Priority Technology Holdings, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The company provides consumer payment processing and commercial payment and managed services. On July 25, 2018, it completed a business combination with SPAC MI Acquisitions, renamed itself Priority Technology Holdings, Inc., and began trading as PRTH. The transaction was accounted for as a reverse merger; pre-combination results are those of Priority. Priority became subject to corporate income taxes after the transaction, limiting comparability with prior periods.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $103.6 million | $110.9 million | $323.9 million | $305.6 million |
| Operating income | $3.6 million | $9.5 million | $14.6 million | $24.3 million |
| Operating margin | 3.4% | 8.5% | 4.5% | 8.0% |
| Net income (loss) | $(2.6) million | $2.3 million | $(11.4) million | $2.7 million |
| Basic and diluted EPS | $(0.04) | $0.03 | $(0.19) | $0.04 |
| Adjusted EBITDA (non-GAAP) | $12.7 million | $15.6 million | $40.4 million | $40.8 million |
| Operating cash flow | Not separately presented for the quarter | $24.8 million | $29.0 million |
Liquidity and debt at September 30, 2018: Cash was $17.2 million and restricted cash $18.3 million. Working capital was $24.0 million, versus $39.5 million at December 31, 2017. Gross debt was $352.2 million, compared with $283.1 million at year-end 2017; reported long-term debt, net of discounts and financing costs, was $342.3 million. The $25 million revolver was undrawn at quarter-end. The company drew $8 million in October.
Cash flow and investment: Nine-month investing cash outflow was $42.3 million, including $26.4 million for merchant portfolios, $7.5 million for business acquisitions, and $8.4 million for property, equipment, and software. Financing provided $8.8 million. Cash and restricted cash together declined $8.7 million to $35.5 million.
Material changes versus prior periods
- Q3 revenue fell 6.6%, while nine-month revenue rose 6.0%. Merchant card fee revenue declined 8.7% in Q3 but grew 4.7% year to date.
- Management attributed Q3 weakness chiefly to the closure or suspension of higher-margin e-commerce merchant accounts amid risk-management efforts related to card-network requirements. Despite lower revenue, Consumer Payments processing volume increased 10.5% and transactions rose 6.8% in Q3.
- Operating income and margins declined in both comparison periods. Management cited merchant mix, public-company transaction costs, the legal settlement, and investment in the Commercial Payments and Managed Services segment, including the CPX ramp-up.
- Interest expense increased to $21.9 million for the nine months from $18.6 million, primarily reflecting higher borrowings after the January 2018 debt upsizing. The company also recorded $3.5 million of nine-month expense from changes in the Goldman Sachs warrant liability before redeeming that warrant for $12.7 million in July.
- Three third-quarter acquisitions and the April PayRight acquisition added operations and goodwill. Goodwill increased to $109.4 million and net intangible assets to $65.6 million by September 30; acquisition purchase-price allocations remained preliminary.
Outlook, risks, contingencies, and unusual items
- Liquidity outlook: Management said cash on hand, operating cash generation, and available revolver borrowings were expected to meet working-capital needs for at least the next 12 months. No specific revenue or earnings guidance was provided. Management expects seasonal revenue patterns, generally lower in Q1 and higher in Q4.
- Leverage and rates: Senior debt carried a 7.1% rate at September 30 (LIBOR plus a 5.0% margin); subordinated debt carried a 10.5% actual rate, including PIK interest. A 1 percentage-point LIBOR change would alter annual interest expense by approximately $2.6 million, according to the filing. The company did not hedge interest-rate risk. It reported compliance with debt covenants at quarter-end; substantially all assets secure the debt.
- Controls: Management concluded disclosure controls were not effective at a reasonable assurance level because of material weaknesses involving insufficient accounting and reporting resources and deficiencies in financial-statement review and close processes. Remediation efforts included hiring, outside consultants, and additional procedures.
- Legal and transaction items: An October 2018 legal settlement of $1.6 million was recorded as Q3 and nine-month other operating expense. Business-combination costs totaled $13.3 million, including $3.6 million expensed in SG&A and $9.7 million charged to equity.
- Other risks and contingencies: Nasdaq maintained the common-stock listing after the company demonstrated compliance with the 400 round-lot-holder requirement, but extended the compliance deadline for warrants; warrant delisting remained a disclosed risk. Up to 9.8 million earn-out shares could be issued if specified Adjusted EBITDA and share-price hurdles are met. A potential Section 382 ownership change may affect tax-loss carryforwards; the company was still analyzing the issue. Goodwill impairment testing was scheduled for November 30, 2018; no impairment indicators were identified at September 30.
Important facts for investors to verify
- Whether the company restores higher-margin e-commerce merchant business and sustains processing-volume growth.
- Progress in improving operating margins and the profitability of the Commercial Payments and Managed Services segment.
- Debt covenant headroom, interest-rate exposure, and the effect of the October revolver draw and merchant-portfolio purchase.
- Remediation of the disclosed material weaknesses and whether controls are later assessed as effective.
- Final acquisition valuations, earn-out share conditions and potential dilution, and Nasdaq’s final warrant-listing outcome.
- The outcome of the Section 382 tax analysis and the assumptions supporting deferred tax assets and goodwill.