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, 2022. Certain amounts in this section may not add mathematically due to rounding. 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: • negative economic and political conditions that adversely affect the general economy, consumer confidence and consumer and commercial spending habits, which may, among other things, negatively impact our business, financial condition and results of operations; • 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 22 Table of Contents available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements. 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. 23 Table of Contents Results of Operations This section includes certain components of our results of operations for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. We have derived this data, except key indicators for merchant bankcard processing dollar values, transaction volumes and average billed accounts 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, 2022. Revenue For the three months ended March 31, 2023, our consolidated revenue of $185.0 million increased by $31.8 million, or 20.8%, from $153.2 million for the three months ended March 31, 2022. This overall increase was mainly driven by increased volumes across all segments. The following table presents our revenues by type for the three months ended March 31, 2023 and 2022: (in thousands) Three Months Ended March 31, 2023 2022 $ Change Revenue Type: Merchant card fees $ 149,644 $ 127,952 $ 21,692 Money transmission services 21,406 16,283 5,123 Outsourced services and other services 11,005 7,097 3,908 Equipment 2,973 1,907 1,066 Total revenues $ 185,028 $ 153,239 $ 31,789 For the three months ended March 31, 2023, our merchant card fees revenue of $149.6 million increased by $21.7 million, or 17.0%, from $128.0 million for the three months ended March 31, 2022. This increase was primarily driven by an increase in the merchant bankcard volume processed by the Company. Money transmission services of $21.4 million increased by $5.1 million, or 31.3%, from $16.3 million for the three months ended March 31, 2022. This increase was primarily driven by an increase in customer enrollments. Outsourced services and other services revenue of $11.0 million for the three months ended March 31, 2023 increased by $3.9 million, or 54.9%, from $7.1 million for the three months ended March 31, 2022, primarily due to growth in revenue from AP automation solutions, increased volumes in the card issuing business and growth in interest income due to higher interest rates and deposit balances offset by decreased managed services revenue due to wind down of certain programs. Equipment revenue of $3.0 million for the three months ended March 31, 2023 increased by $1.1 million, or 57.9%, from $1.9 million for the three months ended March 31, 2022. The increase was primarily due to increased sales of point of sale equipment. 24 Table of Contents Operating expenses for three months ended March 31, 2023 and 2022 were as follows: (in thousands) Three Months Ended March 31, 2023 2022 $ Change Operating expenses Cost of services (excludes depreciation and amortization) $ 121,966 $ 101,480 $ 20,486 Salary and employee benefits 19,048 16,077 2,971 Depreciation and amortization 18,048 17,353 695 Selling, general and administrative 9,118 7,503 1,615 Total operating expenses $ 168,180 $ 142,413 $ 25,767 Cost of services (excludes depreciation and amortization) Cost of revenue (excludes depreciation and amortization) of $122.0 million for the three months ended March 31, 2023 increased by $20.5 million, or 20.2%, from $101.5 million for the three months ended March 31, 2022, primarily due to the corresponding increase in revenues. Salary and employee benefits Salary and employee benefits expense of $19.0 million for the three months ended March 31, 2023 increased by $2.9 million, or 18.0%, from $16.1 million for the three months ended March 31, 2022, primarily due to pay raises, an increase in stock-based compensation and increased headcount to support overall growth of the Company. Depreciation and amortization expense Depreciation and amortization expense of $18.0 million for the three months ended March 31, 2023 increased by $0.6 million, or 3.4%, from $17.4 million for the three months ended March 31, 2022, primarily due to the depreciation of capitalized internal use software. Selling, general and administrative Selling, general and administrative expenses of $9.1 million for the three months ended March 31, 2023 increased by $1.6 million, or 21.3%, from $7.5 million for the three months ended March 31, 2022, primarily due to an increase in travel and other expenses to support overall growth of the Company. Other Expense, net Other expenses, net for three months ended March 31, 2023 and 2022 were as follows: (in thousands) Three Months Ended March 31, 2023 2022 $ Change Other (expense) income Interest expense $ (17,699) $ (11,535) $ (6,164) Other income, net 212 51 161 Total other expense, net $ (17,487) $ (11,484) $ (6,003) Interest expense Interest expense of $17.7 million for the three months ended March 31, 2023 increased by $6.2 million, or 53.9%, from $11.5 million for the three months ended March 31, 2022, due to increased interest rates in the three months ended March 31, 2023. 25 Table of Contents Income tax benefit Income tax benefit for three months ended March 31, 2023 and 2022 was as follows: (in thousands) Three Months Ended March 31, 2023 2022 $ Change Loss before income taxes $ (639) $ (658) $ 19 Income tax benefit $ (133) $ (325) $ 192 Effective tax rate 20.8 % 49.4 % 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 2023 is 63.8% 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 2023 interest expense. The effective tax rate for 2023 changed 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 2023 may not be indicative of our effective tax rate for future periods. On August 16, 2022, the U.S. government enacted the Inflation Reduction Act into law. The IRA, among other provisions, implements a 15% corporate alternative minimum tax based on global adjusted financial statement income and a 1% excise tax on share repurchases, which shall take effect in tax years beginning after December 31, 2022. We do not expect the enactment of the IRA will have a material effect on our reported results, cash flows, or financial position. If applicable, we expect to reflect the excise tax within equity as part of the repurchase price of common stock. Segment Results SMB Payments (in thousands) Three Months Ended March 31, 2023 2022 $ Change Revenue $ 154,933 $ 129,959 $ 24,974 Operating expenses 142,922 117,473 25,449 Operating income $ 12,011 $ 12,486 $ (475) Operating margin 7.8 % 9.6 % Depreciation and amortization $ 10,846 $ 10,824 $ 22 Key Indicators: Merchant bankcard processing dollar value $ 15,220,715 $ 14,076,847 $ 1,143,868 Merchant bankcard transaction count 163,406 145,948 17,458 Revenue Revenue from our SMB Payments segment was $154.9 million for the three months ended March 31, 2023, compared to $130.0 million for the three months ended March 31, 2022. The increase of $24.9 million, or 19.2%, was primarily driven by increased merchant bankcard volume, accrual of certain incentives, offset by decrease in certain fee-based revenue. The Company's revenue from the SMB Payments segment as a percentage of merchant bankcard processing dollar value during 26 Table of Contents 2023 increased to 1.0% from 0.92% during 2022. The increase was primarily driven by an increase in the incentive revenue and changes in the merchant mix. Operating Income Operating income from our SMB Payments segment was $12.0 million for the three months ended March 31, 2023, compared to $12.5 million for the three months ended March 31, 2022. The decrease of $0.5 million, or 4.0%, was primarily driven by mix related margin compression, a $2.1 million increase in salary and employee benefits due to higher headcount, higher stock-based compensation and annual pay raises, and a $1.0 million increase in selling, general and administrative expenses driven by higher software and travel and other operating costs offset by an increase in operating income from higher revenue. The increase in headcount and selling, general and administrative expenses are mainly attributable to growth initiatives. Depreciation and Amortization Depreciation and amortization expense of our SMB Payments segment was $10.8 million for the three months ended March 31, 2023, which is consistent with $10.8 million for the three months ended March 31, 2022. B2B Payments (in thousands) Three Months Ended March 31, 2023 2022 $ Change Revenue $ 2,786 $ 5,925 $ (3,139) Operating expenses 3,635 5,516 (1,881) Operating income (loss) $ (849) $ 409 $ (1,258) Operating margin (30.5) % 6.9 % Depreciation and amortization $ 125 $ 73 $ 52 Key Indicators: B2B issuing dollar volume $ 198,546 $ 186,380 $ 12,166 B2B issuing transaction count 280 206 74 Revenue Revenue from our B2B Payments segment was $2.8 million for the three months ended March 31, 2023, compared to $5.9 million for the three months ended March 31, 2022. The decrease of $3.1 million, or 52.5%, was primarily driven by a decrease in managed services business due to wind down of certain programs and recognition of certain revenues during 2022 related to a contract termination. Operating Income (Loss) Operating loss from our B2B Payments segment was $0.8 million for the three months ended March 31, 2023 compared to an operating income of $0.4 million for the three months ended March 31, 2022. The decrease of $1.2 million was primarily attributable to decreases in revenue. 27 Table of Contents Enterprise Payments (in thousands) Three Months Ended March 31, 2023 2022 $ Change Revenue $ 27,309 $ 17,355 $ 9,954 Operating expenses 14,646 12,861 1,785 Operating income $ 12,663 $ 4,494 $ 8,169 Operating margin 46.4 % 25.9 % Depreciation and amortization $ 6,690 $ 6,197 $ 493 Key Indicators: Average billed clients 465,219 346,394 118,825 Average new enrollments 45,948 23,441 22,507 Revenue Revenue from our Enterprise Payments segment was $27.3 million for the three months ended March 31, 2023, compared to $17.4 million for the three months ended March 31, 2022. The increase of $9.9 million or 56.9%, was primarily driven by an increase in customer enrollments, and growth in interest income due to higher interest rates and deposit balances. Operating Income Operating income from our Enterprise Payments segment was $12.7 million for the three months ended March 31, 2023, compared to $4.5 million for the three months ended March 31, 2022. The increase of $8.2 million or 182.2%, was primarily driven by increases in revenues. Depreciation and Amortization Depreciation and amortization from our Enterprise Payments segment was $6.7 million for the three months ended March 31, 2023, compared to $6.2 million depreciation and amortization expense for the three months ended March 31, 2022. The increase of $0.5 million or 8.1%, was primarily driven by the amortization of additional capitalized internal use software and acquired intangibles. 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, 2022. There have been no material changes to these critical accounting policies and estimates as of March 31, 2023. 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 and other anticipated needs, including our acquisition strategy. We anticipate that cash on hand, funds generated from operations and available borrowings under our revolving credit facility are sufficient to meet our working capital requirements for at least the next 12 months. During the second quarter of 2022, PRTH's Board of Directors authorized the Company to implement a general share repurchase program under which the Company may purchase up to 2.0 million shares of its outstanding Common Stock for a 28 Table of Contents total of up to $10.0 million. Under the terms of this plan, the Company may purchase shares through open market purchases, unsolicited or solicited privately negotiated transactions, or in another manner so long as it complies with applicable rules and regulations. The Company did not repurchase any shares under the share repurchase program during the first quarter of 2023. 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 $8.9 million at March 31, 2023 and $22.5 million at December 31, 2022. As of March 31, 2023, we had cash totaling $15.9 million compared to $18.5 million at December 31, 2022. These cash balances do not include restricted cash of $11.0 million and $10.6 million at March 31, 2023 and December 31, 2022, 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, 2023 and December 31, 2022. At March 31, 2023, we had availability of approximately $33.5 million under our revolving credit facility. The following table and discussion reflect our changes in cash flows for the comparative three month periods. Three Months Ended March 31, (in thousands) 2023 2022 Net cash provided by (used in): Operating activities $ 27,677 $ 9,613 Investing activities (7,583) (5,711) Financing activities 57,537 2,538 Net increase in cash and cash equivalents and restricted cash $ 77,631 $ 6,440 Cash Provided by Operating Activities Net cash provided by operating activities was $27.7 million for the three months ended March 31, 2023 compared to $9.6 million of net cash used in operating activities for the three months ended March 31, 2022. The $18.1 million increase in 2023 was primarily driven by changes in the operating assets and liabilities. Cash Used in Investing Activities Net cash used in investing activities was $7.6 million and $5.7 million for the three months ended March 31, 2023 and 2022, respectively. For the three months ended March 31, 2023, net cash used in investing activities included additions to property, equipment and software of $5.0 million, and acquisitions of intangible assets of $2.7 million offset by $0.2 million related to the net payments received on loans to ISOs. For the three months ended March 31, 2022, net cash used in investing activities included $0.9 million of cash used to fund acquisitions of intangible assets, $2.4 million related to the funding of new loans to ISOs and $2.4 million of cash used to acquire property, equipment and software. Cash Provided by Financing Activities Net cash used in financing activities was $57.5 million for the three months ended March 31, 2023, compared to $2.5 million of cash provided by financing activities for the three months ended March 31, 2022. The net cash provided by financing activities for the three months ended March 31, 2023 included changes in the net obligations for funds held on the behalf of customers of $79.3 million, offset by $7.6 million of cash used for the repayment of debt, $11.4 million of cash dividends paid to redeemable senior preferred stockholders, $0.8 million of cash used for shares withheld for taxes, and $2.0 million of payments of contingent consideration for business combinations. 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. 29 Table of Contents Long-term Debt As of March 31, 2023, we had outstanding debt obligations, including the current portion and net of unamortized debt discount of $598.5 million, compared to $605.1 million at December 31, 2022, resulting in a decrease of $6.6 million. The debt balance at March 31, 2023 consisted of $609.2 million outstanding under the term facility and $6.5 million outstanding under the revolving credit facility, offset by $17.2 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 the 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 credit 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, 2023, the Total Net Leverage Ratio was not applicable and the Company was in compliance with the covenants in the Credit Agreement. 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, 2022. Our exposures to market risk have not changed materially since December 31, 2022.