NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND ACCOUNTING POLICIES
The Business
Headquartered in Alpharetta, Georgia, Priority Technology Holdings, Inc. and subsidiaries (together, the "Company") began operations in 2005 with a mission to build a merchant inspired payments platform that would advance the goals of its customers and partners. Today, the Company is a leading provider of merchant acquiring and commercial payment solutions, offering unique product capabilities to small and medium size businesses ("SMBs") and enterprises and distribution partners in the United States. The Company operates from a purpose-built business platform that includes tailored customer service offerings and bespoke technology development, allowing the Company to provide end-to-end solutions for payment and payment-adjacent needs.
The Company provides:
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Consumer payments processing solutions for business-to-consumer ("B2C") transactions through independent sales organizations ("ISOs"), financial institutions, independent software vendors ("ISVs"), and other referral partners. Our proprietary MX platform for B2C payments provides merchants a fully customizable suite of business management solutions.
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Commercial payments solutions such as automated vendor payments and professionally curated managed services to industry leading financial institutions and networks. Our proprietary business-to-business ("B2B") Commercial Payment Exchange (CPX) platform was developed to be a best-in-class solution for buyer/supplier payment enablement.
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Institutional services (also known as Managed Services) solutions that provide audience-specific programs for institutional partners and other third parties looking to leverage the Company's professionally trained and managed call center teams for customer onboarding, assistance, and support, including marketing and direct-sales resources.
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Integrated partners solutions for ISVs and other third-parties that allow them to leverage the Company's core payments engine via robust application program interfaces ("APIs") resources and high-utility embeddable code.
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Consulting and development solutions focused on the increasing demand for integrated payments solutions for transitioning to the digital economy.
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The Company provides its services through two reportable segments: (1) Consumer Payments and (2) Commercial Payments and Managed Services. For additional information about our reportable segments, see Note 16,
Segment Information
.
To provide many of its services, the Company enters into agreements with payment processors which in turn have agreements with multiple card associations. These card associations comprise an alliance aligned with insured financial institutions ("member banks") that work in conjunction with various local, state, territory, and federal government agencies to make the rules and guidelines regarding the use and acceptance of credit and debit cards. Card association rules require that vendors and processors be sponsored by a member bank and register with the card associations. The Company has multiple sponsorship bank agreements and is itself a registered ISO with Visa®. The Company is also a registered member service provider with MasterCard®. The Company's sponsorship agreements allow the capture and processing of electronic data in a format to allow such data to flow through networks for clearing and fund settlement of merchant transactions.
Corporate History and Recapitalization
M I Acquisitions, Inc. ("MI Acquisitions") was incorporated under the laws of the state of Delaware as a special purpose acquisition company ("SPAC") whose objective was to acquire, through a merger, share exchange, asset acquisition, stock purchase, recapitalization, reorganization or other similar business combination, one or more businesses or entities. MI Acquisitions completed an initial public offering ("IPO") in September 2016, and MI Acquisitions' common stock began trading on The Nasdaq Capital Market with the symbol MACQ. In addition, MI Acquisitions completed a private placement to certain initial stockholders of MI Acquisitions. MI Acquisitions received gross proceeds of approximately
$54.0
million from the IPO and private placement.
On July 25, 2018, MI Acquisitions acquired all of the outstanding member equity interests of Priority Holdings, LLC ("Priority") in exchange for the issuance of MI Acquisitions' common stock (the "Business Combination") from a private placement. As a
result, Priority, which was previously a privately-owned company, became a wholly-owned subsidiary of MI Acquisitions. Simultaneously with the Business Combination, MI Acquisitions changed its name to Priority Technology Holdings, Inc. and its common stock began trading on The Nasdaq Global Market with the symbol PRTH.
As a SPAC, MI Acquisitions had substantially no business operations prior to July 25, 2018. For financial accounting and reporting purposes under accounting principles generally accepted in the United States ("U.S. GAAP"), the acquisition was accounted for as a "reverse merger," with no recognition of goodwill or other intangible assets. Under this method of accounting, MI Acquisitions was treated as the acquired entity whereby Priority was deemed to have issued common stock for the net assets and equity of MI Acquisitions consisting mainly of cash of
$49.4
million, accompanied by a simultaneous equity recapitalization (the "Recapitalization") of Priority. The net assets of MI Acquisitions are stated at historical cost and, accordingly, the equity and net assets of the Company have not been adjusted to fair value. As of July 25, 2018, the consolidated financial statements of the Company include the combined operations, cash flows, and financial positions of both MI Acquisitions and Priority. Prior to July 25, 2018, the results of operations, cash flows, and financial position are those of Priority.
The units and corresponding capital amounts and earnings per unit of Priority prior to the Recapitalization have been retroactively restated as shares reflecting the exchange ratio established in the Recapitalization.
The Company's President, Chief Executive Officer and Chairman controls a majority of the voting power of the Company's outstanding common stock. As a result, the Company is a "controlled company" within the meaning of the corporate governance standards of the Nasdaq Stock Market, LLC ("Nasdaq").
The Company operates in
two
reportable segments: 1) Consumer Payments and 2) Commercial Payments and Managed Services. For more information about the Company's segments, refer to Note 16,
Segment Information
.
Emerging Growth Company
The Company is an "emerging growth company" (EGC), as defined in the Jumpstart Our Business Startups Act of 2012 ("JOBS Act"). 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 or if its revenue for any year exceeds
$1.07
billion, the Company would cease to be an EGC immediately, 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 is not required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Additionally, the Company as an EGC 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. As such, the Company's financial statements may not be comparable to companies that comply with public company effective dates.
Basis of Presentation and Consolidation
The accompanying consolidated financial statements include those of the Company and its controlled subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation. Investments in unconsolidated affiliated companies are accounted for under the equity method and are included in "Other non-current assets" in the accompanying consolidated balance sheets. The Company generally utilizes the equity method of accounting when it has an ownership interest of between 20% and 50% in an entity, provided the Company is able to exercise significant influence over the investee's operations.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could materially differ from those estimates.
Components of Revenues and Expenses
Revenues
Merchant card fees revenue consists mainly of fees for processing electronic payments, including credit, debit and electronic benefit transaction card processing. The fees are generally based on a variable percentage of the dollar amount of each transaction and, in some cases, additional fees for each transaction. In addition, merchant customers may also be charged miscellaneous fees, including statement fees, annual fees, monthly minimum fees, fees for handling chargebacks, gateway fees, and fees for other miscellaneous services. Merchant card fees revenue is attributable primarily to our Consumer Payments segment.
Outsourced services and other revenue consist mainly of cost-plus fees related to B2B services, merchant financing and buyer-initiated payment programs sold on behalf of certain enterprise customers, originated through our in-house sales force, including incentives for meeting sales targets. Outsourced services revenue is attributable primarily to our Commercial Payments and Managed Services reportable segment. Other revenues include revenue from the sales of equipment (primarily point of sale terminals) and processing of automated clearing house ("ACH") transactions.
Costs of Services
Costs of Merchant Card Fees
Costs of merchant card fees primarily consist of residual payments to agents and ISOs and other third-party costs directly attributable to payment processing. The residual payments represent commissions paid to agents and ISOs based upon a percentage of the net revenues generated from merchant transactions.
Costs of Outsourced Services and Other Revenue
Costs of outsourced services and other revenue consist of salaries directly related to outsourced services revenue, the cost of equipment (point of sale terminals) sold, and third-party fees and commissions related to the Company's ACH processing activities.
Selling, General and Administrative
SG&A expenses include mainly professional services, advertising, rent,
office supplies, software licenses, utilities, state and local franchise and sales taxes, litigation settlements, executive travel, insurance,
and expenses related to the Business Combination.
Interest Expense
Interest expense consists of interest on outstanding debt and amortization of deferred financing costs and original issue discounts.
Other, net
Other, net is composed of interest income, debt modification and extinguishment expenses, changes in fair value of warrant liabilities, and equity in losses and impairment of unconsolidated entities. Interest income consists mainly of interest received pursuant to notes receivable from independent sales agents. Debt modification and extinguishment expenses includes write-offs of unamortized deferred financing costs and original issue discount relating to the extinguished debt. Equity in loss and impairment of unconsolidated entities consists of the Company's share of the income or loss of its equity method investment as well as any impairment charges related to such investments.
Comprehensive Income (Loss)
Comprehensive income (loss) represents the sum of net income (loss) and other amounts that are not included in the audited consolidated statement of operations as the amounts have not been realized. For the years ended December 31, 2018, 2017, and 2016, there were no differences between the Company's net income (loss) and comprehensive income (loss). Therefore, no separate Statements of Other Comprehensive Income (Loss) are included in the financial statements for the reporting periods.
Significant Accounting Policies
Revenue Recognition
The Company recognizes revenue when (1) it is realized or realizable and earned, (2) there is persuasive evidence of an arrangement, (3) delivery and performance has occurred, (4) there is a fixed or determinable sales price and (5) collection is reasonably assured.
The Company's reportable segments are organized by services the Company provides and distinct business units. Set forth below is a description of the Company's revenue recognition polices by segment.
Consumer Payments
The Company's Consumer Payments segment represents merchant card fee revenues, which are based on the electronic transaction processing of credit, debit and electronic benefit transaction card processing authorized and captured through third-party networks, check conversion and guarantee, and electronic gift certificate processing. Merchants are charged rates which are based on various factors, including the type of bank card, card brand, merchant charge volume, the merchant's industry and the merchant's risk profile. Typically, revenues generated from these transactions are based on a variable percentage of the dollar amount of each transaction, and in some instances, additional fees are charged for each transaction. The Company's contracts in most instances involve
three
parties: the Company, the merchant and the sponsoring bank. The Company's sponsoring banks collect the gross revenue from the merchants, pay the interchange fees and assessments to the credit card associations, retain their fees and pay to the Company a residual payment representing the Company's fee for the services provided. Merchant customers may also be charged miscellaneous fees, including statement fees, annual fees, and monthly minimum fees, fees for handling chargebacks, gateway fees and fees for other miscellaneous services.
The determination of whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors should be considered in the evaluation. The Company recognizes merchant card fee revenues net of interchange fees, which are assessed to the Company's merchant customers on all transactions processed by third parties. Interchange fees and rates are not controlled by the Company, which effectively acts as a clearing house collecting and remitting interchange fee settlement on behalf of issuing banks, debit networks, credit card associations and its processing customers. All other revenue is reported on a gross basis, as the Company contracts directly with the merchant, assumes the risk of loss and has pricing flexibility.
Commercial Payments and Managed Services
This segment provides business-to-business ("B2B") automated payment processing services to buyers and suppliers, including virtual payments, purchase cards, electronic funds transfers, ACH payments, and check payments. Revenues are generally earned on a per-transaction basis and through implementation services. Additionally, this segment provides outsourced services by providing a sales force to certain enterprise customers. Such services are provided on a cost-plus fee arrangement and revenue is recognized to the extent of billable rates times hours worked and other reimbursable costs incurred.
Cash and Restricted Cash
Cash includes cash held at financial institutions that is owned by the Company. Restricted cash is held by the Company in financial institutions for the purpose of in-process customer settlements or reserves held per contact terms.
Accounts Receivable
Accounts receivable are stated net of allowance for doubtful accounts and are amounts primarily due from the Company's sponsor banks for revenues earned, net of related interchange and bank processing fees, and do not bear interest. Other types of accounts receivable are from agents, merchants and other customers. Amounts due from sponsor banks are typically paid within 30 days following the end of each month.
Allowance for Doubtful Accounts Receivable
The Company records an allowance for doubtful accounts when it is probable that the accounts receivable balance will not be collected, based upon loss trends and an analysis of individual accounts. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recognized when received.
Customer Deposits and Advance Payments
The Company may receive cash payments from certain customers and vendors that require future performance obligations by the Company. Amounts associated with obligations expected to be satisfied within one year are reported in Customer deposits and advance payments on the Company's consolidated balance sheets and amounts associated with obligations expected to be satisfied after one year are reported as a component of Other non-current liabilities on the Company's consolidated balance sheets. These payments are subsequently recognized in the Company's consolidated statements of operations when the Company satisfies the performance obligations required to retain and earn these deposits and advance payments.
Property and Equipment, Including Leases
Property and equipment are stated at cost, except for property and equipment acquired in a merger or business combination, which is recorded at fair value at the time of the transaction. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets.
The Company has multiple operating leases related to office space. Operating leases do not involve transfer of risks and rewards of ownership of the leased asset to the lessee, therefore the Company expenses the costs of its operating leases. The Company may make various alterations (leasehold improvements) to the office space and capitalize these costs as part of property and equipment. Leasehold improvements are amortized on a straight-line basis over the useful life of the improvement or the term of the lease, whichever is shorter.
Expenditures for repairs and maintenance which do not extend the useful life of the respective assets are charged to expense as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. At the time of retirements, sales, or other dispositions of property and equipment, the original cost and related accumulated depreciation are removed from the respective accounts, and the gains or losses are presented as a component of income or loss from operations.
Costs Incurred to Develop Software for Internal Use
Costs incurred to develop computer software for internal use are capitalized once: (1) the preliminary project stage is completed, (2) management authorizes and commits to funding a specific software project, and (3) it is probable that the project will be completed and the software will be used to perform the function intended. Costs incurred prior to meeting the qualifications are expensed as incurred. Capitalization of costs ceases when the project is substantially complete and ready for its intended use. Post-implementation costs related to the internal use computer software, are expensed as incurred. Internal use software development costs are amortized using the straight-line method over its estimated useful life which ranges from three to
five years
. Software development costs may become impaired in situations where development efforts are abandoned due to the viability of the planned project becoming doubtful or due to technological obsolescence of the planned software product. For the years ended December 31, 2018, 2017, and 2016, there has been
no
impairment associated with internal use software. For the years ended December 31, 2018, 2017, and 2016, the Company capitalized software development costs of
$6.7 million
,
$3.1 million
, and
$3.1 million
, respectively. As of December 31, 2018 and 2017, capitalized software development costs, net of accumulated amortization, totaled
$10.8 million
and
$6.7 million
, respectively, and is included in property, equipment, and software, net on the consolidated balance sheets. Amortization expense for capitalized software development costs for the years ended December 31, 2018, 2017, and 2016 was
$2.6 million
,
$1.6 million
, and
$1.0 million
, respectively.
Settlement Assets and Obligations
Settlement processing assets and obligations recognized on the Company's consolidated balance sheet represent intermediary balances arising in the Company's settlement process for merchants and other customers. See Note 3,
Settlement Assets and Obligations
.
Debt Issuance Costs
Eligible debt issuance costs associated with the Company's credit facilities are deferred and amortized to interest expense over the term of the related debt using the effective interest method. Debt issuance costs associated with Company's term debt are presented on the Company's consolidated balance sheets as a direct reduction in the carrying value of the associated debt liability.
Business Combinations
The Company uses the acquisition method of accounting for business combinations which requires assets acquired and liabilities assumed to be recognized at their fair values on the acquisition date. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired. The fair values of the assets acquired and liabilities assumed are determined based upon the valuation of the acquired business and involves making significant estimates and assumptions based on facts and circumstances that existed as of the acquisition date. The Company uses a measurement period following the acquisition date to gather information that existed as of the acquisition date that is needed to determine the fair value of the assets acquired and liabilities assumed. The measurement period ends once all information is obtained, but no later than one year from the acquisition date.
Non-Controlling Interests
The Company has issued non-voting profit-sharing interests in
two
of its subsidiaries that were formed in 2018 to acquire the operating assets of certain businesses (see Note 2,
Business Combinations
). The Company is still the majority owner of these subsidiaries and therefore the profit-sharing interests are deemed to be non-controlling interests ("NCI").
To estimate the initial fair value of a profit-sharing interest, the Company utilizes future cash flow scenarios with focus on those cash flow scenarios that could result in future distributions to the NCIs. In subsequent periods, profits or losses are attributed to an NCI based on the hypothetical-liquidation-at-book-value method that utilizes the terms of the profit-sharing agreement between the Company and the NCIs.
As the majority owner, the Company has call rights on the profit-sharing interests issued to the NCIs. These call rights can be executed only under certain circumstances and execution is always voluntary at the Company's discretion. The call rights do not meet the definition of a free-standing financial instrument or derivative, thus no separate accounting is required for these call rights.
Goodwill
The Company tests goodwill for impairment for its reporting units on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit is below its carrying value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that implied fair value of the goodwill within the reporting unit is less than its carrying value. The Company performed its most recent annual goodwill impairment test as of November 30, 2018 using market data and discounted cash flow analysis. Based on this analysis, it was determined that the fair value exceeded the carrying value of its reporting units. The Company concluded there were
no
indicators of impairment for the years ended December 31, 2018, 2017 and 2016.
Intangible Assets
Intangible assets, acquired in connection with various acquisitions, are recorded at fair value determined using a discounted cash flow model as of the date of the acquisition. Intangible assets primarily include merchant portfolios and other intangible assets such as non-compete agreements, trade names, acquired technology (developed internally by acquired companies prior to the business combination with the Company) and customer relationships.
Merchant Portfolios
Merchant portfolios represent the value of the acquired merchant customer base at the time of acquisition. The Company amortizes the cost of its acquired merchant portfolios over their estimated useful lives, which range from
one year
to
ten years
, using either a straight-line or an accelerated method that most accurately reflects the pattern in which the economic benefits of the respective asset is consumed.
Other Intangible Assets
Other intangible assets consist of values relating to non-compete agreements, trade names, acquired technology, and customer relationships. These values are amortized over the estimated useful lives ranging from
one year
to
25 years
.
Impairment of Long-lived Assets
The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. For long-lived assets, except goodwill, an impairment loss is indicated when the undiscounted future cash flows estimated to be generated by the asset group are not sufficient to recover the unamortized balance of the asset group. If indicated, the loss is measured as the excess of carrying value over the asset groups' fair value, as determined based on discounted future cash flows. The Company concluded there were no indications of impairment for the years ended December 31, 2018, 2017 and 2016.
Accrued Residual Commissions
Accrued residual commissions consist of amounts due to independent sales organizations ("ISOs") and independent sales agents on the processing volume of the Company's merchant customers. The commissions due are based on varying percentages of the volume processed by the Company on behalf of the merchants. Percentages vary based on the program type and transaction volume of each merchant. Residual commission expenses were
$242.8 million
,
$249.9 million
, and
$195.4 million
, respectively, for the years ended December 31, 2018, 2017 and 2016, and are included in costs of merchant card fees in the accompanying consolidated statements of operations.
ISO Deposit and Loss Reserve
ISOs may partner with the Company in an executive partner program in which ISOs are given negotiated pricing in exchange for bearing risk of loss. Through the arrangement, the Company accepts deposits on behalf of the ISO and a reserve account is established by the Company. All amounts maintained by the Company are included in the accompanying consolidated balance sheets as other liabilities, which are directly offset by restricted cash accounts owned by the Company.
Equity-Based Compensation
The Company recognizes the cost resulting from all equity-based payment transactions in the financial statements at grant date fair value. Equity-based compensation expense is recognized over the requisite service period and is reflected in Salary and employee benefits expense on the Company's consolidated statements of operations. The effects of forfeitures are recognized as they occur.
Stock options
Under the Company's 2018 Equity Incentive Plan, the Company determines the fair value of stock options using the Black-Scholes option pricing model, which requires the use of the following subjective assumptions:
Expected Volatility
- Measure of the amount by which a stock price has fluctuated or is expected to fluctuate. Due to the relatively short amount of time that the Company's common stock (Nasdaq: PRTH) has traded on a public market, the Company uses volatility data for the common stocks of a peer group of comparable public companies. An increase in the expected volatility will increase the fair value of the stock option and related compensation expense.
Risk-free interest rate
- U.S. Treasury rate for a stripped-principal treasury note as of the grant date having a term equal to the expected term of the stock option. An increase in the risk-free interest rate will increase the fair value of the stock option and related compensation expense.
Expected term
- Period of time over which the stock options granted are expected to remain outstanding. As a newly-public company, the Company lacks sufficient exercise information for its stock option plan. Accordingly, the Company uses a method permitted by the Securities and Exchange Commission ("SEC") whereby the expected term is estimated to be the mid-point between the vesting dates and the expiration dates of the stock option grants. An increase in the expected term will increase the fair value of the stock option and the related compensation expense.
Dividend yield
- The Company used an amount of zero as the Company has paid no cash or stock dividends and does not anticipate doing so in the foreseeable future. An increase in the dividend yield will decrease the fair value of the stock option and the related compensation expenses.
Time-Based Restricted Stock Awards
The fair value of time-based restricted stock awards is determined based on the quoted closing price of the Company's common stock on the date of grant and is recognized as compensation expense over the vesting term of the awards.
Performance-Based Restricted Stock Awards
The Company accounts for its performance-based restricted equity awards based on the quoted closing price of the Company's common stock on the date of grant, adjusted for any market-based vesting criteria, and records equity-based compensation expense over the vesting term of the awards based on the probability that the performance criteria will be achieved. The Company reassesses the probability of vesting at each reporting period and prospectively adjusts equity-based compensation expense based on its probability assessment.
Advertising
The Company expenses advertising and promotion costs as incurred. Advertising and promotion expenses were approximately
$0.9 million
,
$0.5 million
, and
$0.4 million
for the years ended December 31, 2018, 2017 and 2016, respectively.
Earnings (Loss) Per Share
Basic earnings (loss) per share ("EPS") is computed by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period, excluding the effects of any potentially dilutive securities. Diluted EPS gives effect to the potential dilution, if any, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, using the more dilutive of the two-class method or if-converted method. Diluted EPS excludes potential shares of common stock if their effect is anti-dilutive. If there is a net loss in any period, basic and diluted EPS are computed in the same manner.
The two-class method determines net income (loss) per common share for each class of common stock and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. The two-class method requires income available to common shareholders for the period to be allocated between common stock and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed. Prior to redemption in July 2018, the Goldman Sachs warrants were deemed to be participating securities because they had a contractual right to participate in non-forfeitable dividends on a one-for-one basis with the Company's common stock. Accordingly, the Company applied the two-class method for EPS when computing net income (loss) per common share. For periods beginning after September 30, 2018, EPS using the two-class method is no longer required due to the redemption of the Goldman Sachs warrant. See Note 8,
Long-term Debt and Warrant Liability
.
Income Taxes
Prior to July 25, 2018, Priority was a "pass-through" entity for income tax purposes and had no material income tax accounting reflected in its financial statements since taxable income and deductions were "passed through" to Priority's unconsolidated owners.
As a limited liability company, Priority Holdings, LLC elected to be treated as a partnership for the purpose of filing income tax returns, and as such, the income and losses of Priority Holdings, LLC flowed through to its members. Accordingly, no provisions for federal and most state income taxes was provided in the consolidated financial statements. However, periodic distributions were made to members to cover company-related tax liabilities.
MI Acquisitions was a taxable "C-Corp" for income tax purposes. As a result of Priority's acquisition by MI Acquisitions, the combined Company is now a taxable "C-Corp" that reports all of Priority's income and deductions for income tax purposes. Accordingly, subsequent to July 25, 2018, the consolidated financial statements of the Company reflect the accounting for income taxes in accordance with Financial Accounting Standards Board 's ("FASB") Accounting Standards Codification ("ASC") 740, Income Taxes ("ASC 740").
The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered or settled. Realization of deferred tax assets is dependent upon future taxable income. A valuation allowance is recognized if it is more likely than not that some portion or all of a deferred tax asset will not be realized based on the weight of available evidence, including expected future earnings.
The Company recognizes an uncertain tax position in its financial statements when it concludes that a tax position is more likely than not to be sustained upon examination based solely on its technical merits. Only after a tax position passes the first step of recognition will measurement be required. Under the measurement step, the tax benefit is measured as the largest amount of benefit that is more likely than not to be realized upon effective settlement. This is determined on a cumulative probability basis. The full impact of any change in recognition or measurement is reflected in the period in which such change occurs. The Company recognized interest and penalties associated with uncertain tax positions as a component of interest expense.
Fair Value Measurements
The Company measures certain assets and liabilities at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The Company uses a three-level fair value hierarchy to prioritize the inputs used to measure fair value and maximizes the use of observable inputs and minimizes the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 – Quoted market prices in active markets for identical assets or liabilities as of the reporting date.
Level 2 – Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3 – Unobservable inputs that are not corroborated by market data.
The fair values of the Company's merchant portfolios, assets and liabilities acquired in mergers and business combinations, and former warrant liability are primarily based on Level 3 inputs and are generally estimated based upon valuation techniques that include discounted cash flow analysis based on cash flow projections and, for years beyond the projection period, estimates based on assumed growth rates. Assumptions are also made regarding appropriate discount rates, perpetual growth rates, and capital expenditures, among others. In certain circumstances, the discounted cash flow analysis is corroborated by a market-based approach that utilizes comparable company public trading values and, where available, values observed in public market transactions.
The carrying values of accounts and notes receivable, accounts payable and accrued expenses, long-term debt and cash, including settlement assets and the associated deposit liabilities approximate fair value due to either the short-term nature of such instruments or the fact that the interest rate of the debt is based upon current market rates.
Warrant Liability
As discussed in Note 8,
Long-Term Debt and Warrant Liability
, the Company issued warrants to purchase Class A common units of Priority Holdings, LLC representing
2.2%
of the outstanding common units of Priority Holdings, LLC. These warrants were
redeemed in full during July 2018. Prior to redemption in July 2018, the warrants were accounted for as a liability at estimated fair value with changes in fair value recognized in earnings for each reporting period. See Note 15,
Fair Value
.
New Accounting and Reporting Standards
Prior to July 25, 2018, Priority was defined as a non-public entity for purposes of applying transition guidance related to new or revised accounting standards under U.S. GAAP, and as such was typically required to adopt new or revised accounting standards subsequent to the required adoption dates that applied to public companies. MI Acquisitions was classified as an EGC. Subsequent to the Business Combination, the Company will cease to be an EGC no later than December 31, 2021. The Company will maintain the election available to an EGC to use any extended transition period applicable to non-public companies when complying with a new or revised accounting standards. Therefore, as long as the Company retains EGC status, the Company can continue to elect to adopt any new or revised accounting standards on the adoption date (including early adoption) required for a private company.
Accounting Standards Adopted in 2018
Modifications to Share-Based Compensation Awards (ASU 2017-09)
As of January 1, 2018, the Company adopted Accounting Standards Update ("ASU") No. 2017-09,
Compensation-Stock Compensation Topic 718 - Scope of Modification Accounting
("ASU 2017-09"). ASU 2017-09 clarifies when changes to the terms and conditions of share-based payment awards must be accounted for as modifications. Entities apply the modification accounting guidance if the value, vesting conditions, or classification of an award changes. The Company has not modified any share-based payment awards since the adoption of ASU 2017-09, therefore this new ASU has had no impact on the Company's financial position, operations, or cash flows. Should the Company modify share-based payment awards in the future, it will apply the provisions of ASU 2017-09.
Balance Sheet Classification of Deferred Income Taxes (ASU 2015-17)
In connection with the Business Combination and Recapitalization, the Company prospectively adopted the provisions of ASU No. 2015-17,
Balance Sheet Classification of Deferred Taxes
("ASU 2015-17"), during the third quarter of 2018. ASU 2015-17 simplifies the balance sheet presentation of deferred income taxes by reporting the net amount of deferred tax assets and liabilities for each tax-paying jurisdiction as non-current on the balance sheet. Prior guidance required the deferred taxes for each tax-paying jurisdiction to be presented as a net current asset or liability and net non-current asset or liability.
Definition of a Business (ASU 2017-01)
On October 1, 2018, the Company prospectively adopted the provisions of ASU No. 2017-01,
Business Combinations (Topic 805): Clarifying the Definition of a Business
("ASU 2017-01")
.
ASU 2017-01 assists entities in determining if acquired assets constitute the acquisition of a business or the acquisition of assets for accounting and reporting purposes. The guidance requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. In practice prior to ASU 2017-01, if revenues were generated immediately before and after a transaction, the acquisition was typically considered a business. The Company's December 2018 acquisition of certain assets of Direct Connect Merchant Services, LLC was not deemed to be the acquisition of a business under ASU 2017-01 because substantially all of the fair value was concentrated in a single identifiable group of similar identifiable assets.
Accounting for Share-Based Payments to Employees (ASU 2016-09)
For its annual reporting period beginning January 1, 2018, the Company adopted the provisions of ASU 2016-09,
Improvements to Employee Share-Based Payment Accounting
("ASU 2016-09"), which amends ASC Topic 718,
Compensation–Stock Compensation
. This adoption of this new ASU had the following effects:
Consolidated Statement of Operations - ASU 2016-09 imposes a new requirement to record all of the excess income tax benefits and deficiencies (that result from an increase or decrease in the value of an award from grant date to settlement date) related to
share-based payments at settlement through the statement of operations instead of the former requirement to record income tax benefits in excess of compensation cost ("windfalls") in equity, and income tax deficiencies ("shortfalls") in equity to the extent of previous windfalls, and then to operations. This change is required to be applied prospectively upon adoption of ASU 2016-09 to all excess income tax benefits and deficiencies resulting from settlements of share-based payments after the date of adoption. This particular provision of ASU 2016-09 had no material effect on the Company's financial position, operations, or cash flows.
Consolidated Statement of Cash Flows - ASU 2016-09 requires that all income tax-related cash flows resulting from share-based payments, such as excess income tax benefits, are to be reported as operating activities on the statement of cash flows, a change from the prior requirement to present windfall income tax benefits as an inflow from financing activities and an offsetting outflow from operating activities. This particular provision of ASU 2016-09 had no material effect on the Company's financial position, operations, or cash flows.
Additionally, ASU 2016-09 clarifies that:
|
|
•
|
All cash payments made to taxing authorities on an employee's behalf for withheld shares at settlement are presented as financing activities on the statement of cash flows. This change must be applied retrospectively. This particular provision of ASU 2016-09 had no material effect on the Company's financial position, operations, or cash flows.
|
|
|
•
|
Entities are permitted to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated or recognized when they occur. Estimates of forfeitures will still be required in certain circumstances, such as at the time of modification of an award or issuance of a replacement award in a business combination. If elected, the change to recognize forfeitures when they occur needs to be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings. The Company made a policy election to recognize the impact of forfeitures when they occur. This policy election primarily impacted the Company's new equity compensation plans originating in 2018 (see Note 13,
Equity-Based Compensation)
, thus not requiring a cumulative effect adjustment to opening retained earnings for these new plans. For the Company's previously existing equity compensation plan (the Management Incentive Plan), see Note 13,
Equity-Based Compensation.
The amount of the cumulative effect upon adoption of ASU 2016-09 was not material and therefore has not been reflected in opening retained earnings on the Company's consolidated balance sheets or consolidated statements of changes in stockholders' equity (deficit).
|
Recently Issued Accounting Standards Pending Adoption
Revenue Recognition (ASC 606)
In May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers
, which since has been codified and amended in ASC 606,
Revenue from Contracts with Customers
. This guidance clarifies the principles for recognizing revenue and will be applicable to all contracts with customers regardless of industry-specific or transaction-specific fact patterns. Further, the guidance will require improved disclosures as well as additional disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. Since its original issuance, the FASB has issued several updates to this guidance. The new standard could change the amount and timing of revenue and costs for certain significant revenue streams, increase areas of judgment and related internal controls requirements, change the presentation of revenue for certain contract arrangements and possibly require changes to the Company's software systems to assist in both internally capturing accounting differences and externally reporting such differences through enhanced disclosure requirements. As an EGC, the standard is effective for the Company's 2019 annual reporting period and for interim periods after 2019. The standard permits the use of either the retrospective or modified retrospective transition method. The Company has not yet selected a transition method and is currently evaluating the effect that the standard may have on its consolidated financial statements and disclosures.
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
. 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. As an EGC, this standard is effective for the Company's annual reporting period beginning in 2020 and interim reporting periods beginning first quarter of 2021. 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, but it is not expected to have a material effect on the Company's results of operations or cash flows. ASC 842 will also require additional footnote disclosures to the Company's consolidated financial statements.
Credit Losses (ASU 2016-13 and ASU 2018-19)
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. ASU 2018-19,
Codification Improvements to Topic 326, Financial Instruments – Credit Losses
, was issued in November 2018 and excludes operating leases from the new guidance. 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. As an EGC, the ASU is effective for annual periods beginning in 2021 and interim periods within annual periods beginning in 2022.
Statement of Cash Flows (ASU 2016-15)
In August 2016, the FASB issued ASU No. 2016-15,
Statement of Cash Flows (Topic 230)
. This ASU represents a consensus of the FASB's Emerging Issues Task Force on eight separate issues that each impact classifications on the statement of cash flows. In particular, issue number three addresses the classification of contingent consideration payments made after a business combination. Under ASU 2016-15, cash payments made soon after an acquisition's consummation date (i.e., approximately three months or less) will be classified as cash outflows from investing activities. Payments made thereafter will be classified as cash outflows from financing activities up to the amount of the original contingent consideration liability. Payments made in excess of the amount of the original contingent consideration liability will be classified as cash outflows from operating activities. As an EGC, this ASU is effective for the Company for years beginning in 2019 and interim periods within years beginning in 2020. The Company is evaluating the effect this ASU will have on its consolidated statement of cash flows.
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. As an EGC, this ASU will be effective for annual and interim impairment tests performed in periods beginning in 2022. 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 periods beginning first quarter 2021, but not before the Company adopts ASC 606,
Revenue Recognition
. The Company is evaluating the impact this ASU will have on its consolidated financial statements.
Disclosures for Fair Value Measurements (ASU 2018-13)
In August 2018, the FASB issued ASU 2018-13,
Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement
. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements as part of the FASB's disclosure framework project. For all entities, this ASU is effective for annual and interim reporting periods beginning in 2020. Certain amendments must be applied prospectively while others are to be applied on a retrospective basis to all periods presented. As disclosure guidance, the adoption of this ASU will not have an effect on the Company's financial position, results of operations or cash flows.
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.
Concentration of Risk
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.
Substantially all of the Company's revenues and receivables are attributable to merchant customer transactions, which are processed by third-party payment processors.
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.
In 2018, 2017, and 2016, no one merchant customer accounted for 10% or more of the Company's consolidated revenues.
Reclassifications
Certain prior year amounts in these consolidated financial statements have been reclassified to conform to the current year presentation, with no net effect on the Company's stockholders' equity (deficit) or net income (loss) for any period.
2. BUSINESS COMBINATIONS
Business Combinations in 2018
PayRight
In April 2018, Priority PayRight Health Solutions, LLC ("PPRHS"), a subsidiary of the Company, purchased the majority of the operating assets and certain operating liabilities of PayRight Health Solutions LLC ("PayRight"). This purchase allowed PPRHS to gain control over the PayRight business and therefore the Company's consolidated financial statements include the financial
position, results of operations, and cash flows of PayRight from the date of acquisition. PayRight utilizes technology assets to deliver customized payment solutions to the health care industry. The results of the acquired business and goodwill of
$0.3
million from the transaction are being reported by the Company as part of the Commercial Payments and Managed Services reportable segment. Additionally, the acquisition resulted in the recognition of intangible and net tangible assets with a fair value of
$0.6
million. The Company transferred total consideration with a fair value of
$0.9
million consisting of:
$0.5
million in cash and forgiveness of amounts owed to the Company by PayRight;
$0.3
million fair value of the Company's previous equity-method investment in PayRight described in the following paragraph; and
$0.1 million
of other consideration. Certain PayRight sellers were provided profit-sharing rights in PayRight as non-controlling interests, however, based on this arrangement no losses or earnings were allocated to the non-controlling interests for the year ended December 31, 2018.
Previously, in October 2015, the Company purchased a non-controlling interest in the equity of PayRight, and prior to April 2018 the Company accounted for this investment using the equity method of accounting. At December 31, 2017, the Company's carrying value of this investment was
$1.1 million
. Immediately prior to PPRHS' April 2018 purchase of substantially all of PayRight's business assets, the Company's existing non-controlling investment in PayRight had a carrying value of approximately
$1.1
million with an estimated fair value on the acquisition date of approximately
$0.3
million. The Company recorded an impairment loss of
$0.8
million during the second quarter of 2018 for the difference between the carrying value and the fair value of the non-controlling equity-method investment in PayRight. The loss is reported within Other, net in the Company's consolidated statements of operations for the year ended December 31, 2018.
RadPad and Landlord Station
In July 2018, the Company acquired substantially all of the net operating assets of RadPad Holdings, Inc. ("RadPad") and Landlord Station, LLC ("Landlord Station"). RadPad is a marketplace for the rental real estate market. Landlord Station offers a complementary toolset that focuses on facilitation of tenant screening and other services to the fast-growing independent landlord market. These asset purchases were deemed to be a business under ASC 805. The Company formed a new entity, Priority Real Estate Technology, LLC ("PRET"), to acquire and operate these businesses. Due to the related nature of the two sets of business assets, same acquisition dates, and how the Company intends to operate them under the "RadPad" name and operating platform within PRET, the Company deemed them to be one business for accounting and reporting purposes. PRET is reported within the Company's Commercial Payments and Managed Services reportable segment.
Total consideration paid for RadPad and Landlord Station was
$4.3
million consisting of
$3.9
million in cash plus forgiveness of pre-existing debt owed by the sellers to the Company of
$0.4
million. Additionally, the Company paid and expensed
$0.1
million for transaction costs. Net tangible and separately-identifiable intangible assets with an initial fair value of
$2.1
million were acquired along with goodwill with an initial value of
$2.2
million. Non-controlling equity interests in PRET were issued to certain sellers in the form of residual profit interests and distribution rights, however the fair value of these non-controlling interests was deemed to be immaterial at time of acquisition due to the nature of the profit-sharing and liquidations provisions contained in the operating agreement for PRET. Under the terms of the profit-sharing arrangement between the controlling and non-controlling interests, no losses or earnings were allocated to the non-controlling interests for the year ended December 31, 2018.
During the fourth quarter of 2018, the Company received additional information about the fair values of assets acquired and liabilities assumed. Accordingly, measurement period adjustments were made to the opening balance sheet to decrease net assets acquired and increase goodwill by
$0.2
million.
Priority Payment Systems Northeast
In July 2018, the Company acquired substantially all of the net operating assets of Priority Payment Systems Northeast, Inc. ("PPS Northeast"). This purchase of these net assets was deemed to be a business under ASC 805. Prior to this acquisition, PPS Northeast was an independent brand-licensed office of the Company where it developed expertise in software-integrated payment services designed to manage turnkey installations of point-of-sale and supporting systems, as well as marketing programs that place emphasis on online ordering systems and digital marketing campaigns. PPS Northeast is reported within the Company's Consumer Payments reportable segment.
Initial consideration of
$3.5
million consisted of
$0.5
million plus
285,117
shares of common stock of the Company with a fair value of approximately of
$3.0
million. In addition, contingent consideration in an amount up to
$0.5
million was deemed to have a fair value of
$0.4
million at acquisition date. If earned, the seller can receive this contingent consideration in either cash or
additional shares of the Company's common stock, as mutually agreed by the Company and seller. Net tangible and separately-identifiable intangible assets with an initial fair value of
$2.0
million were acquired along with goodwill with an initial value of
$1.9
million, including the
$0.4
million estimated fair value of the contingent consideration due to the seller. At December 31, 2018, the fair value of the contingent consideration still approximated the original
$0.4
million fair value assigned on date of acquisition. Transaction costs were not material and were expensed.
Priority Payment Systems Tech Partners
In August 2018, the Company acquired substantially all of the net operating assets of M.Y. Capital, Inc. and Payments In Kind, Inc., collectively doing business as Priority Payment Systems Tech Partners ("PPS Tech"). These related asset purchases were deemed to be a business under ASC 805. Due to the related nature of the two sets of business assets and how the Company intends to operate them, the Company deemed them to be one business for accounting and reporting purposes. Prior to this acquisition, PPS Tech was an independent brand-licensed office of the Company where it developed a track record and extensive network in the integrated payments and B2B marketplaces. PPS Tech is reported within the Company's Consumer Payments reportable segment.
Initial consideration of
$5.0
million consisted of
$3.0
million plus
190,078
shares of common stock of the Company with a fair value of approximately
$2.0
million. In addition, contingent consideration in an amount up to
$1.0
million was deemed to have a fair value of
$0.6
million at acquisition date. If earned, the seller will receive half of any contingent consideration in cash and the other half in a number of shares of common stock of the Company equal to the portion of the earned contingent consideration payable in shares of common stock of the Company. Net tangible and separately-identifiable intangible assets with an initial fair value of
$2.2
million were acquired along with goodwill with an initial value of
$3.4
million, including the
$0.6
million estimated fair value of the contingent consideration due to the seller. At December 31, 2018, the fair value of the contingent consideration still approximated the original
$0.6
million fair value assigned on date of acquisition. Transaction costs were not material and were expensed.
Other Information
Based on their purchase prices and pre-acquisition operating results and assets, none of the business combinations consummated by the Company in 2018, as described above, met the materiality requirements for disclosure of pro-forma financial information, either individually or in the aggregate. The measurement periods, as defined by ASC 805,
Business Combination
("ASC 805"), are still open for all of these business combinations since the Company is awaiting information to finalize the acquisition-date fair values of certain acquired assets and assumed liabilities.
Goodwill for all 2018 business combinations is deductible by the Company for income tax purposes.
The Company did not consummate any business combinations during 2017 or 2016.
3. SETTLEMENT ASSETS AND OBLIGATIONS
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 the member bank until the merchant is funded. The Company has relationships with member banks to facilitate payment transactions. These agreements allow the Company to route transactions under a member bank's control to process and clear transactions through card networks. Amounts for payment card settlements included in settlement assets and obligations on the Company's consolidated balance sheets represent intermediary balances arising in the settlement process.
Reserves Held For ACH Customers
For the Company's ACH business component that conducts business as ACH.com, the Company earns revenues by processing ACH transactions for financial institutions and other business customers. Certain customers establish and maintain reserves with the Company to cover potential losses in processing ACH transactions. These reserves are held in bank accounts controlled by
the Company. As such, the Company recognizes the cash balances within restricted cash and settlement obligations on its consolidated balance sheets.
Merchant Reserves and Estimated Shortfalls
Under agreements between the Company and merchants, merchants assume liability for obligations such as chargebacks, customer disputes, and unfilled orders. However, under its risk-based underwriting policy, the Company may require certain merchants to establish and maintain reserves designed to protect the Company from anticipated obligations such as chargebacks, customer disputes, and unfilled orders. A merchant reserve account is funded by the merchant but controlled by a sponsor 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. Sponsor banks held merchant reserves of approximately
$186.2
million and
$191.5
million at December 31, 2018 and 2017, respectively. Since these merchant reserves held at sponsor banks are not assets of the Company and the associated risks are not liabilities of the Company, neither is recognized on the Company's consolidated balance sheets.
In the event the amount in a merchant reserve is insufficient to cover expected or incurred losses, the Company may be liable to cover the shortfall. The Company recognized a liability for estimated shortfalls of approximately
$2.0 million
and
$1.1 million
at December 31, 2018 and 2017, respectively. The liabilities are included in the Company's consolidated balance sheet as contra balances against settlement assets.
The Company's settlement assets and obligations at December 31, 2018 and 2017 were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
|
|
|
|
Settlement Assets:
|
|
|
|
Card settlements due from merchants, net of estimated losses
|
$
|
988
|
|
|
$
|
7,207
|
|
Card settlements due from processors
|
54
|
|
|
—
|
|
Total Settlement Assets
|
$
|
1,042
|
|
|
$
|
7,207
|
|
|
|
|
|
Settlement Obligations:
|
|
|
|
Card settlements due to merchants
|
$
|
777
|
|
|
$
|
—
|
|
Due to ACH payees (1)
|
10,355
|
|
|
10,474
|
|
Total Settlement Obligations
|
$
|
11,132
|
|
|
$
|
10,474
|
|
(1) Amounts due to ACH payees are held by the Company in restricted cash.
4. NOTES RECEIVABLE
The Company has notes receivable from sales agents of
$1.8 million
and
$7.2 million
as of December 31, 2018 and 2017, respectively. These notes bear an average interest rate of
12.8%
and
10.5%
as of December 31, 2018 and 2017, respectively. Interest and principal payments on the notes are due at various dates through January 2021.
Under the terms of the agreements, the Company preserves the right to holdback residual payments due to the applicable sales agents and applies such residuals against future payments due to the Company. Based on the terms of these agreements and historical experience,
no
reserve has been recorded for notes receivable as of December 31, 2018 and 2017.
Principal contractual maturities on the notes receivable at December 31, 2018 were as follows:
|
|
|
|
|
|
(in thousands)
|
|
|
Years Ended December 31,
|
|
Maturities
|
2019
|
|
$
|
979
|
|
2020
|
|
852
|
|
|
|
$
|
1,831
|
|
5. GOODWILL AND INTANGIBLE ASSETS
The Company records goodwill when an acquisition is made and the purchase price is greater than the fair value assigned to the underlying tangible and intangible assets acquired and the liabilities assumed. The Company's goodwill is allocated to reporting units as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
Consumer Payments
|
$
|
106,832
|
|
|
$
|
101,532
|
|
Commercial Payments and Managed Services
|
2,683
|
|
|
—
|
|
|
$
|
109,515
|
|
|
$
|
101,532
|
|
The Company's intangible assets primarily include merchant portfolios and other intangible assets such as non-compete agreements, trade names, acquired technology (developed internally by acquired companies prior to acquisition by the Company) and customer relationships. For the year ended December 31, 2018, the Company acquired merchant portfolios totaling approximately
$90.9 million
, including
$44.8 million
in December 2018 related to Direct Connect Merchant Services, LLC. For the year ended December 31, 2017, the Company acquired merchant portfolios totaling approximately
$2.5 million
.
There were no changes in the carrying amount of goodwill for the year ended December 31, 2017. The following table summarizes the changes in the carrying amount of goodwill for the year ended December 31, 2018:
|
|
|
|
|
(in thousands)
|
Amount
|
|
|
Balance at December 31, 2017:
|
|
Pipeline Cynergy Holdings, LLC and ACCPC, Inc.
|
$
|
101,532
|
|
Goodwill arising from business combinations in 2018:
|
|
PayRight
|
298
|
|
RadPad/Landlord Station
|
2,385
|
|
PPS Northeast
|
1,920
|
|
PPS Tech
|
3,380
|
|
Balance at December 31, 2018
|
$
|
109,515
|
|
For business combinations consummated during the year ended December 31, 2018, goodwill is deductible for income tax purposes.
As of December 31, 2018 and
December 31, 2017
intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
|
|
|
|
Other intangible assets:
|
|
|
|
Merchant portfolios
|
$
|
137,576
|
|
|
$
|
46,716
|
|
Non-compete agreements
|
3,390
|
|
|
3,390
|
|
Trade names
|
2,870
|
|
|
2,580
|
|
Acquired technology
|
14,390
|
|
|
13,200
|
|
Customer relationships
|
55,940
|
|
|
51,090
|
|
|
214,166
|
|
|
116,976
|
|
Less accumulated amortization:
|
|
|
|
Merchant portfolios
|
(48,492
|
)
|
|
(41,915
|
)
|
Non-compete agreements
|
(3,390
|
)
|
|
(3,243
|
)
|
Trade names
|
(1,017
|
)
|
|
(776
|
)
|
Acquired technology
|
(10,222
|
)
|
|
(7,928
|
)
|
Customer relationships
|
(26,408
|
)
|
|
(21,052
|
)
|
|
(89,529
|
)
|
|
(74,914
|
)
|
|
|
|
|
Balance at December 31, 2018
|
$
|
124,637
|
|
|
$
|
42,062
|
|
The weighted-average amortization periods for intangible assets at December 31, 2018 and December 31, 2017 were as follows:
|
|
|
|
|
|
|
|
Useful Life
|
|
Amortization Method
|
|
Weighted-Average Life
|
Merchant portfolios
|
1 - 10 years
|
|
Straight-line and double declining
|
|
6.3 years
|
Non-compete agreements
|
3 years
|
|
Straight-line
|
|
3.0 years
|
Trade name
|
5 - 12 years
|
|
Straight-line
|
|
11.6 years
|
Technology
|
6 - 7 years
|
|
Straight-line
|
|
6.1 years
|
Customer relationships
|
1 - 25 years
|
|
Straight-line and sum-of-years digits
|
|
14.4 years
|
Amortization expense for intangible assets was
$14.7
million,
$10.5
million, and
$11.9
million for the years ended December 31, 2018, 2017 and 2016, respectively.
The estimated amortization expense of intangible assets as of December 31, 2018 for the next five years and thereafter is:
|
|
|
|
|
|
(in thousands)
|
|
|
Years Ending December 31,
|
|
Maturities
|
2019
|
|
$
|
26,544
|
|
2020
|
|
24,250
|
|
2021
|
|
22,575
|
|
2022
|
|
21,133
|
|
2023
|
|
16,132
|
|
Thereafter
|
|
14,003
|
|
Total
|
|
$
|
124,637
|
|
Actual amortization expense to be reported in future periods could differ from these estimates as a result of new intangible asset acquisitions, changes in useful lives, and other relevant events or circumstances.
The Company tests goodwill for impairment for each of its reporting units on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit is below its carrying value. The Company performed its most recent annual goodwill impairment test as of November 30, 2018 using market data and discounted cash flow analysis. The Company concluded there were no indicators of impairment as of December 31, 2018 and
December 31, 2017
. As such, there was
no
impairment loss for the years ended December 31, 2018, 2017, and 2016.
6. 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 December 31, 2018 and
December 31, 2017
follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
|
Useful Life
|
Furniture and fixtures
|
$
|
2,254
|
|
|
$
|
1,871
|
|
|
2-7 years
|
Equipment
|
8,164
|
|
|
6,256
|
|
|
3-7 years
|
Computer software
|
27,804
|
|
|
20,443
|
|
|
3-5 years
|
Leasehold improvements
|
5,935
|
|
|
4,965
|
|
|
5-10 years
|
|
44,157
|
|
|
33,535
|
|
|
|
Less accumulated depreciation
|
(26,675
|
)
|
|
(21,592
|
)
|
|
|
Property, equipment, and software, net
|
$
|
17,482
|
|
|
$
|
11,943
|
|
|
|
Depreciation expense totaled
$5.1 million
,
$4.2 million
, and
$2.8 million
for the years ended December 31, 2018, 2017, and 2016, respectively.
7. 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 consisted of the following at December 31, 2018 and December 31, 2017 consisted of the following:
|
|
|
|
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
Accounts payable
|
$
|
8,030
|
|
|
$
|
8,751
|
|
Accrued compensation
|
$
|
6,193
|
|
|
$
|
6,136
|
|
Accrued network fees
|
$
|
6,971
|
|
|
$
|
1,529
|
|
8. LONG-TERM DEBT AND WARRANT LIABILITY
Long-term debt owed by certain subsidiaries (the "Borrowers") of the Company consisted of the following as of December 31, 2018 and December 31, 2017:
|
|
|
|
|
|
|
|
|
(dollar amounts in thousands)
|
December 31, 2018
|
|
December 31, 2017
|
Term Loan - Senior, matures January 3, 2023 and bears interest at LIBOR plus 5.0% at December 31, 2018 and 6.0% at December 31, 2017 (actual rate of approximately 7.5% at December 31, 2018 and 7.4% at December 31, 2017)
|
$
|
322,666
|
|
|
$
|
198,000
|
|
Term Loan - Subordinated, matures July 3, 2023 and bears interest at 5.0% plus payment-in-kind interest (actual rate of 10.5% at December 31, 2018 and 11.3% at December 31, 2017)
|
90,016
|
|
|
85,118
|
|
Revolving credit agreement - expires January 2, 2022
|
—
|
|
|
—
|
|
Total Debt
|
412,682
|
|
|
283,118
|
|
Less: current portion of long-term debt
|
(3,293
|
)
|
|
(7,582
|
)
|
Less: unamortized debt discounts
|
(3,300
|
)
|
|
(3,212
|
)
|
Less: deferred financing costs
|
(3,994
|
)
|
|
(4,385
|
)
|
Total long-term debt
|
$
|
402,095
|
|
|
$
|
267,939
|
|
Substantially all of the Company's assets are pledged as collateral under the long-term debt agreements, which are described in more detail in the following sections of this footnote. However, the parent entity, Priority Technology Holdings, Inc., is neither a borrower nor a guarantor of the long-term debt.
Debt Refinancing in January 2017
On January 3, 2017, the Company refinanced existing long-term debt whereby the Borrowers entered into a credit agreement with a syndicate of lenders (the "Senior Credit Agreement"). The Senior Credit Agreement had an original maximum borrowing amount of
$225.0
million, consisting of a
$200.0
million term loan and a
$25.0
million revolving credit facility. Borrowings under the Senior Credit Agreement were subject to an applicable margin, or percentage per annum, equal to: (i) with respect to initial term loans, (a) for LIBOR rate loans,
6.00%
per annum and (b) for base rate loans,
5.00%
per annum; and (ii) with respect to revolving loans (a) for LIBOR rate loans and letter of credit fees,
6.00%
, (b) for base rate loans,
5.00%
and (c) for unused commitment fees,
0.50%
.
As part of the debt refinancing on January 3, 2017, the Borrowers also entered into a Credit and Guaranty Agreement (the "GS Credit Agreement") with Goldman Sachs Specialty Lending Group, L.P. ("Goldman Sachs" or "GS") for an
$80.0
million term loan, the proceeds of which were used to refinance the amounts previously outstanding with Goldman Sachs.
The term loans under the Senior Credit Agreement and the GS Credit Agreement were issued at a discount of
$3.7
million. The Company determined that the
2017
debt refinancing should be accounted for as a debt extinguishment. The Company recorded an extinguishment loss of approximately
$1.8
million, which consisted primarily of lender fees incurred in connection with the refinancing and the write-off of unamortized deferred financing fees and original issue discount. The extinguishment loss is reported within "Other, net" on the Company's consolidated statements of operations.
First Amendment in November 2017
The Senior Credit Agreement and the GS Credit Agreement were amended on November 14, 2017 (the "First Amendment"). The First Amendment allows for loan advances of less than
$5.0 million
and for certain liens on cash securing the Company's funding obligations under a new product involving a virtual credit card program. There were no other substantive changes in the First Amendment.
Second Amendment in January 2018
On January 11, 2018, the Borrowers modified the Senior Credit Agreement and the GS Credit Agreement (collectively, the "Second Amendment"). The Second Amendment increased the Senior Credit Agreement term loans by
$67.5
million and lowered the applicable margin under the Senior Credit Agreement. The
$67.5
million in additional borrowings under the Senior Credit
Agreement was issued at a discount of
$0.4
million. As a result of the Second Amendment, borrowings under the Senior Credit Agreement were subject to an applicable margin, or percentage per annum, equal to: (i) with respect to initial term loans, (a) for LIBOR rate loans,
5.00%
per annum, and (b) for base rate loans,
4.00%
per annum; and (ii) with respect to revolving loans (a) for LIBOR rate loans and letter of credit fees,
5.00%
, (b) for base rate loans,
4.00%
, and (c) for unused commitment fees,
0.50%
.
The Company determined that the Second Amendment should be accounted for as a debt modification. Therefore, all previously deferred fees and costs continued to be amortized to interest expense using the effective interest method over the respective terms of the amended term. The Company incurred
$0.8
million in issuance costs related to the Second Amendment, which were expensed as incurred and recorded as a component of Other, net in the accompanying consolidated statement of operations for the year ended December 31, 2018. In connection with the new lenders to the Senior Credit Agreement as a result of the Second Amendment, the Company capitalized incremental deferred financing costs of
$0.3
million and fees paid to lenders of
$0.4
million. As a result of the Second Amendment, the Senior Credit Agreement had a maximum borrowing amount of
$292.5
million, consisting of a
$267.5
million Term Loan and a
$25.0
million revolving credit facility.
Third Amendment in December 2018
On December 24, 2018, the Borrowers modified the Senior Credit Agreement and the GS Credit Agreement (collectively, the "Third Amendment"). Under the Third Amendment, (i) the term loan under the Senior Credit Agreement was increased in an aggregate principal amount of
$60.0 million
(issued at a discount of
$0.3 million
) and (ii) the term loan commitments under the Senior Credit Agreement were increased by
$70.0 million
on a delayed basis (
$130.0 million
increase in total). Until the additional
$70.0 million
is drawn, the Borrowers will pay a fee on the undrawn amounts at a rate of
2.50%
per annum from the 31st day after the date of the Third Amendment to the 60th day and
5.00%
per annum thereafter for so long as the amounts remain committed and undrawn. In addition, the Borrowers will be required to pay a fee of
0.50%
of any of the additional
$70.0 million
that is drawn. The existing applicable margins, or interest rates, in the Second Amendment did not change as a result of the Third Amendment.
The terms of the GS Credit Agreement were amended to allow for the increase in borrowings under the Senior Credit Agreement but otherwise the terms of the GS Credit Agreement were not substantively changed by the Third Amendment. The allowed borrowings amount under the GS Credit Agreement are
$80.0 million
and this was not changed by the Third Amendment.
The Company determined that the Third Amendment should be accounted for as a debt modification. Therefore, all previously deferred fees and costs continue to be amortized to interest expense using the effective interest method over the respective terms. The Company incurred approximately
$1.3 million
in issuance costs related to the Third Amendment, of which
$1.2 million
was expensed as a component of Other, net in the Company's consolidated statement of operations for the year ended December 31, 2018 and approximately
$0.1 million
was recorded as deferred financing costs on the Company's consolidated balance sheet as of December 31, 2018. As a result of the Third Amendment, the Senior Credit Agreement has a maximum borrowing amount of
$422.5 million
, consisting of a
$327.5 million
term loan, a
$70.0 million
undrawn term loan commitment, and a
$25.0
million revolving credit facility.
Additional Information
The Senior Credit Agreement matures on January 3, 2023, with the exception of the revolving credit facility which expires on January 2, 2022. Any amounts outstanding under the revolving credit facility must be paid in full before the maturity date of January 2, 2022. There were
no
amounts outstanding under the revolving credit facility as of December 31, 2018 and
December 31, 2017
. The Company recorded
$0.2
million of interest expense for the year ended December 31, 2018 as a penalty for not drawing on the revolving credit facility. The GS Credit Agreement matures on July 3, 2023.
Under the Senior Credit Agreement, the Company is required to make quarterly principal payments of
$0.8
million. Additionally, the Company may be obligated to make certain additional mandatory prepayments based on excess cash flow, as defined in the Senior Credit Agreement. No such prepayment was due for the year ended December 31, 2018. At
December 31, 2017
, the mandatory prepayment was
$5.6
million, which was included in current portion of long-term debt. On April 30, 2018, the Company entered into a limited waiver and consent whereby the
2017
mandatory prepayment was waived. Accordingly, this
$5.6
million at December 31, 2017 was not paid.
Principal contractual maturities on long-term debt at December 31, 2018 are as follows:
|
|
|
|
|
|
(in thousands)
|
|
|
Years Ended December 31,
|
|
Maturities
|
2019
|
|
$
|
3,293
|
|
2020
|
|
3,293
|
|
2021
|
|
3,293
|
|
2022
|
|
3,293
|
|
2023
|
|
399,510
|
|
|
|
$
|
412,682
|
|
For the years ended December 31, 2018 and 2017, the payment-in-kind (PIK) interest under the GS Credit Agreement added
$4.9
million and
$5.1
million, respectively, to the principal amount of the subordinated debt, which totaled
$90.0 million
and
$85.1 million
as of December 31, 2018 and 2017, respectively.
For the years ended December 31, 2018, 2017, and 2016, the Company recorded interest expense, including amortization of deferred financing costs and debt discounts, of
$29.9
million,
$25.1
million, and
$4.8
million, respectively.
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 Priority Technology Holdings, Inc., 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. Substantially all of the borrowers' assets are pledged as collateral under the Senior Credit Agreement and GS Credit Agreement. The borrowers are also required to comply with certain restrictions on their Total Net Leverage Ratio (as defined in the Senior Credit Agreement and GS Credit Agreement). As of December 31, 2018, the Borrowers were in compliance with the covenants.
The Total Net Leverage Ratio covenant under the Senior Credit Facility requires a Total Net Leverage Ratio of no more than
6.50
:1.00 as of December 31, 2018,
6.25
:1.00 as of March 31, 2019, and further steps down in each subsequent quarter of 2019 to be no more than
5.25
:1.00 as of December 31, 2019 and for each quarter thereafter. The Senior Credit Facility defines Total Net Leverage Ratio as the consolidated total debt of the Borrowers, less unrestricted cash subject to certain restrictions, divided by the Earnout Adjusted EBITDA (a non-GAAP measure) of the Borrowers for the prior four quarters. As of December 31, 2018, the Borrowers' Total Net Leverage Ratio was
5.06
:1.00.
Goldman Sachs Warrant ("GS warrant")
In connection with the prior GS Credit Agreement, Priority Holdings, LLC issued a warrant to GS to purchase
1.0%
of Priority Holdings, LLC's outstanding Class A common units. As part of the 2017 debt amendment, the
1.0%
warrant with GS was extinguished and Priority Holdings, LLC issued a new warrant to GS to purchase
1.8%
of Priority Holding, LLC's outstanding Class A common units. As of
December 31, 2017
, the warrant had a fair value of
$8.7 million
and was presented as a warrant liability in the accompanying consolidated balance sheets.
On January 11, 2018, the
1.8%
warrant was amended to provide GS with a warrant to purchase
2.2%
of Priority Holdings, LLC's outstanding Class A common units. The change in the warrant percentage was the result of anti-dilution provisions in the warrant agreement, which were triggered by Priority Holdings, LLC's Class A common unit redemption that occurred during the first quarter of 2018. The warrant had a term of
7 years
and an exercise price of
$0
. Since the obligation was based solely on the fact that the
2.2%
interest in equity of Priority Holdings, LLC was fixed and known at inception as well as the fact that GS could exercise the warrant with a settlement in cash any time prior to the expiration date of December 31, 2023, the warrant was recorded as a liability in the Company's historical financial statements prior to redemption on July 25, 2018. On July 25, 2018, Priority Holdings, LLC and GS agreed to redeem the warrant in full in exchange for
$12.7
million in cash.
Deferred Financing Costs
Capitalized deferred financing costs related to the Company's credit facilities totaled of
$4.0 million
and
$4.4
million at December 31, 2018 and December 31, 2017, respectively. Deferred financing costs are being amortized using the effective interest method over the remaining term of the respective debt and are recorded as a component of interest expense. Interest expense related to amortization of deferred financing costs was
$0.8
million,
$0.7 million
, and
$0.4
million for the years ended December 31, 2018, 2017, and 2016, respectively. Deferred financing costs are included in long-term debt in the Company's consolidated balance sheets.
9. INCOME TAXES
In connection with the Business Combination as disclosed in Note 1,
Nature of Business and Accounting Policies
, the partnership tax status was terminated on July 25, 2018. Under the former partnership status, Priority Holdings, LLC was a dual member limited liability company and as such its financial statements reflected no income tax provisions as a pass-through entity. As a result of the Business Combination, for income tax purposes Priority Holdings, LLC became a disregarded subsidiary of the Company, the successor entity to MI Acquisitions, Inc., whereby its operations became taxable. For all periods subsequent to the Business Combination, the income tax provision reflects the taxable status of the Company as a corporation. The initial net deferred tax asset from the Business Combination is the result of the difference between initial tax basis, generally substituted tax basis, and the reflective carrying amounts of the assets and liabilities for financial statement purposes. The net deferred tax asset as of July 25, 2018 was approximately
$47.5
million, which was recorded and classified on the Company's consolidated balance sheet at December 31, 2018 in accordance with ASU 2015-17 and as an adjustment to Additional Paid-In Capital in the Company's consolidated statement of changes in stockholders' equity (deficit) for the year ended December 31, 2018. In addition, the Company's consolidated financial statements for the years ended December 31, 2018 and 2017 reflect unaudited pro-forma income tax disclosure amounts to illustrate the income tax effects had the Company been subject to federal and state income taxes for both full years.
Components of income tax (benefit) expense for the year ended December 31, 2018 was as follows:
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
U.S. current income tax expense
|
|
Federal
|
$
|
29
|
|
State and local
|
418
|
|
Total current income tax expense
|
447
|
|
|
|
U.S. deferred income tax (benefit)
|
|
Federal
|
(1,901
|
)
|
State and local
|
(305
|
)
|
Total deferred income tax (benefit)
|
(2,206
|
)
|
|
|
Total income tax (benefit)
|
$
|
(1,759
|
)
|
The Company's effective income tax rate was
10.5%
for the year ended December 31, 2018. This rate differs from the statutory federal rate of
21%
primarily due to the partnership status of Priority Holdings, LLC. for periods prior to July 25, 2018. The following table provides a reconciliation of the income tax benefit at the statutory U.S. federal tax rate to actual income tax benefit for the year ended December 31, 2018:
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
U.S. federal statutory (benefit)
|
$
|
(3,528
|
)
|
Earnings as dual-member LLC
|
1,643
|
|
State and local income taxes, net
|
89
|
|
Excess tax benefits pursuant to ASU 2016-09
|
140
|
|
Valuation allowance changes
|
(66
|
)
|
Nondeductible items
|
86
|
|
Tax credits
|
(123
|
)
|
Income tax (benefit)
|
$
|
(1,759
|
)
|
Deferred income taxes reflect the expected future tax consequences of temporary differences between the financial statement carrying amount of the Company's assets and liabilities, tax credits and their respective tax bases, and loss carry forwards. The significant components of deferred income taxes were as follows:
|
|
|
|
|
(in thousands)
|
December 31, 2018
|
|
|
Deferred Tax Assets:
|
|
Accruals and reserves
|
$
|
861
|
|
Intangible assets
|
53,383
|
|
Net operating loss carryforwards
|
796
|
|
Interest limitation carryforwards
|
2,638
|
|
Other
|
1,098
|
|
Gross deferred tax assets
|
58,776
|
|
Valuation allowance
|
(842
|
)
|
Total deferred tax assets
|
57,934
|
|
|
|
Deferred Tax Liabilities:
|
|
Prepaid assets
|
(632
|
)
|
Investments in partnership
|
(3,896
|
)
|
Property and equipment
|
(3,714
|
)
|
Total deferred tax liabilities
|
(8,242
|
)
|
|
|
Net deferred tax assets
|
$
|
49,692
|
|
In accordance with the provisions of ASC 740,
Income Taxes
("ASC 740"), the Company will provide a valuation allowance against deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The assessment considers all available positive and negative evidence and is measured quarterly. As of December 31, 2018, the Company has recorded a valuation allowance of approximately
$0.8
million against certain deferred income tax assets related to Business Combination costs that the Company believes are not more likely than not to be realized.
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 December 31, 2018, 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
2015
and all years thereafter remain open to examination by the federal and state taxing jurisdictions and tax periods for
2014
and all years thereafter remain open for certain state taxing jurisdictions to which the Company is subject.
A change in MI Acquisitions' beneficial ownership occurred concurrent with the Business Combination and Recapitalization on July 25, 2018, which likely caused a stock ownership change for purposes of Section 382 of the Internal Revenue Code. However, this ownership change should have no material impact to the net operating losses ("NOLs") available as of this date. At December 31, 2018, the Company had federal NOL carryforwards of approximately
$2.8 million
which can offset future taxable income as follows: 1) approximately
$2.5 million
can offset 80% of future taxable income for an indefinite period of time and 2) approximately
$0.2 million
can offset 100% of future taxable income through expiration dates ranging from 2036 to 2038. Also at December 31, 2018, the Company had state NOL carryforwards of approximately
$3.8 million
with expirations dates ranging from 2019 to 2024.
On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was enacted. The Tax Act included a number of changes to existing U.S. tax laws. The most notable provisions of the Tax Act that impacted the Company included a reduction of the U.S. corporate
income tax rate from
35%
to
21%
and the limitations on interest deductibility, both effective January 1, 2018, as well as immediate expensing for certain assets placed into service after September 27, 2017. The Company did not experience any material impacts of the provisions of the Tax Act for the year ended December 31, 2018 other than the impact of the reduction of the U.S. corporate rate from
35%
to
21%
and the limitation on interest deductibility. As of December 31, 2018, the Company has completed the accounting for the income tax effects of all elements of the Tax Act in accordance with the SEC's Staff Accounting Bulletin No. 118.
The Company was affected by the new interest deductibility rule under the Tax Act. This rule disallows interest expense to the extent it exceeds 30% of adjusted taxable income, as defined. For the year ended December 31, 2018, the Company's interest deduction was limited to
$11.7 million
. The excess interest not deducted for the year ended December 31, 2018 can be carried forward indefinitely for use in future years.
10. COMMITMENTS AND CONTINGENCIES
Leases
The Company has various operating leases for office space and equipment. These leases range in terms from one to
16 years
. Most of these leases are renewable at expiration, subject to terms acceptable to the lessors and the Company.
Future minimum lease commitments under non-cancelable operating leases with initial or remaining terms in excess of one year are as follows:
|
|
|
|
|
|
(in thousands)
|
Due In
|
|
Amount Due
|
2019
|
|
$1,637
|
2020
|
|
1,353
|
2021
|
|
1,234
|
2022
|
|
1,258
|
2023
|
|
1,315
|
Thereafter
|
|
3,831
|
Total
|
|
$10,628
|
Total rent expenses for the years ended December 31, 2018, 2017, and 2016 was
$1.9 million
,
$1.5 million
, and
$1.3 million
, respectively, which is included in SG&A expenses in the Company's consolidated statements of operations.
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 December 31, 2018, the Company is committed to pay minimum processing fees under these agreements of approximately
$21.0 million
over the next four years.
Legal Proceedings
During 2017, the Company settled a legal matter that resulted in a loss to the Company of
$2.2 million
, which was recorded within SG&A expenses in the Company's consolidated statement of operations for the year ended December 31, 2017.
During the fourth quarter of 2018, the Company settled a legal matter for
$1.6 million
, which is included in SG&A expenses in the Company's consolidated statement of operations for the year ended December 31, 2018.
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.
Merchant Reserves
See Note 3,
Settlement Assets and Obligations
, for information about merchant reserves.
11. RELATED PARTY TRANSACTIONS
Management Services Agreement
During the years ended December 31, 2018, 2017, and 2016, Priority Holdings, LLC had a management services agreement with PSD Partners LP, which is owned by Mr. Thomas Priore, the Company's President, Chief Executive Officer and Chairman. The Company incurred total expenses of
$1.1
million for the year ended December 31, 2018 and
$0.8
million for each of the years ended December 31, 2017 and 2016 related to management service fees, annual bonus payout, and occupancy fees, which are recorded in SG&A expenses in the Company's consolidated statements of operations.
Call Right
The Company's President, Chief Executive Officer and Chairman was given the right to require any of the founders of MI Acquisitions to sell all or a portion of their Company securities at a call-right purchase price, payable in cash. The call right purchase price for common stock will be based on the greater of: 1)
$10.30
; 2) a preceding volume-weighted average closing price (as defined in the governing document); or 3) a subsequent volume-weighted average closing price (as defined in the governing document). The call right purchase price for warrants will be determined by the greater of: 1) a preceding volume-weighted average closing price (as defined in the governing document) of the called security or 2) a subsequent volume-weighted average closing price of the called security. For the Company, the call right does not constitute a financial instrument or derivative under GAAP since it does not represent an asset or obligation of the Company, however the Company discloses it as a related party matter.
12. STOCKHOLDERS' EQUITY (DEFICIT)
As disclosed in Note 1,
Nature of Business and Accounting Policies
, on July 25, 2018 the Company executed the Business Combination which was accounted for as a "reverse merger" between Priority Holdings, LLC and MI Acquisitions, resulting in the Recapitalization of the Company's equity. The combined entity was renamed Priority Technology Holdings, Inc.
Common and Preferred Stock
For periods prior to July 25, 2018, equity has been retroactively restated to reflect the number of shares received as a result of the Recapitalization.
The equity structure of the Company was as follows on December 31, 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
December 31, 2018
|
|
December 31, 2017
|
|
|
Authorized
|
|
Issued
|
|
Authorized
|
|
Issued
|
Common stock, par value $0.001
|
|
1,000,000
|
|
|
67,038
|
|
|
1,000,000
|
|
|
73,110
|
|
Preferred stock, par value $0.001
|
|
100,000
|
|
|
—
|
|
|
—
|
|
|
—
|
|
In connection with the Business Combination and Recapitalization, the following occurred:
|
|
•
|
In exchange for the
4.6
million common units of Priority Holdings, LLC,
60.1
million shares of common stock were issued in a private placement that resulted in the Company receiving approximately
$49.4
million. The
60.1
million shares exclude
0.5
million shares issued as partial consideration in
two
business acquisitions (see Note 2,
Business Combinations
) and includes
3.0
million shares issued in connection with the 2014 Management Incentive Plan (see Note 13,
Equity-Based Compensation
).
|
|
|
•
|
Approximately
4.9
million shares of common stock were deemed to have been issued through share conversion in exchange for the publicly-traded shares of MI Acquisitions that originated from MI Acquisitions' 2016 IPO.
|
|
|
•
|
$2.1
million was paid to MI Acquisitions' founding shareholders (the "MI Founders") in exchange for
421,107
units and
453,210
shares of common stock held by the MI Founders. Each unit consisted of
one
share and
one
warrant of MI Acquisitions.
|
|
|
•
|
The MI Founders forfeited
174,863
shares of their common stock.
|
At December 31, 2018, the Company had
67,038,304
shares of common stock outstanding, of which: 1)
60,071,200
shares were issued in the Recapitalization through the private placement; 2)
874,317
shares were transferred to the sellers of Priority Holdings, LLC that were purchased from the MI Founders; 3)
4,918,138
shares were issued in MI Acquisitions' 2016 IPO; 4)
699,454
shares were issued to the MI Founders; and 5)
475,195
shares were issued as partial consideration for
two
business acquisitions. Certain holders of common stock from the private placement may be subject to holding period restrictions under applicable securities laws.
Except as otherwise required by law or as otherwise provided in any certificate of designation for any series of preferred stock, the holders of the Company's common stock possess all voting power for the election of members of the Company's board of directors and all other matters requiring stockholder action and will at all times vote together as one class on all matters submitted to a vote of the Company's stockholders. Holders of the Company's common stock are entitled to
one
vote per share on matters to be voted on by stockholders. Holders of the Company's common stock will be entitled to receive such dividends and other distributions, if any, as may be declared from time to time by the Company's board of directors in its discretion. Since the Business Combination and Recapitalization, the Company has neither declared nor paid dividends. The holders of the Company's common stock have no conversion, preemptive or other subscription rights and there is no sinking fund or redemption provisions applicable to the common stock.
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 December 31, 2018, the Company has not issued any shares of preferred stock.
Earn-Out Consideration
Subsequent to July 25, 2018, an additional
9.8
million shares of common stock may be issued as earn-out consideration to the sellers of Priority, or at their election, to members of Priority's management or other service providers, pursuant to the Company's Earn-Out Incentive Plan. For the first earn-out of up to
4.9
million shares of common stock, Consolidated Adjusted EBITDA (as defined in the Earn-Out Incentive Plan) of the Company must be no less than
$82.5
million for the year ended December 31, 2018 and the Company's stock price must have traded in excess of
$12.00
for any 20 trading days within any consecutive 30-day trading period at any time on or before December 31, 2019. For the second earn-out of up to
4.9
million shares of common stock, Consolidated Adjusted EBITDA of the Company must be no less than
$91.5
million for the year ending December 31, 2019 and the Company's stock price must have traded in excess of
$14.00
for any 20 trading days within any consecutive 30-day trading period at any time between January 1, 2019 and December 31, 2020. In the event that the first earn-out targets are not met, the
entire
9.8
million shares may be issued if the second earn-out targets are met. As of December 31, 2018,
none
of the
9.8
million shares have been earned. Any shares issued to management or directors under compensation plans are subject to the provisions of ASC 718,
Stock Compensation
. See Note 13,
Equity-Based Compensation Plans
.
Warrants issued by MI Acquisitions
Prior to July 25, 2018, MI Acquisitions issued warrants that allow the holders to purchase up to
5,731,216
shares of the Company's common stock at an exercise price of
$11.50
per share, subject to certain adjustments (
5,310,109
of these warrants are designated as "public warrants" and
421,107
are designated as "private warrants"). The warrants may only be exercised during the period commencing on the later to occur of (i) 30 days following the completion of the MI Acquisitions' initial business combination and (ii) 12 months following the closing of MI Acquisitions' IPO, and terminating on the earlier to occur of (i) five years following the date the warrants became exercisable, and (ii) the date fixed for redemption upon the Company electing to redeem the warrants. The Company has the option to redeem all (and not less than all) of the outstanding public warrants at any time from and after the warrants become exercisable, and prior to their expiration, at the price of
$0.01
per warrant; provided that the last sales price of the Company's common stock has been equal to or greater than
$16.00
per share (subject to adjustment for splits, dividends, recapitalizations and other similar events), for any 20 trading days within a 30 trading day period ending on the third business day prior to the date on which notice of redemption is given and provided further that (i) there is a current registration statement in effect with respect to the shares of common stock underlying the public warrants for each day in the 30-day trading period and continuing each day thereafter until the redemption date or (ii) the cashless exercise is exempt from the registration requirements under the Securities Act of 1933, as amended. The warrants are classified as equity, and therefore, subsequent changes in the fair value of the warrants will not be recognized in earnings.
The outstanding purchase option that was sold to the underwriters (in addition to the warrants discussed above) for an aggregate purchase price of
$100
, allows the holders to purchase up to a total of
300,000
units (each consisting of a share of common stock and a public warrant) exercisable at
$12.00
per unit commencing on the later of the consummation of a business combination and six months from September 13, 2016 (the "Purchase Option"). The Purchase Option expires five years from September 13, 2016. The units issuable upon exercise of the Purchase Option are identical to the units offered in MI Acquisitions' IPO. The Purchase Option is classified as equity in the accompanying consolidated balance sheets.
In August 2018, the Company was informed by Nasdaq that it intended to delist the Company's outstanding warrants and units due to an insufficient number of round lot holders for the public warrants. The Company subsequently filed a Registration Statement on Form S-4 with the SEC for the purpose of offering holders of the Company's outstanding
5,310,109
public warrants and
421,107
private warrants the opportunity to exchange each warrant for
0.192
shares of the Company's common stock. The exchange offer expired in February 2019 resulting in a total of
2,174,746
warrants being tendered in exchange for
417,538
shares of the Company's common stock plus cash in lieu of fractional shares. Nasdaq proceeded to delist the remaining outstanding warrants and units, which were comprised of one share of common stock and one warrant, from The Nasdaq Global Market at the open of business on March 6, 2019. The delisting of the remaining outstanding warrants and units had no impact on the Company's financial statements.
Business Combination and Recapitalization Costs
In connection with the Business Combination and Recapitalization, the Company incurred
$13.3
million in fees and expenses, of which
$9.7
million of recapitalization costs were charged to Additional Paid in Capital since these costs were less than the cash received in conjunction with the Recapitalization costs and were directly related to the issuance of equity for the Recapitalization. These costs are presented as Recapitalization costs in the accompanying consolidated statements of changes in stockholders' equity (deficit). The remaining
$3.6
million of expenses were related to the Business Combination and are presented in SG&A expenses in the accompanying consolidated statements of operations.
Authorization to Repurchase Shares of Common Stock
On December 19, 2018, the Company's Board of Directors authorized a stock repurchase program. Under the program, the Company may purchase up to
$5.0 million
of its outstanding common stock from time to time through June 30, 2019. As of March 22, 2019, the Company has not repurchased any of its common stock pursuant to the repurchase plan.
Equity Events for Priority Holdings, LLC that Occurred Prior to July 25, 2018 (date of Business Combination)
On January 3, 2017, Priority used the proceeds from the 2017 debt refinancing (see Note 8,
Long-Term Debt and Warrant Liability
) to redeem
4,681,590
Class A common units for
$200.0
million (the "Redemption"). Concurrent with the Redemption, (i) Priority and its members entered into an amended and restated operating agreement that eliminated the Class A preferred units and the Class C common units and (ii) the Plan of Merger, dated as of May 21, 2014 between Priority Payment Systems Holdings, LLC and Pipeline Cynergy Holdings, LLC was terminated which resulted in the cancellation of related contingent consideration due to holders of Class A preferred units.
On January 31, 2017, Priority entered into a redemption agreement with one of its minority unit holders to redeem their former Class A common membership units for a total redemption price of
$12.2
million. Priority accounted for the Common Unit Repurchase Obligation as a liability because it was required to redeem these former Class A common units for cash. The liability was recorded at fair value at the date of the redemption agreement, which was equal to the redemption value. Under this agreement, Priority redeemed
$3.0
million of
69,450
former Class A common units in April 2017. As of
December 31, 2017
, the Common Unit Repurchase Obligation had a redemption value of
$9.2
million.
The remaining
$9.2
million was redeemed through the January 17, 2018 redemption of
115,751
former Class A common units for
$5.0
million and the February 23, 2018 redemption of
96,999
former Class A common units for
$4.2
million.
In addition to the aforementioned redemptions, Priority redeemed
295,834
former Class A common units for
$25.9
million on January 17, 2018 and
445,410
former Class A common units for
$39.0
million on January 19, 2018. As a result of the aforementioned redemptions, Priority was
100%
owned by Priority Investment Holdings, LLC and Priority Incentive Equity Holdings, LLC until July 25, 2018.
The former Class A common units redeemed in January and February 2018 were then canceled by Priority. The redemption transactions and the amended and restated operating agreement resulted in one unit holder gaining control and becoming the majority unit holder of the Company. These changes in the equity structure of Priority were recorded as capital transactions.
At December 31, 2017, Priority had
5,249
voting former Class A common stock authorized and issued, and
335
and
302
non-voting former Class B common stock authorized and issued, respectively.
Prior to the Business Combination, Priority recorded distributions of
$7.1
million,
$3.4 million
, and
$10.0
million to its members during the years ended December 31, 2018, 2017 and 2016, respectively.
13. EQUITY-BASED COMPENSATION PLANS
The Company has three active equity-based compensation plans: 2018 Equity Incentive Plan; Earnout Incentive Plan; and 2014 Management Incentive Plan. Total equity-based compensation expense was approximately
$1.6 million
,
$1.0 million
, and
$2.3 million
for the years ended December 31, 2018, 2017, and 2016, respectively, which is included in Salary and employee benefits in the accompanying consolidated statements of operations. Beginning in 2018, the Company elected to recognize the effects of forfeitures on compensation expense as the forfeitures occur for all plans.
2018 Equity Incentive Plan
The 2018 Equity Incentive Plan ("2018 Plan") was approved by the Company's board of directors and shareholders in July 2018. The 2018 Plan provides for the issuance of up to
6,703,830
of the Company's common stock. Under the 2018 Plan, the Company's compensation committee may grant awards of non-qualified stock options, incentive stock options, stock appreciation rights ("SARs"), restricted stock awards ("RSU"), restricted stock units, other stock-based awards (including cash bonus awards) or any combination of the foregoing. Any current or prospective employees, officers, consultants or advisors that the Company's compensation committee (or, in the case of non-employee directors, the Company's board of directors) selects, from time to time, are eligible to receive awards under the 2018 Plan. If any award granted under the 2018 Plan expires, terminates, or is canceled or forfeited without being settled or exercised, or if a SAR is settled in cash or otherwise without the issuance of shares, shares of the Company's common stock subject to such award will again be made available for future grants. In addition, if any shares are
surrendered or tendered to pay the exercise price of an award or to satisfy withholding taxes owed, such shares will again be available for grants under the 2018 Plan.
A summary of the cumulative activity for the 2018 Plan is provided in the following table:
|
|
|
|
|
6,703,830
|
|
|
Common stock authorized for the plan in July 2018
|
(2,098,792
|
)
|
|
Stock options granted in December 2018
|
7,558
|
|
|
Stock options grants forfeited in 2018
|
(202,200
|
)
|
|
RSU grants in 2018
|
4,410,396
|
|
|
Common stock available for issuance under the plan at December 31, 2018
|
Stock Options
In December 2018, the Company issued stock option grants to substantially all of the Company's employees excluding the Company's executive officers. The stock options vest as follows:
50%
on July 27, 2019;
25%
on July 27, 2020; and
25%
on July 27, 2021. If a participate terminates employment with the Company, vested options may be exercised for a short period of time while unvested options are forfeited. However, in any event, a stock option will expire
ten years
from date of grant.
Details about the time-based stock options issued under the plan are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-
|
|
|
|
|
|
|
Options for
|
average
|
|
Weighted-average
|
|
Aggregate
|
|
|
number of
|
exercise
|
|
remaining
|
|
intrinsic value
|
|
|
shares
|
price
|
|
contractual terms
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
Outstanding, January 1, 2018
|
|
—
|
|
—
|
|
|
|
|
|
Granted in 2018
|
|
2,098,792
|
|
$
|
6.95
|
|
|
|
|
|
Exercised in 2018
|
|
—
|
|
—
|
|
|
|
|
|
Forfeited in 2018
|
|
(7,558
|
)
|
$
|
6.95
|
|
|
|
|
|
Expired in 2018
|
|
—
|
|
—
|
|
|
|
|
|
Outstanding, December 31, 2018
|
|
2,091,234
|
|
$
|
6.95
|
|
|
9.9 years
|
|
$
|
2,196
|
|
|
|
|
|
|
|
|
|
Vested and Expected to Vest
|
|
2,091,234
|
|
$
|
6.95
|
|
|
9.9 years
|
|
$
|
2,196
|
|
Exercisable at December 31, 2018
|
|
—
|
|
—
|
|
|
|
|
—
|
|
No
stock options have become vested as of December 31, 2018. For the year ended December 31, 2018, compensation expense of
$0.2 million
was recognized for these stock option grants. As of December 31, 2018, there was
$4.0 million
of unrecognized compensation cost related to stock options, which is expected to be recognized over a remaining weighted-average period of
1.3 years
.
The table below presents the assumptions used to calculate the fair value of the stock options issued during 2018:
|
|
|
|
|
Expected volatility
|
|
30
|
%
|
Risk-free interest rate
|
|
2.4
|
%
|
Expected term (years)
|
|
4.3
|
Dividend yield
|
|
—
|
%
|
Exercise price
|
|
$6.95
|
Restricted Stock Units - Service Based
During December 2018, the Company issued
107,143
RSUs with a grant-date fair value of
$7.00
each and a total grant-date fair value of approximately
$0.8 million
. These RSUs have service-based vesting with
50%
vesting in each of the years 2019 and 2020. At December 31, 2018, unrecognized compensation of approximately
$0.7 million
is expected to be recognized over remaining weighted-average period of approximately
1.4 years
. Compensation expense for the year ended December 31, 2018 was not material.
Restricted Stock Units - Performance Based with Market Condition
During the third quarter of 2018, the Company issued
95,057
RSUs with a fair value of
$10.52
each. In addition to the service vesting requirements, these RSUs vest only if certain performance metrics are achieved separately for 2018 and 2019. The performance metrics were not achieved for 2018 and it is not probable that the 2019 performance metrics will be achieved, thus no compensation expense has been recognized for the year ended December 31, 2018 for these RSUs. At the end of each subsequent reporting period, the Company will evaluate the probability of achievement for the performance metrics and adjust cumulative recognized compensation expense accordingly if the service requirements are also expected to be achieved.
Earnout Incentive Plan
The Company's Earnout Incentive Plan (the "EIP") was approved by the Company's board of directors and shareholders in July 2018. See Note 12,
Stockholders'
Equity (Deficit),
for information about the EIP and the potential to issue up to
9.8 million
additional shares of the Company's common stock. Awards issued under the EIP vest upon achievement of performance metrics and a market metric.
During the third quarter of 2018, the Company issued
95,057
RSUs under the EIP with a fair value of
$10.52
each (these were in addition to the
95,057
RSUs issued under the 2018 Plan, as previously noted above). At December 31, 2018, it is not probable that the performance metrics will be achieved, thus
no
compensation expense has been recognized for these RSUs for the year ended December 31, 2018. At the end of each subsequent reporting period, the Company will evaluate the probability of achievement for the performance metrics and adjust cumulative recognized compensation expense accordingly. Under GAAP, the market metric only impacts the fair value of the RSUs, not the requirement to recognize compensation expense if the performance metrics are achieved or probable of being achieved.
As of December 31, 2018, up to
9,704,943
additional grants may be issued under the EIP.
2014 Management Incentive Plan
The Priority Holdings Management Incentive Plan (the "MIP") was established in 2014 to issue equity-based compensation awards to selected employees. Simultaneously with the Business Combination and Recapitalization (see Note 12,
Stockholders'
Equity (Deficit)
), the fair value of the outstanding equity awards under the MIP were exchanged for approximately
3
.0 million shares of common stock of Priority Technology Holdings, Inc. having approximately the same fair value. As such, this exchange was not deemed to be a modification for accounting purposes. The Company continues to recognize compensation expense under the original vesting schedule for the MIP grants whereby each participant's awards vested at either
40%
or
20%
on September 21, 2016 and then continue to vest over various time periods with all vesting to be completed by May 2021.
Compensation expense under the MIP was approximately
$1.5 million
,
$1.0 million
, and
$2.3 million
for 2018, 2017, and 2016, respectively. At December 31, 2018, there was approximately
$0.7 million
of unrecognized compensation that is expected to be recognized by the Company as follows:
$0.5
million in 2019;
$0.1
million in 2020; and
$0.1
million in 2021.
14. EMPLOYEE BENEFIT PLANS
The Company sponsors a 401(k) defined contribution savings plan that covers substantially all of its eligible employees. Under the plan, the Company contributes safe-harbor matching contributions to eligible plan participants on an annual basis. The Company may also contribute additional discretionary amounts to plan participants. Company contributions to the plan were
$0.9 million
,
$1.0 million
, and
$0.8 million
for the years ended December 31, 2018, 2017, and 2016, respectively.
The Company offers a comprehensive medical benefits plan to eligible employees. All obligations under the plan are fully insured through third-party insurance companies. Employees participating in the medical plan pay a portion of the costs for the insurance benefits.
15. FAIR VALUE
Fair Value Measurements
The following is a description of the valuation methodology used for the GS warrant and contingent consideration which are recorded and remeasured at fair value at the end of each reporting period.
Goldman Sachs Warrant
The GS warrant was classified as level 3 in the fair value hierarchy. Historically, the fair value of the GS warrant was estimated based on the fair value of Priority Holdings, LLC using a weighted-average of values derived from generally accepted valuation techniques, including market approaches, which consider the guideline public company method, the guideline transaction method, the recent funding method, and an income approach, which considers discounted cash flows. Priority Holdings, LLC adjusted the carrying value of the warrant to fair value as determined by the valuation model and recognized the change in fair value as an increase or decrease in interest and other expense. On July 25, 2018, the GS warrant was redeemed in exchange for
$12.7
million cash, which resulted in a gain of
$0.1
million, as the value of the GS warrant immediately prior to the cancellation was
$12.8
million. See Note 8,
Long-Term Debt and Warrant Liability.
The warrant is no longer outstanding as of December 31, 2018 and had a fair value of
$8.7
million as of
December 31, 2017
.
Contingent Consideration
Business Combinations
The estimated fair values of contingent consideration related to the PPS Tech and PPS Northeast business acquisitions (see Note 2,
Business Combinations
) were based on a weighted payout probability at the measurement date, which falls within Level 3 on the fair value hierarchy. Both of these acquisitions occurred during the third quarter of 2018, and at December 31, 2018, the total fair value of the contingent consideration for both acquisitions was approximately
$1.0
million, which was not materially different than the fair values on their original measurement dates.
Former Preferred A Units Earnout
A preferred equity earnout plan resulted from the 2014 merger between Priority Payment Systems Holdings, LLC and Pipeline Cynergy Holdings, LLC. A level 3 valuation model was used to estimate the fair value of the earnout consideration. Changes in fair value were reflected in earnings for each reporting period prior to the 2017 expiration of the earnout arrangement.
The following table shows a reconciliation of the beginning and ending balances for liabilities measured at fair value on a recurring basis using significant unobservable inputs that are classified as Level 3 in the fair value hierarchy for the years ended December 31, 2018, 2017, and 2016:
|
|
|
|
|
|
|
|
|
(in thousands)
|
Warrant Liability
|
|
Contingent Consideration
|
|
|
|
|
Balance at January 1, 2016
|
$
|
3,149
|
|
|
$
|
6,887
|
|
Adjustment to fair value included in earnings
|
1,204
|
|
|
(2,665
|
)
|
Balance at December 31, 2016
|
4,353
|
|
|
4,222
|
|
Extinguishment of GS 1.0% warrant liability (Note 8)
|
(4,353
|
)
|
|
—
|
|
GS 1.8% warrant liability (Note 8)
|
4,503
|
|
|
—
|
|
Release and adjustment of contingent consideration (Note 12)
|
—
|
|
|
(4,222
|
)
|
Adjustment to fair value included in earnings
|
4,198
|
|
|
—
|
|
Balance at December 31, 2017
|
8,701
|
|
|
—
|
|
Extinguishment of GS 1.8% warrant liability (Note 8)
|
(8,701
|
)
|
|
—
|
|
GS 2.2% warrant liability (Note 8)
|
12,182
|
|
|
—
|
|
Adjustment to fair value included in earnings
|
591
|
|
|
—
|
|
Extinguishment of GS 2.2% warrant liability (Note 8)
|
(12,701
|
)
|
|
—
|
|
Change in fair value of warrant liability
|
(72
|
)
|
|
—
|
|
Earnout liabilities arising from business combinations (Note 2)
|
—
|
|
|
980
|
|
Balance at December 31, 2018
|
$
|
—
|
|
|
$
|
980
|
|
There were no transfers among the fair value levels during the years ended December 31, 2018, 2017, and 2016.
Fair Value of Debt
The Company's outstanding debt obligations (see Note 8,
Long-term Debt and Warrant Liability
) are reflected in the consolidated balance sheets at carrying value since the Company did not elect to remeasure its debt obligations to fair value at the end of each reporting period. The carrying values of the Company's long-term debt approximate fair value due to mechanisms in the credit agreements that adjust the applicable interest rates.
16. SEGMENT INFORMATION
The Company has
two
reportable segments that are reviewed by the Company's chief operating decision maker ("CODM"), who is the Company's President, Chief Executive Officer and Chairman. The Consumer Payments operating segment is
one
reportable segment. The Commercial Payments, Institutional Services, and Integrated Partners operating segments are aggregated into
one
reportable segment, Commercial Payments and Managed Services.
|
|
•
|
Consumer Payments –
represents consumer-related services and offerings including merchant acquiring and transaction processing services including the proprietary MX enterprise suite. Either through acquisition of merchant portfolios or through resellers, the Company becomes a party or enters into contracts with a merchant and a sponsor bank. Pursuant to the contracts, for each card transaction, the sponsor bank collects payment from the credit, debit or other payment card issuing bank, net of interchange fees due to the issuing bank, pays credit card association (e.g., Visa, MasterCard) assessments and pays the transaction fee due to the Company for the suite of processing and related services it provides to merchants, with the remainder going to the merchant.
|
|
|
•
|
Commercial Payments and Managed Services –
represents services provided to certain enterprise customers, including outsourced sales force to those customers and accounts payable automation services to commercial customers. Additional payment and payment adjacent services are provided to the health care and residential real estate industries.
|
Corporate includes costs of corporate functions and shared services not allocated to our reportable segments. For the year ended December 31, 2018, the Company adjusted its methodology of allocating certain corporate overhead costs to its reportable segments. All prior periods presented have been adjusted to reflect the current allocation methodology.
Information on segments and reconciliations to consolidated revenues, consolidated income (loss) from operations, and consolidated depreciation and amortization are as follows for the years presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Years Ended December 31,
|
|
|
2018
|
|
2017
|
|
2016
|
Revenues:
|
|
|
|
|
|
|
Consumer Payments
|
|
$
|
394,986
|
|
|
$
|
400,320
|
|
|
$
|
322,666
|
|
Commercial Payments and Managed Services
|
|
29,429
|
|
|
25,299
|
|
|
21,448
|
|
Consolidated revenues
|
|
$
|
424,415
|
|
|
$
|
425,619
|
|
|
$
|
344,114
|
|
|
|
|
|
|
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
Consumer Payments
|
|
$
|
50,528
|
|
|
$
|
55,473
|
|
|
$
|
37,772
|
|
Commercial Payments and Managed Services
|
|
(2,921
|
)
|
|
972
|
|
|
1,861
|
|
Corporate
|
|
(27,688
|
)
|
|
(21,196
|
)
|
|
(13,793
|
)
|
Consolidated income from operations
|
|
$
|
19,919
|
|
|
$
|
35,249
|
|
|
$
|
25,840
|
|
|
|
|
|
|
|
|
Depreciation and amortization:
|
|
|
|
|
|
|
Consumer Payments
|
|
$
|
17,945
|
|
|
$
|
13,336
|
|
|
$
|
13,706
|
|
Commercial Payments and Managed Services
|
|
702
|
|
|
451
|
|
|
401
|
|
Corporate
|
|
1,093
|
|
|
887
|
|
|
626
|
|
Consolidated depreciation and amortization
|
|
$
|
19,740
|
|
|
$
|
14,674
|
|
|
$
|
14,733
|
|
A reconciliation of total income from operations of reportable segments to the Company's net (loss) income is provided in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Years Ended December 31,
|
|
|
2018
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
Total income from operations of reportable segments
|
|
47,607
|
|
|
56,445
|
|
|
$
|
39,633
|
|
Less Corporate
|
|
(27,688
|
)
|
|
(21,196
|
)
|
|
(13,793
|
)
|
Less interest expense
|
|
(29,935
|
)
|
|
(25,058
|
)
|
|
(4,777
|
)
|
Less other, net
|
|
(6,784
|
)
|
|
(5,597
|
)
|
|
(877
|
)
|
Income tax benefit
|
|
(1,759
|
)
|
|
—
|
|
|
—
|
|
Net (loss) income
|
|
$
|
(15,041
|
)
|
|
$
|
4,594
|
|
|
$
|
20,186
|
|
The Company is not significantly reliant upon any single customer for the years ended December 31, 2018, 2017, or 2016. Substantially all revenues are generated in the United States.
Total assets, all located in the United States, by reportable segment reconciled to consolidated assets as of December 31, 2018 and 2017 were as follows:
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
As of December 31,
|
|
|
2018
|
|
2017
|
|
|
|
|
|
Consumer Payments
|
|
$
|
267,111
|
|
|
$
|
216,345
|
|
Commercial Payments and Managed Services
|
|
71,756
|
|
|
50,362
|
|
Corporate
|
|
49,751
|
|
|
—
|
|
Total consolidated assets
|
|
$
|
388,618
|
|
|
$
|
266,707
|
|
Assets in Corporate at December 31, 2018 primarily represent net deferred income tax assets of
$49.7 million
. The Company had no material tax assets at December 31, 2017 due to its former status as a pass-through entity for income tax purposes. Substantially all assets related to business operations are assigned to one of the Company's
two
reportable segments even though some of those assets result in Corporate expenses.
17. (LOSS) EARNINGS PER SHARE
As a result of the Recapitalization, the Company has retrospectively adjusted the weighted-average Class A units outstanding prior to July 25, 2018 by multiplying them by the exchange ratio used to determine the number of Class A common stock into which they converted.
The following tables set forth the computation of the Company's (loss) earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands except per share amounts)
|
|
Years Ended December 31,
|
|
|
2018
|
|
2017
|
|
2016
|
Numerator:
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(15,041
|
)
|
|
$
|
4,594
|
|
|
$
|
20,186
|
|
Less: Income allocated to participating securities
|
|
(45
|
)
|
|
(236
|
)
|
|
(101
|
)
|
Net (loss) income available to common stockholders
|
|
$
|
(15,086
|
)
|
|
$
|
4,358
|
|
|
$
|
20,085
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
Weighted-average common shares outstanding - basic and diluted
|
|
61,607
|
|
|
67,144
|
|
|
131,706
|
|
|
|
|
|
|
|
|
Basic and diluted (loss) earnings per share
|
|
$
|
(0.24
|
)
|
|
$
|
0.06
|
|
|
$
|
0.15
|
|
Anti-dilutive securities that were excluded from EPS that could potentially be dilutive in future periods are as follows:
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Years Ended December 31,
|
|
|
2018
|
|
2017
|
|
2016
|
Stock options
|
|
2,091
|
|
|
—
|
|
|
—
|
|
Restricted stock awards
|
|
202
|
|
|
—
|
|
|
—
|
|
Earnout incentive awards
|
|
95
|
|
|
—
|
|
|
—
|
|
Warrants on common stock (see Note 12, Stockholders' Equity (Deficit))
|
|
5,731
|
|
|
3,402
|
|
|
7,202
|
|
18. SELECTED QUARTERLY FINANCIAL RESULTS (UNAUDITED)
The following tables show a summary of the Company's quarterly financial information for each of the four quarters of 2018 and 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands, except per share amounts)
|
|
2018
|
|
|
1Q
|
|
2Q
|
|
3Q
|
|
4Q
|
|
Year
|
Revenues
|
|
$
|
115,596
|
|
|
$
|
104,762
|
|
|
$
|
103,591
|
|
|
$
|
100,466
|
|
|
$
|
424,415
|
|
Operating expenses
|
|
107,718
|
|
|
101,557
|
|
|
100,031
|
|
|
95,190
|
|
|
404,496
|
|
Income from operations
|
|
7,878
|
|
|
3,205
|
|
|
3,560
|
|
|
5,276
|
|
|
19,919
|
|
Interest expense
|
|
(6,929
|
)
|
|
(7,630
|
)
|
|
(7,334
|
)
|
|
(8,042
|
)
|
|
(29,935
|
)
|
Other, net
|
|
(4,126
|
)
|
|
(1,203
|
)
|
|
221
|
|
|
(1,676
|
)
|
|
(6,784
|
)
|
Income tax benefit
|
|
—
|
|
|
—
|
|
|
(991
|
)
|
|
(768
|
)
|
|
(1,759
|
)
|
Net loss
|
|
$
|
(3,177
|
)
|
|
$
|
(5,628
|
)
|
|
$
|
(2,562
|
)
|
|
$
|
(3,674
|
)
|
|
$
|
(15,041
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted (loss) per common share (1)
|
|
$
|
(0.06
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.04
|
)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.24
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands, except per share amounts)
|
|
2017
|
|
|
1Q
|
|
2Q
|
|
3Q
|
|
4Q
|
|
Year
|
Revenues
|
|
$
|
93,092
|
|
|
$
|
101,611
|
|
|
$
|
110,946
|
|
|
$
|
119,970
|
|
|
$
|
425,619
|
|
Operating expenses
|
|
86,528
|
|
|
93,341
|
|
|
101,480
|
|
|
109,021
|
|
|
390,370
|
|
Income from operations
|
|
6,564
|
|
|
8,270
|
|
|
9,466
|
|
|
10,949
|
|
|
35,249
|
|
Interest expense
|
|
(7,570
|
)
|
|
(4,612
|
)
|
|
(6,418
|
)
|
|
(6,458
|
)
|
|
(25,058
|
)
|
Other, net
|
|
(215
|
)
|
|
(1,976
|
)
|
|
(790
|
)
|
|
(2,616
|
)
|
|
(5,597
|
)
|
Net (loss) income
|
|
$
|
(1,221
|
)
|
|
$
|
1,682
|
|
|
$
|
2,258
|
|
|
$
|
1,875
|
|
|
$
|
4,594
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted (loss) per common share
(1)
|
|
$
|
(0.02
|
)
|
|
$
|
0.02
|
|
|
$
|
0.03
|
|
|
$
|
0.03
|
|
|
$
|
0.06
|
|
(1) May not be additive to the net income (loss) per common share amounts for the year due to the calculation provision of ASC 260,
Earnings Per Share
.
19. SUBSEQUENT EVENTS
Acquisitions from Related Party
In February 2019, a subsidiary of the Company, Priority Hospitality Technology, LLC ("PHT"), acquired substantially all of the operating assets and assumed certain liabilities of eTab, LLC ("eTab") and CUMULUS POS, LLC ("Cumulus") under asset contribution agreements. Prior to these transactions, eTab was
80%
owned by the Company's President, Chief Executive Officer and Chairman. No cash consideration was paid to the sellers of eTab or Cumulus at acquisition. As consideration for these acquired net assets, the sellers were issued preferred equity interests in PHT. Under these preferred equity interests, the sellers are eligible to receive up to
$4.5 million
of profits earned by PHT, plus a preferred yield on any of the
$4.5 million
amount that has not been distributed to them. The Company's President, Chief Executive Officer and Chairman owns
80%
of the preferred equity interests in PHT. Once a total of
$4.5 million
plus the preferred yield has been distributed to the holders of the preferred equity interests,
the preferred equity interests will cease to exist. The Company will recognize the fair value of the net assets acquired since the consideration was of a non-cash nature. At this time, the Company is finalizing the estimated fair values of the net assets acquired.
See Note 12,
Stockholders'
Equity (Deficit)
, for information about subsequent events pertaining to certain warrants to purchase shares of common stock of the Company and units, consisting of one share of common stock and one warrant, of the Company.
Asset Acquisition
On March 22, 2019, the Company, through one of its subsidiaries, acquired certain assets and assumed certain related liabilities (the "net assets") from YapStone, Inc. ("YapStone") under an asset purchase and contribution agreement. The purchase price for the net assets was
$65.0
million in cash and a
6.142%
non-controlling interest in the Company's subsidiary that purchased the net assets of YapStone. The
$65.0 million
was funded from a draw down of the Senior Credit Facility on a delayed basis as provided for and pursuant to the third amendment thereto executed in December 2018. See Note 8,
Long-Term Debt and Warrant Liability
.
Residual Portfolio Asset Acquisition
On March 15, 2019, a subsidiary of the Company paid
$15.2 million
cash to acquire certain residual portfolio rights. Of the
$15.2 million
,
$5.0 million
was funded from a delayed draw down of the Senior Credit Facility as provided for and pursuant to the third amendment thereto executed in December 2018. See Note 8,
Long-Term Debt and Warrant Liability
. 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 purchase price may be subject to an increase of up to
$6.4 million
in accordance with the terms of the agreement between the Company and the sellers.