Priority Technology Holdings, Inc. (NASDAQ:PRTH) Q1 2023 Earnings Call Transcript

Priority Technology Holdings, Inc. (NASDAQ:PRTH) Q1 2023 Earnings Call Transcript May 12, 2023

Operator: Good morning, and welcome to the Priority Technology Holdings First Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Chris Kettman.

Chris Kettmann: Good morning, and thank you for joining us. With me today are Tom Priore, Chairman and Chief Executive Officer of Priority Technology Holdings; and Tim O’Leary, Chief Financial Officer. Before we give our prepared remarks, I would like to remind all participants that our comments today will include forward-looking statements, which involve a number of risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. The company undertakes no obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. We provide a detailed discussion of the various risk factors in our SEC filings, and we encourage you to review these filings.

Additionally, we may refer to non-GAAP measures, including but not limited to, EBITDA and adjusted EBITDA during the call. Reconciliations of our non-GAAP performance and liquidity measures to the appropriate GAAP measures can be found in our press release and SEC filings available in the Investors section of our website. With that, I would like to turn the call over to our Chairman and CEO, Tom Priore.

Tom Priore: Thank you, Chris, and thanks to everyone for joining us for our first quarter 2023 earnings call. Before walking you through our financial results, I’d like to highlight some key takeaways about current business trends. First, when reporting full year earnings back in March, we noted the business has been performing consistent with our Q4 trends. Even better, activity began to accelerate toward the end of March, and we ended the quarter on a substantially high note. We continue to grow market share in SMB acquiring and generated excellent results in both B2B and Enterprise payments. While other companies were pulling back in response to uncertain macroeconomic conditions and the recent banking turmoil, we remain committed to our vision for the convergence of payments and banking, driving priority aggressively forward on the strength of our countercyclical business lines that were positioned to benefit from higher interest rates and the macroeconomic pullback.

Second, we continue to outperform our peers, both from a growth and margin expansion perspective. In doing so, we continue to strengthen our competitive market position for the future. Importantly, our second quarter performance remains on a similar trajectory to what we saw in the first quarter. Last, our decision last year to accelerate investment in Passport, our unified commerce API combining full featured payments and Banking as a Service continues to be rewarded in the marketplace, especially as underfunded fintechs and Banking as a Service providers have come under pressure and a crisis and confidence in banks continues among businesses of all sizes. We believe that the numbers demonstrate that Priority is well built to thrive in a somewhat dislocated environment, and the current pace of our new partner adoption of Passport to collect, store and send money will drive results going forward.

With that as a backdrop, let’s dig into the numbers. As you saw in our earnings release, we continued our positive momentum with a very impressive start to the year. Our first quarter revenue organically increased 21% from the prior year to a record $185 million. This led to a 22% increase in adjusted gross profit to $63.1 million and a 24% improvement in adjusted EBITDA to $37.6 million. Adjusted gross margin of 34.1% increased 30 basis points from the prior year quarter, demonstrating the operating leverage of our purpose-built platform. As I noted earlier, we anticipate that our strong first quarter performance and established trends in our business channels will continue. As such, we remain confident in our ability to deliver consistent double-digit top line and bottom line growth, projecting revenue of $740 million to $755 million and adjusted EBITDA of $160 million to $165 million for the full year 2023.

For those of you who are new to Priority, Slide 5 highlights the architecture of our proprietary unified commerce platform, which is purpose-built to collect, store and send money, combining robust payment and banking functionality to monetize the merchant networks we serve. Our growing customer base, combined with current market conditions, continue to reinforce our belief that systems combining features of both payments and banking to accelerate cash flow and distribute funds in multiparty environments will be critical as businesses put greater demands on software and payment solution providers. We’re committed to meeting our customers’ growing demands by simplifying the experience for our partners, making working with Priority as simple as possible.

Partners simply choose the application that best fits their business, whether that’s a small business operator choosing from the MX Merchant POS suite, an FI or middle market customer adopting CPX for automated payables, or an Enterprise partner connecting to us via our API. They can select the Passport financial tools that fit their needs and begin to move money. We continue to stay on the cutting edge of payment technology by innovating our SaaS payment suite of services and Passport commerce engine to meet the evolving needs of our customers. As evidence of this, in the first quarter alone, we have 18 new program managers activating on Passport and have deployed nearly 220 MX Merchant POS terminals from our direct sales channels. During the quarter, we’ve also signed 28 resellers to our MX Merchant POS distributor program that we’ll be rolling out in the early third quarter.

Importantly, we’re on track in the end of Q2 and beginning of Q3 to initiate the rollout of financial tools like instant funding, checking, debit card issuing and other Banking as a Service tools across our channels. At this point, I’d like to hand it over to Tim who will provide further insight into our segment level performance during the first quarter, along with current trends in each that inform our guidance for the upcoming year.

Tim O’Leary: Thank you, Tom, and good morning, everyone. As I review the first quarter financial results, including the segment level contribution to the consolidated results, please refer to the supplemental slides or the MD&A for further details. Our MD&A is included in the Form 10-Q that was filed with the SEC this morning and provides a discussion of our comparative first quarter results. A link to that filing can also be found on our website. As Tom mentioned, the strong financial performance we saw in the first quarter of 2023 was driven by a diverse mix of our business segments, which demonstrates the ability of Priority to perform in varying market conditions. I won’t reiterate the financial highlights that Tom already spoke about.

But before I go into the segment level results, I do want to provide a few other key metrics as it relates to the consolidated results for the first quarter. For the quarter, we had 10.6% growth in bankcard dollar volume across all segments to roughly $15.9 billion and 12% growth in bankcard transaction count to 164 million transactions. If you include ACH debit and other volumes, the total payments volume for the quarter was $29.4 billion, which is up 10% from $26.6 billion in the first quarter of 2022. Again, all of those metrics are for the consolidated business. I’ll now go into more detail on each of the business segments results for the first quarter. Let’s start with SMB payments on Slide 8. For the first quarter, the SMB segment had revenue of approximately $155 million, which was a 19% or a $25 million increase over the prior year’s first quarter.

This strong organic revenue growth was driven by a combination of 8% growth in bankcard dollar volume to $15.2 billion and 12% growth in bankcard transaction count to 163.4 million transactions. We averaged just under 260,000 merchants during the quarter, which is almost 7% higher than Q1 of 2022. However, we finished the quarter with just over 257,000 merchants as a result of certain resellers closing a number of inactive accounts in March. Despite those measures, the ending merchant count still grew over 5% from the prior year. The growth in our merchant base continues to be driven by strong boarding trends where new monthly merchant boards averaged almost 5,100 throughout the quarter. That compares to an average of just under 4,700 per month in the first quarter of 2022 and an average of just over 4,700 per month for all of 2022.

Continuing with SMB on the next page and moving down the P&L to focus on profitability. Adjusted gross profit increased by $2.5 million or 8% to $35.4 million for the quarter. The underlying improvement was even better when recognizing the year-over-year comparative quarterly gross profit and related gross margin performance was negatively impacted by the timing of the recognition of certain incentives and other fees that benefited the Q1 2022 period more than Q1 of this year. If you normalize for the net impact of those differences, we saw an approximate 40 basis point decline in gross margins in Q1 of 2023, which is consistent with prior quarters and continues to be driven by a combination of our larger reseller partners growing at a faster pace, while also attracting higher commission rates.

Lastly, for SMB. Quarterly operating income of $12 million represents a 4% decline from the prior year’s first quarter. Consistent with my comments on gross profit, the comparative quarterly operating profit on a year-over-year basis was negatively impacted by the timing of certain fee recognition. In addition, the first quarter had $3 million of higher operating expenses, which were mostly headcount related as compared to last year. When combined with the $2.5 million increase in gross profit, it resulted in a $500,000 decline in operating income for the quarter. Moving to B2B payments. Revenue of $2.8 million in the first quarter was a decrease of just over 50% from the prior year. This decrease was largely the result of the previously discussed reduction in revenue from Managed Services due to the final wind down of certain programs with a large customer.

I know we’ve spoken about this on the last few earnings calls, but to provide some additional context, the Managed Services wind down had a $2.3 million impact on revenue from Q1 of last year to Q1 this year. Given the timing of the wind down in late 2022, Q2 will have a similar headwind from a year-over-year comparison standpoint, but that impact will lessen with each successive quarter this year. Separately, the CPX business saw an $800,000 decrease in revenue over that same time period as a result of certain contract termination fees recognized in 2022. If you normalize for that item, the CPX business was up modestly in Q1 with 9.5% growth in ACH volume and 6.5% growth in issuing volume. With respect to B2B’s profitability on Slide 11, adjusted gross profit declined to $2 million as a result of the Managed Services wind down.

But as we indicated as an expectation on our last earnings call, the adjusted gross profit margin increased by over 17 percentage points during the quarter as the lower margin Managed Services business rolled off, leaving behind the higher-margin CPX business. For the quarter, the B2B segment had an operating loss of $800,000 as operating expenses remained stable but were impacted by the lower gross profit. Moving to the Enterprise segment on the next page. Q4 [ph] revenue of $27.3 million was an increase of almost $10 million or 57% from $17.3 million in Q1 of 2022. The themes from the past several quarters have continued as favorable trends in new monthly enrollments and increase in the number of build clients, growth in deposit balances and the benefit of rising interest rates all contributed to the strong first quarter revenue growth.

As shown on the next slide, adjusted gross profit for the Enterprise segment increased by 64% to $25.7 million, while adjusted gross profit margins expanded to 94.1%. Operating income for the Enterprise segment also benefited from operating leverage as exemplified by profit growth significantly outpacing revenue growth for the quarter. Given the broader market environment and the increasing need for better Banking as a Service alternatives, we remain very optimistic about the revenue and earnings opportunities inherent in the Enterprise segment and really throughout Priority as we bring the Passport offering and its benefits to more of our clients and end markets. Operating expenses are shown on Page 14 and totaled $46.2 million for the quarter, an increase of just under 13% from the prior year.

As discussed on prior calls, this change was driven by the impact of increased expenses in the business throughout 2022, resulting from investments in personnel and technology to support our top-line growth and also position us for continued growth. Salaries and benefits of $19.1 million increased 19% from Q1 last year as a result of headcount and wage increases during fiscal 2022. We finished Q1 of this year with approximately 900 employees, including 320 in India, which is compared to approximately 870 at the end of 2022 and just under 840 at the end of Q1 2022. I also want to highlight that the $19.1 million of salaries and benefits in Q1 was a modest increase from $16.9 million in Q4 and was largely the result of growover from hires made during the fourth quarter, along with certain expenses that are typically higher at the beginning of the year, including stock compensation expense and benefits.

For the balance of the year, we remain focused on leveraging the investments made to date in the team and technology to manage our operating expense base. SG&A of $9.1 million increased 21% from $7.5 million in Q1 of 2022. Again, continued investment in business expansion drove that level of growth. But consistent with my comments on salaries and benefits, we will continue to focus on our cost structure throughout the following quarters to drive operating efficiencies. Depreciation and amortization of $18 million for the quarter increased modestly from the comparable quarter last year and was consistent with Q4 levels. Moving to the next slide. Adjusted EBITDA for the quarter was $37.6 million, which was an increase of 24.1% from $30.3 million in Q1 of 2022.

Working down the EBITDA walk on this slide. Interest expense of $17.7 million for the quarter was an increase of $6.2 million from Q1 2022 levels as a result of the impact of the rising interest rate environment and the floating rate nature of our existing debt. However, as I detailed on our last earnings call, we have a natural hedge in place for the floating rate debt given the interest income we generate on the deposits. At the end of 2022, that natural hedge covered about 90% of the debt. But at the end of Q1, it covered 100% of the debt as our deposit balances grew throughout the quarter. If you include the floating rate component of our preferred stock, the natural hedge at the end of Q1 covered about 70% of our floating rate liabilities.

The further adjustments to arrive at adjusted EBITDA for Q1 include noncash stock compensation expense of $1.9 million and approximately $600,000 of other adjustments, consisting of certain noncash or nonrecurring expenses. While not listed on the page, for the last 12 months or LTM period ending on March 31, adjusted EBITDA of $147.3 million represents $7 million of growth from the $140.3 million we had at the end of 2022 and $13 million of growth since March of 2022. Moving to the outstanding debt slide on Page 16. Our debt levels have continued to decline, and we finished the quarter with $615.7 million of gross debt, which is down from $623.2 million at the end of 2022. Our net debt of $599.8 million is down by $4.9 million compared to the balance at the end of 2022.

From a liquidity standpoint, we had $33.5 million of borrowing capacity under our revolving credit facility in addition to $15.9 million of unrestricted cash on the balance sheet at quarter end. On Slide 17, the preferred stock on our balance sheet totaled $235.4 million at March 31 and is net of $20.3 million of unaccreted discounts and issuance costs. The first quarter preferred dividend of $11.3 million is comprised of $6.1 million paid in cash and $4.4 million of a PIK component. This is supplemented on our income statement with the accretion of discounts and issuance costs of just over $800,000. Before turning the call back over to Tom, I want to take a minute to reaffirm our revenue and adjusted EBITDA guidance for the full year 2023.

As noted in our earnings release, we continue to forecast 12% to 14% growth in revenue to a range of $740 million to $755 million for the year and adjusted EBITDA growth of 14% to 18%, which will result in a range of $160 million to $165 million for the full year. With that, I’ll now turn the call back over to Tom for his closing comments.

Tom Priore: Thank you, Tim. As we wrap up our Q1 review, I wanted to reinforce a few of the more meaningful attributes that will continue to set Priority apart from others in the fintech and payment sector. First, as our performance demonstrates we are built for efficiency and our platform can support a diverse portfolio of software and payment assets that perform in a challenging economic environments. Second, our lean, focused technology stack is built for the future of payments and the accelerating convergence with banking functions that will drive above-market growth with minimal, if any, investment. Our products are positioned to capture new sources of revenue from banking and financial services embedded in emerging modern commerce business models.

If there are those that question the veracity of this view, perhaps you might consider the recently announced partnership between Apple and Goldman Sachs to deliver banking function to Apple Card users, or Twitter’s reported intention to embed payments and banking into its commercial network to name a few. Meshing payments and banking functionalities will inevitably be table stakes in our sector. Last, we’re an organization that continues to operationalize vision. What I mean by this statement is that beyond the unwavering work ethic and commitment of our technology, service and sales, and operational support teams, we have dedicated effort and personnel to be at the forefront of evolving strategy and customer trends to deliver results day-in and day-out.

We believe it is our clear informed vision and passion to execute that will deliver the long-term value our shareholders should expect. We appreciate you all taking the time to participate in today’s call and the ongoing support of our investors and analysts. Operator, we’d now like to open the call for questions.

Q&A Session

Operator: [Operator Instructions] The first question is from Brian Kinstlinger of Alliance Global Partners.

Tom Priore: So, and just to clarify your question, you’re speaking specifically about the retail SIC codes in the SMB acquiring space?

Operator: [Operator Instructions] The next question is from Taylor Johnson [ph] of CGI. Please go ahead.

Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Tom Priore for any closing remarks.

Tom Priore: All right, well, on behalf of the team at Priority, we want to thank everybody for taking the time to participate in this morning’s call. Special thanks to the analysts that continue to evangelize Priority, and of course, to our supportive investors. We’ll keep delivering results. Thanks very much.

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.