Priority Technology Holdings, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The company provides consumer and commercial payment processing, managed services, and integrated payment solutions. Comparative results require context: the July 2018 business combination changed the company’s tax status and reporting structure, and 2018 results before that date reflect the predecessor business.
Financial performance
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Revenue | $107.4 million | $104.8 million | $207.4 million | $220.4 million |
| Income from operations | $2.4 million | $3.2 million | $3.4 million | $11.1 million |
| Operating margin | 2.3% | 3.1% | 1.6% | 5.0% |
| Interest expense | $10.8 million | $7.6 million | $20.1 million | $14.6 million |
| Net loss | $14.1 million | $5.6 million | $20.6 million | $8.8 million |
| Loss per share | $0.21 | $0.10 | $0.31 | $0.15 |
| Cash from operating activities | Not separately reported by quarter | $3.7 million | $14.9 million |
Q2 revenue rose 2.5%, while first-half revenue fell 5.9%. Merchant card fees were $99.1 million in Q2 and $191.0 million for the half; outsourced services and other revenue were $8.3 million and $16.4 million, respectively. Processing dollar value and transaction volume increased 10.9% and 8.7% in Q2, and 11.8% and 9.2% for the first half.
At June 30, cash was $5.5 million and restricted cash was $21.7 million. Working capital was $2.5 million, down from $21.1 million at year-end 2018. Total assets were $460.3 million; stockholders’ deficit was $100.6 million. Long-term debt, net of discounts and issuance costs, was $472.5 million, with a further $4.0 million current portion and $14.0 million drawn on the revolver. The company reported $11.0 million of remaining revolver availability.
First-half investing cash outflow was $89.8 million, including $81.2 million for merchant portfolio and asset acquisitions and $5.4 million for property, equipment, and software. Financing provided $79.4 million, including $69.7 million of term debt proceeds and a $14.0 million revolver draw. Cash and restricted cash decreased by $6.6 million to $27.2 million.
Material changes and drivers
- Consumer Payments revenue declined 5.6% in Q2 and 11.9% for the first half. Management attributed the decline to closures of subscription-billing e-commerce merchants following industry-wide card-association compliance changes. Related revenue fell to $1.7 million in Q2 from $14.4 million and to $5.6 million for the half from $46.0 million.
- Excluding those merchants, Consumer Payments revenue grew 8.7% in Q2 and 9.8% for the first half, with higher processing volume and positive net merchant onboarding. Consumer Payments operating margin nevertheless fell to 8.0% in Q2 from 10.6%, and to 8.3% for the half from 12.4%.
- Integrated Partners revenue increased substantially, largely reflecting the March 2019 acquisition of YapStone assets. The segment generated $8.1 million revenue and $0.6 million operating income in Q2; first-half figures were $11.3 million and $0.3 million.
- Depreciation and amortization rose 143% in Q2 and 140% for the first half, primarily from acquired portfolios and intangible assets and internally developed software. Interest expense rose 41% in Q2 and 38% for the half, mainly due to higher acquisition-related borrowings.
- First-half operating cash flow fell to $3.7 million from $14.9 million, driven principally by working-capital changes and a $4.7 million increase in cash interest payments.
Outlook, risks, and unusual items
- No quantitative earnings or revenue guidance is provided. Management stated that cash on hand, operating cash flow, and available revolver borrowings were expected to meet working-capital requirements for at least the next 12 months.
- The company recorded a $7.9 million valuation allowance for deferred tax assets related to business-interest carryforwards; income tax expense was $5.9 million in Q2 and $4.2 million for the first half despite pre-tax losses. Management said the valuation allowance could change as recoverability is reassessed.
- Debt bears significant interest, including senior term debt at LIBOR plus 5% (7.41% at June 30) and subordinated debt at 10.5%, including payment-in-kind interest. A 1% LIBOR increase would add approximately $3.9 million of annual interest expense on senior borrowings; the company does not hedge this exposure. Debt agreements include leverage and other restrictive covenants; the borrowers reported compliance at June 30.
- Acquisition-related commitments include contingent consideration of up to $7.3 million for a 2018 portfolio acquisition and up to $6.4 million for the March 2019 residual-rights acquisition. A separate loan provided $3.0 million to another entity at 12% interest, with a commitment to lend up to an additional $10.0 million subject to conditions.
- In a transaction involving assets contributed by eTab and Cumulus, eTab was previously 80% owned by the CEO. Contributors received preferred interests potentially entitled to $4.5 million plus a 6% preferred yield; the CEO owns 83.3% of those interests. No material related non-controlling-interest amount was recognized at June 30.
- Management concluded disclosure controls and procedures were not effective because of previously identified material weaknesses in financial-reporting resources and the financial-statement review and close process. Remediation efforts included hiring, outside consultants, and additional procedures.
- Management said ordinary-course legal proceedings were not expected to have a material effect. The filing also identifies payment-network compliance, data security, processing-system disruptions, third-party dependencies, competition, and acquisition integration among relevant risks.
Most important facts for investors to verify
- Whether merchant onboarding and processing growth can offset the lost high-margin subscription-billing merchant revenue, and how card-network compliance changes may affect future results.
- Acquisition performance and integration costs, including YapStone-related revenue, amortization, transition services, and any contingent purchase-price payments.
- Debt service capacity, covenant headroom, revolver availability, and sensitivity to interest-rate increases.
- Cash conversion and liquidity trends, given low unrestricted cash, reduced operating cash flow, and limited working capital.
- Progress in remediating the material weaknesses and any future effects of the tax valuation allowance.
- Potential conflicts and financial exposure from the CEO-associated eTab/Cumulus interests, the loan commitment, and possible earn-out dilution of up to 9.8 million shares.