Priority Technology Holdings, Inc. (NASDAQ:PRTH) Q3 2023 Earnings Call Transcript

Priority Technology Holdings, Inc. (NASDAQ:PRTH) Q3 2023 Earnings Call Transcript November 11, 2023

Operator: Good morning and welcome to the Priority Technology Holdings Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Chris Kettmann. Please go ahead.

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 comment 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.

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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.

Thomas Priore: Thank you, Chris and thanks everyone for joining us for our third quarter 2023 earnings call. I’d like to start today by discussing some of the trends we’re currently seeing in the business. And then provide an update on important developments at Priority, including the successful integration process of our August acquisition of Plastiq. Consistent with what we saw in the first half of the year, during the third quarter, we continued to execute in all 3 segments of our business. Delivering strong results in SMB acquiring, B2B and Enterprise Payments. We remain committed to our unified commerce vision of combining payments and banking on a single platform, accelerated by the strength of our diverse business lines that were positioned to benefit from higher interest rates and the current macroeconomic environment.

Total accounts operating on our commerce platform now exceed 820,000, processing over $118 billion in transaction volume on a last 12-month basis while administrating in excess of $850 million in average daily deposits. We’re excited about our 2023 progress to-date, and working hard to close out the year strongly and position ourselves to accelerate in 2024. As you saw on our announcement earlier today, we maintained our positive momentum with strong financial results in the third quarter. Our Q3 revenue of $189 million increased 14% from the prior year, this led to a 23.6% increase in adjusted gross profit to $72.3 million, and a 28% improvement in adjusted EBITDA to $45 million. Adjusted gross profit margin of 38.3% increased 310 basis points from the prior year quarter, highlighting the strong operating leverage of our purpose-built platform.

On a year-to-date basis, revenue increased 14.4% to $556.3 million, leading to a 22% gain in adjusted gross profit to $202.4 million. Now combined with a 230 basis point increase in adjusted gross profit margin in the first 9 months of 2023 to 36.4%, we generated a 23% increase in adjusted EBITDA thus far in 2023. As you can see from our published guidance this morning, we expect to end the year strong as current growth and margin trends in our business channels continue. As a result, we project to deliver full year revenue of between $755 million to $765 million, an increase of approximately 15% over 2022. More importantly, we’re increasing our full year adjusted EBITDA guidance from our previously estimated $160 million to $165 million range to $167 million to $170 million, a 20-plus percent increase over 2022.

Our confidence reflects the value our customers see in our product and technology offering, the strength of our diverse sales channel performance, and the efficiency of our operating teams that continue to deliver. A notable example contributing to our outlook is accelerating operating trends in the Plastiq B2B channel. Since closing on August 1, our teams went to work synergizing operations and embracing revenue growth initiatives that mitigated drag on EBITDA from the acquisition and demonstrated once again that we’re uniquely built to systematically absorb and operate software and payment assets to quickly drive profits. Now for those of you who are new to Priority, Slide 6 highlights the architecture of our proprietary unified commerce platform that combines robust payments and banking functionality to monetize the merchant and partner networks we serve.

Our growing customer base, combined with current uncertain 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’ expectations by refining the experience of our partners, to make working with Priority seamless and simple. Our performance illustrates that partners consistently choose the unified commerce applications in SMB, B2B and Enterprise Payments segments that best fit their business, adopt the Passport financial tools that fit their needs and are moving their money with Priority.

We’re laser focused on the continued innovation of our SaaS payment suite of services and passport commerce engine, and eager to meet the evolving needs of our growing portfolio of customers. At this point, I’d like to hand it over to Tim, who will provide further insight into our segment level performance during the quarter, along with current trends in each that factored into our guidance for the full year.

Tim O’Leary: Thank you, Tom, and good morning, everyone. As I review the third 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 provide a discussion of our comparative third quarter and year-to-date results. A link to that filing can also be found in our website. As Tom mentioned, we had strong financial performance across the business in the third quarter and for the first 9 months of the year. Starting with the SMB segment on Slide 8. SMB generated Q3 revenue of $140.1 million, which was a $0.2 million increase over the prior year’s third quarter.

As discussed on our last earnings call, one of our larger reseller partners started to diversify their activity. And we said at the time that we expected their diversification strategy to continue throughout 2023, which we continue to believe is the case. If you look at the year-over-year impact of that shift on the Q3 results, it was a $15 million headwind to revenue in the quarter. If you were to exclude that impact, the SMB business would have had over 13% revenue growth on a normalized basis, which demonstrates that we continue to see strong results in the balance of the business. Bankcard dollar volumes in SMB were $14.2 billion in the quarter, which is down 6% from $15.1 billion in the prior year. But again, the impact from the large reseller was the primary contributor to the decline as it more than offset year-over-year growth in the remainder of the segment.

From a merchant standpoint, we averaged just under 240,000 accounts during the quarter, which is 5% lower than a 252,000 average in Q3 of 2022. But if you exclude the impact of the large reseller, the average grew by over 5,000 accounts on a year-over-year comparative basis. For the quarter, new monthly merchant boards averaged 4,000 compared to an average of 5,000 per month in the third quarter of 2022. Adjusted gross profit in SMB for the quarter was down by $1.3 million or 4% to $34.2 million compared to last year. The decline in comparative quarterly gross profit was partially impacted by the lower volumes and revenue from the large reseller. But as we stated in the past, that relationship generates lower margins for Priority. So the related quarterly reduction in gross profit was under $1 million.

The quarter was impacted more by a $2.3 million billing adjustment in Q3 of last year that provided for a tough year-over-year comparison in this year’s third quarter. If you exclude those 2 items, adjusted gross profit on an unaffected basis would have increased by approximately $2 million in the quarter, which again demonstrates strong growth in the balance of the portfolio. Gross margins of 24.4% are down slightly from 25.4% in Q3 of last year. But if you exclude the impact of the billing adjustment in Q3 of 2022, gross margins in the core business improved by 30 basis points due to the favorable mix of revenues resulting from the combination of strong growth in the core acquiring business, and a decline in the large but low-margin reseller.

Lastly, for SMB, quarterly operating income of $11.8 million represents a $1.7 million or a 13% decline from $13.5 million in the prior year’s third quarter. Operating income was negatively impacted by the factors already discussed in gross profit. Moving to B2B payments. Revenue of $13.8 million was an increase of $8.9 million or 182% from the prior year. The acquisition of Plastiq, which closed on July 31, contributed $10 million of the increase during the quarter, but that was partially offset by the final wind down of the Managed Services business. As previously discussed, we expected to see a year-over-year impact from Managed Services in Q3, but that comparative headwind will go away in Q4. And looking separately at CPX, that business grew by $1.2 million or 47% in Q3 compared to last year’s third quarter.

Adjusted gross profit in B2B increased to $5 million as a result of the Plastiq acquisition, combined with 60% growth in gross profit for the CPX business, which was also partially offset by the Managed Services wind down. For the quarter, gross margins were 36.2% compared to 61.2% last year, but that decline is fully attributable to the Plastiq acquisition, including the impact of the GAAP reporting requirements for the Plastiq business compared to the balance of the B2B segment. Gross margins for CPX continued to improve and were almost 85% for the quarter. The B2B segment produced $0.1 million of operating income during the quarter, which was down $0.1 million compared to last year due to the previously discussed operating losses of Plastiq and wind down of Managed Services.

Moving to the enterprise segment on the next page. Q3 revenue of $35.1 million was an increase of $13.5 million or 63% from $21.6 million in Q3 of 2022. I’ll sound like a broken record on this, but the favorable trends from the past several quarters in new monthly enrollments and increase in the number of build clients, growth in deposit balances and the higher interest rate environment have all continued to contribute to strong revenue growth. That strong revenue growth then flows through the P&L at a high conversion rate, which resulted in adjusted gross profit for the Enterprise segment, increasing by 66% to $33.1 million, while adjusted gross profit margins improved to just over 94%. Operating income was $21.3 million for the quarter in the enterprise segment.

Moving on to consolidated operating expenses on Slide 11. Salaries and benefits of $20.1 million increased 23% from Q3 of last year, but that was only $1 million higher sequentially than during Q2 of this year, as we continue to maintain our expense discipline after investing in the business and team during 2022. Compared to the Q2 levels, the $1 million sequential increase was almost entirely attributable to the acquisition of Plastiq on July 31. We finished the quarter with approximately 990 employees, including 370 in our India development center, which is compared to approximately 875 at the end of Q3 in 2022. SG&A of $11.4 million increased by $1.2 million or 12% from $10.2 million in Q3 2022 and $0.6 million sequentially from $10.8 million in Q2 of this year.

The year-over-year increase was due to certain nonrecurring items, including transaction-related expenses for the Plastiq acquisition. Depreciation and amortization of $17.3 million for the quarter decreased modestly from the comparable quarter last year and from Q2 of this year. Moving to the next slide. Adjusted EBITDA for the quarter was $45 million, which was an increase of 28% from $35.1 million in Q3 of 2022. Interest expense of $20 million for the quarter increased $6.6 million from Q3 2022 levels as a result of acquisition-related debt increases in the quarter, combined with the impact of the higher interest rate environment. For those that have joined our prior calls, you’ll likely remember that we have a natural hedge in place for the floating rate debt, given the interest income we generate in our deposits.

At the end of Q3, that natural hedge covered over 130% of the debt and just over 100% of the floating rate liabilities if you also include the preferred stock. Moving to the capital structure and liquidity slide on Page 13. Debt levels increased during the quarter to $639.1 million, which was driven by the acquisition of Plastiq on July 31 and the related borrowings on the revolver at that time. Net debt of $614.5 million was higher by $19.4 million compared to the balance at the end of Q2 for the same reason. From a liquidity standpoint, we ended the quarter with $32 million of borrowing capacity available under our $65 million revolving credit facility, and $24.6 million of unrestricted cash on the balance sheet. Subsequent to quarter end, we raised an incremental $50 million of term loan borrowings.

That transaction was neutral on a net leverage basis with proceeds being used to repay the quarter-end revolver borrowings in full and put additional cash on the balance sheet. For the LTM period ended September 30, adjusted EBITDA of $163.5 million represents approximately $7 million of sequential quarterly growth from $153.6 million at the end of Q2. Preferred stock on our balance sheet totaled $252.9 million at September 30 and is net of $17.8 million of unaccreted discounts and issuance costs. The third quarter preferred dividend of $11.4 million consists of $6.8 million paid in cash, and $4.5 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 wanted to discuss the revised revenue and adjusted EBITDA guidance for the full year. Based on the combination of year-to-date results and our latest expectations for the fourth quarter of 2023, we are reducing our full year revenue guidance to a range of $755 million to $765 million, but we are simultaneously increasing our adjusted EBITDA guidance to a range of $167 million to $170 million for the full year. The revised guidance reflects the revenue impact that we’ve already discussed related to the diversification strategy being employed by one of our large lower-margin resellers. But it also importantly reflects the continued strong performance that we expect in our higher-margin operating segments.

I’ll state the obvious from a math standpoint, but this is the first quarter where the combined gross profit from our higher growth and higher-margin B2B and Enterprise segments totals more than the gross profit of the SMB segment. Simply put, our business and the related mix of profit pools has evolved, and not all revenue is created equal. So we will continue to invest our capital, both human and financial, and products and markets that we believe will create significant shareholder value. With that, I’ll now turn the call back over to Tom for his closing comments.

Thomas Priore: Thank you, Tim. As we conclude our third quarter review, I want to take a moment to reflect on the execution of our vision for unified commerce and a multiyear planning in work that underpins our consistently strong performance. For those of you who have participated on these calls in the past few years and certainly, if you work at Priority, you’ve likely heard me share my belief that the decisions of the past are the architects of our present. I would like to offer a brief reminder of a handful of the decisions that we emphasize to investors. In 2020, amidst the height of the pandemic, we noted that, and I’m quoting, we have and will continue to target growth in countercyclical assets where businesses look for revenue in down markets and cash acceleration has more value.

And we are managing our business several quarters ahead by building a platform to maintain stability and growth through varying business cycles. That is a one-stop shop for companies looking to monetize payments and acquiring and issuing without the headaches of managing payment operations, client service risk, underwriting and compliance. And again, following the acquisition of our Banking as a Service assets in 2021, we stated that ’21 would be regarded as Priority’s year of transformation, when we realize our emergence as a payments powerhouse with a meticulously curated platform to collect store and send money that would deliver differentiated products to our business channels. As the economic downturn unfolded in 2022, what we had anticipated and planned for became a reality.

Our strategy to remain lean and position our innovative, agile technology to leverage the combination of traditional and countercyclical assets performed as expected, delivering nearly 29% top line and 45% bottom line growth. Our foresight allowed us to continue to accelerate our initiatives in new revenue channels that are early in the conversion to embedded finance and unified commerce solutions that positioned us to benefit from higher interest rates and the inflationary environment. Now, I highlight these decisions of the past because I would submit that first, it’s time that Priority be recognized as an organization that operates with superior vision and is built to last. And second, we’re delivering on the promise of unified commerce with clear and sustainable financial performance as evidenced in our quarterly results throughout tumultuous economic environments like the pandemic and today.

And last, that we’ve invested thoughtfully in technology and build scalable operations and financial resources that will continue to outperform as market demands evolve. To simply put, regardless of investment disclaimers that say otherwise, past performance is a predictor of future results. In closing, I want to share a short anecdote that I believe is informative of the culture of Priority. We have a tradition each Monday for one of our now 990 team members to share a reflection, what we call a Monday morning motivation, and they share it with the entire company. Last week’s submission came from one of our UI/UX designers, Jahanvi, that speaks to who we are as an organization. She shared, ‘we honor the dream by doing the work.’ Priority is on a mission to change how businesses of all types and sizes think about the movement of money and their expectations for cash acceleration, reconciliation and simplicity from their payment and banking partners.

Our entire team is dedicated to our mission and honors our goals each day by doing the work. I want to say thank you to our dedicated team at Priority for delivering again this quarter and throughout 2023. And thank you to our investors and analysts for your ongoing support. Operator, we’d now like to open the call for questions.

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Q&A Session

Operator: [Operator Instructions] The first question is from Michael Perito of KBW.

Michael Perito: Hey, guys. Thanks for having me on the call and taking my questions. I wanted to start — so I was out in Las Vegas a couple of weeks ago for Money 20/20, and I felt like there was a lot of conversations around, kind of, margins and pricing in the payment space, B2B enterprises and merchant acquirer, you kind of name it. And I was just wondering maybe if you guys could provide some context around how the pricing dynamics in your business are trending? And how the unified commerce approach has maybe helped insulate you guys a little bit from some of the pressures that some of your peers are clearly seeing and speaking to?

Thomas Priore: Yes, sure. Michael, by the way, great question. And like this is the — this is what unified commerce is designed to address, right? At the end of the day, customers of all sizes, whether you want to talk about the SMB market or looking upmarket, kind of more middle market, and even enterprise customers. There’s a wallet share, if you will, right? And what we’ve been very successful at, I’ll think about it if from a reseller’s standpoint, what they’re recognizing at Priority is that payments are about more than card acceptance. It’s about — certainly part of it, card acceptance or I’ll call it, digital revenue acceptance, whether it’s card ACH, right? But I want to redisposition that money to actually help my business grow.

And Priority gives you all the tools to do that. Because when you get a — while we’re doing that AR work, it makes itself into — makes its way into a routable FDIC insured bank account, where you could use that money quickly to pay vendors through a virtual card. Or you can use that using Plastiq with your existing credit to maybe capture early pay discounts, and pay vendors who won’t accept card, but get a benefit nonetheless. Because you have a cashback card and you’re generating an early pay discount and the funds can get resolved to your pay either way they want them. So those are the types of elements we’re bringing into a seamless experience across our channels, that just make doing business with Priority, a better revenue proposition.

Not just for the customer but also for our reselling channels that are the beneficiaries of; one, a more loyal customer, which is why our attrition is so low; and two, additional sources of really just earnings from services being provided. That’s why when you look at the composition, and I think Tim alluded to this, of our gross profit, more than 50% of it now is coming from services unrelated to, I’ll call it, transaction volume.

Michael Perito: That’s helpful. Yes. I mean it’s an interesting time, and I think it’s a good time to kind of have a different approach to growing and especially outside transactional volumes. I guess if we try to kind of bridge that to some of the financials, I know you guys aren’t really yet providing a ton of color on ’24. But based on the dynamics of what you’re seeing today and particularly some of the good trends in enterprise and B2B, I mean, is the expectation still, I mean, is it fair for us still to be kind of thinking about double-digit top line and bottom line as we think about the — maybe the intermediate term? Or would you guys qualify or change that at all?

Thomas Priore: Yes, I would say that, that is a fair expectation. If I were to offer an opinion on the current guidance that is in the market, I would say it’s a very low-end reflection of the trend of the business. And one of the — look our — the mix of our business and the — frankly, just the rapid adoption of our Passport Commerce platform by large enterprise partners. We would like to have a very keen appreciation and expectation of conversion before we, I’ll say, offer the 2024 guidance. That’s why we’ve been evaluating because it dramatically changes the picture. And we don’t want to be inaccurate, it’s really that simple.

Michael Perito: Yes. No, that’s helpful context on both sides. So I appreciate that. And then just lastly for me, maybe for Tim. The enterprise segment, can you maybe give us a little bit more inside baseball on how — I mean who knows what the macro is going to do in ’24, but presumably, I mean, rights has been beneficial for this business. Can you maybe provide a little context about what some of the puts and takes are around rates on the enterprise revenue trajectory, both kind of just on an absolute basis, but also on the margins?

Tim O’Leary: Sure, happy to. So obviously, the rate components where we earn interest income on the deposit balances in that business, that flows through effectively 100% margins, right? It’s a straight flow through. So that revenue in total interest income across the franchise for the quarter was just under $10 million. Roughly $6 million of that was attributable to the enterprise segment, right? So if you took the balance of the revenue in Enterprise, a lot of that still flows through at very high margins as well, right? To Tom’s point, you have a high percentage of that revenue is monthly recurring revenue that’s not volume or transaction dependent. So it is highly recurring, highly valuable revenue stream that now is just north of 50% of our gross profit. So I think while we’ve got some weight to the interest income, I think we’re pretty balanced with the other types of fee income we’re generating across the business.

Michael Perito: Great. Perfect. Appreciate you guys — Sorry, go ahead.

Thomas Priore: I would submit to you as well. Just on that topic, we’re still early innings in taking that capability and pushing it into the SME vertical, right?

Michael Perito: Right. So there’s a lot of volume growth opportunity still you would say kind of regardless of where rates are.

Thomas Priore: Yes, yes. That’s exactly right. The other thing I would just note about it, and the way we’re positioned in that segment, we have a lot of assets that have come on to platform or call a lot of partners that have come on the platform that, let’s just say, a decline in rates would indicate some probably economic softening, which would further increase adoption. So to your point —

Michael Perito: So there are some levers to it. The rate benefit might not be as great, but it’s not necessarily like a dollar-for-dollar drop, if that’s the case.