.6 million, net of intercompany eliminations, to our revenue for the year ended September 30, 2021.
Revenue within Merchant Services increased $10.9 million, or 10.8%, to $111.9 million for the year ended September 30, 2021 from $100.9 million for the year ended September 30, 2020.
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Revenue within Proprietary Software and Payments increased $63.5 million, or 124.6%, to $114.4 million for the year ended September 30, 2021 from $51.0 million for the year ended September 30, 2020. This increase was principally driven by acquisitions completed during the 2021 and 2020 fiscal years, in addition to an overall increase in consumer spending, as a result of recovery from the COVID-19 pandemic.
Payment volume increased $4.4 billion, or 30.7%, to $18.8 billion for the year ended September 30, 2021 from $14.4 billion for the year ended September 30, 2020. This increase was principally driven by acquisitions completed during the 2021 and 2020 fiscal years and organic growth prior to the COVID-19 pandemic.
Other Costs of Services
Other costs of services increased $10.5 million, or 22.2%, to $57.7 million for the year ended September 30, 2021 from $47.2 million for the year ended September 30, 2020. Acquisitions completed during the 2021 and 2020 fiscal years contributed an incremental $4.6 million, net of inter-segment eliminations, to our other costs of services for the year ended September 30, 2021. The remaining increase was driven by an increase in revenue from existing businesses of $5.9 million, primarily due to an overall increase in consumer spending as a result of recovery from the COVID-19 pandemic.
Other costs of services within Merchant Services increased $7.3 million, or 16.6%, to $51.2 million for the year ended September 30, 2021 from $43.9 million for the year ended September 30, 2020. This increase was principally driven an increase in other cost of services from existing businesses of $6.6 million as a result of recovery from the COVID-19 pandemic.
Other costs of services within Proprietary Software and Payments increased $3.6 million, or 70.3%, to $8.6 million for the year ended September 30, 2021 from $5.1 million for the year ended September 30, 2020. Acquisitions completed during the 2020 and 2021 fiscal years contributed an incremental $3.9 million, net of intercompany eliminations, to our other cost of sales for the year ended September 30, 2021.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $56.5 million, or 72.2%, to $134.9 million for the year ended September 30, 2021 from $78.3 million for the year ended September 30, 2020. This increase was principally driven by a $50.4 million increase in employment expense, primarily resulting from an increase in headcount that resulted from acquisitions and an increase in stock compensation expense. The majority of the remaining increase was comprised of increases in professional services and insurane of $1.7 million and technological services of $1.3 million.
Depreciation and Amortization
Depreciation and amortization increased $6.2 million, or 34.0%, to $24.4 million for the year ended September 30, 2021 from $18.2 million for the year ended September 30, 2020. Amortization expense increased $5.7 million to $22.1 million for the year ended September 30, 2021 from $16.4 million for the year ended September 30, 2020 primarily due to greater amortization expense resulting from acquisitions completed during the 2021 and 2020 fiscal years. Depreciation expense increased $0.5 million to $2.3 million for the year ended September 30, 2021 from $1.8 million for the year ended September 30, 2020.
Change in Fair Value of Contingent Consideration
Change in fair value of contingent consideration to be paid in connection with acquisitions was a charge of $7.1 million for the year ended September 30, 2021 due to the performance of some of our acquisitions exceeding our expectations. The change in fair value of contingent consideration for the year ended September 30, 2020 was a benefit of $1.4 million.
Interest Expense, net
Interest expense, net, increased $0.9 million, or 9.8%, to $9.8 million for the year ended September 30, 2021 from $8.9 million for the year ended September 30, 2020. The increase reflected a higher average outstanding debt balance for the year ended September 30, 2021 as compared to the year ended September 30, 2020.
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Other (income) expense
Other income was $2.6 million for the year ended September 30, 2021, relating to a net gain on sales of investments of $2.1 million and adjustments of liabilities under our Tax Receivable Agreement related to the remeasurement of the underlying deferred tax asset for changes in estimated income tax rates of $0.5 million. Other expense was $2.6 million for the year ended September 30, 2020, relating to a loss on retirement of debt due to the carrying value exceeding the fair value of the repurchased portion of the Exchangeable Notes at the dates of repurchases.
Provision for Income Taxes
The provision for income taxes increased to $0.6 million for the year ended September 30, 2021 from a benefit of $2.8 million for the year ended September 30, 2020. As described in Note 2 to our consolidated financial statements, we had a $2.7 million reduction in the valuation allowance on the deferred tax asset related to our investment in partnership and a corresponding increase in the benefit from income taxes in the year ended September 30, 2020 that did not recur in the year ended September 30, 2021. In addition, current state income tax expense increased for the year ended September 30, 2021 from the year ended September 30, 2020 due to the mix of earnings within the Company. Our effective tax rate of (9)% for the year ended September 30, 2021 differs from the federal statutory rate due to the increase in the valuation allowance, increase in state taxes, and increase in the tax effect of the revaluation of liabilities. i3 Verticals, Inc. is subject to federal, state and local income taxes with respect to its allocable share of any taxable income of i3 Verticals, LLC and is taxed at the prevailing corporate tax rates.
Year Ended September 30, 2020 Compared to Year Ended September 30, 2019
For discussion of our results of operations for fiscal 2020 compared to fiscal 2019, refer to the Management's Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 of our Form 10-K for the fiscal year ended September 30, 2020, filed with the SEC on November 23, 2020.
Seasonality
We have experienced in the past, and may continue to experience, seasonal fluctuations in our revenues as a result of consumer and business spending patterns. Revenues during the first quarter of the calendar year, which is our second fiscal quarter, tend to decrease in comparison to the remaining three quarters of the calendar year on a same store basis. This decrease is due to the relatively higher number and amount of electronic payment transactions related to seasonal retail events, such as holiday and vacation spending in their second, third and fourth quarters of the calendar year. The number of business days in a month or quarter also may affect seasonal fluctuations. Revenue in our education vertical fluctuates with the school calendar. Revenue for our education customers is strongest in August, September, October, January and February, at the start of each semester, and generally weakens throughout the semester, with little revenue in the summer months of June and July. Operating expenses show less seasonal fluctuation, with the result that net income is subject to the same seasonal factors as our revenues. The growth in our business may have partially overshadowed seasonal trends to date, and seasonal impacts on our business may be more pronounced in the future. Furthermore, we are not able to predict the impact that the COVID-19 pandemic may have on the seasonality of our business.
Liquidity and Capital Resources
We have historically financed our operations (not including acquisitions) and working capital through net cash from operating activities. As of September 30, 2021, we had $3.6 million of cash and cash equivalents and available borrowing capacity of $170.6 million under our Senior Secured Credit Facility, subject to the financial covenants. We usually minimize cash balances by making payments on our revolving credit facility to minimize borrowings and interest expense. As of September 30, 2021, we had borrowings outstanding of $104.4 million under the Senior Secured Credit Facility.
Our primary cash needs are to fund working capital requirements, invest in our technology infrastructure, fund acquisitions and related contingent consideration, make scheduled principal and interest payments on our outstanding indebtedness and pay tax distributions to members. We historically have had positive cash flow provided by operations. We currently expect that our cash flow from operations, current cash and cash equivalents and available borrowing capacity under the Senior Secured Credit Facility will be sufficient to fund our operations and planned capital expenditures and to service our debt obligations for at least the next twelve months.
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Material Cash Requirements
The following table summarizes our material cash requirements as of September 30, 2021 related to contracts, leases and borrowings:
| Payments Due by Period | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Material Cash Requirements | Total | Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | ||||||||||||||
| (in thousands) | |||||||||||||||||||
| Processing minimums(1) | $ | 7,052 | $ | 3,912 | $ | 3,140 | $ | — | $ | — | |||||||||
| Facility leases | 17,916 | 4,014 | 6,291 | 4,142 | 3,469 | ||||||||||||||
| Senior Secured Credit Facility and related interest(2) | 107,808 | 3,579 | 104,229 | — | — | ||||||||||||||
| Exchangeable Notes and related interest(3) | 120,949 | 1,170 | 2,340 | 117,439 | — | ||||||||||||||
| Contingent consideration(4) | 36,229 | 25,768 | 10,461 | — | — | ||||||||||||||
| Total | $ | 289,954 | $ | 38,443 | $ | 126,461 | $ | 121,581 | $ | 3,469 |
__________________________
1.We have non-exclusive agreements with several processors to provide us services related to transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. Certain of these agreements require us to submit a minimum monthly number of transactions for processing. If we submit a number of transactions that is lower than the minimum, we are required to pay to the processor the fees it would have received if we had submitted the required minimum number of transactions.
2.We estimated interest payments through the maturity of our Senior Secured Credit Facility by applying the interest rate of 3.41% in effect on the outstanding balance as of September 30, 2021, plus the unused fee rate of 0.30% in effect as of September 30, 2021.
3.We calculated interest payments through the maturity of our Exchangeable Notes by applying the coupon interest rate of 1.00% on the outstanding principal balance as of September 30, 2021 of $117.0 million.
4.In connection with certain of our acquisitions, we may be obligated to pay the seller of the acquired entity certain amounts of contingent consideration as set forth in the relevant purchasing documents, whereby additional consideration may be due upon the achievement of certain specified financial performance targets. i3 Verticals, Inc. accounts for the fair values of such contingent payments in accordance with the Level 3 financial instrument fair value hierarchy at the close of each subsequent reporting period. The acquisition-date fair value of contingent consideration is valued using a Monte Carlo simulation. i3 Verticals, Inc. subsequently reassesses such fair value based on probability estimates with respect to the acquired entity’s likelihood of achieving the respective financial performance targets.
Potential payments under the Tax Receivable Agreement are not reflected in this table. See “—Tax Receivable Agreement” below.
Tax Receivable Agreement
We are a party to a Tax Receivable Agreement with i3 Verticals, LLC and each of the Continuing Equity Owners, as described in Note 11 of our consolidated financial statements. As a result of the Tax Receivable Agreement, we have been required to establish a liability in our consolidated financial statements. That liability, which will increase upon the redemptions or exchanges of Common Units for our Class A common stock, generally represents 85% of the estimated future tax benefits, if any, relating to the increase in tax basis associated with the Common Units we received as a result of the Reorganization Transactions and other redemptions or exchanges by holders of Common Units. If this election is made, the accelerated payment will be based on the present value of 100% of the estimated future tax benefits and, as a result, the associated liability reported on our consolidated financial statements may be increased. We expect that the payments required under the Tax Receivable Agreement will be substantial. The actual increase in tax basis, as well as the amount and timing of any payments under the Tax Receivable Agreement, will vary depending upon a number of factors, including the timing of redemptions or exchanges by the holders of Common Units, the price of our Class A common stock at the time of the redemption or exchange, whether such redemptions or exchanges are taxable, the amount and timing of the taxable income we generate in the future and the tax rate then applicable as well as the portion of our payments under the Tax Receivable Agreement constituting imputed interest. We intend to fund the payment of the amounts due under the Tax Receivable Agreement out of the cash savings that we actually realize in respect of the attributes to which Tax Receivable Agreement relates.
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As of September 30, 2021, the total amount due under the Tax Receivable Agreement was $39.1 million, and payments to the Continuing Equity Owners related to exchanges through September 30, 2021 will range from approximately $0 to $3.2 million per year and are expected to be paid over the next 25 years. The amounts recorded as of September 30, 2021, approximate the current estimate of expected tax savings and are subject to change after the filing of the Company’s U.S. federal and state income tax returns. Future payments under the Tax Receivable Agreement with respect to subsequent exchanges would be in addition to these amounts.
Our liquidity profile reflects our completed offering in February 2020 of an aggregate principal amount of $138.0 million in 1.0% Exchangeable Senior Notes due 2025, with substantially all the proceeds being used to pay down outstanding borrowings under our Senior Secured Credit Facility, as well as our September 2020 Public Offering as described below under the heading “Follow-on Offerings.” During the year ended September 30, 2020, we repurchased $21.0 million in aggregate principal amount of the Exchangeable Notes for an aggregate purchase price of approximately $17.4 million. We recorded a loss on retirement of debt of $2.3 million due to the carrying value exceeding the fair value of the repurchased portion of the Exchangeable Notes at the dates of repurchases. We may elect from time to time to purchase our outstanding debt in open market purchases, privately negotiated transactions or otherwise. Any such debt repurchases will depend upon prevailing market conditions, our liquidity requirements, contractual restrictions, applicable securities law and other factors.
As amended on February 18, 2020 in connection with our offering of Exchangeable Notes, our Senior Secured Credit Facility requires us to maintain a consolidated interest coverage ratio not less than 3.00 to 1.00, a total leverage ratio not exceeding 5.00 to 1.00 and a consolidated senior secured leverage ratio not exceeding 3.25 to 1.00, provided that for each of the four fiscal quarters immediately following a qualified acquisition, the total leverage ratio and the consolidated senior secured leverage ratio would increase by up to 0.25, subject to certain limitations. As of September 30, 2021, we were in compliance with these covenants with a consolidated interest coverage ratio, total leverage ratio and consolidated senior leverage ratio of 10.3x, 3.5x and 1.6x, respectively. Although we believe our liquidity position remains strong, there can be no assurance that we will be able to raise additional funds, in the form of debt or equity, or to amend our Senior Secured Credit Facility on terms acceptable to us, if at all, even if we determined such actions were necessary in the future.
Any material adverse change in client demand and our ability to retain clients, competitive market forces, or uncertainties caused by the COVID-19 pandemic, as well as other factors listed under the heading “Note Regarding Forward-looking Statements,” and in our risk factors included herein could affect our ability to continue to fund our liquidity needs from business operations.
Cash Flows
The following table presents a summary of cash flows from operating, investing and financing activities for the following comparative periods.
Year Ended September 30, 2021 Compared to Year Ended September 30, 2020
| Year ended September 30, | ||||||
|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||
| (in thousands) | ||||||
| Net cash provided by operating activities | $ | 46,774 | $ | 23,720 | ||
| Net cash used in investing activities | $ | (156,315) | $ | (35,431) | ||
| Net cash provided by financing activities | $ | 102,103 | $ | 29,112 |
Cash Flow from Operating Activities
Net cash provided by operating activities increased $23.1 million to $46.8 million for the year ended September 30, 2021 from $23.7 million for the year ended September 30, 2020. While our net loss increased $6.9 million for the year ended September 30, 2021 from the year ended September 30, 2020, most of this increase was driven by non-cash expenses that do not impact cash flows from operating activities. The increase in net cash provided by operating activities was due to comparatively higher increases for the year ended September 30, 2021 from the year ended September 30, 2020 in equity-based compensation of $10.4 million, liabilities for non-cash contingent consideration of $8.5 million, depreciation and amortization of $6.2 million, benefit from deferred income taxes of $2.9 million and debt discount and issuance cost amortization of $1.7 million, partially
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offset by the loss on the repurchase of Exchangeable Notes of $2.3 million recognized during the year ended September 30, 2020 and net gain on sale of investments of $2.1 million recognized during the year ended September 30, 2021. Operating assets and liabilities increased $1.4 million, which are impacted by the timing of collections and payments.
Cash Flow from Investing Activities
Net cash used in investing activities increased $120.9 million to $156.3 million for the year ended September 30, 2021 from $35.4 million for the year ended September 30, 2020. The increase in net cash used in investing activities was primarily driven by an increase of $121.8 million in cash used in acquisitions, net of cash acquired, and an increase of $3.3 million in expenditures for capitalized software. These increases were partially offset by $3.2 million in proceeds received from sales of investments during the year ended September 30, 2021, and a decrease of $1.0 million in expenditures for property and equipment for the year ended September 30, 2021 compared to the year ended September 30, 2020.
Cash Flow from Financing Activities
Net cash provided by financing activities increased $73.0 million to $102.1 million for the year ended September 30, 2021 from $29.1 million for the year ended September 30, 2020. The increase in net cash provided by financing activities was primarily the result of an increase in proceeds from the revolving credit facility of $130.7 million and a decrease in payments on the revolving credit facility of $114.8 million for the year ended September 30, 2021 from the year ended September 30, 2020. Additionally, we made payments for purchases of exchangeable senior note hedges of $28.7 million, payments for the repurchase of Exchangeable Notes of $17.4 million, payments for Common Units in i3 Verticals, LLC from selling unitholders of $10.9 million and payments of debt issuances costs of $5.3 million during the year ended September 30, 2020 that did not recur in the year ended September 30, 2021. These increases in net cash provided by financing activities were partially offset by proceeds from borrowings on exchangeable notes of $138.0 million, proceeds from issuance of Class A common stock sold in public offerings of $82.9 million and proceeds from issuance of warrants of $14.7 million during the year ended September 30, 2020 that did not recur in the year ended September 30, 2021.
Year Ended September 30, 2020 Compared to Year Ended September 30, 2019
For a discussion of the cash flows for the year ended September 30, 2020 compared to the year ended September 30, 2019, refer to Part II, Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2020, which was filed with the Securities and Exchange Commission on November 23, 2020.
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Senior Secured Credit Facility
On May 9, 2019, we replaced our then existing credit facility (the “2017 Senior Secured Credit Facility”) with a new Amended and Restated Credit Agreement with the guarantors and lenders party thereto and Bank of America, N.A., as administrative agent (the “Senior Secured Credit Facility”). For a discussion of our existing 2017 Senior Secured Credit Facility, which consisted of $40.0 million in term loans and a $110.0 million revolving line of credit, please refer to Note 10 to the accompanying consolidated financial statements in this Annual Report on Form 10-K. The Senior Secured Credit Facility, as amended on February 18, 2020 in connection with our offering of Exchangeable Notes, provides for aggregate commitments of $275.0 million in the form of a senior secured revolving credit facility.
The Senior Secured Credit Facility provides that we have the right to seek additional commitments to provide additional term loan facilities or additional revolving credit commitments in an aggregate principal amount up to $50.0 million so long as, among other things, after giving pro forma effect to the incurrence of such additional borrowings and any related transactions, our consolidated interest coverage ratio would not be less than 3.00 to 1.00, our total leverage ratio would not exceed 5.00 to 1.00 and our consolidated senior leverage ratio would not exceed 3.25 to 1.00, provided that for each of the four fiscal quarters immediately following a qualified acquisition, the total leverage ratio and the consolidated senior secured leverage ratio would increase by up to 0.25, subject to certain limitations.
The provision of any such additional amounts under the additional term loan facilities or additional revolving credit commitments are subject to certain additional conditions and the receipt of certain additional commitments by existing or additional lenders. The lenders under the Senior Secured Credit Facility are not under any obligation to provide any such additional term loan facilities or revolving credit commitments.
The proceeds of the Senior Secured Credit Facility, together with proceeds from any additional amounts under the additional term loan facilities or additional revolving credit commitments, may only be used by us to (i) finance working capital, capital expenditures and other lawful corporate purposes, (ii) finance permitted acquisitions and (iii) to refinance certain existing indebtedness.
Borrowings under the Senior Secured Credit Facility will be made, at our option, at the base rate or the Eurodollar rate, plus, in each case, an applicable margin. The base rate is a fluctuating rate of interest per annum equal to the highest of (a) the federal funds rate plus ½ of 1%, (b) the interest announced from time to time by Bank of America as its prime rate and (c) the Eurodollar rate plus 1%. The Eurodollar rate will be the rate of interest per annum equal to LIBOR (based upon an interest period of one, two, three or six months or, under some circumstances, up to twelve months). The applicable margin is based upon our consolidated total leverage ratio, as reflected in the schedule below:
| Consolidated Total Leverage Ratio | Commitment Fee | Letter of Credit Fee | Eurodollar Rate Loans | Base Rate Loans | |||
|---|---|---|---|---|---|---|---|
| 3.00 to 1.0 | 0.30% | 3.25% | 3.25% | 1.25% | |||
| 2.50 to 1.0 but 3.00 to 1.0 | 0.25% | 2.75% | 2.75% | 0.75% | |||
| 2.00 to 1.0 but 2.50 to 1.0 | 0.20% | 2.50% | 2.50% | 0.50% | |||
| 2.00 to 1.0 | 0.15% | 2.25% | 2.25% | 0.25% |
In addition to paying interest on outstanding principal under the Senior Secured Credit Facility, we will be required to pay a commitment fee equal to the product of between 0.15% and 0.30% (the applicable percentage depending on our consolidated total leverage ratio as reflected in the schedule above) times the actual daily amount by which $275.0 million exceeds the total amount outstanding under the Senior Secured Credit Facility and available to be drawn under all outstanding letters of credit.
We will be permitted to voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans under the Senior Secured Credit Facility, whether such amounts are issued under the Senior Secured Credit Facility or under the additional term loan facilities or additional revolving credit facilities, at any time without premium or penalty.
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In addition, if the total amount borrowed under the Senior Secured Credit Facility exceeds $275.0 million at any time, the Senior Secured Credit Facility requires us to prepay such excess outstanding amounts.
All obligations under the Senior Secured Credit Facility are unconditionally guaranteed by i3 Verticals, Inc., a Delaware corporation, and each of i3 Verticals, Inc.’s existing and future direct and indirect material, wholly owned domestic restricted subsidiaries, subject to certain exceptions. The obligations are secured by first-priority security interests in substantially all of our tangible and intangible assets, i3 Verticals, Inc. and each subsidiary guarantor, in each case whether owned on the date of the initial borrowings or thereafter acquired.
The Senior Secured Credit Facility places certain restrictions on the ability of us, i3 Verticals, Inc. and their restricted subsidiaries to, among other things, incur debt and liens; merge, consolidate or liquidate; dispose of assets; enter into hedging arrangements; make certain restricted payments; undertake transactions with affiliates; enter into sale-leaseback transactions; make certain investments; prepay or modify the terms of certain indebtedness; and modify the terms of certain organizational agreements.
The Senior Secured Credit Facility contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other material indebtedness, certain events of bankruptcy and insolvency, material judgments, certain ERISA events, invalidity of loan documents and certain changes in control.
As of September 30, 2021, we were in compliance with these covenants with a consolidated interest coverage ratio, total leverage ratio and consolidated senior leverage ratio of 10.3x, 3.5x and 1.6x, respectively.
Follow-on Offerings
On June 10, 2019, we completed the June 2019 Secondary Public Offering of 5,165,527 shares of our Class A common stock, at a public offering price of $22.75 per share, which included a full exercise of the underwriters' option to purchase 673,764 additional shares of Class A common stock from us. We received approximately $111.6 million of net proceeds, after deducting underwriting discounts and commissions, but before offering expenses. We used the net proceeds to purchase (1) 1,000,000 Common Units directly from i3 Verticals, LLC, and (2) 4,165,527 Common Units (including 673,764 Common Units due to the exercise of the underwriters' option to purchase additional shares in full) and an equivalent number of Class B common stock (which shares were then canceled) from certain Continuing Equity Owners, in each case at a price per Common Unit equal to the price per share paid by the underwriters for shares of our Class A common stock in the offering. i3 Verticals, LLC received $20.9 million in net proceeds from the sale of Common Units to us, which we used to repay outstanding indebtedness. In connection with this offering, we recognized an additional deferred tax asset of $26.2 million related to the Tax Receivable Agreement and a corresponding liability of $22.2 million.
On September 15, 2020, we completed a public offering (the “September 2020 Public Offering”) of 3,737,500 shares of our Class A common stock, at a public offering price of $23.50 per share, which included a full exercise of the underwriters' option to purchase 487,500 additional shares of Class A common stock from us. We received approximately $83.4 million of net proceeds, after deducting underwriting discounts and commissions, but before offering expenses. We used the net proceeds to purchase (1) 3,250,000 Common Units directly from i3 Verticals, LLC, and (2) 487,500 Common Units pursuant to the exercise of the underwriters' option to purchase additional shares in full and an equivalent number of Class B common stock (which shares were then canceled) from certain Continuing Equity Owners, in each case at a price per Common Unit equal to the price per share paid by the underwriters for shares of our Class A common stock in the offering. i3 Verticals, LLC received $72.0 million in net proceeds from the sale of Common Units to the Company, which we used to repay outstanding indebtedness. In connection with this offering, we recognized an additional deferred tax asset of $3.0 million related to the Tax Receivable Agreement and a corresponding liability of $2.5 million.
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Exchangeable Notes
On February 18, 2020, i3 Verticals, LLC issued $138.0 million aggregate principal amount of its 1.0% Exchangeable Senior Notes due February 15, 2025. The Exchangeable Notes bear interest at a fixed rate of 1.0% per year, payable semiannually in arrears on February 15 and August 15 of each year, beginning on August 15, 2020. The Exchangeable Notes are exchangeable on the terms set forth in the Indenture into cash, shares of Class A common stock, or a combination thereof, at i3 Verticals, LLC’s election. The Exchangeable Notes mature on February 15, 2025, unless earlier exchanged, redeemed or repurchased. We received approximately $132.8 million in net proceeds from the sale of the Exchangeable Notes, as determined by deducting estimated offering expenses paid to third-parties from the aggregate principal amount. i3 Verticals, LLC used a portion of the net proceeds of the Exchangeable Notes offering to pay down outstanding borrowings under the Senior Secured Credit Facility in connection with the effectiveness of the operative provisions of the Amendment and to pay the cost of the note hedge transactions.
At-the-Market Program
On August 20, 2021, we entered into an at-the-market offering sales agreement with Raymond James & Associates, Inc., Morgan Stanley & Co. LLC and BTIG, LLC (each a “Sales Agent”), under which we may issue and sell, from time to time and through the Sales Agents, shares of our Class A common stock having an aggregate offering price of up to $125.0 million (the “ATM Program”). As of the date of this report, we have not sold any shares of Class A common stock under the ATM Program.
Critical Accounting Estimates
The preparation of consolidated financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”) and the Company’s discussion and analysis of its financial condition and operating results requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Note 2, “Summary of Significant Accounting Policies” in the notes to the accompanying consolidated financial statements in Part II, Item 8 of this Form 10-K describe the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements. Estimates include, but are not limited to, the value of purchase consideration paid and identifiable assets acquired and assumed in acquisitions, goodwill and intangible asset impairment review, revenue recognition for contracts with multiple performance obligations, loss reserves, assumptions used in the calculation of equity-based compensation and in the calculation of income taxes, and certain tax assets and liabilities as well as the related valuation allowances.
Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from those estimates.
Below is a summary of our critical accounting estimates for which the nature of management’s assumptions are material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and for which the impact of the estimates and assumptions on financial condition or operating performance is material.
Contingent Consideration in Acquisitions
On occasion, we may have acquisitions that include contingent consideration. Accounting for business combinations requires us to estimate the fair value of any contingent purchase consideration at the acquisition date. Where relevant, the fair value of material contingent consideration included in an acquisition is calculated using a Monte Carlo simulation.
The contingent consideration is revalued each period until it is settled. Management reviews the historical and projected performance of each acquisition with contingent consideration and uses an income probability method to revalue the contingent consideration. The revaluation requires management to make certain assumptions and represent management's best estimate at the valuation date. The probabilities are determined based on a management review of the expected likelihood of triggering events that would cause a change in the contingent consideration paid. For example, if management’s forecasted performance for an acquisition increased, we would have anticipated a higher probability of contingent consideration being paid on the acquisition and would have
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recorded additional losses from the change in fair value of contingent consideration. Conversely, if management’s forecasted performance for an acquisition decreased, we would have anticipated a higher probability of contingent consideration being paid on the acquisition and would have recorded a gain from change in fair value of contingent consideration. As of September 30, 2021, the fair value of contingent consideration recorded is $36.2 million, with maximum contingent consideration payout of $111.7 million dependent upon achievement of specified financial performance targets, as defined in the purchase agreements.
Goodwill
We test goodwill for impairment using a fair value approach at least annually, absent some triggering event that would require an interim impairment assessment. Absent any impairment indicators, we perform our goodwill impairment testing as of July 1 each year.
In our goodwill impairment review, we use significant estimates and assumptions that include the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units and determining the fair value of each reporting unit. Our assessment of qualitative factors involves significant judgments about expected future business performance and general market conditions. In a quantitative assessment, the fair value of each reporting unit is determined based on a combination of techniques, including the present value of future cash flows, applicable multiples of competitors and multiples from sales of like businesses, and requires management to make estimates and assumptions regarding discount rates, growth rates and our future long-term business plans. Changes in any of these estimates or assumptions could materially affect the determination of fair value and the associated goodwill impairment charge for each reporting unit. For example, if management’s forecasted earnings decreased for a reporting unit, we may have recorded an impairment loss for that reporting unit.
Related Parties
Transactions involving related parties cannot be presumed to be carried out at an arm's length basis, as the requisite conditions of competitive, free-dealing markets may not exist. A description of related-party transactions is provided in Note 16 in the accompanying consolidated financial statements.
Recently Issued Accounting Pronouncements
Refer to Note 2, “Summary of Significant Accounting Policies” in the notes to the accompanying consolidated financial statements for further discussion.