Priority Technology Holdings, Inc. annual report, FY2018

Business context and reporting period

Priority Technology Holdings, Inc. filed this Form 10-K for the fiscal year ended December 31, 2018. It provides consumer merchant payment processing and commercial payment and accounts-payable automation services, principally in the United States. On July 25, 2018, the company completed a business combination with MI Acquisitions, Inc., accounted for as a reverse merger; results before that date are those of Priority Holdings, LLC. The company reported two segments: Consumer Payments and Commercial Payments and Managed Services.

Financial performance and position

Revenue was nearly flat year over year, while bankcard processing dollar volume rose 10.1% to $38.2 billion and transaction count increased 6.1% to 465.8 million. At year-end, cash was $15.6 million and restricted cash was $18.2 million; working capital was $21.1 million. The $25 million revolving facility was undrawn at December 31, 2018. Total debt was $412.7 million, up from $283.1 million; interest expense was $29.9 million. Total assets were $388.6 million, total liabilities $474.1 million, and stockholders’ deficit $85.5 million.

In the fourth quarter, revenue was $100.5 million versus $120.0 million in Q4 2017; operating income was $5.3 million versus $10.9 million, and net loss was $3.7 million versus net income of $1.9 million. Quarterly cash-flow figures are not presented in the supplied filing text.

Material changes and unusual items

• Revenue and operating income were pressured by closures of high-margin subscription-billing e-commerce merchants. Revenue from this channel declined to $65.2 million from $95.6 million; the company closed more than 1,200 merchant accounts in Q1 2018 to address card-network compliance concerns.
• Consumer Payments revenue decreased 1.3% to $395.0 million; segment operating income fell 8.9% to $50.5 million. Commercial Payments and Managed Services revenue grew 16.3% to $29.4 million, but the segment recorded a $2.9 million operating loss, reflecting investment in new businesses, staffing, and infrastructure.
• Corporate expenses related to the business combination, public-company conversion, and certain legal matters totaled $12.4 million, versus $5.6 million in 2017. A $1.6 million legal settlement was recorded in 2018. Debt modification costs and other items also weighed on results.
• Investing outflows included $90.9 million for merchant portfolio acquisitions, $7.5 million for business acquisitions, and $10.6 million for property, equipment, and software. Four businesses were acquired in 2018, with additional contingent consideration possible.
• The July business combination ended the company’s partnership tax status. It recognized a $47.5 million net deferred tax asset; the reported tax benefit reflects only the post-combination period. The audit opinion on the financial statements was unqualified.

Outlook, risks, and contingencies

Management stated that cash, operating cash generation, and available revolving borrowings were expected to meet working-capital needs for at least the next 12 months. For the subscription-billing e-commerce merchant channel, it expected 2019 revenue of approximately $15 million and operating income of approximately $6 million. This is channel-specific outlook, not company-wide guidance.

Debt is substantially floating-rate and secured by substantially all borrower assets. The reported borrower net leverage ratio was 5.06:1.00 at year-end; the senior facility’s maximum leverage covenant tightens from 6.50:1.00 at December 31, 2018 to 5.25:1.00 at December 31, 2019. The company was in covenant compliance at year-end and disclosed no current interest-rate hedge. A 1% change in LIBOR was estimated to change annual cash interest by approximately $3.2 million.

Key risks include cybersecurity or processing outages, dependence on processors and sponsor banks, payment-network compliance and merchant chargebacks, intense pricing competition, merchant and reseller attrition, acquisition integration, regulatory and privacy changes, and the company’s substantial debt. The company disclosed material weaknesses in accounting resources and financial close/review controls; disclosure controls were deemed ineffective, and remediation was ongoing. Ordinary-course legal claims were not expected to be material according to management, but future accruals could be material.

Subsequent events included February 2019 acquisitions of eTab and Cumulus in a related-party transaction involving the CEO, with sellers eligible for up to $4.5 million plus a preferred yield from subsidiary profits. In March 2019, the company acquired YapStone assets for $65 million cash plus a 6.142% non-controlling interest, and acquired residual portfolio rights for $15.2 million, with a possible additional $6.4 million purchase price. These transactions were funded partly with debt; the filing also reports a $10 million revolver draw after year-end.

Most important facts for investors to verify

• Whether payment-network compliance actions and merchant closures have stabilized, and whether the projected decline in subscription-channel revenue continues.
• Current debt, post-year-end borrowing and acquisition funding, covenant headroom, interest-rate exposure, and liquidity after the 2019 transactions.
• Whether Commercial Payments investments and acquired portfolios generate the expected revenue, cash flow, and operating returns.
• Progress remediating material weaknesses and improving disclosure controls and financial reporting processes.
• Terms, valuation, and related-party governance for the eTab/Cumulus transaction, and final purchase-price and contingent-consideration amounts for acquisitions.
• Adjusted EBITDA and Earnout Adjusted EBITDA reconciliations and definitions; these non-GAAP measures include adjustments and are not substitutes for GAAP results.