Priority Technology Holdings, Inc. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Audited Consolidated Financial Statements and related Notes and the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in the Company's Annual Report on Form 10-K for the year ended December 31, 2021. Cautionary Note Regarding Forward-looking Statements Some of the statements made in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements include, but are not limited to, statements regarding our management's expectations, hopes, beliefs, intentions or strategies regarding the future. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, such as statements about our future financial performance, including any underlying assumptions, are forward-looking statements. The words "anticipate," "believe," "continue," "could," "estimate," "expect," "future," "goal," "intend," "likely," "may," "might," "plan," "possible," "potential," "predict," "project," "seek," "should," "would," "will," "approximately," "shall" and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about: • the impact of the COVID-19 pandemic; • competition in the payment processing industry; • the use of distribution partners; • any unauthorized disclosures of merchant or cardholder data, whether through breach of our computer systems, computer viruses or otherwise; • any breakdowns in our processing systems; • government regulation, including regulation of consumer information; • the use of third-party vendors; • any changes in card association and debit network fees or products; • any failure to comply with the rules established by payment networks or standards established by third-party processors; • any proposed acquisitions or dispositions or any risks associated with completed acquisitions or dispositions; and • other risks and uncertainties set forth in the " Item 1A - Risk Factors " section of this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K. We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q. The forward-looking statements contained in this Quarterly Report on Form 10-Q are based on our current expectations and beliefs concerning future developments and their potential effects on us. You should not place undue reliance on these forward-looking statements in deciding whether to invest in our securities. We cannot assure you that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions, including the risk factors set forth in the " Item 1A - Risk Factors " section of this Quarterly Report on Form 10-Q or our Annual Report on Form 10-K, that may cause our actual results or performance to be materially different from those expressed or implied by these forward-looking statements. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. In addition, statements that "we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements. 21 Table of Con tents You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. Forward-looking statements speak only as of the date they were made. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. Terms Used in this Quarterly Report on Form 10-Q As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to the terms "Company," "Priority," "we," "us" and "our" refer to Priority Technology Holdings, Inc. and its consolidated subsidiaries. 22 Table of Con tents Results of Operations This section includes certain components of our results of operations for the three months ended March 31, 2022, compared to the three months ended March 31, 2021. We have derived this data, except key indicators for merchant bankcard processing dollar values and transaction volumes, from our Unaudited Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q and our audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2021. Revenue For the three months ended March 31, 2022, our consolidated revenue of $153.2 million increased by $39.9 million, or 35.2%, from $113.3 million for the three months ended March 31, 2021. This overall increase was mainly driven by an increase in bankcard volumes fueled by increased consumer spending and acquisitions completed by the Company in 2021. The following table presents our revenues by type for the three months ended March 31, 2022 and 2021: (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Revenue Type: Merchant card fees $ 127,952 $ 107,702 $ 20,250 18.8 % Outsourced services and other services 7,097 4,378 2,719 62.1 % Money transmission services revenue 16,283 — 16,283 nm Equipment 1,907 1,217 690 56.7 % Total revenues $ 153,239 $ 113,297 $ 39,942 35.3 % For the three months ended March 31, 2022, our merchant card fees revenue of $128.0 million increased by $20.3 million, or 18.8%, from $107.7 million for the three months ended March 31, 2021. This increase was primarily driven by an increase in the merchant bankcard volume processed by the Company and purchased residuals related to the C&H acquisition, slightly offset by rate decreases. Outsourced services and other services revenue of $7.1 million for the three months ended March 31, 2022 increased by $2.7 million, or 61.4%, from $4.4 million for the three months ended March 31, 2021, primarily due to growth in revenue from AP automation solutions and the acceleration of certain customer programs which were scaled back in 2021 due to the impact of the COVID-19 pandemic. Money transmission services revenue of $16.3 million for the three months ended March 31, 2022 is related to the acquisition of Finxera in September 2021. Equipment revenue of $1.9 million for the three months ended March 31, 2022 increased by $0.7 million, or 58.3%, from $1.2 million for the three months ended March 31, 2021. The increase was primarily due to increased sales of mobile card reader equipment and other equipment from our MX product line. 23 Table of Con tents Operating Expenses Operating expenses for three months ended March 31, 2022 and 2021 were as follows: (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Operating expenses Costs of services $ 101,480 $ 81,863 $ 19,617 24.0 % Salary and employee benefits 16,077 9,548 6,529 68.4 % Depreciation and amortization 17,353 9,070 8,283 91.3 % Selling, general and administrative 7,503 8,289 (786) (9.5) % Total operating expenses $ 142,413 $ 108,770 $ 33,643 30.9 % Costs of Services Costs of services of $101.5 million for the three months ended March 31, 2022 increased by $19.6 million, or 23.9%, from $81.9 million for the three months ended March 31, 2021, primarily due to the corresponding increase in revenues. For the three months ended March 31, 2022, costs of services as a percentage of total revenues decreased to 66.2% as compared to 72.3% for the three months ended March 31, 2021. This decrease was primarily due to the impact of the Finxera acquisition on gross profit margins, partially offset by bankcard volume growth from larger partners with higher commissions and contraction of the specialized merchant acquiring portfolio. Salary and Employee Benefits Salary and employee benefits expense of $16.1 million for the three months ended March 31, 2022 increased by $6.6 million, or 69.5%, from $9.5 million for the three months ended March 31, 2021, primarily due to increases in headcount related to our acquisition of Finxera in September 2021, an increase in stock-based compensation and overall growth of the Company. Depreciation and Amortization Expense Depreciation and amortization expense of $17.4 million for the three months ended March 31, 2022 increased by $8.3 million, or 91.2%, from $9.1 million for the three months ended March 31, 2021, primarily due to the amortization of finite-lived intangible assets acquired from the business combinations completed during 2021. Selling, General and Administrative Selling, general and administrative expenses of $7.5 million for the three months ended March 31, 2022 decreased by $0.8 million, or 9.6%, from $8.3 million for the three months ended March 31, 2021, primarily due to an increase in expenses from acquired businesses offset by one-time transaction expenses in the prior year period. Other (Expenses) Income, net (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Other (expense) income Interest expense $ (11,535) $ (9,168) $ (2,367) 25.8 % Other income (expense), net 51 (269) 320 (119.0) % Total other expense, net $ (11,484) $ (9,437) $ (2,047) 21.7 % 24 Table of Con tents Interest Expense Interest expense of $11.5 million for the three months ended March 31, 2022 increased by $2.3 million, or 25.0%, from $9.2 million for the three months ended March 31, 2021, due to additional borrowings to fund the acquisition of Finxera in September 2021. Income Tax Expense (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Loss before income taxes $ (658) $ (4,910) $ 4,252 (86.6) % Income tax benefit $ (325) $ (2,231) $ 1,906 (85.4) % Effective tax rate 49.4 % 45.4 % We compute our interim period income tax expense or benefit by using a forecasted EAETR and adjust for any discrete items arising during the interim period and any changes in our projected full-year business interest expense and taxable income. The EAETR for 2022 is 51.5% and includes the income tax provision on pre-tax income and a tax provision related to establishment of a valuation allowance for deferred income tax on the future portion of the Section 163(j) limitation created by additional 2022 interest expense. The effective tax rate for 2022 increased primarily due to an increase in the valuation allowance against certain business interest carryover deferred tax assets. Our consolidated effective income tax rates differ from the statutory rate due to timing and permanent differences between amounts calculated under accounting principles GAAP and the U.S. tax code. The consolidated effective income tax rate for 2022 may not be indicative of our effective tax rate for future periods. Segment Results The Company reorganized its business segments as of December 31, 2021, resulting in three segments: SMB Payments, B2B Payments and Enterprise Payments. Segment results included in the discussion below were restated in accordance with the new segment structure for comparison purposes. 25 Table of Con tents The impact of the restatement of the prior period results is as follows: (in thousands) Three Months Ended March 31, 2021 SMB Payments (1) B2B Payments (2) Enterprise Payments (3) Revenue: Restated $ 109,101 $ 3,500 $ 696 Historically reported 108,393 3,500 1,404 Difference $ 708 $ — $ (708) Operating Income (Loss): Restated $ 13,289 $ (409) $ 164 Historically reported 13,363 (409) 92 Difference $ (74) $ — $ 72 Depreciation and Amortization: Restated $ 8,708 $ 74 $ — Historically reported 8,579 74 129 Difference $ 129 $ — $ (129) (1) Compared to the Company's legacy Consumer Payments segment. (2) Compared to the Company's legacy Commercial Payments segment. (3) Compared to the Company's legacy Integrated Partners segment. SMB Payments (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Revenue $ 129,959 $ 109,101 $ 20,858 19.1 % Operating expenses 117,473 95,812 21,661 22.6 % Operating income $ 12,486 $ 13,289 $ (803) (6.0) % Operating margin 9.6 % 12.2 % Depreciation and amortization $ 10,824 $ 8,708 $ 2,116 24.3 % Key Indicators: Merchant bankcard processing dollar value $ 14,076,847 $ 11,883,166 $ 2,193,681 18.5 % Merchant bankcard transaction volume 145,948 127,583 18,365 14.4 % Revenue Revenue from our SMB Payments segment was $130.0 million for the three months ended March 31, 2022, compared to $109.1 million for the three months ended March 31, 2021. The increase of $20.9 million, or 19.2%, was primarily driven by increased merchant bankcard volume. The Company's revenue from the SMB Payments segment as a percentage of merchant bankcard processing dollar value during 2022 decreased to 0.88% from 0.90% during 2021. The decrease is primarily driven by a decrease in revenue from the specialized merchant acquiring portfolio offset by an increase in other fees revenues. Operating Income Operating income from our SMB Payments segment was $12.5 million for the three months ended March 31, 2022, compared to $13.3 million for the three months ended March 31, 2021. The decrease of $0.8 million, or 6.0%, was primarily driven by the increase in volumes from partners with higher commissions. 26 Table of Con tents Depreciation and Amortization Depreciation and amortization expense from our SMB Payments segment was $10.8 million for the three months ended March 31, 2022, compared to $8.7 million depreciation expense for the three months ended March 31, 2021. The increase of $2.1 million was primarily driven by the amortization of acquired intangibles resulting from the C&H and Wholesale Payments, Inc. acquisitions. B2B Payments (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Revenue $ 5,925 $ 3,500 $ 2,425 69.3 % Operating expenses 5,516 3,909 1,607 41.1 % Operating income (loss) $ 409 $ (409) $ 818 (200.0) % Operating margin 6.9 % (11.7) % Depreciation and amortization $ 73 $ 74 $ (1) (1.4) % Key Indicators: Merchant bankcard processing dollar value $ 108,407 $ 63,650 $ 44,757 70.3 % Merchant bankcard transaction volume 88 39 49 125.6 % Revenue Revenue from our B2B Payments segment was $5.9 million for the three months ended March 31, 2022, compared to $3.5 million for the three months ended March 31, 2021. The increase of $2.4 million, or 68.6%, was primarily driven by $1.5 million, or 42.9%, as a result of the acceleration of certain programs in the Managed Services business operations that were scaled back in 2021 as a result of the COVID-19 pandemic and volume growth in the CPX business. The remaining increase of $0.9 million, or 25.7%, is from the recognition of certain revenues for which recovery became probable during the current quarter. Operating Income (Loss) Operating income from our B2B Payments segment was $0.4 million for the three months ended March 31, 2022, compared to an operating loss of $(0.4) million for the three months ended March 31, 2021. The increase of $0.8 million, or 200.0%, was primarily attributable to increases in revenue. Enterprise Payments (in thousands) Three Months Ended March 31, 2022 2021 $ Change % Change Revenue $ 17,355 $ 696 $ 16,659 nm Operating expenses 12,861 532 12,329 nm Operating income $ 4,494 $ 164 $ 4,330 nm Operating margin 25.9 % 23.6 % Depreciation and amortization $ 6,197 $ — $ 6,197 nm Key Indicators: Merchant bankcard processing dollar value $ 216,398 $ — $ 216,398 nm Merchant bankcard transaction volume 372 — 372 nm 27 Table of Con tents Revenue Revenue from our Enterprise Payments segment was $17.4 million for the three months ended March 31, 2022, compared to $0.7 million for the three months ended March 31, 2021. The increase of $16.7 million was primarily driven by revenues contributed by the Finxera business acquired in September 2021. Operating Income Operating income from our Enterprise Payments segment was $4.5 million for the three months ended March 31, 2022, compared to $0.2 million for the three months ended March 31, 2021. The increase of $4.3 million was primarily driven by operating income contributed by the Finxera business acquired in September 2021. Depreciation and Amortization Depreciation and amortization expense from our Enterprise Payments segment was $6.2 million for the three months ended March 31, 2022, compared to no depreciation expense for the three months ended March 31, 2021. The increase of $6.2 million was primarily driven by the amortization of acquired intangibles resulting from the Finxera acquisition in September 2021. Liquidity and Capital Resources Liquidity and capital resource management is a process focused on providing the funding we need to meet our short-term and long-term cash and working capital needs. We have used our funding sources to build our merchant portfolio, for technology solutions and to make acquisitions with the expectation that such investments will generate cash flows sufficient to cover our working capital needs and other anticipated needs, including for our acquisition strategy. We anticipate that cash on hand, funds generated from operations and available borrowings under our revolving credit agreement are sufficient to meet our working capital requirements for at least the next twelve months. This is based upon management's estimates and assumptions, including utilizing the most currently available information regarding the effects of the COVID-19 pandemic on our financial results. Actual future results could differ materially, as the magnitude, duration and effects of the COVID-19 pandemic are difficult to predict, and ultimately could negatively impact our liquidity and capital resources. Our principal uses of cash are to fund business operations and administrative costs, and to service our debt. Our working capital, defined as current assets less current liabilities, was $18.9 million at March 31, 2022 and $19.6 million at December 31, 2021. As of March 31, 2022, we had cash totaling $13.6 million compared to $20.3 million at December 31, 2021. These cash balances do not include restricted cash of $13.6 million and $28.9 million at March 31, 2022 and December 31, 2021, respectively, which reflects cash accounts holding customer settlement funds and cash reserves for potential losses. The current portion of long-term debt included in current liabilities was $6.2 million at March 31, 2022 and December 31, 2021. At March 31, 2022, we had availability of approximately $30.0 million under our revolving credit arrangement. The following table and discussion reflect our changes in cash flows for the comparative three month periods. Three Months Ended March 31, (in thousands) 2022 2021 Net cash provided by (used in): Operating activities $ 9,613 $ 9,100 Investing activities (5,711) (5,691) Financing activities 2,538 (26,769) Net increase in cash and cash equivalents and restricted cash $ 6,440 $ (23,360) 28 Table of Con tents Cash Provided by Operating Activities Net cash provided by operating activities was $9.6 million and $9.1 million for the three months March 31, 2022 and 2021, respectively. The $0.5 million, or 5.5%, increase in 2022 was primarily driven by cash generated from the operations of the Company, offset by changes in operating assets and liabilities Cash Used in Investing Activities Net cash used in investing activities was $5.7 million for both the three months ended March 31, 2022 and 2021. For the three months ended March 31, 2022, net cash used in investing activities included $2.4 million related to the funding of new loans to ISOs, additions to property, equipment and software of $2.4 million, and acquisitions of intangible assets of $0.9 million. For three months ended March 31, 2021, net cash used in investing activities included $2.9 million of cash used to fund a portfolio acquisition and $2.8 million of cash used to acquire property, equipment and software. Cash Provided by (Used in) Financing Activities Net cash provided by financing activities was $2.5 million for the three months ended March 31, 2022, compared to $26.8 million of cash used in financing activities for the three months ended March 31, 2021. The net cash provided by financing activities for three months ended March 31, 2022 included $6.6 million of cash used for the repayment of debt, $3.5 million of cash dividends paid to redeemable senior preferred stockholders and $0.2 million of cash used for other financing activities, offset by changes in the net obligations for funds held on the behalf of customers of $12.7 million. The net cash used in financing activities for the three months ended March 31, 2021 included $22.5 million of cash used related to changes in the net obligations for funds held on behalf of customers and $4.9 million of cash used for the repayment of debt, slightly offset by $0.6 million of cash provided by other financing activities. Long-Term Debt As of March 31, 2022, we had outstanding debt obligations, including the current portion and net of unamortized debt discount of $604.6 million, compared to $610.3 million at December 31, 2021, resulting in a decrease of $5.7 million. The debt balance at March 31, 2022 consisted of $615.3 million outstanding under the term facility and $10.0 million outstanding under the revolving credit facility, offset by $20.7 million of unamortized debt discounts and issuance costs. Minimum amortization of the term facility are equal quarterly installments in aggregate annual amounts equal to 1.0% of original principal, with the balance paid upon maturity. The term facility matures in April 2027 and the revolving credit facility expires in April 2026. The Credit Agreement contains representations and warranties, financial and collateral requirements, mandatory payment events, events of default and affirmative and negative covenants, including without limitation, covenants that restrict among other things, the ability to create liens, pay dividends or distribute assets from the loan parties to the Company, merge or consolidate, dispose of assets, incur additional indebtedness, make certain investments or acquisitions, enter into certain transactions (including with affiliates) and to enter into certain leases. If the aggregate principal amount of outstanding revolving loans and letters of credit under the Credit Agreement exceeds 35% of the total revolving facility thereunder, the loan parties are required to comply with certain restrictions on its Total Net Leverage Ratio. If applicable, the maximum permitted Total Net Leverage Ratio is: 1) 6.50:1.00 at each fiscal quarter ended September 30, 2021 through June 30, 2022; 2) 6.00:1.00 at each fiscal quarter ended September 30, 2022 through June 30, 2023; and 3) 5.50:1.00 at each fiscal quarter ended September 30, 2023 each fiscal quarter thereafter. As of March 31, 2022, the Company was in compliance with our financial covenants. Critical Accounting Policies and Estimates Our Unaudited Consolidated Financial Statements have been prepared in accordance with GAAP for interim periods, which often require the judgment of management in the selection and application of certain accounting principles and methods. Our critical accounting policies and estimates are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2021. There have been no material changes to these critical accounting policies and estimates as of March 31, 2022. 29 Table of Con tents Effect of New Accounting Pronouncements and Recently Issued Accounting Pronouncements Not Yet Adopted From time to time, new accounting pronouncements are issued by the FASB or other standards setting bodies that may affect our current and/or future financial statements. See Note 1, Basis of Presentation and Significant Accounting Policies , to our Unaudited Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, for a discussion of recently issued accounting pronouncements not yet adopted. Item 3. Quantitative and Qualitative Disclosures About Market Risk For quantitative and qualitative disclosures about market risk, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the year ended December 31, 2021. Our exposures to market risk have not changed materially since December 31, 2021.