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Edited Transcript of PRTH.OQ earnings conference call or presentation 14-Aug-19 12:30pm GMT

Q2 2019 Priority Technology Holdings Inc Earnings Call

NEW YORK Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Priority Technology Holdings Inc earnings conference call or presentation Wednesday, August 14, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael T. Vollkommer

Priority Technology Holdings, Inc. - CFO

* Thomas Charles Priore

Priority Technology Holdings, Inc. - Executive Chairman, President & CEO

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Conference Call Participants

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* Georgios Mihalos

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Chris Kettmann

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Priority Technology Holdings Second Quarter 2019 Earnings Conference Call. (Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Chris Kettmann. You may begin.

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Chris Kettmann, [2]

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Good morning, and thank you for joining us today. With me today are Tom Priore, Chairman and Chief Executive Officer of Priority Technology Holdings; and Mike Vollkommer, Chief Financial Officer. Before we provide our prepared remarks, I would like to remind all participants that our comments today will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, regarding future expectations about the company's business, management's plans for future operations or similar matters, which are subject to certain risks and uncertainties. The company's actual results could differ materially due to several important factors, many of which are beyond the company's control, including those risks and uncertainties described in the current report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2019.

Any forward-looking statements we make today are only as of today's date, and we undertake no obligation to publicly update or review any forward-looking statements. Additionally, we may refer to non-GAAP measures, including EBITDA, adjusted EBITDA and earnout adjusted EBITDA during the call.

Please refer to our public filings and disclosures including those referenced in our press release announcing this call for definitions of our non-GAAP measures and the reconciliation of these measures to net income. We have also provided an accompanying presentation with today's call that will help us more clearly articulate our results and go-forward strategy. With that, I would now like to turn the call over to our Chairman and CEO, Tom Priore.

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Thomas Charles Priore, Priority Technology Holdings, Inc. - Executive Chairman, President & CEO [3]

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Thank you, Chris, and thanks to everyone for joining us. Our second quarter 2019 results reflected the strong momentum we've seen over the past several quarters despite the ongoing impact from the change in the subscription-billing e-commerce business. Consolidated revenue of $107.4 million during the quarter increased 2.5% from the prior year's second quarter, driven by strong increases in merchant bankcard volume in the Consumer Payments segment and impressive growth in the Integrated Partners business and steady improvement in Commercial Payments. The one factor still holding us back from reporting exceptionally strong year-over-year growth is the continued impact of the subscription e-commerce business, as most of you know on a prudent risk management decision, we choose to close the accounts of roughly 1,200 merchants in order to ensure compliance and good standing with Mastercard subscription e-commerce criteria. After slow reboarding of these merchants in the months following the change, I'm pleased to report that the business is coming back and it's coming back quite strong.

In the second quarter, we generated $1.7 million of revenue from subscription -- from e-commerce subscription customers, and we expect that number to rise even further in the quarters ahead. Adjusted consolidated revenue of $105.8 million, which excludes the impact of subscription-billing e-commerce merchants grew a healthy 17% compared to the second quarter of 2018. Gross profit margin for the quarter is an important metric for Priority, increased 470 basis points from 23.4% to 28.1%.

In a few minutes, Mike will provide greater detail on our second quarter 2019 financial results. Before he does, I'd like to share with you how we've continued to build a foundation that will allow Priority to compete through changing business cycles both in the near term and the long term. As all of you know, the U.S. economy is starting to show a bit of fatigue from the 10-plus years of economic expansion, GDP is slowing, and simultaneously we're seeing consumer lending businesses feel the impact of rising delinquencies and a pullback of bank lenders from the sector.

The Federal Reserve's recent interest rate reduction for the first time in 10 years is obviously intended to counteract the anticipated slowdown. We've been preparing for this eventual slowdown and future ones like it by adding defensive assets to our portfolio, including health care and real estate, where the trend toward electronic payments is still in the early stages, and volumes will continue to grow fast regardless of the macroeconomic environment.

In this quarter, we also established a foothold in the consumer finance arena through an integrated partnership with a small but emerging player in debt repayment technology. We have and will continue to target growth in countercyclical assets such as our Commercial Payments initiatives, where businesses look for revenue sources in down markets and cash acceleration has greater value as well as focus our acquisition strategy to further diversify our end markets and strengthen penetration into our existing customer base as noted above.

As we continue to naturally deleverage our balance sheet through our organic growth initiatives, we intend to supplement our efforts by using our equity currency opportunistically for acquisition. Over our 13-plus year history, we have demonstrated our ability to grow the business in a strong economy and that won't change. But if I leave you with one key takeaway from this call, it is this, Priority is managing its business several quarters ahead by building a platform to maintain impeccable stability and long-term compound growth through varying economic cycles. I'd like to now talk a bit about the different segments of our business and we'll start with the acquiring -- the Core Acquiring business.

Our Consumer Payments business continued to be driven by of our MX platform technology despite headwinds caused by the pause in subscription-billing e-commerce business, second quarter merchant bankcard volume processed by Consumer Payments segment increased 9.7%. Merchant bankcard transactions grew by 8.4% and our average ticket increased 1.2% year-over-year.

Overall, new merchant boarding trends continue to be strong at approximately 5,000 per month, which is an increase of nearly 20% from the year-ago's trend, which was closer to 4,000. Importantly, portfolio volume attrition, which benefits from 75% of our volume processing on our integrated or semi-integrated products, remains at one of the lowest rates in the industry.

As I mentioned earlier, we were excited to see the reboarding of e-commerce subscription customers accelerate in the quarter. As I mentioned, we are well on our way to having our specialized merchant acquiring segments, including subscription e-commerce, transition from a year-over-year headwind to a tailwind by the end of this year.

In addition to the underlying organic growth we've seen throughout Consumer Payments, the segment has been bolstered by our fourth quarter acquisition of Direct Connect merchant services and Blue Parasol Group's merchant portfolio assets. As part of the transaction, Priority added a diverse and low risk merchant portfolio processing $1.7 billion in annual volume as well as a productive sales engine, contributing to enterprise growth.

Since becoming integrated into Priority's infrastructure, Direct Connect's merchant boarding has more than doubled, as resellers have witnessed firsthand how much simpler it is to do business at Priority. We expect to continue driving similar levels of growth as we deepen our relationships with retailers and introduce new products into this network. Building on our efforts to grow the business organically, a key part of Priority's acquisition strategy remains focused on identifying accretive purchases with existing and new sales channels designed to improve earnings and lock-in long-term revenue and sales commitments with independent resellers and integrated software partnerships.

We are presently engaged in several opportunities that will complement our existing platform. Moving on to commercial payments and managed services. Commercial Payments division revenue was 7.1% -- I'm sorry, $7.1 million in the second quarter, increased 3.1% compared to the 2018 second quarter. Despite not growing at the pace we expected, the Commercial Payments business continues to steadily improve by leveraging our CPX-automated payables technology.

Commercial merchant bankcard volume increased 20.5% in the quarter compared to the prior year period. Current and potential customers continue to recognize the strength of our platform as we continue to win some of the most sought after contracts in the B2B payment space. We'll remain focused on optimizing the platform as the industry further realizes the cost and efficiency benefits of electronic payments, particularly in today's more challenging economic environment.

To highlight the potential opportunity in front of us and the strength of our sales efforts, our total payment volume, either under contract or currently being negotiated, is roughly $41.5 billion, and that's a $7.9 billion increase from the end of quarter one.

Priority's third and final segment is the Integrated Partners business. Several years ago, we strategically aligned Priority to capitalize on our anticipated conversions of software and payments by creating a purpose-built cloud platform where applications and payment adjacent products reside. And the Integrated Partners channel is the structural manifestation of that vision, as one of the fastest-growing segments in the payment space, providing Priority the opportunity to capitalize on this intersection between SaaS and payments.

Although we only formed Integrated Partners less than a year ago, the segment generated $8.1 million in revenue during the second quarter, led predominantly by Priority Real Estate Technology or PRET. Priority PayRight Health Solutions and Priority Hospitality Technology make up the remainder of the Integrated Partners segment. And I'll expand on each of these areas now.

Priority Real Estate Technology is being fueled by our March 2019 real-estate payments operating partnership with YapStone and the integration of our RadPad and Landlord Station properties. As majority owner of the partnership, Priority's assumed responsibility of the management and daily operations of the business and integration to Priority's processes is largely on track.

PRET maintains a single platform that addresses the needs of the full spectrum of Landlord constituents, from integrated-enterprise property managers and middle market partners to small/local landlords for rents, dues and storage payment processing.

The growing preference of consumers to pay their rent electronically aligns nicely with our defensive-minded integrated-payments solution strategy. We continue to expect PRET to contribute more than $10 million in annualized EBITDA.

Priority Hospitality Technology was formed to provide technology solutions to the hospitality market place. Priority's portfolio of approximately 32,000 hospitality merchants has been historically underserved with proprietary product offerings, and we're strategically solving that problem with integrated point of sale and order ahead -- and an order ahead products suite that can be sold as a full package or individually.

While we are still refining our proprietary point-of-sale offering, our order ahead technology, e-Tab experienced fantastic 34% total processing volume growth in quarter 2 versus the previous quarter. Broken down by channel, referral partner volume growth was 21% for the quarter, while direct-channel processing volume grew over 1,100% for the same period.

On the health care front, Priority PayRight has continued its growth trajectory on the yields of some newly released integrated product offerings. As in prior quarters, we thought we'd provide some highlights of PayRight's year-over-year performance to demonstrate how far this businesses has come and these include a 757% increase in third-party payments billing volume, 550% increase in PayRight's software revenue, 162% increase in PayRight's payment gateway processing volumes, 153% increase in portfolio residuals, a 35% increase in gross statement revenue and 113% increase in both gross revenue and net revenue.

Before concluding, I'd like to reintroduce the theme I highlighted in the first quarter call, where I noted that our investment approach has always been to identify markets where there's a meaningful transition from check-to-cash or an under-optimized segment of our existing portfolio. Recognizing our inherent exposure to U.S. consumer spending that contributes approximately 2/3 of U.S. GDP, we are continuing to seek assets that can grow with a defensive and/or countercyclical value proposition to help us maintain consistent performance even in challenging consumer spending environments like those emerging.

I'd like to conclude by expressing how excited we are to be in the strong competitive position we are in today. Our market-leading platform is bearing fruit throughout each segment of the business, and we're very pleased that prior headwinds such as the e-commerce subscription sector will become tailwinds in the relatively near future. Even more, our business is well positioned to successfully navigate through all economic cycles, and we expect to capitalize on further acquisition opportunities as market turbulence arises, driving long-term value for our shareholders.

We look forward to sharing further updates on our progress in the quarters ahead. And I'd now like to ask Mike Volkommer to provide further information on our second quarter results. Mike?

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [4]

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Thanks, Tom. And good morning to everyone. I'll review the second quarter consolidated results along with comments on the segment performance. With respect to our segment reporting, as discussed in our last call, we begun presenting our Integrated Partner businesses as a separate segment. We had previously included these businesses with Commercial Payments, but due to its significant growth over the past year, it now warrants separate segment reporting.

Throughout my summary, I will cite both GAAP and adjusted non-GAAP measures. Today's press release, as Chris mentioned, provides a reconciliation of these measures. We've also provided a supplemental set of slides that are available on the IR portion of our website to assist you with a review of our results.

Consolidated revenue in the second quarter of 2019 was $107.4 million, an increase of $2.7 million or 2.5% compared with 2018 second quarter. Growth in consolidated revenue was significantly restrained by the previously discussed 2018 wind down of subscription-billing e-commerce merchants.

Revenue from these merchants, which was captured entirely within our Consumer Payments segment amounted to $1.7 million in the second quarter of 2019, compared with $14.4 million in the second quarter of 2018. Excluding these merchants from the comparison of financial results, consolidated adjusted revenue was $105.8 million in the second quarter of 2019, an increase of $15.4 million or 17% compared with the second quarter of 2018. Consumer Payments segment revenue totaled $92.2 million in the second quarter, compared with $97.7 million in the prior year quarter. Adjusted revenue in this segment increased $7.2 million or 8.7%. Merchant bankcard volume processed by the Consumer Payments segment in the second quarter of 2019 totaled $10.8 billion, which was 9.7% higher than in the second quarter of 2018. Merchant bankcard transactions of $130.1 million in the second quarter of '19 grew by 8.4%, and average ticket grew 1.2% in the second quarter of '19 compared with the second quarter of '18.

Commercial Payments revenue in the second quarter of 2019 totaled $7.1 million, a 3.1% increase over $6.9 million in the 2018's second quarter.

Revenue from our CPX accounts payable automated solutions increased 58.5%, while revenue from our managed services programs declined slightly compared with the 2018's second quarter. The managed services decline was largely driven by lower incentive revenue in the second quarter of 2019 and the incentive revenue portion can be lumpy from time to time. Integrated Partners revenue in the second quarter of 2019 amounted to $8.1 million compared with $0.1 million in the second quarter of 2018. PRET comprised $7.6 million of this reportable segment's revenue in the second quarter of 2019. And as Tom mentioned, revenue from Priority PayRight Health Solutions and Priority Hospitality Technology, which both commenced operations in April of '18 and February of '19 respectively, comprised the remainder of this reportable segments revenue.

Gross profit in the second quarter of '19 increased by $5.6 million from $24.5 million to $30.1 million, while gross profit margin increased 470 basis points from 23.4% to 28.1%. Company's non-GAAP gross profit metric represents consolidated revenue, less costs of merchant card fees and other costs of services. The subscription-billing e-commerce merchants contributed $0.7 million of gross profit and income from operations in the second quarter of 2019 and $4.2 million in the second quarter of 2018. Excluding these merchants from the comparison, adjusted gross profit increased by $9.2 million or 45.1%. Consolidated income from operations was $2.4 million in the second quarter of '19, compared with $3.2 million in the second quarter of '18. An increase in depreciation and amortization of $5.7 million and an increase in other operating expenses of $0.7 million slightly more than offset the $5.6 million increase in gross profit. Other operating expenses included $1.6 million of nonrecurring expenses in the second quarter of 2019, compared with $3.4 million in the second quarter of 2018. In the '19 quarter, these expenses were primarily associated with allocation of purchase price to temporary free transition services from YapStone related to the integration of the March 2019 operating partnership.

Also -- it also included some certain litigation and advisory costs. In the 2018 quarter, the nonrecurring expenses were largely associated with conversion to a public company and certain litigation costs.

The Consumer Payments segment income from operations in the second quarter of 2019 amounted to $7.4 million, a decline of $2.9 million compared with the 2018 quarter. Now excluding the $3.5 million declined from subscription-billing e-commerce, segment gross profit increased to $5.5 million. This gross profit increase was partially offset by a $4.5 million increase in depreciation and amortization, which is largely driven by the acquisitions of affiliate assets and Direct Connect during the past 12 months. The Consumer Payments segment adjusted income from ops, which excludes the impact of subscription-billing e-commerce merchants increased 9% year-over-year.

Commercial Payments segment loss from operations in the second quarter of '19 was $0.3 million compared with $0.4 million in the second quarter of '18. Gross profit of $3.1 million increased by $0.2 million and operating expenses, including depreciation and amortization increased by $0.1 million.

Integrated Partners income from operations in the second quarter of was $0.6 million compared to a loss from operations of $0.2 million in the second quarter of 2018. Gross profit was $3.6 million, which increased by that exact amount $3.6 million. Depreciation and amortization of $1.1 million increased $1.1 million and other operating expenses of $2 million increased $1.7 million. Now the depreciation and amortization is related to assets acquired and forming the Integrated Partner businesses.

Other operating expenses include $0.7 million of purchase price allocated to temporary free transition services from YapStone, related to the integration of the business operations. Now Integrated Partners adjusted income from operations in the second quarter of 2019, excluding these nonrecurring transition services, was $1.3 million.

Corporate expense in the second quarter of 2019 amounted to $5.2 million compared to $6.6 million in the second quarter of 2018. The nonrecurring expenses amounted to $0.8 million and $3.4 million in the '19 and '18 quarters respectively. Excluding the nonrecurring operating expenses, corporate expense increased $1.3 million year-over-year, due largely to the establishment of the public company corporate office. Interest expense of $10.8 million in the second quarter of '19 increased by $3.1 million, from $7.6 million in the prior year quarter. The increase is due to higher outstanding borrowings driven by debt financing of acquisitions, subsequent to the second quarter of 2018. Other income net of $0.1 million in the second quarter of '19 compares with other expense net of $1.2 million in the second quarter of 2018. 2018 quarter includes $800,000 of equity investment loss and $600,000 of nonrecurring expense, primarily related to debt modification costs last year.

Now moving on to income tax expense in the second quarter of 2019. It reflects the impact of recognizing a valuation allowance on the deferred tax asset related to Internal Revenue Code section 163(j), which is the limitation on deduction of business interest.

Section 163(j) limits the business interest deduction to 30% of adjusted taxable income. Now for taxable years through 2021, the calculation of adjusted taxable income or ATI closely aligns with EBITDA. Then commencing in 2022, the calculation of ATI becomes more stringent and closely aligns with earnings before interest and taxes or EBIT, without regard to depreciation and amortization. So any business interest expense in excess of this limitation is carried forward indefinitely.

Now with respect to recording a deferred tax benefit for this carryforward, GAAP applies a more likely than not threshold as to assessing recoverability. Based on our assessment, we recorded a valuation allowance against the deferred tax asset for the portion of interest that exceeds the limitation due to the number of years we forecasted to recover the excess interest deduction.

Therefore, the second quarter of 2019 includes a discrete valuation allowance of $2.7 million related to the associated deferred tax asset for interest, recorded in the second half of 2018 and the 2019 effective tax rate reflects the impact of a valuation allowance for the 2019 excess interest.

So as of June 30, 2019, we recorded a deferred tax provision for this valuation allowance and the total amount of $7.9 million. Now I will say that there are ways to recover that in short order, acquisitions is one way that in the next 3 to 6 to 12 months could certainly increase the whole forecast, and we could reverse that reserve.

And also we had conservatively trended out our long-term forecast. So an uptick in that forecast and those trends, we can have a different assessment.

As far as the EBITDA, consolidated adjusted EBITDA was $14.9 million in the second quarter of 2019, a $4.3 million increase when compared to the second quarter of 2018. Company's non-GAAP consolidated adjusted EBITDA measure, is earnings before interest margin taxes, depreciation and amortization, further adjusted for noncash comp and certain expenses considered nonrecurring. Consolidated adjusted EBITDA, excluding the impact of subscription-billing e-commerce merchants, was $14.3 million in the second quarter of '19, an increase of $7.8 million compared to the 2018's second quarter.

Now our previously discussed earnings guidance for 2019 provided an outlook of full year revenue growth, despite the forecast of $50 million gross revenue decline from the subscription e-commerce business, and a target earnout adjusted EBITDA of approximately $75 million.

We remain confident in achieving these results. Our guidance continues to forecast an acceleration of revenue and EBITDA growth in the second half of 2019, driven by positive contributions from each of our 3 business segments. Our specialized merchant acquiring program is expected to accelerate growth in Consumer Payments as we add more high-margin merchants, and we anticipate the boarding of volume under existing customer contracts in both Commercial Payments and Integrated Partners. So now I'll turn the call back over to Tom.

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Thomas Charles Priore, Priority Technology Holdings, Inc. - Executive Chairman, President & CEO [5]

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Thanks, Mike. Operator, we'll now open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from George Mihalos with Cowen.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [2]

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I guess first to kick things off, maybe a bit of a housekeeping item. Mike, exactly, what was the inorganic contribution to revenue in the quarter?

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [3]

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Well, we had the acquisitions from an Integrated Partners and then Direct Connect and PPS Northeast, and in total they contributed approximately 10% to the revenue growth.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [4]

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Okay.

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [5]

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When adjusted for the, calling it, e-commerce. So of that 17% growth, about 10% was from those acquisitions.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [6]

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Okay. Understood. And then as it's relates to the e-commerce, is that -- seems like it will be another headwind in 3Q. Is the expectation that that is not a headwind in 4Q or that it's not a headwind as we go into 2020?

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [7]

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We'll still talk about it in 4Q. But mainly, with respect to the full year results, I think, it turns into -- we lap the comparison issue in the fourth quarter. So we will stop talking about it certainly in 2020.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [8]

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Okay. And then just as it relates to the guide, you reiterated the outlook. I think certainly from the revenue standpoint you're trending very well on that, putting a positive growth for the year. Can you just talk a little bit more about the acceleration in EBITDA that you're looking for in the back half of the year? Is that basically coming from Consumer and Integrated? Just maybe how you're thinking about the ramping of those margins to kind of achieve the $75 million?

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [9]

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Well, it's coming from really all 3 business segments. It's -- the business that we're talking about is the e-commerce reboarding, the specialized merchant acquiring program will certainly boost revenue and EBITDA in the consumer business. PRET -- Integrated Partners is going to have even better results as 3 large real estate management companies that have begun to board volume, and we expect that to accelerate through the third and fourth quarter into next year. And CPX, it's just -- CPX is going to have some pretty explosive growth. I'd say, certainly more in 2020, but it looks like we may be boarding some of the -- that $45 billion of volume sooner than we thought. So while that's not in what we're talking about, it certainly helps counterbalance any other timing issues that might happen with the boarding of business throughout the rest of the company in the third and fourth quarters. So, no, we're bullish, I mean, our first half we tracked to pretty much what we had thought we would do in the first half. So we're pretty confident that we'll hit these marks. However, there's risk to any forecast, but in this case, I think, the risk is only timing.

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Georgios Mihalos, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [10]

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Okay, okay. That's helpful. And just last question for me, how you're thinking about M&A versus debt paydown and the like?

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Michael T. Vollkommer, Priority Technology Holdings, Inc. - CFO [11]

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Well, we just slugged a little bit against the revolver just yesterday. So when we have cash sitting around, we'll take down debt where we can. And that gives us dry powder to do tuck-in acquisitions, and we are looking at those as we speak, as always. So we maintain the liquidity to enable us to take advantage of accretive acquisitions along the way.

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Thomas Charles Priore, Priority Technology Holdings, Inc. - Executive Chairman, President & CEO [12]

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And George if I can just as a -- just an anecdote, I think, the larger investment folks that follow payments recognize that we are probably undervalued versus our peers. So we see some real opportunity in those conversations to make accretive acquisitions that really are consistent with our acquisition strategy and kind of defensive assets and really leverage our platform. So we're quite optimistic about what we have in pipeline currently.

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Operator [13]

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(Operator Instructions)

And at this time, I'm showing no further questions. I'd like to turn the call back over to Tom for any closing remarks.

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Thomas Charles Priore, Priority Technology Holdings, Inc. - Executive Chairman, President & CEO [14]

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All right. Well, thank you, everyone, for your participation in the call. And we'll look forward to sharing our continued results with you in the quarters ahead. Hope everyone has a great day.

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Operator [15]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone, have a great day.