Priority Technology Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes for the years ended December 31, 2019, 2018 and 2017 and the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in the Company's Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 30, 2020 (the "Annual Report"). Cautionary Note Regarding Forward-Looking Statements Some of the statements made in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements include, but are not limited to, statements regarding our or our management's expectations, hopes, beliefs, intentions or strategies regarding the future. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, such as statements about our future financial performance, including any underlying assumptions, are forward- looking statements. The words "anticipate," "believe," "continue," "could," "estimate," "expect," "future," "goal," "intend," "likely," "may," "might," "plan," "possible," "potential," "predict," "project," "seek," "should," "would," "will," "approximately," "shall" and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about: • the impact of the COVID-19 pandemic; • competition in the payment processing industry; • the use of distribution partners; • any unauthorized disclosures of merchant or cardholder data, whether through breach of our computer systems, computer viruses, or otherwise; • any breakdowns in our processing systems; • government regulation, including regulation of consumer information; • the use of third-party vendors; • any changes in card association and debit network fees or products; • any failure to comply with the rules established by payment networks or standards established by third-party processor; • any proposed acquisitions or any risks associated with completed acquisitions; and • other risks and uncertainties set forth in the "Item 1A - Risk Factors" included in this Quarterly Report or our Annual Report. We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q. The forward-looking statements contained in this Quarterly Report on Form 10-Q are based on our current expectations and beliefs concerning future developments and their potential effects on us. You should not place undue reliance on these forward-looking statements in deciding whether to invest in our securities. We cannot assure you that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause our actual results or performance to be materially different from those expressed or implied by these forward-looking statements. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. In addition, statements that "we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially - 32 - Table of Contents available relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements. You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. Forward-looking statements speak only as of the date they were made. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. Terms Used in this Quarterly Report on Form 10-Q As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to the terms "Company," "we," "us" and "our" refer to Priority Technology Holdings, Inc. and its consolidated subsidiaries. - 33 - Table of Contents Results of Operations This section includes a discussion and analysis of our results of operations for the three months ended September 30, 2020 (or third quarter 2020) compared to the three months ended September 30, 2019 (or third quarter 2019), and the nine months ended September 30, 2020 (or 2020 period) compared to the nine months ended September 30, 2019 (or 2019 period). We have derived this data, except key indicators for merchant bankcard processing dollar values and transaction volumes, from our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements included in our latest Annual Report on Form 10-K. Three Months Ended September 30, 2020 Compared to the Three Months Ended September 30, 2019 (dollars in thousands) Three Months Ended September 30, 2020 2019 Change % Change REVENUES $ 108,962 $ 93,883 $ 15,079 16.1 % OPERATING EXPENSES: Costs of services 74,971 63,718 11,253 17.7 % Salary and employee benefits 10,010 10,668 (658) (6.2) % Depreciation and amortization 10,251 10,077 174 1.7 % Selling, general and administrative 6,688 6,695 (7) (0.1) % Total operating expenses 101,920 91,158 10,762 11.8 % Income from operations 7,042 2,725 4,317 158.4 % OTHER INCOME (EXPENSES): Interest expense (13,471) (10,463) (3,008) 28.7 % Debt extinguishment costs (1,523) — (1,523) nm Gain on sale of business 107,239 — 107,239 nm Other income, net 190 158 32 20.3 % Total other income (expenses), net 92,435 (10,305) 102,740 nm Income (loss) before income taxes 99,477 (7,580) 107,057 nm Income tax expense (benefit) 13,737 (1,736) 15,473 nm Net income (loss) 85,740 (5,844) 91,584 nm Less net income attributable to non-controlling interests (45,348) — (45,348) nm Net income (loss) attributable to stockholders of Priority Technology Holdings, Inc. $ 40,392 $ (5,844) $ 46,236 nm nm = not meaningful - 34 - Table of Contents Nine Months Ended September 30, 2020 Compared to the Nine Months Ended September 30, 2019 (dollars in thousands) Nine Months Ended September 30, 2020 2019 Change % Change REVENUES $ 298,251 $ 273,671 $ 24,580 9.0 % OPERATING EXPENSES: Costs of services 203,733 185,827 17,906 9.6 % Salary and employee benefits 29,695 31,923 (2,228) (7.0) % Depreciation and amortization 30,886 28,763 2,123 7.4 % Selling, general and administrative 19,305 21,031 (1,726) (8.2) % Total operating expenses 283,619 267,544 16,075 6.0 % Income from operations 14,632 6,127 8,505 138.8 % OTHER INCOME (EXPENSES): Interest expense (35,454) (30,602) (4,852) 15.9 % Debt modification and extinguishment costs (1,899) — (1,899) nm Gain on sale of business 107,239 — 107,239 nm Other income, net 414 523 (109) (20.8) % Total other income (expenses), net 70,300 (30,079) 100,379 nm Income (loss) before income taxes 84,932 (23,952) 108,884 nm Income tax (benefit) expense 12,919 2,468 10,451 nm Net income (loss) 72,013 (26,420) 98,433 nm Less net income attributable to non-controlling interests (45,348) — (45,348) nm Net income (loss) attributable to stockholders of Priority Technology Holdings, Inc. $ 26,665 $ (26,420) $ 53,085 nm nm = not meaningful - 35 - Table of Contents The following table shows our reportable segments' financial performance data and selected performance measures for the three months ended September 30, 2020 compared to the three months ended September 30, 2019: (in thousands) Three Months Ended September 30, 2020 2019 Change % Change Consumer Payments: Revenue $ 99,301 $ 82,742 $ 16,559 20.0 % Operating expenses 88,203 75,528 12,675 16.8 % Income from operations $ 11,098 $ 7,214 $ 3,884 53.8 % Operating margin 11.2 % 8.7 % Depreciation and amortization $ 8,481 $ 8,302 $ 179 2.2 % Key Indicators: Merchant bankcard processing dollar value $ 11,235,068 $ 10,566,501 $ 668,567 6.3 % Merchant bankcard transaction volume 122,623 131,646 (9,023) (6.9) % Commercial Payments: Revenue $ 4,995 $ 6,338 $ (1,343) (21.2) % Operating expenses 4,826 6,720 (1,894) (28.2) % Income (loss) from operations $ 169 $ (382) $ 551 (144.2) % Operating margin 3.4 % (6.0) % Depreciation and amortization $ 77 $ 69 $ 8 11.6 % Key Indicators: Merchant bankcard processing dollar value $ 58,304 $ 92,290 $ (33,986) (36.8) % Merchant bankcard transaction volume 24 26 (2) (7.7) % Integrated Partners: Revenue $ 4,666 $ 4,803 $ (137) (2.9) % Operating expenses 4,413 3,800 613 16.1 % Income from operations $ 253 $ 1,003 $ (750) (74.8) % Operating margin 5.4 % 20.9 % Depreciation and amortization $ 1,403 $ 1,299 $ 104 8.0 % Key Indicators: Merchant bankcard processing dollar value $ 105,537 $ 119,747 $ (14,210) (11.9) % Merchant bankcard transaction volume 371 421 (50) (11.9) % Income from operations of reportable segments $ 11,520 $ 7,835 $ 3,685 47.0 % Less: Corporate expense (4,478) (5,110) 632 (12.4) % Consolidated income from operations $ 7,042 $ 2,725 $ 4,317 158.4 % Corporate depreciation and amortization $ 290 $ 407 $ (117) (28.7) % Key indicators: Merchant bankcard processing dollar value $ 11,398,909 $ 10,778,538 $ 620,371 5.8 % Merchant bankcard transaction volume 123,018 132,093 (9,075) (6.9) % - 36 - Table of Contents The following table shows our reportable segments' financial performance data and selected performance measures for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019: (in thousands) Nine Months Ended September 30, 2020 2019 Change % Change Consumer Payments: Revenue $ 267,039 $ 243,205 $ 23,834 9.8 % Operating expenses 241,519 220,909 20,610 9.3 % Income from operations $ 25,520 $ 22,296 $ 3,224 14.5 % Operating margin 9.6 % 9.2 % Depreciation and amortization $ 25,721 $ 24,215 $ 1,506 6.2 % Key Indicators: Merchant bankcard processing dollar value $ 30,632,724 $ 31,551,405 $ (918,681) (2.9) % Merchant bankcard transaction volume 334,896 382,676 (47,780) (12.5) % Commercial Payments: Revenue $ 17,017 $ 19,492 $ (2,475) (12.7) % Operating expenses 15,609 20,607 (4,998) (24.3) % Income (loss) from operations $ 1,408 $ (1,115) $ 2,523 (226.3) % Operating margin 8.3 % (5.7) % Depreciation and amortization $ 231 $ 248 $ (17) (6.9) % Key Indicators: Merchant bankcard processing dollar value $ 195,229 $ 236,716 $ (41,487) (17.5) % Merchant bankcard transaction volume 70 84 (14) (16.7) % Integrated Partners: Revenue $ 14,195 $ 10,974 $ 3,221 29.4 % Operating expenses 12,729 9,632 3,097 32.2 % Income from operations $ 1,466 $ 1,342 $ 124 9.2 % Operating margin 10.3 % 12.2 % Depreciation and amortization $ 4,048 $ 3,086 $ 962 31.2 % Key Indicators: Merchant bankcard processing dollar value $ 352,144 $ 259,894 $ 92,250 35.5 % Merchant bankcard transaction volume 1,207 913 294 32.2 % Income from operations of reportable segments $ 28,394 $ 22,523 $ 5,871 26.1 % Less: Corporate expense (13,762) (16,396) 2,634 (16.1) % Consolidated income from operations $ 14,632 $ 6,127 $ 8,505 138.8 % Corporate depreciation and amortization $ 886 $ 1,214 $ (328) (27.0) % Key indicators: Merchant bankcard processing dollar value $ 31,180,097 $ 32,048,015 $ (867,918) (2.7) % Merchant bankcard transaction volume 336,173 383,673 (47,500) (12.4) % - 37 - Table of Contents Impact of COVID-19 on Results and Trends The outbreak of COVID-19 in the United States, which was declared a pandemic by the World Health Organization on March 11, 2020, continues to adversely affect commercial activity and has contributed to a significant decline in economic activity in 2020 compared to 2019. Starting in mid-March 2020 through April 2020, COVID-19 had a significant negative affect on our results. This impact was evident in a significant decline in merchant bankcard volume and revenue during the period of restrictive shelter-in-place requirements instituted across the United States toward the end of March 2020 through April 2020. In May, as shelter in place restrictions began to be lifted and regional economies started to reopen, our processing volumes began to return and revenue growth was supplemented by the acceleration of certain specialized product offerings and ecommerce payment transactions. As a result, we experienced consolidated revenue growth of 10.6% and 0.2% in the first and second quarters of 2020, respectively. Within the second quarter of 2020 we experienced a trough revenue decline of 11.7% in April with accelerating revenue performance of 1.7% growth in May and 10.8% revenue growth in June as compared with the comparable months in 2019. This momentum continued to accelerate in the third quarter of 2020 where we experienced revenue growth of 16.1% over the third quarter of 2019. Beginning in late summer and continuing into autumn, the level of new COVID-19 cases began to increase again in the United States, with certain states impacted more than others. While there continues to be considerable uncertainty regarding the future economic impacts of this current surge of the pandemic, our October 2020 operating results remained consistent with the third quarter 2020 results. The future impact on the overall economy and our results are beyond our ability to predict or control. Revenue Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019 Consolidated revenue Our consolidated revenue in third quarter 2020 of $109.0 million increased by $15.1 million, or 16.1%, from revenue in third quarter 2019 of $93.9 million. Revenue growth of $16.6 million in our Consumer Payments segment was partially offset by revenue declines of $1.3 million and $0.1 million in our Commercial Payments and Integrated Partners segments, respectively. Revenue in Consumer Payments segment Consumer payments revenue in third quarter 2020 of $99.3 million increased $16.6 million, or 20.0%, compared to revenue in third quarter 2019 of $82.7 million. This increase was driven by $8.1 million, or 806.8%, revenue growth from high-margin specialized ecommerce merchants, and higher overall average revenue per processing dollar value. Merchant bankcard processing dollar value in the third quarter of 2020 of $11.2 billion increased by $668.6 million, or 6.3%, as compared with $10.6 billion in the third quarter of 2019. Merchant bankcard transactions of 122.6 million in the third quarter of 2020 declined by 6.9%, as compared with 131.6 million in the third quarter of 2019. However, our merchant volume mix drove a 14.2% higher average ticket of $91.62 in the third quarter of 2020, as compared with $80.26 in the third quarter of 2019. Current economic factors have impacted the merchant volume mix, including shifts in payment transaction activity among certain vertical industries, spending trends related to the COVID-19 pandemic that appear to have resulted in consumers conducting fewer payment transactions at higher average transaction values, and an increase in card-not-present transactions. Card-not-present volume generally offers more favorable pricing to us than other types of transactions. The trend of new merchant boarding remains within our historical range of 4,500 to 5,000 new merchants per month. During the third quarter of 2020, our monthly average of new merchants boarded was 4,638 compared with 4,774 in the third quarter of 2019. Revenue in Commercial Payments segment - 38 - Table of Contents Commercial Payments revenue in third quarter 2020 of $5.0 million decreased by $1.3 million, or 21.2%, compared to revenue in third quarter 2019 of $6.3 million. Revenue in this segment is derived primarily from our accounts payable automated solutions business and from our curated managed services business. Revenue from our accounts payable automated solutions business in third quarter 2020 of $1.5 million increased $0.1 million, or 6.9%, from $1.4 million in third quarter 2019. This increase was due to increased business from existing customers. Revenue from our curated managed services business in third quarter 2020 of $3.5 million decreased by $1.4 million, or 29.3%, from revenue in third quarter 2019 of $4.9 million. This decrease was driven by curtailment of a customer’s merchant financing program in response to the COVID related economic conditions. Revenue in Integrated Partners segment Integrated Partners revenue in third quarter 2020 of $4.7 million decreased by $0.1 million, or 2.9%, compared to revenue in third quarter 2019 of $4.8 million. Priority Real Estate Technology, LLC ("PRET") comprised $4.1 million and $4.2 million of this segment's revenue in third quarter 2020 and third quarter 2019, respectively. PRET is comprised of the RentPayment business, primarily assets acquired from YapStone, Inc. in March 2019, and our RadPad/Landlord Station business. The RentPayment business, which was sold in September 2020, generated revenue of $3.9 million in the third quarter of 2020 and $3.7 million in the third quarter of 2019. Revenue from PRET’s RadPad/Landlord Station, Priority PayRight Health Solutions ("PayRight") and Priority Hospitality Technology ("PHOT") comprise the remainder of this segment's revenue. As disclosed in Note 2, Sale of Business , to the unaudited condensed consolidated financial statements, in September 2020 we sold the RentPayment business. Simultaneously with this sale, PRET entered into revenue-producing agreements with the buyer to provide ongoing technology support and payment processing services to the sold business, and offer us an opportunity to expand this relationship and provide payment processing services to existing customers of the buyer. The RentPayment business sale will impact the trend of future results of Integrated Partners. Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019 Consolidated revenue Our consolidated revenue in the first nine months of 2020 of $298.3 million increased by $24.6 million, or 9.0%, from revenue in the first nine months of 2019 of $273.7 million. Revenue growth of $23.8 million in our Consumer Payments segment and $3.2 million in our Integrated Partners segments was partially offset by a decline of $2.5 million in our Commercial Payments segment. Revenue in Consumer Payments segment Consumer Payments revenue in the first nine months of 2020 of $267.0 million increased $23.8 million, or 9.8%, compared to revenue in the first nine months of 2019 of $243.2 million. This increase was driven by $11.6 million, or 199.4%, revenue growth from high margin specialized ecommerce merchants, and higher overall average revenue per processing dollar value. Merchant bankcard processing dollar value in the first nine months of 2020 of $30.6 billion decreased by $918.7 million, or 2.9%, as compared with $31.6 billion in the first nine months of 2019. Merchant bankcard transactions of 334.9 million in the first nine months of 2020 declined 12.5%, as compared with 382.7 million in the first nine months of 2019. However, our merchant volume mix drove a 10.9% higher average ticket of $91.47 in the first nine months of 2020, as compared with $82.45 in the first nine months of 2019. Current economic factors have impacted the merchant volume mix, including shifts in payment transaction activity among certain vertical industries, spending trends related to the COVID-19 pandemic that appear to have resulted in consumers conducting fewer payment transactions at higher average transaction values, and an increase in card-not-present transactions. Card-not-present volume generally offers more favorable pricing to us than other types of transactions. The trend of new merchant boarding remains within our historical range of 4,500 to 5,000 new merchants per - 39 - Table of Contents month. During the first nine months of 2020, our monthly average of new merchants boarded was 4,722 compared with 4,595 in the first nine months of 2019. Revenue in Commercial Payments segment Commercial Payments revenue in the first nine months of 2020 of $17.0 million decreased by $2.5 million, or 12.7%, compared to revenue in the first nine months of 2019 of $19.5 million. The increase in revenues from our accounts payable automated solutions services were offset by a decrease in revenues from our curated managed services programs. Revenue from our accounts payable automated solutions business in the first nine months of 2020 of $4.5 million increased $0.6 million, or 14.8%, compared to revenue in the first nine months of 2019 of $3.9 million. This increase was due to increased business from existing customers. Revenue from our curated managed services business in the first nine months of 2019 of $12.5 million decreased by $3.1 million, or 19.6%, compared to revenue in the first nine months of 2019 of $15.6 million. This decrease was driven by a decline and third quarter 2020 curtailment of a customer’s merchant financing program in response to the COVID related economic conditions. Revenue in Integrated Partners segment Integrated Partners revenue in the first nine months of 2020 of $14.2 million increased by $3.2 million, or 29.4%, compared to revenue in the first nine months of 2019 of $11.0 million. PRET comprised $12.6 million and $9.5 million of this segment's revenue in the first nine months of 2020 and the first nine months of 2019, respectively. The RentPayment business, which was formed upon the March 2019 asset acquisition from YapStone, Inc., generated revenue of $12.1 million in the first nine months of 2020 and $8.1 million in the first nine months of 2019. Revenue from PRET’s RadPad/Landlord Station, Priority PayRight Health Solutions ("PayRight") and PHOT comprise the remainder of this segment's revenue. As noted in the previous discussion for the third quarters of 2020 and 2019, the RentPayment business sale in September 2020 will impact the trend of future results of Integrated Partners. Consolidated Operating expenses Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019 Our consolidated operating expenses in third quarter 2020 of $101.9 million increased $10.8 million, or 11.8%, from consolidated operating expenses in third quarter 2019 of $91.2 million. This overall increase was driven by an increase in costs of services of $11.3 million, or 17.7%, resulting from higher revenues in third quarter 2020. Depreciation and amortization expense of $10.3 million increased slightly by $0.2 million, or 1.7%, in third quarter 2020. Salary and employee benefits expenses of $10.0 million decreased $0.7 million, or 6.2%, in third quarter 2020 driven by lower headcount in 2020. Selling, general and administrative expenses ("SG&A") of $6.7 million in third quarter 2020 approximated $6.7 million in third quarter 2019. Decreases in office and travel-related costs due to the COVID-19 pandemic, lower outside professional fees due to in-sourcing of certain services, and an overall focus on cost containment, was offset by a $1.0 million write-down in the carrying value of an intangible asset in the Consumer Payments segment. Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019 Our consolidated operating expenses in first nine months of 2020 of $283.6 million increased $16.1 million, or 6.0%, from consolidated operating expenses in third quarter 2019 of $267.5 million. This overall increase was driven by an increase in costs of services of $17.9 million, or 9.6%, resulting from higher revenues in first nine months of 2020. Depreciation and amortization expense of $30.9 million increased by $2.1 million, or 7.4%, in the first nine months of 2020 due to higher intangible amortization in the Consumer Payments and Integrated Partners segments. Salary and employee benefits expenses of $29.7 million decreased $2.2 million, or 7.0%, in first nine months of 2020 driven by lower headcount in 2020. SG&A of $19.3 - 40 - Table of Contents million decreased $1.7 million, or 8.2%, in first nine months of 2019 driven by decreases in office and travel-related costs due to the COVID-19 pandemic, lower outside professional fees due to in-sourcing of certain services, and an overall focus on cost containment. These reductions were partially offset by a $1.0 million write-down in the carrying value of an intangible asset in the Consumer Payments segment during the first nine months of 2020. Income (loss) from operations Three Months Ended September 30, 2020 Compared to Three Months Ended September 30, 2019 Consolidated income from operations in third quarter 2020 of $7.0 million increased by $4.3 million, or 158.4%, from $2.7 million in third quarter 2019. Our consolidated operating margin for third quarter 2020 was 6.5% compared to 2.9% for third quarter 2019. This margin increase was the result of lower salary and employee benefits expenses of $0.7 million due to headcount reductions, and higher revenues less costs of services of $3.8 million. These favorable changes for third quarter 2020 were partially offset by higher depreciation and amortization expense of $0.2 million and a $1.0 million write-down in the carrying value of an intangible asset in the Consumer Payments segment. Our Consumer Payments segment contributed $11.1 million in income from operations for third quarter 2020, an increase of $3.9 million, or 53.8%, from $7.2 million for third quarter 2019. The main driver of this change was an improved operating margin of 11.2% for third quarter 2020 compared to 8.7% for the third quarter of 2019 which reflected higher revenue less costs of services of $4.2 million. Growth in higher-margin specialty ecommerce transactions and the increase in the average ticket, both previously discussed, were the main drivers of the improved operating margin for third quarter 2020. Income from operations also benefited from a $0.7 million decrease in salary and employee benefits expenses due to lower headcount. Our Commercial Payments segment earned income from operations of $0.2 million for third quarter 2020 compared to a loss from operations of $0.4 million for third quarter 2019. This improvement was largely driven by a $0.2 million decrease in salaries and employee benefits expenses due to lower headcount and a $0.5 million decrease in SG&A expenses. Included in SG&A expenses for third quarter 2019 were certain one-time operational losses of $0.5 million which were substantially recovered in third quarter 2020. Our Integrated Partners segment earned income from operations of $0.3 million for third quarter 2020, a decrease of $0.8 million compared to $1.0 million of income from operations for third quarter 2019. The overall decrease was caused by a $0.2 million decrease in revenues less costs of services and a $0.6 million increase in SG&A expenses primarily related to transition services provided by YapStone, Inc. in connection with the assets acquired in March 2019. These transition services were $1.0 million in third quarter 2020 and $0.4 million in third quarter 2019. Operating results for third quarter 2020 and third quarter 2019 included depreciation and amortization expense of $1.4 million and $1.3 million, respectively. These factors were partially offset by a $0.2 million decrease in salary and employee benefit expenses. Corporate expenses were $4.5 million for third quarter 2020, a decrease of $0.6 million, or 12.4%, from expenses of $5.1 million for third quarter 2019. Salaries and employee benefits increased $0.4 million due to higher incentive compensation accruals, SG&A expenses declined $0.9 million, and depreciation and amortization expense decreased $0.1 million. Included in SG&A in third quarter 2020 are expenses we deem to be non-recurring in nature of $0.6 million, offset by litigation settlement income of $0.8 million, and in the third quarter 2019 are non-recurring expenses of $0.9 million, slightly offset by litigation settlement income of $0.1 million. Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019 Consolidated income from operations in the first nine months of 2020 of $14.6 million increased by $8.5 million, or 138.8%, from $6.1 million for the first nine months of 2019. Our consolidated operating margin for the first nine months of 2020 was 4.9% compared to 2.2% for the first nine months of 2019. This margin increase was the result of higher revenues less costs of services of $6.7 million, lower salary and employee benefits expenses of $2.2 million, and lower SG&A expenses of $1.7 million, partially offset by higher depreciation and amortization expense of $2.1 million. - 41 - Table of Contents Our Consumer Payments segment contributed $25.5 million of income from operations for the first nine months of 2020, an increase of $3.2 million, or 14.5%, from the $22.3 million for the first nine months of 2019. This increase was the result of higher revenue less costs of services of $3.6 million and an improved operating margin of 9.6% in the 2020 period from 9.2% in the 2019 period. The overall improvement in the 2020 period was also the result of a $1.7 million decrease in salary and employee benefit expenses due to lower headcount. The improvement was partially offset by a $1.5 million increase in depreciation and amortization expense and a $1.0 million write-down in SG&A for the carrying value of an intangible asset. Our Commercial Payments segment earned income from operations of $1.4 million for the first nine months of 2020 compared to a loss from operations of $1.1 million for the first nine months of 2019. This improvement was driven by a $0.5 million improvement in revenues less costs of services, a $0.5 million decrease in salaries and employee benefits expenses due to lower headcount, and a $1.5 million decrease in SG&A expenses. The decrease in SG&A expenses was driven by reduced travel and trade show expenses due to the COVID-19 pandemic. Also included in SG&A expenses for the 2019 period were certain one-time operational losses of $0.5 million which were substantially recovered in the 2020 period. Our Integrated Partners segment contributed $1.5 million of income from operations for the first nine months of 2020, an increase of $0.1 million compared to $1.3 million in the first nine months of 2019. The increase was due to a $2.5 million increase in revenues less costs of services and a $0.3 million decrease in salary and employee benefit expenses, largely offset by $1.7 million increase in SG&A expenses and a $1.0 million increase in depreciation and amortization expense. The increase in SG&A expenses primarily related to transition services provided by YapStone, Inc. in connection with the assets acquired in March 2019. These transition services were $2.8 million in first nine months of 2020 and $1.2 million in first nine months of 2019. The increase in depreciation and amortization expense was due to amortization of the intangible assets acquired in March 2019 from YapStone, Inc. Corporate expenses were $13.8 million for the first nine months of 2020, a decrease of $2.6 million, or 16.1%, from expenses of $16.4 million for the first nine months of 2019. Salaries and employee benefits increased $0.2 million, SG&A expenses declined $2.5 million, and depreciation and amortization expense decreased $0.3 million. Included in SG&A in the first nine months of 2020 are expenses we deem to be non-recurring in nature of $1.5 million, offset by litigation settlement income of $0.8 million, and in the third quarter 2019 are non-recurring expenses of $2.8 million. Interest expense The amortization of deferred financing costs and debt discounts increases our reported interest expense and the effective interest rates under our Senior Credit Agreement and GS Credit Agreement. For third quarter 2020, interest expense increased by $3.0 million, or 28.7%, to $13.5 million from $10.5 million in third quarter 2019. The additional expense was due to increases in the applicable margins on the Senior Credit Agreement and the GS Credit Agreement that resulted from the Sixth Amendment in March 2020. For third quarter 2020, the effective interest rates on the term facility of our Senior Credit Agreement and GS Credit agreement were 9.87% and 14.62%, respectively, compared to 7.92% and 10.90%, respectively, for third quarter 2019. For the first nine months of 2020, interest expense increased $4.9 million, or 15.9%, to $35.5 million from $30.6 million in the first nine months of 2019. The additional expense was due to the increases in the applicable margins noted above, along with higher outstanding borrowings driven by draws on the Senior Credit Agreement in March 2019 and draws on the revolving credit facility. For the first nine months of 2020, the effective interest rates on the term facility of our Senior Credit Agreement and GS Credit Agreement were 8.57% and 12.99%, respectively, compared to 7.50% and 10.80% for the first nine months of 2019. As a result of the $106.5 million principal pay down that we made in late September 2020 to reduce our outstanding indebtedness under the term facility of our Senior Credit Agreement and the related partial write off of unamortized deferred loans costs and discounts associated with the principal pay down, the applicable margins on the Senior Credit Agreement and the GS Credit Agreement are expected to decrease. Based on applicable margins and LIBOR rate in effect on September 30, 2020, we expect the effective interest rates on the term facility of our Senior Credit Agreement and GS Credit Agreement to be 8.2% and 12.8%, respectively, for the foreseeable future. - 42 - Table of Contents Debt extinguishment and modification costs As noted above, during September 2020 we wrote off unamortized deferred debt costs and discount of $1.5 million associated with the $106.5 million principal prepayment for the term facility under our Senior Credit Agreement. In first quarter 2020, we expensed $0.4 million of third-party costs related to the Sixth Amendment to the Senior Credit Agreement and the GS Credit Agreement. Gain on sale of business As disclosed in Note 2, Sale of Business , to the unaudited condensed consolidated financial statements, during late September 2020 our consolidated PRET subsidiary sold the RentPayment business, which is substantially all of the assets acquired from YapStone, Inc. in March 2019. Based on efforts and changes made by us since the March 2019 acquisition of these assets, the assets constituted a business, as defined by GAAP, when sold in September 2020 for $179.4 million, net of a working capital adjustment. The sale price does not contain any contingent components. After removing the carrying values of the disposed business and incurring costs related to the transaction, PRET recognized a pre-tax gain of $107.2 million. PRET had non-controlling interests ("NCIs"), and based on the cash waterfall provisions in PRET's operating agreement, the NCIs were entitled to $45.1 million of the $107.2 million pre-tax gain, which is included in Net Income Attributable to Non-Controlling Interests on our consolidated statement of operations for the three months and nine months ended September 30, 2020. The $45.1 million was distributed in cash to the NCIs, and the $45.1 million of payments along with the $5.7 million redemption payment made to one of the NCIs, resulted in the full redemption of all NCIs of PRET. Income taxes We assess all available positive and negative evidence to estimate whether sufficient taxable income will be generated in the future to permit use of the existing deferred tax assets. ASC 740, Income Taxes ("ASC 740"), requires that all sources of future taxable income be considered in making this determination. The Tax Cuts and Jobs Act of 2017 amended section 163(j) of the Internal Revenue Code. Section 163(j), as amended, 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. With respect to recording a deferred tax benefit for the carryforward of business interest expense, GAAP applies a "more likely than not" threshold for assessing recoverability. Adjustments to the valuation allowance are a component of income tax expense (benefit) in our 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). On the basis of our assessment, during third quarter 2020, the nine months ended September 30, 2020, and the nine months ended September 30, 2019, we increased the valuation allowance for deferred income taxes by $1.2 million, $5.4 million, and $5.2 million, respectively, associated with excess business interest for the then-current reporting periods. In first quarter 2020, we recorded a discrete decrease to the valuation allowance of $1.5 million for business interest related to 2019 as a result of the CARES Act, and in third quarter 2020 we recorded another discrete decrease to the valuation allowance of $7.6 million for business interest related to the expected utilization of the prior year carryforward during 2020. During the nine months ended September 30, 2019, we recorded a discrete increase to the valuation allowance of $2.6 million for excess business interest related to a prior years. - 43 - Table of Contents We will continue to evaluate the realizability of the net deferred tax asset on a quarterly basis and, as a result, the valuation allowance may change in future periods. We compute our interim period income tax expense or benefit by using a forecasted estimated annual effective tax rate ("EAETR") and adjust for any discrete items arising during the interim period and any changes in our projected full-year business interest expense and taxable income. The EAETR for 2020 is 25.0% and includes the income tax provision on pre-tax income, a tax provision related to establishment of a valuation allowance for deferred income tax on the future portion of the Section 163(j) limitation created by the 2020 debt refinancing, and a reduction of the tax provision related to income attributable to non-controlling interests of a consolidated subsidiary. In addition, a discrete income tax benefit was recorded related to the release of a portion of our valuation allowance on our 2018 and 2019 Section 163(j) limitation as a result of the CARES Act and forecasted utilization of our 163(j) interest limitation carryforward during 2020. Approximately $12.4 million of income tax expense for the three months and nine months ended September 30, 2020 was a attributable to the gain on the business sale (see Note 2, Sale of Business ). Earnings attributable to non-controlling interests In addition to the $45.1 million discussed above for the NCIs of PRET, we attributed and paid $0.2 million to the NCIs of PHOT for the three months ended September 30, 2020. See Note 4, Non-Controlling Interests , to the unaudited condensed consolidated financial statements. - 44 - Table of Contents Financial Condition Compared to our consolidated balance sheet as of December 31, 2019, the following key changes have occurred at September 30, 2020. Cash Total cash and unrestricted cash increased by $8.4 million during the first nine months of 2020. Excluding restricted cash, the increase in cash was $18.5 million. The increase in unrestricted cash was largely attributable to the sale of the real estate business by our PRET subsidiary in September 2020, net of a large debt repayment and payments to the non-controlling interests of PRET. Restricted cash decreased by $10.1 million, in line with the decrease in settlement obligations reflected on our balance sheet. For an explanation of the key drivers of this change, see the subsequent section, Liquidity and Capital Resources , and our unaudited consolidated statement of cash flows included in this Form 10-Q. Intangible Assets Intangible assets, net of accumulated amortization, decreased a net of $85.6 million during the first nine months of 2020. As disclosed in Note 2, Sale of Business , intangible assets were reduced by a net of $63.4 million in September 2020. An impairment charge and resulting impairment reserve for a residual buyout reduced the net carrying value of an intangible asset by $1.0 million in third quarter 2020. Amortization expense during the 2020 period was $25.2 million. The carrying value increased by $4.4 million for acquisitions. Debt Obligations Outstanding amounts for our debt obligations under our Senior Credit Agreement and our GS Credit Agreement decreased by a net of $103.4 million during the first nine months of 2020. This decrease was attributable to principal repayments of $109.5 million for term debt, including an unscheduled payment of $106.5 million made in September 2020. PIK interest of $6.6 million added to the outstanding balances. All new advances made in the 2020 period on the revolving credit facility were repaid by September 2020. See the additional discussion about our debt obligations in the subsequent section for Liquidity and Capital Resources. Stockholders' Deficit Stockholders' deficit attributable to the stockholders of the Company changed by $28.1 million, from a deficit of $126.3 million at December 31, 2019 to a deficit of $98.3 million at September 30, 2020. The primary driver of this change was the net income attributable to stockholders of the Company of $26.7 million for the first nine months of 2020 million and $1.4 million of increases to additional paid-in capital for equity-based stock compensation. Liquidity and Capital Resources Liquidity and capital resource management is a process focused on providing the funding we need to meet our short-term and long-term cash and working capital needs. We have used our funding sources to build our merchant portfolio, technology solutions, and to make acquisitions with the expectation that such investments will generate cash flows sufficient to cover our working capital needs and other anticipated needs, including for our acquisition strategy. We anticipate that cash on hand, funds generated from operations and available borrowings under our revolving credit facility are sufficient to meet our working capital requirements for at least the next twelve months. This is based upon management’s estimates and assumptions utilizing the most currently available information regarding the effects of the COVID-19 pandemic on our financial results. Actual future results could differ materially, as the magnitude, duration and effects of the COVID-19 pandemic are difficult to predict, and ultimately could negatively impact our liquidity, capital resources, and debt covenant compliance. - 45 - Table of Contents Our principal uses of cash are to fund business operations, administrative costs, and debt service. Our working capital, defined as current assets less current liabilities, was $3.6 million and $1.2 million at September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020, we had unrestricted cash totaling $21.7 million compared to $3.2 million at December 31, 2019. These balances do not include restricted cash, which reflects cash accounts holding customer settlement funds of $37.1 million at September 30, 2020 and $47.2 million at December 31, 2019. At September 30, 2020, approximately $14.0 million was available under the revolving credit facility of our Senior Credit Agreement. The following tables and narrative reflect our changes in cash flows for the comparative periods: (dollars in thousands) Nine Months Ended September 30, 2020 2019 Net cash provided by (used in): Operating activities $ 3,136 $ 10,617 Investing activities 168,990 (93,623) Financing activities (163,761) 76,018 Net increase (decrease) in cash and restricted cash $ 8,365 $ (6,988) Cash Provided By Operating Activities Net cash provided by operating activities, which includes changes in restricted cash, in the first nine months of 2020 was $3.1 million compared to net cash provided by operating activities of $10.6 million for the first nine months of 2019. This $7.5 million decrease for the 2020 period was largely the result of changes in settlement obligations and restricted cash as well as payments for transactions costs related to the business sale. Cash Provided By (Used In) Investing Activities Net cash provided by (used in) investing activities was $169.0 million and $(93.6) million for the first nine months of 2020 and the first nine months of 2019, respectively. During the 2020 period, we received gross cash of $179.4 million from the sale of a business. Cash used in investing activities for the first nine months of 2019 included $18.0 million used for residual buyouts and $63.8 million used to acquire assets from YapStone, Inc. Cash of $4.4 million was used during the 2020 period to partially fund a portfolio acquisition and to fund the contingent portion of a residual buyout. Cash used to acquire property, equipment, and software amounted to $6.0 million and $8.7 million for the 2020 period and the 2019 period, respectively. Cash (Used In) Provided By Financing Activities Net cash used in financing activities was $163.8 million for the first nine months of 2020 compared to cash provided of $76.0 million in the first nine months of 2019. The amount for the 2020 period included $109.5 million in principal repayments on the term facility for our Senior Credit Agreement and $51.0 million of cash payments to the non-controlling interests of PRET and PHOT. The amount for the 2019 period included net borrowings under our Senior Credit Agreement consisting of $11.5 million under the revolving facility and a $69.7 million delayed draw under the term facility that was used to acquire certain assets from YapStone, Inc. in March 2019. - 46 - Table of Contents Long-Term Debt As of September 30, 2020, we had outstanding long-term debt of $392.1 million compared to $495.5 million at December 31, 2019, a decrease of $103.4 million. The debt balance at September 30, 2020 consisted of outstanding term debt of $280.4 million under the Senior Credit Facility and $100.7 million in term debt under the subordinated Credit and Guaranty Agreement with Goldman Sachs Specialty Lending Group, L.P. (the "GS Credit Facility") (including accrued payment-in-kind ("PIK") interest through September 30, 2020). Additionally, under the Senior Credit Facility, we have a $25 million revolving credit facility, which had $11.0 million drawn and outstanding as of September 30, 2020. The outstanding principal amounts under the Senior Credit Facility and the subordinated GS Credit Facility mature in January 2023 and July 2023, respectively. The $25 million revolving credit facility expires in January 2022. The Senior Credit Facility and the subordinated GS Credit Facility are secured by substantially all of our assets, however, the parent entity, Priority Technology Holdings, Inc., is neither a borrower nor guarantor to the Senior Credit Facility or the GS Credit Facility. On March 18, 2020, we modified the Senior Credit Agreement and the GS Credit Amendment (collectively, the "Sixth Amendment"). As of September 30, 2020, financial covenants, as amended, under the Senior Credit Facility required the Total Net Leverage Ratio, as defined in the agreement, not to exceed 7.75:1.00 at September 30, 2020 through December 31, 2020. The Total Net Leverage Ratio steps down thereafter. The Total Net Leverage Ratio covenant is a material term within the Sixth Amendment. As of September 30, 2020, we were in compliance with our financial covenants. Noncompliance in the future could have materially adverse impacts on our financial condition, including giving the lenders the right to accelerate the debt repayment schedule and restricting access to the revolving credit facility. Based upon current projections, the Company expects to be in compliance with its debt covenants for at least the foreseeable future. For additional information about the risks associated with our debt agreements and related covenants, refer to the "Risk Factors Related to Our Indebtedness" in Item 1A, Risk Factors, in our most recent Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 30, 2020. Total Net Leverage Ratio, Consolidated Total Debt, and Consolidated Adjusted EBITDA are defined in Section 1.01 of Exhibit A to the Sixth Amendment (Exhibit 10.2 and Exhibit 10.3 to this Quarterly Report on Form 10-Q) and summarized below: • The Total Net Leverage Ratio means, at any date of determination, the ratio of Consolidated Total Debt for such date, to Consolidated Adjusted EBITDA. • Consolidated Total Debt is the aggregate principal amount of indebtedness minus the aggregate amount of unrestricted cash at the balance sheet date. • Consolidated Adjusted EBITDA is consolidated net income plus any applicable items determined in accordance with clauses (i)(b) through (i)(v) of the Consolidated Adjusted EBITDA definition, minus any applicable items determined in accordance with clauses (ii)(a) through (ii)(g) of the Consolidated Adjusted EBITDA definition in Section 1.01 of the Sixth Amendment ("Applicable Adjustments"). Under the provisions of the Sixth Amendment, calculation of Consolidated Adjusted EBITDA at each interim quarterly measurement period in 2020 is determined as the current year-to-date Consolidated Adjusted EBITDA annualized. For interim quarterly and full year measurement periods commencing in January 2021, calculation of Consolidated Adjusted EBITDA is determined on a last twelve months basis. Consolidated Adjusted EBITDA is a non-GAAP liquidity measure. For determining the Total Net Leverage Ratio at September 30, 2020, Consolidated Adjusted EBITDA was calculated as follows in accordance with the referenced clause definitions from Section 1.01 of the Sixth Amendment: - 47 - Table of Contents Nine Months (in thousands) Ended September 30, 2020 Consolidated Net Income Attributable to Stockholders of Priority Technology Holdings, Inc.(GAAP) $ 26,665 Applicable Adjustments: Gain on sale of business, less amounts attributable and paid to NCIs (clause (ii)(c)) (62,091) Interest expense (clause (i)(b)) 35,454 Depreciation and amortization (clause (i)(d) and (i)(e)) 30,886 Income tax expense (clause (i)(c)) 12,919 Non-cash stock-based compensation (clause (i)(j)) 1,627 Acquisition transition services (clause (i)(k)) 2,747 Debt extinguishment and modification costs (clause (i)(h)) 1,899 Impairment of intangible asset (clause (i)(f)) 980 Write off of an equity-method investment (clause (i)(f)) 211 Certain legal fees and expenses (clause (i)(m)) 1,380 Litigation settlement (clause (i)(k)) (722) Professional, accounting and consulting fees (clause (i)(k)) 145 Other professional and consulting fees (clause(i) (h)) 1,125 Other adjustments and tax expenses (clause (i)(q)) 162 Pro forma impact of disposal (8,320) Consolidated Adjusted EBITDA (non-GAAP) 45,067 Factor to annualize year-to-date 12/9 Annualized $ 60,089 At September 30, 2020, the Total Net Leverage Ratio was 6:16:1.00, calculated as follows: (in thousands, except ratio) September 30, 2020 Consolidated Total Debt: Current portion of long-term debt $ 15,583 Long-term debt, net of discounts and deferred financing costs 371,206 Unamortized debt discounts and deferred financing costs 5,323 392,112 Less unrestricted cash (21,695) Consolidated Net Debt $ 370,417 Annualized Consolidated Adjusted EBITDA (non-GAAP) $ 60,089 Total Net Leverage Ratio 6.16 - 48 - Table of Contents COVID-19 Pandemic Our current assessment is that we anticipate cash on hand, funds generated from operations and available borrowings under our revolving credit facility to be sufficient to meet our working capital requirements, and that we will remain in compliance with our debt covenants. However, the ongoing magnitude, duration and effects of the COVID-19 pandemic on our future results of operation, cash flows, and financial condition are difficult to predict at this time, and our current assessment is subject to material revision. Off-Balance Sheet Arrangements We have not entered into any other transactions with third parties or unconsolidated entities whereby we have financial guarantees, subordinated retained interest, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities or other obligations. Commitments and Contractual Obligations Commitments See Note 11, Commitments and Contingencies , to our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for disclosure information about potential contingent payments that we may be required to make in future periods that are not required to be recognized in our consolidated balance sheets as of September 30, 2020 or December 31, 2019. Contractual Obligations There have been no significant changes to our contractual obligations and commitments compared to those disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations of Priority" included in the Annual Report for the year ended December 31, 2019, except for changes in minimum principal repayments under our Senior Credit Agreement. For an updated schedule of debt repayments, see Note 9, Debt Obligations , to the unaudited condensed consolidated financial statements contained in Part 1, Item 1 of this Quarterly Report on Form 10-Q. Related Party Transactions See Note 12, Related Party Transactions , to the unaudited condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q. Critical Accounting Policies and Estimates Our unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim periods, which often require the judgment of management in the selection and application of certain accounting principles and methods. Our critical accounting policies and estimates are discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our most recent Annual Report on Form 10-K. There have been no material changes to these critical accounting policies and estimates as of September 30, 2020. - 49 - Table of Contents Effect of New Accounting Pronouncements and Recently Issued Accounting Pronouncements Not Yet Adopted From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standards setting bodies that may affect our current and/or future financial statements. See Note 1, Basis of Presentation and Significant Accounting Policies , to our unaudited condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q for a discussion of recently issued accounting pronouncements not yet adopted. - 50 - Table of Contents ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For quantitative and qualitative disclosures about market risk, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk," of our Annual Report on Form 10-K for the year ended December 31, 2019. Our exposures to market risk have not changed materially since December 31, 2019.