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UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2020

OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                    to 
                 
Commission file number: 001-37872
Priority Technology Holdings, Inc.
(Exact name of registrant as specified in its charter)
Delaware47-4257046
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
2001 Westside Parkway
Suite 155
Alpharetta,GA30004
(Address of principal executive offices, including zip code)
(800)935-5964
(Registrant's phone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)


Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading SymbolName of each exchange on which registered
Common stock, par value $0.001PRTHNasdaq Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and  (2) has been subject to such filing requirements for the past 90 days.   Yes       No  
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes       No  
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes      No  
 
As of November 6, 2020, a total of 67,670,753 shares of common stock, par value $0.001 per share, were issued and 67,219,529 shares were outstanding.



  Priority Technology Holdings, Inc.
Quarterly Report on Form 10-Q
September 30, 2020

Page
 


Table of Contents
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Priority Technology Holdings, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)Unaudited
September 30, 2020December 31, 2019
ASSETS
Current assets:
Cash$21,695 $3,234 
Restricted cash37,135 47,231 
Accounts receivable, net of allowance for doubtful accounts of $544 and $803
40,122 37,993 
Prepaid expenses and other current assets3,968 3,897 
Current portion of notes receivable1,435 1,326 
Settlement assets327 533 
Total current assets104,682 94,214 
Notes receivable, less current portion4,684 4,395 
Property, equipment, and software, net23,490 23,518 
Goodwill106,832 109,515 
Intangible assets, net97,239 182,826 
Deferred income taxes, net42,962 49,657 
Other non-current assets522 380 
Total assets$380,411 $464,505 
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued expenses$23,744 $26,965 
Accrued residual commissions22,028 19,315 
Customer deposits and advance payments3,449 4,928 
Income taxes payable5,950  
Current portion of long-term debt15,583 4,007 
Settlement obligations30,288 37,789 
Total current liabilities101,042 93,004 
Long-term debt, net of current portion, discounts and debt issuance costs371,206 485,578 
Other non-current liabilities6,424 6,612 
Total long-term liabilities377,630 492,190 
Total liabilities478,672 585,194 
Stockholders' deficit:
Preferred stock - $0.001 par value per share; 100,000,000 shares authorized; zero issued or outstanding
  
Common stock - $0.001 par value per share; 1,000,000,000 shares authorized; 67,617,561 and 67,512,167 shares issued, respectively; 67,166,337 and 67,060,943 shares outstanding, respectively
68 68 
Additional paid-in capital5,068 3,651 
Treasury stock, 451,224 common shares, at cost
(2,388)(2,388)
Accumulated deficit(101,009)(127,674)
Total Priority Technology Holdings, Inc. stockholders' deficit(98,261)(126,343)
Non-controlling interest in subsidiary 5,654 
Total stockholders' deficit(98,261)(120,689)
Total liabilities and stockholders' deficit$380,411 $464,505 
See Notes to Unaudited Condensed Consolidated Financial Statements
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Priority Technology Holdings, Inc.
Condensed Consolidated Statements of Operations
Unaudited
(in thousands, except per share amounts)Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
REVENUES$108,962 $93,883 $298,251 $273,671 
OPERATING EXPENSES:
Costs of services74,971 63,718 203,733 185,827 
Salary and employee benefits10,010 10,668 29,695 31,923 
Depreciation and amortization10,251 10,077 30,886 28,763 
Selling, general and administrative6,6886,695 19,305 21,031 
Total operating expenses101,920 91,158 283,619 267,544 
Income from operations7,042 2,725 14,632 6,127 
OTHER INCOME (EXPENSES):
Interest expense(13,471)(10,463)(35,454)(30,602)
Debt extinguishment and modification costs(1,523) (1,899) 
Gain on sale of business107,239  107,239  
Other income, net190 158 414 523 
Total other income (expenses), net92,435 (10,305)70,300 (30,079)
Income (loss) before income taxes99,477 (7,580)84,932 (23,952)
Income tax expense (benefit)13,737 (1,736)12,919 2,468 
Net income (loss)85,740 (5,844)72,013 (26,420)
Less net income attributable to redeemable non-controlling interests and redeemed non-controlling interests (45,348) (45,348) 
Net income (loss) attributable to stockholders of Priority Technology Holdings, Inc.$40,392 $(5,844)$26,665 $(26,420)
Income (loss) per common share:
Basic$0.60 $(0.09)$0.40 $(0.39)
Diluted$0.60 $(0.09)$0.40 $(0.39)
Weighted-average common shares and equivalents:
Basic67,167 67,007 67,114 67,109 
Diluted67,286 67,007 67,131 67,109 


See Notes to Unaudited Condensed Consolidated Financial Statements
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Priority Technology Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
Unaudited
(in thousands)Nine Months Ended September 30,
20202019
Cash flows from operating activities:
Net income (loss)$72,013 $(26,420)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Gain recognized on sale of business(107,239) 
Transaction costs upon sale of business(4,372) 
Depreciation and amortization of assets30,886 28,763 
Equity-classified and liability-classified stock compensation1,627 3,354 
Amortization of debt issuance costs and discounts1,798 1,250 
Deferred income tax expense (benefit)10,442 (5,376)
Change in allowance for deferred tax assets(3,747)7,844 
Payment-in-kind interest6,643 3,807 
Debt extinguishment and modification costs1,523  
Impairment charge for intangible asset980  
Other non-cash items, net211 (157)
Change in operating assets and liabilities, excluding business sale:
Accounts receivable(3,962)(1,840)
Settlement assets and obligations, net(7,295)6,696 
Prepaid expenses and other current assets(296)(810)
Income taxes payable6,026  
Notes receivable(398)(376)
Accounts payable and other accrued liabilities287 (6,091)
Customer deposits and advance payments(1,479)250 
Other assets and liabilities, net(512)(277)
Net cash provided by operating activities3,136 10,617 
Cash flows from investing activities:
Sale of business179,416  
Additions to property, equipment and software(6,011)(8,662)
Acquisitions of intangible assets(4,415)(81,777)
Note receivable loan funding (3,000)
Other investing activity (184)
Net cash provided by (used in) investing activities168,990 (93,623)
Cash flows from financing activities:
Proceeds from issuance of long-term debt, net of issue discount 69,650 
Repayment of long-term debt(109,505)(2,827)
Debt modification costs (paid) refunded(2,749)83 
Borrowings under revolving credit facility7,000 14,000 
Repayments under revolving credit facility(7,505)(2,500)
Profit distributions to redeemable non-controlling interests of subsidiaries(45,348) 
Redemption of redeemable non-controlling interest of subsidiary(5,654) 
Repurchases of common stock (2,388)
Net cash (used in) provided by financing activities(163,761)76,018 
Net change in cash and restricted cash:
Net increase (decrease) in cash and restricted cash8,365 (6,988)
Cash and restricted cash at beginning of period50,465 33,831 
Cash and restricted cash at end of period$58,830 $26,843 
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Supplemental cash flow information:
Cash paid for interest$26,828 $25,527 
Non-cash investing and financing activities:
Payment-in-kind interest added to principal of debt obligations$6,643 $3,807 
Payment of accrued contingent consideration for asset acquisition from offset of account receivable$1,686 $ 
Accrued purchases of property, equipment and software$ $34 
Intangible assets acquired by issuing non-controlling interest in a subsidiary$ $5,654 
Reconciliation of cash and restricted cash:
Cash$21,695 $4,191 
Restricted cash37,135 22,652 
Total cash and restricted cash$58,830 $26,843 

See Notes to Unaudited Condensed Consolidated Financial Statements
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PRIORITY TECHNOLOGY HOLDINGS, INC.
Notes to Unaudited Condensed Consolidated Financial Statements


1.    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Business, Consolidation, and Presentation

Priority Technology Holdings, Inc. and its consolidated subsidiaries are referred to herein collectively as "Priority," "PRTH," the "Company," "we," "our" or "us," unless the context requires otherwise. Priority is a provider of merchant acquiring, integrated payment software and commercial payment solutions.

The Company operates on a calendar year ending each December 31 and on four calendar quarters ending on March 31, June 30, September 30, and December 31 of each year. Results of operations reported for interim periods are not necessarily indicative of results for the entire year.

These unaudited condensed consolidated financial statements include the accounts of the Company including those of its majority-owned subsidiaries, and all material intercompany balances and transactions have been eliminated in consolidation. These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). The consolidated balance sheet as of December 31, 2019 was derived from the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 but does not include all disclosures required by GAAP for annual financial statements.

In the opinion of the Company's management, all known adjustments necessary for a fair presentation of the results of the interim periods have been made. These adjustments consist of normal recurring accruals and estimates that affect the carrying amount of assets and liabilities. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reported period. Actual results could differ materially from those estimates. In particular, the magnitude, duration and effects of the COVID-19 pandemic are difficult to predict at this time, and the ultimate effect could result in future charges related to the recoverability of assets, including financial assets, long-lived assets, goodwill, and other losses.


Status as an Emerging Growth Company

The Company remains an "emerging growth company" ("EGC"), as defined in the Jumpstart Our Business Startups Act of 2012. The Company may remain an EGC until December 31, 2021. However, if the Company's non-convertible debt issued within a rolling three-year period exceeds $1.0 billion, the Company would cease to be an EGC immediately, or if its revenue for any fiscal year exceed $1.07 billion, or the market value of its common stock that is held by non-affiliates exceeds $700.0 million on the last day of the second quarter of any given year, the Company would cease to be an EGC as of the beginning of the following year. As an EGC, the Company may continue to elect to delay the adoption of any new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. Additionally, as a smaller reporting company ("SRC") as defined by the SEC, the Company has the option to adopt certain new or revised accounting standards on a permitted delayed basis that is not available to other public companies not meeting the definition of a SRC. Therefore, the Company's financial statements may not be comparable to other public companies that are not an EGC and/or SRC.
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Comprehensive Income (Loss)

For the three months and nine months ended September 30, 2020 and September 30, 2019, the Company had no activities to report as components of other comprehensive income (loss). Therefore, no separate Statement of Comprehensive Income (Loss) was prepared for any reporting period as the Company's net income (loss) from continuing operations comprises all of its comprehensive income (loss).


Comparability of Reporting Periods

Certain prior period amounts in these unaudited condensed consolidated financial statements have been reclassified to conform to the current period presentation, with no net effect on income from operations, income (loss) before income taxes, net income (loss), stockholders' deficit, or cash flows from operations, investing, or financing activities for any period presented.

The Company adopted Accounting Standards Codification ("ASC") 606, Revenue from Contracts with Customers, for the 2019 annual reporting period included in its Annual Report on Form 10-K for the year ended December 31, 2019 using the full retrospective transition method. Accordingly, the unaudited condensed consolidated statement of operations for the three months and nine months ended September 30, 2019 presented herein has been recasted to retroactively reflect the provisions of ASC 606. The adoption of ASC 606 had no net effect on the Company's income from operations, income (loss) before income taxes, net income (loss), consolidated balance sheet, or cash flows from operations, investing, or financing activities.


Accounting Policies and New Accounting Standards Adopted

There have been no material changes to the Company's accounting policies as described in its most recent Annual Report on Form 10-K for the year ended December 31, 2019. The Company did not adopt any new accounting standards during the three months and nine months ended September 30, 2020, except for ASU 2018-13, as described below.


Disclosures for Fair Value Measurements (ASU 2018-13)

On January 1, 2020, the Company adopted Accounting Standards Update ("ASU") No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). ASU 2018-13 eliminated, added, and modified certain disclosure requirements for fair value measurements as part of the Financial Accounting Standards Board's ("FASB") disclosure framework project. Certain amendments must be applied prospectively while others are applied on a retrospective basis to all periods presented. As disclosure guidance, the adoption of this ASU had no effect on the Company's financial position, results of operations or cash flows. Note 15, Fair Value, reflects the disclosure provisions of ASU 2018-13.


Recently Issued Accounting Standards Not Yet Adopted

The following standards are pending adoption and will likely apply to the Company in future periods based on the Company's current business activities:

Reference Rate Reform (ASU 2020-04)

On March 12, 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides temporary optional expedients and exceptions to the GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from the London Interbank Offered Rate ("LIBOR") and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financial Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contact at the modification date or reassess a previous accounting determination. ASU
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2020-04 can be adopted at any time before December 31, 2022. The provisions of ASU 2020-04 may impact the Company if future debt modifications or refinancings utilize one or more of the reference rates covered by the provisions of this ASU.


Leases (ASC 842)

In February 2016, the FASB issued new lease accounting guidance in ASU No. 2016-02, Leases-Topic 842, which has been codified in ASC 842, Leases, and supplemented by subsequent ASUs ("ASC 842"). Under this new guidance, lessees will be required to recognize for all leases (with the exception of short-term leases): 1) a lease liability equal to the lessee's obligation to make lease payments arising from a lease, measured on a discounted basis and 2) a right-of-use asset which will represent the lessee's right to use, or control the use of, a specified asset for the lease term. Based on the current expectation for the expiration of the Company's EGC status, the Company must adopt this standard no later than the beginning of 2022 for annual and interim reporting periods. The adoption of ASC 842 will require the Company to recognize non-current assets and liabilities for right-of-use assets and operating lease liabilities on its consolidated balance sheet. The Company is still evaluating the potential effects that the adoption of ASC 842 may have on its results of operations. ASC 842 will also require additional footnote disclosures to the Company's consolidated financial statements.


Credit Losses (ASU 2016-13)

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This new guidance will change how entities account for credit impairment for trade and other receivables, as well as for certain financial assets and other instruments. ASU 2016-13 will replace the current "incurred loss" model with an "expected loss" model. Under the "incurred loss" model, a loss (or allowance) is recognized only when an event has occurred (such as a payment delinquency) that causes the entity to believe that a loss is probable (i.e., that it has been "incurred"). Under the "expected loss" model, a loss (or allowance) is recognized upon initial recognition of the asset that reflects all future events that leads to a loss being realized, regardless of whether it is probable that the future event will occur. The "incurred loss" model considers past events and current conditions, while the "expected loss" model includes expectations for the future which have yet to occur. The standard will require entities to record a cumulative-effect adjustment to the balance sheet as of the beginning of the first reporting period in which the guidance is effective. The Company is currently evaluating the potential impact that ASU 2016-13 may have on the timing of recognizing future provisions for expected losses on the Company's accounts receivable. Since the Company was a SRC on November 15, 2019, the Company must adopt this new standard no later than the beginning of 2023 for annual and interim reporting periods.

Goodwill Impairment Testing (ASU 2017-04)

In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.  ASU 2017-04 will eliminate the requirement to calculate the implied fair value of goodwill (i.e., step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit's carrying amount over its fair value (i.e., measure the charge based on the current step 1). Any impairment charge will be limited to the amount of goodwill allocated to an impacted reporting unit. ASU 2017-04 will not change the current guidance for completing Step 1 of the goodwill impairment test, and an entity will still be able to perform the current optional qualitative goodwill impairment assessment before determining whether to proceed to Step 1. Upon adoption, the ASU will be applied prospectively. Since the Company was a SRC on November 15, 2019, the Company must adopt this new standard no later than the beginning of 2023 for annual and interim reporting periods. The impact that ASU 2017-04 may have on the Company's financial condition or results of operations will depend on the circumstances of any goodwill impairment event that may occur after adoption.


Share-Based Payments to Non-Employees (ASU 2018-07)

In June 2018, the FASB issued ASU 2018-07, Share-based Payments to Non-Employees, to simplify the accounting for share-based payments to non-employees by aligning it with the accounting for share-based payments to employees, with certain exceptions. As an EGC, the ASU is effective for annual reporting periods beginning in 2020 and interim periods within annual
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periods beginning first quarter 2021. The Company is evaluating the impact this ASU will have on its consolidated financial statements, and such impact will be dependent on any share-based payments issued to non-employees.


Share-Based Payments to Customers (ASU 2019-08)

In November 2019, the FASB issued ASU 2019-08, Stock Compensation and Revenue from Contracts with Customers ("ASU 2019-08"). ASU 2019-08 will apply to share-based payments granted in conjunction with the sale of goods and services to a customer that are not in exchange for a distinct good or service. Entities will apply ASC 718 to measure and classify share-based sales incentives, and reflect the measurement of such incentives, as a reduction of the transaction price and also recognize such incentives in accordance with the guidance in ASC 606 on consideration payable to a customer. Entities that receive distinct goods or services from a customer will account for the share-based payment in the same manner as they account for other purchases from suppliers (i.e., by applying the guidance in ASC 718). Any excess of the fair-value-based measure of the share-based payment award over the fair value of the distinct goods or services received will be reflected as a reduction to the transaction price and recognized in accordance with the guidance in ASC 606 on consideration payable to a customer. ASU 2019-08 is effective for the Company at the same time it adopts ASU 2018-07, which is annual reporting periods beginning in 2020 and interim periods within annual periods beginning first quarter 2021. The Company is evaluating the impact this ASU will have on its consolidated financial statements, and such impact will be dependent on any share-based payments issued to customers.

Implementation Costs Incurred in Cloud Computing Arrangements (ASU 2018-15)

In August 2018, the FASB issued ASU 2018-15, Implementation Costs Incurred in Cloud Computing Arrangements ("ASU 2018-15"), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). As an EGC, this ASU is effective for the Company for annual reporting periods beginning in 2021, and interim periods within annual periods beginning in 2022. The amendments should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is evaluating the impact this ASU will have on its consolidated financial statements.


Simplifying the Accounting for Income Taxes (ASU 2019-12)

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 will affect several topics of income tax accounting, including: tax-basis step-up in goodwill obtained in a transaction that is not a business combination; intra-period tax allocation; ownership changes in investments when an equity method investment becomes a subsidiary of an entity; interim-period accounting for enacted changes in tax law; and year-to-date loss limitation in interim-period tax accounting. This ASU is effective for the Company on January 1, 2022. The effects that the adoption of this ASU will have on the Company's results of operations, financial position, and cash flows will depend on specific events occurring for the Company after the adoption of ASU 2019-12.



2. SALE OF BUSINESS

On September 1, 2020, Priority Real Estate Technology LLC ("PRET"), a majority-owned and consolidated subsidiary of the Company, entered into an asset purchase agreement (the "Agreement") with MRI Payments LLC and MRI Software LLC (together, "MRI" or the buyer) to sell certain assets from PRET's real estate services business. The buyer also agreed to assume certain obligations associated with the assets. The transaction contemplated by the Agreement was completed on September 22, 2020 after receiving regulatory approval. Prior to execution of the Agreement, the buyer was not a related party of PRET or the Company.

The assets covered by the Agreement were substantially the same assets that PRET acquired in March 2019 from YapStone, Inc. and these assets constituted PRET's RentPayment component, which was part of the Integrated Partners reporting unit,
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operating segment and reportable segment. These assets consist of contracts with customers, an assembled workforce, technology-related assets, Internet domains, trade names and trademarks. The buyer also assumed obligations under an in-place and off-balance-sheet operating lease for office space. Since PRET's acquisition of these assets from YapStone, Inc. in March 2019, PRET and the Company have made operational changes that resulted in these assets becoming a business as defined by the provisions of ASU 2017-01, Clarifying the Definition of a Business, before their sale to MRI.

Proceeds received by PRET were $179.4 million, net of $584,000 for a working capital adjustment. The gain amounted to $107.2 million as follows:

(in thousands)
Gross cash consideration from buyer$180,000 
Less working capital adjustment paid in cash(584)
Net proceeds from buyer179,416 
Transaction costs incurred(5,383)
Assets sold:
Intangible assets(62,158)
Other assets sold, net of obligations assumed(716)
Goodwill assigned to business sale(2,683)
Other intangible assets(1,237)
Pre-tax gain on sale of business$107,239 


PRET is a limited liability company and is a pass-through entity for income tax purposes. Income tax expenses associated with the gain attributable to the stockholders of the Company were estimated to be approximately $12.4 million.

Allocation of net proceeds, after transaction costs, to the PRET members included return of each member's invested capital in PRET and excess proceeds were distributed in accordance with the distribution provisions of the PRET LLC governing agreement. The Company's invested capital amounted to $71.8 million, which included the assets sold, goodwill and other intangible assets. The non-controlling interest's invested capital was $5.7 million. Approximately $51.4 million and $45.1 million of the excess proceeds were distributed to the Company and the non-controlling interests, respectively.

As disclosed in Note 9, Debt Obligations, $106.5 million of cash received by the Company was used on September 25, 2020 to reduce the outstanding balance of the term loan facility under the Company's Senior Credit Facility.

Operating Lease Obligation

The buyer assumed an in-place operating lease in Dallas, Texas which expires on November 1, 2024. The Company has not adopted ASC 842; therefore this lease obligation was not reflected in the Company's balance sheet prior to the assumption by the buyer. The Company has been relieved of minimum lease payment obligations totaling $467,000 for the remainder of the current lease term.

Continuing Operations

Based on historical financial results, the Company does not believe the sale of the RentPayment component represents a strategic shift. Therefore, in accordance with ASC 205-20, Presentation of Financial Statements - Discontinued Operations, the Company will not classify or report the business that was sold as discontinued operations in its consolidated financial statements for any reporting period. The Company will continue to serve the rental property market through its ongoing PRET operations.

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Pro Forma Information

The following pro forma information is provided for the business (the RentPayment component) that was sold under the Agreement, excluding the gain recognized on the sale transaction:

(in thousands)
Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
Revenues$3,883 $3,652 $12,118 $8,058 
Income from operations (1)
$307 $1,117 $1,805 $2,586 
Net income (2) (3)
$259 $861 $1,765 $2,320 
Net income attributable to the stockholders of Priority Technology Holdings, Inc. (4)
$259 $861 $1,765 $2,320 
Income per common share for stockholders of Priority Technology Holdings, Inc. - Basic and Diluted (4)
$ $0.01 $0.03 $0.03 


(1) Historical financial results are not being reported as discontinued operations.
(2) Does not reflect interest expense on the borrowings used to acquire the YapStone assets in March 2019.
(3) Pro forma income tax expense based on the following consolidated effective tax (benefit) rates of Priority Technology Holdings, Inc.: 15.5% for third quarter 2020; 22.9% for third quarter 2019; 2.2% for the nine months ended September 30, 2020, and (10.3)% for the nine months ended September 30, 2019. These rates exclude the effect of the $107.2 million gain on the sale recognized during the quarter and nine months ended September 30, 2020.
(4) Prior to the September 2020 sale transaction that resulted in the gain on the sale, no earnings or losses of the PRET LLC were attributable to the NCIs of PRET.



3.    REVENUES


For all periods presented, substantially all of the Company’s revenues from services were recognized over time. Revenues and commissions earned from the sales of payment equipment were typically recognized at a point in time.

The following table presents a disaggregation of the Company's consolidated revenues by type, and the relationships to the Company's reportable segments, for the three months and nine months ended September 30, 2020 and September 30, 2019:
(in thousands)Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
Revenue Type
Merchant card fees$102,481 $85,719 $277,253 $249,267 
Outsourced services and other services5,387 7,143 18,143 21,750 
Equipment1,094 1,021 2,855 2,654 
Total revenues$108,962 $93,883 $298,251 $273,671 
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Revenues earned in these disaggregated categories consist of following:

Merchant card fees - revenues related to discount rates and interchange fees earned from payment services provided by the Company's Consumer Payments, Commercial Payments, and Integrated Partners segments.

Outsourced services and other services - business process outsourcing services provided by our Commercial Payments segment primarily to certain business customers of American Express, auxiliary services provided primarily to customers in the Company's Integrated Partners segment, and revenue from automated clearing house ("ACH") services.    

Equipment - revenues from sales of point-of-sale equipment and other payment-processing equipment sold to customers in the Company's Consumer Payments segment.


Transaction Price Allocated to Future Performance Obligations

ASC 606 requires disclosure of the aggregate amount of the transaction price allocated to unsatisfied performance obligations. However, as allowed by ASC 606, the Company has elected to exclude from this disclosure any contracts with an original duration of one year or less and any variable consideration that meets specified criteria. The Company’s most significant performance obligations consist of variable consideration under a stand-ready series of distinct days of service. Such variable consideration meets the specified criteria for the disclosure exclusion. Therefore, the majority of the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied is variable consideration that is not required for this disclosure. The aggregate fixed consideration portion of customer contracts with an initial contract duration greater than one year is not material.


Contract Costs

For new, renewed, or anticipated contracts with customers, the Company does not incur material amounts of incremental costs to obtain such contracts, as those costs are defined by ASC 340-40.

Fulfillment costs, as defined by ASC 340-40, typically benefit only the period (typically a month in duration) in which they are incurred and therefore are expensed in the period incurred (i.e., not capitalized) unless they meet criteria to be capitalized under other accounting guidance.

The Company pays commissions to most of its independent sales organizations ("ISOs"), and for certain ISOs the Company also pays (through a higher commission rate) them to provide customer service and other services directly to our merchant customers. The ISO is typically an independent contractor or agent of the Company. Although certain ISOs may have merchant portability rights, the merchant meets the definition of a customer for the Company even if the ISO has merchant portability rights. Since payments to ISOs are dependent substantially on variable merchant payment volumes generated after the merchant enters into a new or renewed contract, these payments to ISOs are not deemed to be a cost to acquire a new contract since the ISO payments are based on factors that will arise subsequent to the event of obtaining a new or renewed contract. Also, payments to ISOs pertain only to a specific month’s activity. For payments made, or due, to an ISO, the expenses are reported within income from operations on our statements of operations.

The Company from time-to-time may elect to buy out all or a portion of an ISO’s rights to receive future commission payments related to certain merchants. Amounts paid to the ISO for these residual buyouts are capitalized by the Company under the accounting guidance for intangible assets.


Contract Assets and Contract Liabilities

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A contract with a customer creates legal rights and obligations. As the Company performs under customer contracts, its right to consideration that is unconditional is considered to be accounts receivable. If the Company’s right to consideration for such performance is contingent upon a future event or satisfaction of additional performance obligations, the amount of revenues recognized in excess of the amount billed to the customer is recognized as a contract asset. Contract liabilities represent consideration received from customers in excess of revenues recognized. Material contract assets and liabilities are presented net at the individual contract level in the consolidated balance sheet and are classified as current or noncurrent based on the nature of the underlying contractual rights and obligations.

Supplemental balance sheet information related to contracts from customers as of September 30, 2020 and December 31, 2019 was as follows:
(in thousands)Consolidated Balance Sheet LocationSeptember 30, 2020December 31, 2019
Liabilities:
Contract liabilities, net (current)Customer deposits and advance payments$1,634$1,912

The balance for the contract liabilities was $1,315,000, $1,738,000, and $1,776,000 at September 30, June 30, and January 1, 2019, respectively. The changes in the balances during the three months and nine months ended September 30, 2020 and September 30, 2019 were due to the timing of advance payments received from the customer. Substantially all of these balances are recognized as revenue within twelve months.

Net contract assets were not material for any period presented.

Impairment losses recognized on receivables or contract assets arising from the Company's contracts with customers were not material for the three months and nine months ended September 30, 2020 and September 30, 2019.



4.    NON-CONTROLLING INTERESTS

See Note 13, Reconciliation of Stockholders' Deficit and Non-Controlling Interests, for additional information on transactions with non-controlling interests during the three months and nine months ended September 30, 2020.

YapStone

In March 2019, the Company, through one of its subsidiaries, PRET, acquired certain assets and assumed certain related liabilities (the "YapStone net assets") from YapStone, Inc. ("YapStone") under an asset purchase and contribution agreement. The purchase price for the YapStone net assets was $65.0 million in cash plus a non-controlling interest ("NCI") in PRET. The fair value of the NCI was estimated to be approximately $5.7 million. The total purchase price was assigned to customer relationships, except for $1.0 million and $1.2 million which were assigned to a software license agreement and a services agreement, respectively. The $65.0 million of cash was funded from a drawdown of the Senior Credit Facility on a delayed basis as provided for and pursuant to the third amendment thereto executed in December 2018.

During the three months and nine months ended September 30, 2020 and September 30, 2019, no earnings from the operations of PRET were attributable to the NCIs pursuant to the PRET operating agreement. However, as disclosed in Note 2, Sale of Business, during third quarter 2020, PRET sold assets to a third party that substantially represented the YapStone net assets acquired in March 2019. Based on the PRET operating agreement, the NCIs were attributed with $45.1 million of the gain recognized by PRET for the sale transaction in September 2020. This $45.1 million, along with the $5.7 million carrying value of the NCI issued to YapStone, Inc. in March 2019, were distributed in cash to the PRET NCIs in September 2020. Simultaneous with the cash distributions, all of the NCIs of PRET fully redeemed their interests.


Related Party Non-Controlling Interest
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See Note 12, Related Party Transactions, for information about assets contributed to the Company during the first quarter of 2019 that involved a contingent purchase price.


5.    SETTLEMENT ASSETS AND OBLIGATIONS

Consumer Payments Segment

In the Company’s Consumer Payments reportable segment, funds settlement refers to the process of transferring funds for sales and credits between card issuers and merchants. The standards of the card networks restrict non-members, such as the Company, from performing funds settlement or accessing merchant settlement funds. Instead, these funds must be in the possession of a member bank until the merchant is funded. The Company has agreements with member banks which allow the Company to route transactions under the member bank's control to clear transactions through the card networks. Timing differences, interchange fees, merchant reserves and exception items cause differences between the amounts received from the card networks and the amounts funded to the merchants. Since settlement funds are required to be in the possession of a member bank until the merchant is funded, these funds are not assets of the Company and the associated obligations are not liabilities of the Company. Therefore, neither is recognized in the Company’s consolidated balance sheets. Member banks held merchant funds of $97.9 million and $79.8 million at September 30, 2020 and December 31, 2019, respectively.

Exception items include items such as customer chargeback amounts received from merchants and other losses. Under agreements between the Company and its merchant customers, the merchants assume liability for such chargebacks and losses. If the Company is ultimately unable to collect amounts from the merchants for any charges or losses due to merchant fraud, insolvency, bankruptcy or any other reason, it may be liable for these charges. In order to mitigate the risk of such liability, the Company may 1) require certain merchants to establish and maintain reserves designed to protect the Company from such charges or losses under its risk-based underwriting policy and 2) engage with certain ISOs in partner programs in which the ISOs assume liability for these charges or losses. A merchant reserve account is funded by the merchant and held by the member bank during the term of the merchant agreement. Unused merchant reserves are returned to the merchant after termination of the merchant agreement or in certain instances upon a reassessment of risks during the term of the merchant agreement.
Exception items that the Company is attempting to collect from the merchants through the funds settlement process, merchant reserves or from the ISO partners are recognized as settlement assets in the Company’s consolidated balance sheets, with an offsetting reserve for those amounts the Company estimates it will not be able to recover. Provisions for merchant losses are included as a component of costs of services in the Company’s consolidated statements of operations.

Commercial Payments Segment
In the Company’s Commercial Payments segment, the Company earns revenue from certain of its services by processing ACH transactions for financial institutions and other business customers. Customers transfer funds to the Company, which are held in bank accounts controlled by the Company until such time as the ACH transactions are made. The Company recognizes these cash balances within restricted cash and settlement obligations in its consolidated balance sheets.
The Company's settlement assets and obligations at September 30, 2020 and December 31, 2019 were as follows:
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(in thousands)As of
September 30, 2020December 31, 2019
Settlement Assets:
Card settlements due from merchants, net of estimated losses$372 $446 
Card settlements due (to) from processors(45)87 
Total settlement assets$327 $533 
Settlement Obligations:
Card settlements due to merchants$2 $44 
Due to ACH payees (1)30,286 37,745 
Total settlement obligations$30,288 $37,789 

(1) Amounts due to ACH payees are held by the Company in restricted cash.


6. GOODWILL AND OTHER INTANGIBLE ASSETS

As disclosed in Note 2, Sale of Business, in September 2020 PRET sold certain assets from PRET's real estate services business, which resulted in the reduction of certain goodwill and intangible assets in the Company's Integrated Partners reporting unit.

The Company's goodwill was as follows:
(in thousands)September 30, 2020December 31, 2019
Consumer Payments$106,832 $106,832 
Integrated Partners 2,683 
 $106,832 $109,515 

The Company considered the market conditions generated by the COVID-19 pandemic and concluded that there were no indicators of impairment for the goodwill of the Consumer Payments reporting unit for the three months and nine months ended September 30, 2020.

The Company tests goodwill for impairment on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit may be below its carrying value. The Company will continue to monitor the economic impact of COVID-19 on its ongoing assessment of goodwill. The Company expects to perform its next annual goodwill impairment test during the fourth quarter of 2020 using market data and discounted cash flow analysis. The Company concluded there was no impairment as of September 30, 2020 or December 31, 2019. As such, there was no accumulated impairment loss as of September 30, 2020 and December 31, 2019.

The Company's intangible assets include acquired merchant portfolios, customer relationships, ISO relationships, trade names, technology, non-compete agreements, and residual buyouts. As of September 30, 2020 and December 31, 2019, intangible assets consisted of the following:
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(in thousands)September 30, 2020December 31, 2019
Other intangible assets:
Merchant portfolios$48,472 $114,554 
Customer relationships39,770 40,740 
Residual buyouts113,979 112,731 
Non-compete agreements3,390 3,390 
Trade names2,700 2,870 
Technology13,880 15,390 
ISO relationships15,200 15,200 
 Total gross carrying value237,391 304,875 
Less accumulated amortization:
Merchant portfolios(16,036)(12,655)
Customer relationships(28,454)(25,836)
Residual buyouts(69,373)(59,796)
Non-compete agreements(3,390)(3,390)
Trade names(1,421)(1,273)
Technology(13,417)(12,758)
ISO relationships(7,081)(6,341)
Total accumulated amortization (139,172)(122,049)
Accumulated allowance for impairment(980) 
 Net carrying value$97,239 $182,826 
 
See Note 11, Commitments and Contingencies, for information about an acquired merchant portfolio with a contingent purchase price.

Amortization expense for finite-lived intangible assets was $8.3 million and $25.2 million for the three months and nine months ended September 30, 2020, respectively, and $8.4 million and $24.0 million for the three months and nine months ended September 30, 2019, respectively. Amortization expense for future periods could differ due to new intangible asset acquisitions, changes in useful lives of existing intangible assets, and other relevant events or circumstances.

The Company tests intangible assets for impairment when events occur or circumstances indicate that the fair value of an intangible asset or group of intangible assets may be impaired. In the Company's Consumer Payments segment, a residual buyout intangible asset with a net carrying value of $2.4 million was deemed to be partially impaired. The fair value of this intangible asset was estimated to be $1.4 million, thus resulting in the recognition of an impairment charge of $1.0 million during the third quarter of 2020 and this amount is included in SG&A expenses on the Company's unaudited condensed consolidated statement of operations for the three months and nine months ended September 30, 2020. This impairment was the result of diminished cash flows generated by the merchant portfolio. Many of the Company's merchant customers in its Consumer Payments reportable segment are associated with ISOs, and these ISOs typically have a right to receive commissions (residuals) from the Company based upon a percentage of the net revenue generated from merchant transactions. The Company may decide to pay an ISO an agreed-upon amount in exchange for the ISO's surrender of its right to receive future commissions on the merchant portfolio. The amount that the Company pays for these residual buyouts is capitalized and subsequently amortized over the expected life of the underlying merchant relationship.

The Company also considered the market conditions generated by the COVID-19 pandemic and concluded that there were no additional impairment indicators present at September 30, 2020 and that no other intangible assets were likely impaired.





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7.    PROPERTY, EQUIPMENT AND SOFTWARE

The Company's property, equipment, and software balance primarily consists of furniture, fixtures, and equipment used in the normal course of business, computer software developed for internal use, and leasehold improvements. Computer software represents purchased software and internally developed back office and merchant interfacing systems used to assist the reporting of merchant processing transactions and other related information.

A summary of property, equipment, and software as of September 30, 2020 and December 31, 2019 follows:

(in thousands)September 30, 2020December 31, 2019
Furniture and fixtures$2,795 $2,787 
Equipment10,216 10,101 
Computer software42,871 37,440 
Leasehold improvements6,250 6,367 
 62,132 56,695 
Less accumulated depreciation(38,642)(33,177)
Property, equipment, and software, net$23,490 $23,518 

Depreciation expense for property, equipment, and software totaled $2.0 million and $5.7 million for the three months and nine months ended September 30, 2020, respectively, and $1.7 million and $4.7 million for the three months and nine months ended September 30, 2019, respectively.


8.    ACCOUNTS PAYABLE AND ACCRUED EXPENSES

The Company accrues for certain expenses that have been incurred and not paid, which are classified within accounts payable and accrued expenses in the accompanying consolidated balance sheets.

The components of accounts payable and accrued expenses that exceeded five percent of total current liabilities at either September 30, 2020 or December 31, 2019 consisted of the following:
(in thousands)September 30, 2020December 31, 2019
Accounts payable$4,794 $6,968 
Accrued network fees$7,813 $6,950 
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9.    DEBT OBLIGATIONS

Outstanding debt obligations as of September 30, 2020 and December 31, 2019 consisted of the following:
(in thousands)September 30, 2020December 31, 2019
Senior Credit Agreement:
Term facility - Matures January 3, 2023 and bears interest at LIBOR (with a LIBOR "floor" of 1.00% beginning March 18, 2020) plus 6.50% and 5.00% at September 30, 2020 and December 31, 2019, respectively (actual rate of 7.50% and 6.71% at September 30, 2020 and December 31, 2019, respectively)
$280,419 $388,837 
Revolving credit facility - $25.0 million line, matures January 22, 2022, and bears interest at LIBOR plus 6.50% and 5.00% at September 30, 2020 and December 31, 2019, respectively (actual rate of 6.65% and 6.71% at September 30, 2020 and December 31, 2019, respectively)
11,000 11,500 
Term Loan - Subordinated, matures July 3, 2023 and bears interest at 5.00% plus an applicable margin (actual rate of 12.50% and 10.50% at September 30, 2020 and December 31, 2019, respectively)
100,693 95,142 
Total debt obligations392,112 495,479 
Less: current portion of long-term debt(15,583)(4,007)
Less: unamortized debt discounts and deferred financing costs(5,323)(5,894)
Long-term debt, net$371,206 $485,578 

Substantially all of the Company's assets are pledged as collateral under the credit agreements. The Company is neither a borrower nor a guarantor of the credit agreements. The Company's subsidiaries that are borrowers or guarantors under the credit agreements are referred to as the "Borrowers."


Amendments in First Quarter 2020

On March 18, 2020, the Borrowers entered into an amendment to the Senior Credit Agreement with an existing syndicate of lenders (the "Senior Credit Agreement") and into a related amendment to the existing credit agreement with Goldman Sachs Specialty Lending, LLC (the "GS Credit Agreement"). Both amendments were accounted for as debt modifications under GAAP. Together, these amendments are referred to as the "Sixth Amendment."

Under the Sixth Amendment, the outstanding balances under the term loan facilities of the Senior Credit Agreement and the GS Credit Agreement term loan were not changed. Additionally, the Senior Credit Agreement continues to provide a $25.0 million revolving credit facility, which includes accommodation for any outstanding letters of credit and a $5.0 million swing line facility. At September 30, 2020 and December 31, 2019, approximately $14.0 million and $13.5 million, respectively, was available under the revolving credit facility. Undrawn commitments for letters of credit under the revolving credit facility were not material at September 30, 2020 and December 31, 2019.


Senior Credit Agreement

Outstanding borrowings under the Senior Credit Agreement accrue interest using either a base rate (as defined) or a LIBOR rate plus an applicable margin, or percentage per annum, as provided in the amended credit agreement. For the term loan facility of the Senior Credit Facility, the Sixth Amendment provides for a LIBOR "floor" of 1.0% per annum. Accrued interest is payable quarterly. The revolving credit facility incurs a commitment fee on any undrawn amount of the $25.0 million credit line, which equates to 0.50% per annum for the unused portion.


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GS Credit Agreement

Outstanding borrowings under the GS Credit Agreement accrue interest at 5.0%, plus an applicable margin, or percentage per annum, as indicated in the amended credit agreement. Accrued interest is payable quarterly at 5.0% per annum, and the accrued interest attributable to the applicable margin is capitalized as payment-in-kind ("PIK") interest each quarter.


Changes in Applicable Interest Rate Margins

The interest rate margins for the Senior Credit Agreement and the GS Credit Agreement increased incrementally by 1.0% on June 16, 2020, and then increased incrementally by 0.5% on each of the dates July 16, August 15, and September 14, 2020 because the Borrowers did not make a permitted accelerated principal payment of at least $100 million under the term loan facility of the Senior Credit Agreement on or before those dates as described in the Sixth Amendment (the "$100 million principal prepayment"). The additional interest expense incurred by the Borrowers due to the increases in the applicable margin for the revolving credit facility under the Senior Credit Agreement was paid in cash and such increases for the term facility of the Senior Credit Facility and the GS Credit Agreement were accounted for as PIK interest at the election of the Borrowers.

On September 25, 2020, the Borrowers made the $100 million principal prepayment plus an additional $6.5 million principal prepayment to reduce the outstanding indebtedness under the term loan facility of the Senior Credit Agreement. This $106.5 million prepayment resulted in simultaneous reductions in the applicable interest rate margins under the Senior Credit Agreement and the GS Credit Agreement, which prospectively eliminates and reverses the applicable margin increases described in the preceding paragraph.

Under the terms of the Senior Credit Agreement and the GS Credit Agreement, the future applicable interest rate margins may vary based on the Borrowers' future Total Net Leverage Ratio (as defined) in addition to future changes in the underlying market rates for LIBOR and the rate used for base-rate borrowings. The Senior Credit Agreement and the GS Credit Agreement also have incremental margins that would apply to the future applicable interest rates if the Borrowers are deemed to be in violation of the terms of the credit agreement.


Contractual Maturities

Based on terms and conditions existing at September 30, 2020, future minimum principal payments for long-term debt are as follows:
(in thousands)Principal Due
Senior Credit AgreementGS Credit AgreementTotal
Twelve-month period ending September 30,TermRevolverTerm
2021 (current)
$15,583 $ $ $15,583 
202234,023 11,000  45,023 
2023230,813   230,813 
2024  100,693 100,693 
Total$280,419 $11,000 $100,693 $392,112 


Additionally, the Company may be obligated to make certain additional mandatory prepayments after the end of each year based on excess cash flow, as defined in the Senior Credit Agreement. No such prepayments were due for the year ended December 31, 2019.
Under the Senior Credit Agreement, prepayments of outstanding principal may be made in permitted increments with a 1% penalty for certain prepayments. Under the GS Credit Agreement, prepayment of outstanding principal is subject to a 4.0% penalty for certain prepayments occurring prior to March 18, 2021 and 2.0% for certain prepayments occurring between March
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18, 2021 and March 18, 2022. Such penalties will be based on the principal amount that is prepaid, subject to the terms of the credit agreements.

PIK Interest
The principal amount borrowed and outstanding under the GS Credit Agreement was $80.0 million at September 30, 2020 and December 31, 2019. Included in the outstanding principal balance at September 30, 2020 and December 31, 2019 was accumulated PIK interest of $20.7 million and $15.1 million, respectively. The principal amount of the GS Credit Agreement increased for PIK interest by $2.3 million and $5.6 million for the three months and nine months ended September 30, 2020, respectively. For the three months and nine months ended September 30, 2019, PIK interest added $1.3 million and $3.8 million, respectively, to the principal of the GS Credit Agreement.

During the three months and nine months ended September 30, 2020, PIK interest of approximately $0.9 million and $1.1 million, respectively, was added to the principal of the term facility of the Senior Credit Agreement. These amounts were composed entirely of the additional interest expense that resulted from the increases in the applicable margins that were previously described.


Interest Expense and Amortization of Deferred Loan Costs and Discounts

Interest expense, including fees for undrawn amounts under the revolving credit facility and amortization of deferred financing costs and debt discounts, was $13.5 million and $35.5 million for the three months and nine months ended September 30, 2020, respectively, and $10.5 million and $30.6 million for the three months and nine months ended September 30, 2019, respectively. Interest expense for the nine months ended September 30, 2019 also included a $0.4 million fee for the $70.0 million delayed principal draw under December 2018 amendment to the Senior Credit Agreement, which occurred during the first quarter of 2019.

For the Sixth Amendment, $2.7 million of lender fees were capitalized in first quarter of 2020 and this amount was added to then-existing unamortized loan costs and discount of $5.6 million. Interest expense increased due to the amortization of deferred financing costs and debt discounts by $0.7 million and $1.8 million for the three months and nine months ended September 30, 2020, respectively, and by $0.4 million and $1.2 million for the three months and nine months ended September 30, 2019, respectively.

The effective interest rates, which includes PIK interest and amortization of deferred financing costs and debt discounts, for the term debt under the Senior Credit Agreement and the GS Credit Agreement were as follows:
Three Months Ended September 30,Nine Months Ended September 30,
Term Debt2020201920202019
Senior Credit Agreement9.87 %7.92 %8.57 %7.50 %
GS Credit Agreement14.62 %10.90 %12.99 %10.80 %


Debt Extinguishment Costs and Debt Modification Costs

The $106.5 million principal repayment made in September 2020 for the term facility of the Senior Credit Agreement was deemed to be a partial extinguishment of debt that was permitted and contemplated by the existing debt agreement, as previously amended. As a result, a proportional amount of unamortized loan costs and discount in the amount of $1.5 million was removed and expensed during the three months and nine months ended September 30, 2020.

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Costs that the Company incurs for debt modification that are not eligible for deferral and subsequent amortization as interest expense are reported as debt modification costs on the Company's consolidated statement of operations. Approximately $0.4 million of such costs were expensed in connection with the Sixth Amendment during the first quarter of 2020.


Covenants

The Senior Credit Agreement and the GS Credit Agreement, as amended, contain 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 Company's subsidiaries 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.

The Company is also required to comply with certain restrictions on its Total Net Leverage Ratio, which is defined in the credit agreements as the ratio of consolidated total debt of the Borrowers to the Company's consolidated adjusted EBITDA (as defined in the Senior Credit Agreement and GS Credit Agreement). The maximum permitted Total Net Leverage Ratio was 7.75:1.00 at September 30, 2020. As of September 30, 2020, the Company remained in compliance with the covenants.



10.    INCOME TAXES

Income Tax Expense (Benefit)

The Company's expense (benefit) for federal and state income taxes was as follows:
(in thousands)Three Months Ended September 30,Nine Months Ended September 30,
2020201920202019
Current income tax expense$6,115 $18 $6,224 $ 
Deferred income tax expense (benefit)14,011 (1,655)10,442 (5,376)
Increase (decrease) in DTA valuation allowance 1,171 (108)5,353 5,197 
(Decrease) increase in DTA valuation allowance - discrete item(7,560)9 (9,100)2,647 
Total income tax expense (benefit)$13,737 $(1,736)$12,919 $2,468 

    DTA = Deferred income tax asset


The Company's effective income tax rate (benefit) for the three months and nine months ended September 30, 2020 was 13.8% and 15.2%, respectively, and was 22.9% and (10.3)% for the three months and nine months ended September 30, 2019, respectively. Approximately $12.4 million of income tax expense for the three months and nine months ended September 30, 2020 was attributable to the gain on the business sale (see Note 2, Sale of Business).


Valuation Allowance for Deferred Income Tax Assets

The Company considers all available positive and negative evidence to determine whether sufficient taxable income will be generated in the future to permit realization of the existing deferred tax assets. In accordance with the provisions of ASC 740, Income Taxes ("ASC 740"), the Company is required to provide a valuation allowance against deferred income tax assets when it is "more likely than not" that some portion or all of the deferred tax assets will not be realized.
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Among other provisions, the Tax Cuts and Jobs Act of 2017 amended Internal Revenue Code Section 163(j) to create limitations on the deductibility of business interest expense. Section 163(j) limits the business interest deduction to 30% of adjusted taxable income ("ATI"). For taxable years through 2021, the calculation of ATI closely aligns with earnings before interest, taxes, depreciation and amortization ("EBITDA"). Commencing in 2022, the ATI limitation more closely aligns with earnings before interest and taxes ("EBIT"), without adjusting for depreciation and amortization.  Any business interest in excess of the annual limitation is carried forward indefinitely. In March 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted, which among other provisions, provides for the increase of the 163(j) ATI limitation from 30% to 50% for tax years 2019 and 2020.
Adjustments to the valuation allowance are a component of income tax expense (benefit) in the Company's unaudited condensed consolidated statements of operations. An increase in the valuation allowance for deferred income taxes will increase income tax expense (or reduce an otherwise income tax benefit), and a decrease in the valuation allowance will decrease income tax expense (or increase an otherwise income tax benefit).

Based on management’s assessment, the Company decreased the valuation allowance in the three months and nine months ended September 30, 2020 by $6.4 million and $3.7 million, respectively, for the business interest expense carryover comprised of (i) discrete decreases of $7.6 million and $9.1 million for the three months and nine months ended September 30, 2020, respectively, associated with the 2018 and 2019 business interest deferred income tax assets as a result of the CARES Act and expected utilization of these assets in 2020 and (ii) increases of $1.2 million and $5.4 million for the three months and nine months ended September 30, 2020, respectively, associated with the 2020 debt refinancing that results in excess business interest in future years.

For the three months and nine months ended September 30, 2019, the Company recorded a decrease of $0.1 million and an increase of $7.8 million, respectively, in the valuation allowance for the business interest carryover comprised of (i) a discrete increase of $2.6 million for the nine months ended September 30, 2019 associated with the 2018 business interest deferred tax asset and (ii) a decrease of $0.1 million and an increase of $5.2 million for the three months and nine months ended September 30, 2019, respectively, associated with the 2019 excess business interest.

The Company will continue to evaluate the realizability of the deferred tax assets on a quarterly basis and, as a result, the valuation allowance may change in future periods.
Uncertain Tax Positions
The Company recognizes the tax effects of uncertain tax positions only if such positions are more likely than not to be sustained based solely upon its technical merits at the reporting date. The Company refers to the difference between the tax benefit recognized in its financial statements and the tax benefit claimed in the income tax return as an "unrecognized tax benefit." As of September 30, 2020, the net amount of our unrecognized tax benefits was not material.

The Company is subject to U.S. federal income tax and income tax in multiple state jurisdictions. Tax periods for 2016 and all years thereafter remain open to examination by the federal and state taxing jurisdictions and tax periods for 2015 and all years thereafter remain open for certain state taxing jurisdictions to which the Company is subject.


11.    COMMITMENTS AND CONTINGENCIES


Minimum Annual Commitments with Third-Party Processors

The Company has multi-year agreements with third parties to provide certain payment processing services to the Company. The Company pays processing fees under these agreements that are based on the volume and dollar amounts of processed payments transactions. Some of these agreements have minimum annual requirements for processing volumes. As of September 30, 2020 and December 31, 2019, the Company is committed to pay minimum processing fees under these agreements of $14.0 million through the end of 2021.

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Commitment to Lend

See Note 12, Related Party Transactions, for information on a loan commitment extended by the Company to another entity.


Contingent Consideration for Asset Acquisitions

Under GAAP that applies to asset acquisitions that do not meet the definition of a business, the portion of the unpaid purchase price that is contingent on future activities is not initially recorded by the acquirer on the date of acquisition. Rather, the acquirer generally recognizes contingent consideration when it becomes probable and estimable.

During the year ended December 31, 2019, the Company simultaneously entered into two agreements with another entity.  These two related agreements 1) transfer to the Company certain perpetual rights to a merchant portfolio and 2) form a 5-year reseller arrangement whereby the Company will offer and sell to its customer base certain on-line services to be fulfilled by the other entity.  No cash consideration was paid to, or received from, the other entity at execution of either agreement.  Subsequent cash payments from the Company to the other entity for the merchant portfolio rights are determined based on a combination of both: 1) the actual financial performance of the acquired merchant portfolio rights and 2) actual sales and variable wholesale costs for the on-line services sold by the Company under the reseller arrangement.  Amounts subsequently paid to the other entity are accounted for as either 1) standard costs of the services sold by the Company under the 5-year reseller agreement or 2) consideration for the merchant portfolio rights. Amounts paid that are accounted for as consideration for the merchant portfolio rights are capitalized and amortized over the estimated useful life of the merchant portfolio rights.  As of September 30, 2020 and December 31, 2019, $3.8 million and $1.1 million, respectively, was capitalized as cost for the merchant portfolio. The capitalized cost, which is in our Consumer Payments reportable segment, is being amortized using an accelerated method. At this time, the Company cannot reasonably estimate the allocation of future cash payments. However, under the two contracts the Company does not anticipate any net losses.  

On March 15, 2019, a subsidiary of the Company paid $15.2 million cash to acquire certain residual portfolio rights. This asset acquisition became part of the Company's Consumer Payments reportable segment. Of the $15.2 million, $5.0 million was funded from a delayed draw down of the Senior Credit Facility. Additionally, a $10.0 million draw was made against the revolving credit facility under the Senior Credit Facility and cash on hand was used to fund the remaining amount. The initial purchase price is subject to an increase of up to $6.4 million in accordance with the terms of the agreement between the Company and the sellers. As of September 30, 2020, an additional $2.1 million of the $6.4 million total contingent consideration has been paid to the seller. Additional purchase price is accounted for when payment to the seller becomes probable and is added to the amortizable carrying value of the asset. During the second quarter 2020, the Company and the seller amended the agreement to provide the Company with additional guaranteed returns from the acquired residual portfolio rights, and the additional consideration from the Company to the seller of $0.8 million was added to the amortizable carrying value of the asset.


Contingent Consideration for Business Combinations

See Note 15, Fair Value, for information about contingent consideration related to 2018 business acquisitions.


Legal Proceedings

The Company is involved in certain legal proceedings and claims which arise in the ordinary course of business. In the opinion of the Company and based on consultations with inside and outside counsel, the results of any of these matters, individually and in the aggregate, are not expected to have a material effect on the Company's results of operations, financial condition, or cash flows. As more information becomes available, and the Company determines that an unfavorable outcome is probable on a claim and that the amount of probable loss that the Company will incur on that claim is reasonably estimable, the Company will record an accrued expense for the claim in question. If and when the Company records such an accrual, it could be material and could adversely impact the Company's results of operations, financial condition, and cash flows.

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Concentration of Risks

The Company's revenue is substantially derived from processing Visa and MasterCard bank card transactions. Because the Company is not a member bank, in order to process these bank card transactions, the Company maintains sponsorship agreements with member banks which require, among other things, that the Company abide by the by-laws and regulations of the card associations.

A majority of the Company's cash and restricted cash is held in certain financial institutions, substantially all of which is in excess of federal deposit insurance corporation limits. The Company does not believe it is exposed to any significant credit risk from these transactions.


12.    RELATED PARTY TRANSACTIONS

Commitment to Lend and Warrant to Acquire
On May 22, 2019, the Company, through one of its wholly-owned subsidiaries, executed an interest-bearing loan and commitment agreement with another entity. The Company has loaned the entity a total of $3.5 million at September 30, 2020 and December 31, 2019, with a commitment to loan up to a total of $10.0 million based on certain growth metrics of the entity and continued compliance by the entity with the terms and covenants of the agreement. The Company's commitment to make additional advances under the loan agreement is dependent upon such advances not conflicting with covenants or restrictions under any of the Company's debt or other applicable agreements. Amounts loaned to this entity by the Company are secured by substantially all of the assets of the entity and by a personal guarantee. The note receivable has an interest rate of 12.0% per annum and is repayable in full in May 2024. The Company recognized interest income of $56,000 and $166,000 during the three months and nine months ended September 30, 2020, respectively. Interest income for the comparable periods in 2019 was $46,000 and $66,000, respectively. The Company also received a warrant to purchase a NCI in this entity's equity at a fixed amount. The loan agreement also gives the Company certain rights to purchase some or all of this entity's equity in the future, at the entity's then-current fair value. The fair values of the warrant, loan commitment, and purchase right were not material at inception or as of any subsequent reporting period.
Contributions of Assets and Contingent Payment
In February 2019, a subsidiary of the Company, Priority Hospitality Technology, LLC ("PHOT"), received a contribution of substantially all of the operating assets of eTab, LLC ("eTab") and CUMULUS POS, LLC ("Cumulus") under asset contribution agreements. No material liabilities were assumed by PHOT. These contributed assets were composed substantially of technology-related assets. Prior to these transactions, eTab was 80.0% owned by the Company's Chairman and Chief Executive Officer. No cash consideration was paid to the contributors of the eTab or Cumulus assets on the date of the transactions. As consideration for these contributed assets, the contributors were issued redeemable preferred equity interests in PHOT. Under these redeemable preferred equity interests, the contributors are eligible to receive up to $4.5 million of profits earned by PHOT, plus a preferred yield (6.0% per annum) on any of the $4.5 million amount that has not been distributed to them. The Company's Chairman and Chief Executive Officer owns 83.3% of the redeemable preferred equity interests in PHOT. Once a total of $4.5 million plus the preferred yield has been distributed to the holders of the redeemable preferred equity interests, the redeemable preferred equity interests will cease to exist. The Company determined that the contributor's carrying value of the eTab net assets (as a common control transaction under GAAP) was not material. Under the guidance for a common control transaction, the contribution of the eTab net assets did not result in a change of entity or the receipt of a business, therefore the Company's financial statements for prior periods have not been adjusted to reflect the historical results attributable to the eTab net assets. Additionally, no material amount was estimated for the fair value of the contributed Cumulus net assets. PHOT is a part of the Company's Integrated Partners reportable segment.

Pursuant to the limited liability company agreement of PHOT, any material undistributed earnings generated by the eTab and Cumulus assets that are attributable to the holders of the preferred equity interests are reported by the Company as a form of NCI classified as mezzanine equity on the Company's consolidated balance sheet until $4.5 million and the preferred yield have been distributed to the holders of the preferred equity interests. Subsequent changes in the value of the NCI will be reported as
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an equity transaction between the Company's consolidated retained earnings (accumulated deficit) and any carrying value of the NCI in mezzanine equity. Such amounts were not material to the Company's results of operations, financial position, or cash flows for the period covering February 1, 2019 (date the assets were contributed to the Company) through June 30 2020, and therefore no recognition of the NCI was reflected in the Company's consolidated financial statements. For the nine months ended September 30, 2020, $200,000 of PHOT's earnings were attributable to the NCIs of PHOT, and this amount was also distributed in cash to the NCIs during the same period.

Equity-Method Investment

During the first quarter of 2020, the Company wrote off its $0.2 million carrying value in an equity-method investment. This loss is reported as a component of Other (expense) income, net on the Company's unaudited condensed consolidated statement of operations. The Company's share of this entity's income or loss was not material for any reporting period presented.


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13.    RECONCILIATION OF STOCKHOLDERS' DEFICIT AND NON-CONTROLLING INTERESTS

The Company is authorized to issue 100,000,000 shares of preferred stock with such designations, voting and other rights and preferences as may be determined from time to time by the board of directors. As of September 30, 2020 and December 31, 2019, the Company has not issued any shares of preferred stock.
The following tables provide a reconciliation of the beginning and ending carrying amounts for the periods presented for the components of the deficit attributable to stockholders of the Company and equity attributable to NCI:
(in thousands)Additional Paid-In CapitalAccumulated (Deficit)Total Priority Technology Holdings, Inc. Stockholders' (Deficit)NCI (c)
Preferred StockCommon StockTreasury Stock (a)
SharesAmountSharesAmountSharesAmount