Priority Technology Holdings, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; unaudited. Priority provides merchant acquiring, integrated payment software and commercial payment solutions.
Financial performance
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $92.4 million | $92.1 million | $189.3 million | $179.8 million |
| Operating income | $4.0 million | $2.4 million | $7.6 million | $3.4 million |
| Operating margin | 4.4% | 2.6% | 4.0% | 1.9% |
| Interest expense | $11.7 million | $10.8 million | $22.0 million | $20.1 million |
| Net loss | $7.9 million | $14.1 million | $13.7 million | $20.6 million |
| Basic and diluted loss per share | $0.12 | $0.21 | $0.20 | $0.31 |
Revenue was nearly flat year over year in Q2, while first-half revenue rose 5.3%. Operating income improved as lower salaries and SG&A more than offset higher depreciation and amortization. Net losses narrowed, though the comparison also reflects substantially lower income-tax expense in Q2.
For the first half, operating cash flow was $9.8 million, versus $3.7 million in 2019. Investing used $7.5 million, compared with $89.8 million in 2019, which included major acquisitions. Financing used $1.8 million, versus $79.4 million provided in 2019. Cash and restricted cash together increased $0.5 million.
Balance sheet and liquidity
- At June 30, cash was $5.9 million and restricted cash was $45.1 million, primarily held for customer settlement activity. Working capital was negative $4.8 million.
- Total debt obligations were $499.9 million, including $14.5 million drawn on a $25 million revolving facility; approximately $10.5 million remained available. The debt carried high stated rates: 8.5% on the senior term facility, 7.68% on the revolver and 13.5% on the subordinated loan at quarter-end.
- Debt increased $4.4 million from year-end, including $3.3 million of payment-in-kind interest on the subordinated loan. Substantially all borrower assets are pledged as collateral. The company reported compliance with debt covenants at June 30; the maximum permitted total net leverage ratio was 7.75:1.
- Total assets were $449.7 million, against total liabilities of $583.2 million; stockholders’ deficit was $133.5 million. Net intangible assets were $168.8 million.
Material changes and operating trends
- COVID-19 significantly reduced merchant activity beginning in mid-March. Q2 consolidated card-processing dollar volume fell 16.0% and transaction volume fell 28.6%; average ticket size rose 17.5% to $98.63.
- Monthly trends improved: processing volume was down 31.8% year over year in April, 15.8% in May and 1.9% in June. Revenue was down 11.7% in April, then up 1.7% in May and 10.8% in June, according to management.
- Consumer Payments revenue edged up 0.3% in Q2 despite lower processing volume, which management attributed to ecommerce growth and a more favorable merchant mix. Commercial Payments revenue declined 13.0%, reflecting weaker managed-services activity and incentive revenue. Integrated Partners revenue grew 19.2% in Q2 and 54.4% in the first half, partly reflecting acquired YapStone assets.
- First-half consolidated revenue growth was led by Consumer Payments (+4.5%) and Integrated Partners (+54.4%), partly offset by Commercial Payments (-8.6%).
- Q2 operating expenses included $1.4 million of non-recurring expenses; first-half expenses included $2.8 million. Management cited reduced headcount, lower travel and office costs, in-sourcing and cost controls.
Outlook, risks and unusual items
- Management gave no specific revenue or earnings guidance. It expected cash on hand, operating cash generation and available revolver capacity to cover working-capital needs for at least 12 months, but cautioned that COVID-19 could materially change liquidity, results and covenant compliance. The company expected COVID-19 to adversely affect revenue and financial results for the remainder of 2020.
- A March 2020 debt amendment raised interest margins by 1 percentage point on June 16 because borrowers had not made a permitted $100 million principal prepayment. Margins rose another 0.5 percentage point on July 18, with further 0.5-point increases possible every 30 days through October 14, up to an additional 2 points after June 30, unless the required prepayment is made. The company said it was pursuing ways to raise the cash.
- The company recorded a $4.2 million first-half increase in the deferred-tax valuation allowance, partly offset by a $1.5 million release associated with the CARES Act. Goodwill and intangible-asset impairment tests identified no impairment at June 30; management said it would continue monitoring pandemic effects.
- Legal proceedings in the ordinary course were not expected to have a material effect, though an eventual probable and estimable loss could be material. The company also reported minimum third-party processing fee commitments of $14.0 million through 2021.
- Management concluded disclosure controls and procedures were not effective at June 30 because previously reported material weaknesses in internal control over financial reporting remained. Remediation efforts included additional finance staff, consultants and enhanced reconciliation procedures.
Important facts for investors to verify
- Whether the required $100 million debt prepayment was made and the resulting interest margins, liquidity and covenant headroom.
- Whether the recovery in processing volumes and revenue continued after June, especially as pandemic conditions and consumer spending changed.
- How much of reported cash is unrestricted and available for debt service, given restricted customer funds and negative working capital.
- Whether tax-asset valuation allowances, goodwill and acquired intangible assets require further adjustment.
- Progress in remediating internal-control material weaknesses and any resulting changes in reporting reliability.
- Exposure to merchant or ISO losses, including the importance of one ISO whose referred merchants generated about 21% of consolidated revenue in Q2 2020.