Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following management's discussion and analysis of financial condition and results of operations should be read together with our audited financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 2023 and 2022 items and year-over-year comparisons between 2023 and 2022. Discussions of 2021 items and year-over-year comparisons between 2022 and 2021 are not included in this Form 10-K, and can be found in " Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 202 2 .
Certain amounts in this section may not add mathematically due to rounding.
For a description and additional information about our three reportable segments, see Note 18. Segment Information , contained in " Item 8 - Financial Statements and Supplementary Data " of this Annual Report on Form 10-K.
Results of Operations
This section includes certain components of our results of operations for the years ended December 31, 2023 (or "2023"), December 31, 2022 (or "2022"). We have derived this data, except key indicators including merchant bankcard processing dollar values and transaction volumes (SMB Payments), issuing dollar volume and transaction count (B2B Payments), and average billed clients and new enrollments (Enterprise Payments), from our audited Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Revenue
For the year ended December 31, 2023, our consolidated revenue of $755.6 million increased by $92.0 million, or 13.9%, from $663.6 million for the year ended December 31, 2022. This overall increase was driven by increases in merchant card fee rates and equipment revenue, offset by a decrease in certain fee-based revenue, a true up of an invoice from one of the partner banks for certain services provided in Q1 2022 and a decline in processed merchant bankcard dollar value due to diversification of merchant portfolio by one of the referral partners in our SMB Payments segment, an increase in new enrollments and higher interest income in our Enterprise Payments segment and an increase in revenue from the Plastiq business acquired during the year offset by a decrease in revenue in B2B Payments segment due to the wind down of certain managed services programs in Q4 2022.
Revenues by type for 2023 and 2022 were as follows:
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Revenue Type:
Merchant card fees $ 595,205 $ 553,037 $ 42,168
Money transmission services 98,137 71,536 26,601
Outsourced services and other services 49,600 29,627 19,973
Equipment 12,670 9,441 3,229
Total revenues $ 755,612 $ 663,641 $ 91,971
Merchant Card Fees
For the year ended December 31, 2023, our merchant card fees revenue of $595.2 million increased by $42.2 million, or 7.6%, from $553.0 million for the year ended December 31, 2022. This increase was primarily driven by revenue from the Plastiq business that was acquired during the year and merchant card fee rate increases. These increases were partially offset by a decrease in certain fee-based revenue, a true up of an invoice from one of the partner banks for certain services provided in Q1 2022 and a decline in processed merchant bankcard dollar value due to the diversification of processor services by one of the referral partners.
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Money Transmission Services
Money transmission services revenue of $98.1 million for the year ended December 31, 2023 increased by $26.6 million or 37.2%, from $71.5 million for the year ended December 31, 2022 and is primarily driven by an increase in customer enrollments.
Outsourced Services and Other Services
Outsourced services and other services revenue of $49.6 million for the year ended December 31, 2023 increased by $20.0 million, or 67.4%, from $29.6 million for the year ended December 31, 2022. This increase was primarily due to growth in interest income due to higher interest rates and deposit balances, and additional revenues generated by our Passport platform, offset by decreased managed services revenue due to wind down of certain programs in Q4 2022.
Equipment
Equipment revenue of $12.7 million for the year ended December 31, 2023, increased by $3.3 million, or 34.2%, from $9.4 million for the year ended December 31, 2022. The increase was primarily due to increased sales of point-of-sale equipment.
Operating Expenses
Operating expenses for 2023 and 2022 were as follows:
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Operating expenses
Cost of services (excludes depreciation and amortization) $ 480,307 $ 436,753 $ 43,554
Salary and employee benefits 79,974 65,077 14,897
Depreciation and amortization 68,395 70,681 (2,286)
Selling, general and administrative 45,412 34,965 10,447
Total operating expenses $ 674,088 $ 607,476 $ 66,612
Costs of Services (excludes depreciation and amortization)
Costs of services (excludes depreciation and amortization) of $480.3 million for the year ended December 31, 2023 increased by $43.6 million, or 10.0%, from $436.8 million for the year ended December 31, 2022, primarily due to the corresponding increase in revenues. For the year ended December 31, 2023, costs of services (excluding depreciation and amortization) as a percentage of total revenues decreased to 63.6% as compared to 65.8% for the year ended December 31, 2022. This decrease was primarily due to the increase in interest and money transmission revenues which do not have significant cost of services.
Salary and employee benefits
Salary and employee benefits expense of $80.0 million for the year ended December 31, 2023 increased by $14.9 million, or 22.9%, from $65.1 million for the year ended December 31, 2022, primarily due to higher wages, an increase in stock-based compensation and increased headcount from acquisitions and to support overall growth of the Company. The Company's employee headcount increased to 983 in 2023 from 870 in 2022.
Depreciation and amortization expense
Depreciation and amortization expense of $68.4 million for the year ended December 31, 2023 decreased by $2.3 million, or 3.2%, from $70.7 million for the year ended December 31, 2022, primarily due to full amortization of certain intangible assets partially offset by the depreciation of new assets placed in service.
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Selling, general and administrative
Selling, general and administrative expenses of $45.4 million for the year ended December 31, 2023 increased by $10.4 million, or 29.9%, from $35.0 million for the year ended December 31, 2022, primarily due to certain nonrecurring expenses and other expenses to support overall growth of the Company. Nonrecurring expenses for the year primarily include PayRight restructuring costs of $3.5 million, expenses related to the acquisition of the Plastiq business of $1.7 million and certain legal and other costs of $3.0 million.
Other (Expenses) Income, net
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Other (expense) income
Interest expense $ (76,108) $ (53,554) $ (22,554)
Other income, net 1,736 589 1,147
Total other expenses, net $ (74,372) $ (52,965) $ (21,407)
Interest expense
Interest expense of $76.1 million for the year ended December 31, 2023 increased by $22.5 million, or 42.1%, from $53.6 million for the year ended December 31, 2022, due to increased interest rates and higher debt balances to fund the acquisition of Plastiq in the third fiscal quarter of 2023. Other income, net of $1.7 million for the year ended December 31, 2023 increased by $1.1 million, or 194.7%, from $0.6 million for the year ended December 31, 2022, due to increased interest income from the Company's operating accounts.
Income tax expense
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Income (loss) before income taxes $ 7,152 $ 3,200 $ 3,952
Income tax expense $ 8,463 $ 5,350 $ 3,113
Effective tax rate 118.3 % 167.2 %
The decrease in the effective tax rate from 2022 to 2023 is primarily due to a reduction in the amount of additional valuation allowance recorded 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 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 IRA 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 took effect for tax years beginning after December 31, 2022. The IRA did not have a material effect on our reported results, cash flows, or financial position during 2023. If applicable in future periods, we expect to reflect the excise tax within equity as part of the repurchase price of Common Stock.
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Earnings Attributable to Common Shareholders
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Net income (loss) $ (1,311) $ (2,150) $ 839
Less: Dividends and accretion attributable to redeemable senior preferred stockholders (47,744) (36,880) (10,864)
Net loss attributable to common stockholders $ (49,055) $ (39,030) $ (10,025)
Dividends and accretion attributable to redeemable senior preferred stockholders was $47.7 million for the year ended December 31, 2023, and was comprised of $18.0 million of accumulated dividends accrued as part of the carrying value of the redeemable senior preferred stock, $26.4 million of cash dividends, and $3.3 million related to accretion of discounts and issuance costs. The increase in dividends and accretion from 2022 to 2023 is due to an increase in the dividend rate for 2023 resulting from an increase in variable interest rates during the year and increase in carrying value of redeemable senior preferred stocks (as a result of accumulated accrued dividend).
Segment Results
SMB Payments
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Revenue $ 582,870 $ 562,237 $ 20,633
Operating expenses 536,388 507,371 29,017
Operating income $ 46,482 $ 54,866 $ (8,384)
Operating margin 8.0 % 9.8 %
Depreciation and amortization $ 41,036 $ 43,925 $ (2,889)
Key Indicators:
Merchant bankcard processing dollar value $ 59,054,039 $ 59,440,491 $ (386,452)
Merchant bankcard transaction volume 696,203 636,576 59,627
Revenue
Revenue from our SMB Payments segment was $582.9 million for the year ended December 31, 2023, compared to $562.2 million for the year ended December 31, 2022. The increase of $20.6 million, or 3.7%, was primarily driven by merchant card fee rate increases, equipment revenue, and accrual of certain incentives, offset by a decrease in certain fee-based revenue, a true up of an invoice from one of the partner banks for certain services provided in Q1 2022 and a decline in processed merchant bankcard volume due to the diversification of processor services by one of its referral partners. The Company's merchant card fee revenue from the SMB Payments segment ($563.9 million for 2023 and $549.6 million for 2022) as a percentage of merchant bankcard processing dollar value during 2023 increased to 0.95% from 0.92% during 2022. The increase was primarily driven by an increase in incentive revenue and changes in the merchant mix.
Operating Income
Operating income from our SMB Payments segment was $46.5 million for the year ended December 31, 2023, compared to $54.9 million for the year ended December 31, 2022. The decrease of $8.4 million, or 15.3%, is due to a higher mix of volume growth from larger reseller partners with higher commissions of $3.2 million and an increase in other operating expenses. Increase in other operating expenses include a $5.7 million increase in salary and employee benefits due to higher headcount and stock-based compensation and a $2.3 million increase in selling, general and administrative expenses driven by higher travel and other operating costs which was offset by a decrease of $2.8 million in depreciation and amortization for assets fully depreciated and amortized in the prior year.
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Depreciation and Amortization
Depreciation and amortization expense of our SMB Payments segment was $41.0 million for the year ended December 31, 2023, compared to $43.9 million for the year ended December 31, 2022. The decrease of $2.9 million or 6.6% is due to full amortization of certain intangible assets.
B2B Payments
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Revenue $ 40,726 $ 18,890 $ 21,836
Operating expenses 43,261 18,682 24,579
Operating (loss) income $ (2,535) $ 208 $ (2,743)
Operating margin (6.2) % 1.1 %
Depreciation and amortization $ 2,221 $ 744 $ 1,477
Key Indicators:
B2B issuing dollar volume $ 851,948 $ 814,964 $ 36,984
B2B issuing transaction count 1,087 933 154
Revenue
Revenue from our B2B Payments segment was $40.7 million for the year ended December 31, 2023, compared to $18.9 million for the year ended December 31, 2022. The increase of $21.8 million, or 115.6%, was primarily driven by an increase of $27.4 million in the Plastiq business and an increase of $1.7 million in the CPX business due to increased volumes. This increase was offset by a decrease of $7.3 million driven by the wind down of certain customer programs in the managed services business during Q4 2022.
Operating Loss
Operating loss from our B2B Payments segment was $2.5 million for the year ended December 31, 2023, compared to operating income of $0.2 million for the year ended December 31, 2022. This is primarily due to certain provisions for doubtful accounts in the CPX business, transaction bonuses in the Plastiq business, and loss of operating income from the managed services business.
Depreciation and Amortization
Depreciation and amortization from our B2B Payments segment was $2.2 million for the year ended December 31, 2023, compared to $0.7 million depreciation and amortization expense for the year ended December 31, 2022. The increase in depreciation and amortization expense is primarily due to assets acquired from the acquisition of the Plastiq business in the 3rd quarter of 2023.
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Enterprise Payments
(in thousands) Years Ended December 31, 2023 vs 2022
2023 2022 $ Change
Revenue $ 132,016 $ 82,514 $ 49,502
Operating expenses 58,052 51,577 6,475
Operating income $ 73,964 $ 30,937 $ 43,027
Operating margin 56.0 % 37.5 %
Depreciation and amortization $ 23,753 $ 24,892 $ (1,139)
Key Indicators:
Average billed clients $ 556,526 $ 379,725 $ 176,801
Average monthly new enrollments 51,059 32,013 19,046
Revenue
Revenue from our Enterprise Payments segment was $132.0 million for the year ended December 31, 2023, compared to $82.5 million for the year ended December 31, 2022. The increase of $49.5 million, or 60.0%, was primarily driven by an increase in customer enrollments, additional revenues generated by our Passport BaaS platform, and growth in interest income due to higher deposit balances and higher returns on the permissible investments related to our money transmission licenses.
Operating Income
Operating income from our Enterprise Payments segment was $74.0 million for the year ended December 31, 2023, compared to $30.9 million for the year ended December 31, 2022. The increase of $43.1 million, or 139.1%, was primarily driven by the increase in revenue.
Depreciation and Amortization
Depreciation and amortization expense from our Enterprise Payments segment was $23.8 million for the year ended December 31, 2023, compared to $24.9 million for the year ended December 31, 2022. The decrease of $1.1 million, or 4.6%, was primarily driven by full amortization of certain intangible assets in the prior year offset by depreciation expense on assets placed in service during the year.
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 regarding effects of micro and macro factors impacting the economic environment in which the Company operates on our financial results. Actual future results could differ materially, as the magnitude, duration and effects of changes in economic, political and market conditions are difficult to predict, and ultimately could negatively impact our liquidity and capital resources. Our principal uses of cash are to fund business operations (including capital expenditures and strategic investments) and administrative costs, and to service our debt.
Our working capital, defined as current assets less current liabilities, was $29.2 million at December 31, 2023 and $22.5 million at December 31, 2022. As of December 31, 2023, we had cash and cash equivalents with a balance of $39.6 million compared to $18.5 million at December 31, 2022. These cash and cash equivalent balances do not include restricted cash of $11.9 million and $10.6 million at December 31, 2023 and December 31, 2022, respectively, which reflects cash accounts holding customer
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settlement funds and cash reserves for potential losses. The current portion of long-term debt included in current liabilities was $6.7 million and $6.2 million at December 31, 2023 and 2022, respectively.
At December 31, 2023, we had availability of approximately $65.0 million under our revolving credit arrangement.
The following tables and narrative reflect our changes in cash flows for the comparative annual periods.
Years Ended December 31,
(in thousands) 2023 2022
Net cash provided by (used in):
Operating activities $ 81,256 $ 70,518
Investing activities (55,748) (36,503)
Financing activities 210,105 8,502
Net increase in cash and restricted cash $ 235,613 $ 42,517
Cash Provided by Operating Activities
Net cash provided by operating activities was $81.3 million and $70.5 million for the years ended December 31, 2023 and December 31, 2022, respectively. The $10.8 million, or 15.2% increase in 2023 was driven by changes in the operating assets and liabilities.
Cash Used in Investing Activities
Net cash used in investing activities was $55.7 million compared to cash used investing activities of $36.5 million for the years ended December 31, 2023 and 2022, respectively. Net cash used to acquire businesses in 2023 was $28.2 million compared to net cash used of $5.0 million in 2022. Additions to property, equipment and software was $21.3 million for 2023 compared to $18.9 million in 2022 and acquisitions of intangible assets was $6.6 million compared to $8.0 million in 2022. Net payments received of $0.4 million on loans to ISOs for the year ended December 31, 2023, compared to $4.7 million related to the funding of new loans to ISOs in 2022.
Cash Provided by Financing Activities
Net cash provided by financing activities was $210.1 million for the year ended December 31, 2023, compared to $8.5 million for the year ended December 31, 2022. The net cash provided by for 2023 included changes in the net obligations for funds held on the behalf of customers of $211.1 million, $49.8 million related to proceeds from the increase of the Term Facility and $44.0 million related to additional borrowings under the revolving credit facility. This was offset by $56.5 million of cash used for the repayment of borrowings under the revolving credit facility, $6.3 million of cash used for the repayment of the Term Facility, $24.7 million of cash dividends paid to redeemable senior preferred stockholders, $1.3 million of cash used for shares withheld for taxes, $4.7 million of payments of contingent consideration for business combinations and $1.2 million for debt issuance and modification costs paid related to the modification of the Term Facility and the revolving credit facility. The net cash provided by financing activities for 2022 included borrowings from the revolving credit facility of $29.5 million and changes in the net obligations for funds held on the behalf of customers of $43.1 million. These cash inflows were offset by cash used for the repayment of debt of $38.2 million, cash used for the repurchase of Common Stock of $7.5 million, dividends paid to redeemable senior preferred stockholders of $11.5 million and $7.0 million of payments of contingent consideration for business combinations.
Long-Term Debt
For the year ended December 31, 2023, we had outstanding debt obligations, including the current portion and net of unamortized debt discount of $638.7 million, compared to $605.1 million for the year ended December 31, 2022, resulting in an increase of $33.6 million. The debt balance for the year ended December 31, 2023 consisted of funds outstanding under the term facility, offset by $15.7 million of unamortized debt discounts and issuance costs. There were no funds outstanding under the revolving credit facility as of December 31, 2023. Minimum amortization of the term facility are equal quarterly
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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.
On June 30, 2023, the Credit Agreement of the Company was amended to incorporate the following:
• Reference rate : The reference rate for the calculation of interest on the Company’s term loan and revolving credit facility was amended from LIBOR to SOFR effective June 30, 2023. Per the amended terms, the outstanding borrowings under the Credit Agreement interest will accrue using the SOFR rate plus a term SOFR adjustment plus an applicable margin per year, subject to a SOFR floor of 1.00% per year. The applicable interest rate as of December 31, 2023, for the revolving credit facility based on one-month SOFR was 10.20% and for the term facility based on one-month SOFR was 11.21%.
• Increase in the revolving credit facility: The amendments also resulted in an increase in the Company’s revolving credit facility from $40.0 million to $65.0 million.
On October 2, 2023, the Company modified its existing Term Facility Credit agreement with Truist. The agreement increased the principal balance by $50.0 million and increased the quarterly principal amortization payment from $1.6 million to $1.7 million. There were no other significant modifications to the Credit Agreement.
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, which is defined in the Credit Agreement as the ratio of consolidated total debt less unrestricted cash to consolidated adjusted EBITDA (as defined in the Credit Agreement). 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 December 31, 2023, the Company was in compliance with the covenants in the Credit Agreement.
Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ significantly from those estimates. We believe that the following discussion addresses our most critical accounting estimates, which are those that are most important to the portrayal of our financial condition and results of operations and require management's most difficult, subjective, and complex judgments.
Income Taxes
We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled. Realization of deferred tax assets is dependent upon future taxable income. A valuation allowance is recognized if it is more likely than not that some portion or all of a deferred tax asset will not be realized based on the weight of available evidence, including expected future earnings.
We recognize an uncertain tax position in our financial statements when we conclude that a tax position is more likely than not to be sustained upon examination based solely on its technical merits. Only after a tax position passes the first step of recognition will measurement be required. Under the measurement step, the tax benefit is measured as the largest amount of
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benefit that is more likely than not to be realized upon effective settlement. This is determined on a cumulative probability basis. The full impact of any change in recognition or measurement is reflected in the period in which such change occurs. Interest and penalties related to income taxes are recognized in the provision for income taxes.
Goodwill and Long-lived Assets
We test goodwill for impairment for each of our reporting units on an annual basis on October 1 or when events occur, or circumstances indicate the fair value of a reporting unit may be below its carrying value. We perform the annual assessment using the qualitative method. Where deemed appropriate, we may perform a quantitative assessment that uses market data and discounted cash flow analysis, which involve estimates of future revenues and operating cash flows. Changes in these estimates and assumptions or a significant decrease in earnings could materially affect the fair value of goodwill and could result in a goodwill impairment charge.
The annual impairment assessment for goodwill does not change our requirements to assess goodwill on an interim date between scheduled annual testing dates if triggering events are present.
We review our long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. For long-lived assets, except goodwill, an impairment loss is indicated when the undiscounted future cash flows estimated to be generated by the asset group are not sufficient to recover the unamortized balance of the asset group.
We amortize the cost of our acquired intangible assets over their estimated useful lives using either a straight-line or an accelerated method that most accurately reflects the estimated pattern in which the economic benefit of the respective asset is consumed.
Business Combinations
We allocate the purchase price of an acquired business to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill. For acquisitions that include contingent consideration, we estimate the fair value of contingent consideration at the acquisition date. The estimated fair value of contingent consideration is updated in future periods based on information available at that time. Management uses all available information when estimating the fair values of the assets acquired, liabilities assumed and contingent consideration, and must apply judgement and make certain assumptions when making these estimates. The assumptions management uses when determining fair values include estimated future cash flows or income, market rate assumptions, actuarial assumptions and discount rate assumptions. We typically engage third-party valuation advisors to assist in estimating the fair values of acquired assets and assumed liabilities. Our estimates of fair value are based upon assumptions the Company believes to be reasonable, but that are inherently uncertain, and therefore, may not be realized. Accordingly, there can be no assurance that the estimates, assumptions and values reflected in the valuations will be realized, and actual results could differ materially.