GREENSKY, INC. (United States dollars in thousands, except per share data and unless otherwise indicated) You should read the following discussion and analysis of our financial condition and results of operations together with our Unaudited Condensed Consolidated Financial Statements and related notes included elsewhere in this Form 10-Q, as well as the Audited Consolidated Financial Statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in theGreenSky, Inc. 2019 Form 10-K filed with theSecurities and Exchange Commission onMarch 2, 2020 ("2019 Form 10-K"). This discussion and analysis contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various important factors, including those set forth under Part II, Item 1A "Risk Factors" in this Form 10-Q. Organization GreenSky, Inc. (or the "Company," "we" or "our") was formed as aDelaware corporation onJuly 12, 2017 . The Company was formed for the purpose of completing an initial public offering ("IPO") of its Class A common stock and certain Reorganization Transactions, as further described in the 2019 Form 10-K, in order to carry on the business ofGreenSky Holdings, LLC ("GS Holdings ") and its consolidated subsidiaries.GS Holdings , a holding company with no operating assets or operations, was organized inAugust 2017 . OnAugust 24, 2017 ,GS Holdings acquired a 100% interest inGreenSky, LLC ("GSLLC"), aGeorgia limited liability company, which is an operating entity. Common membership interests ofGS Holdings are referred to as "Holdco Units." OnMay 24, 2018 , the Company's Class A common stock commenced trading on the Nasdaq Global Select Market in connection with its IPO. Executive Summary Covid-19 Pandemic OnMarch 11, 2020 , theWorld Health Organization designated the novel coronavirus disease (referred to as "COVID-19") as a global pandemic. In the second half ofMarch 2020 , the impact of COVID-19 and related actions to mitigate its spread within theU.S. began to impact our consolidated operating results. As ofMay 11, 2020 , the date of filing this Quarterly Report on Form 10-Q, the duration and severity of the effects of COVID-19 remain unknown. Likewise, we do not know the duration and severity of the impact of COVID-19 on all members of the GreenSky ecosystem - our merchants,Bank Partners , and GreenSky program borrowers - as well as our associates. In addition to instituting a Company-wide work-at-home program to ensure the safety of all GreenSky associates and their families, we formed a GreenSky Continuity Team that is tasked with communicating to employees on a regular basis regarding such efforts as planning for contingencies related to the COVID-19 pandemic, providing updated information and policies related to the safety and health of all GreenSky associates, and monitoring the ongoing crisis for new developments that may impact GreenSky, our work locations or our associates. Our GreenSky Continuity Team is generally following the requirements and protocols as published by theU.S. Centers for Disease Control and Prevention and theWorld Health Organization , as well as state and local governments. As of the date of this filing, we have not begun to lift the actions put in place as part of our business continuity strategy, including work-at-home requirements and travel restrictions, and we do not believe that these protocols have materially adversely impacted our internal controls or financial reporting processes. We continue to monitor the ongoing crisis and are taking reasonable measures to manage operating costs. OnMarch 27, 2020 , the President ofthe United States signed into law the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). The CARES Act, among other things, includes provisions relating to direct economic assistance to American workers, refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, technical corrections to tax depreciation methods for qualified improvement property and temporary relief from certain troubled debt restructuring provisions. While the impacts of the CARES Act were not material during the three months endedMarch 31, 2020 , we continue to examine both the direct and indirect impacts that the CARES Act may have on our business. 43 -------------------------------------------------------------------------------- Table of
Contents
The following are anticipated key impacts on our business and response initiatives taken by the Company, in coordination with our network partners, to mitigate such impacts: Transaction Volume. Our transaction volume began to be impacted significantly by COVID-19mid-March 2020 . •Through the end ofFebruary 2020 , we generated$905 million of transaction volume, an increase of 16% over the comparable 2019 two-month period. •Additionally, our monthly transaction volume throughMarch 18, 2020 exceeded$289 million , an increase of 14% over the comparable 2019 month-to-date period. •FromMarch 19, 2020 through the end of the month, following nationwide responses to the COVID-19 pandemic, including restrictions on "non-essential" businesses imposed by state and local governments, we experienced a decline in transaction volume of 14% compared to the prior year. Consumer spending behavior has been significantly impacted by the COVID-19 pandemic, principally due to restrictions on "non-essential" businesses, issuances of stay-at-home orders, increased unemployment, uncertainties about the extent and duration of the pandemic and consumers' concerns with allowing merchant providers into their home. To the extent this change in consumer spending behavior continues, we expect transaction volume to decline relative to the prior year. We expect any declines in transaction volume to reduce our transaction fees relative to 2019. In order for our merchants to better adapt to their customers' financing needs in the current economic environment, we partnered to develop a suite of new promotional loan product offerings, primarily additional reduced rate and deferred interest loan products. The extent to which our home improvement merchants have remained open for business has varied across merchant category and geographical location within theU.S. The majority of elective healthcare providers have been temporarily closed nationwide due to state and local restrictions, reducing our elective healthcare transaction volume to de minimis levels. Portfolio Credit Losses. We entered the COVID-19 pandemic with historically strong credit performance and believe our super-prime program borrowers and focus on promotional credit are strongly resilient. To maintain our strong credit position in this uncertain economic environment, we continue to emphasize our super-prime promotional loan programs with our merchants. Additionally, in partnership with ourBank Partners , GreenSky program borrowers impacted by COVID-19 who request hardship assistance will receive temporary relief from payments. While we expect these measures to mitigate credit losses, we anticipate that the rising unemployment rate, while partially mitigated by the effects of government stimulus measures such as the CARES Act, will result in increased portfolio credit losses in 2020 as compared to the prior year, for which we provide limited protection to theBank Partners through our restricted escrow accounts. Increases in credit losses can reduce our incentive payments, thereby potentially increasing our fair value change in finance charge reversal expense, which is a component of cost of revenue. As the impact of COVID-19 continues to evolve, GreenSky remains committed to serving GreenSky program borrowers and ourBank Partners and merchants, while caring for the safety of our associates and their families. The potential impact that COVID-19 could have on our financial condition and results of operations remains highly uncertain. For more information, refer to Part II, Item 1A "Risk Factors" and, in particular, "- The global outbreak of the novel coronavirus, or COVID-19, has caused severe disruptions in theU.S. economy, and may have an adverse impact on our performance and results of operations." Business Updates Funding Diversification. GreenSky continues to actively diversify its funding to include a combination of commitments fromBank Partners and alternative funding structures with one or more institutional investors, financial institutions and other sources. •OnMay 11, 2020 , we established an asset-backed revolving credit facility withJPMorgan Chase Bank, N.A . to finance purchases by a Company-sponsored special purpose vehicle (the "SPV") of participations in loans originated through the GreenSky program (the "SPV Facility"). The SPV Facility provides committed financing of$300 million . The SPV Facility also permits up to$200 million in additional financing, subject 44 -------------------------------------------------------------------------------- Table of
Contents
to satisfying certain conditions specified in the SPV Facility and obtaining the consent of the lenders. The Company currently expects that the SPV Facility will provide financing for approximately 70% of the purchase price for such participations (on average), and the Company will fund the remainder. The Company is in the final stages of finalizing an agreement governing the participation sales with an existing Bank Partner necessary to access funding under the SPV Facility. The assets of the SPV will not be available to satisfy any obligation of the Company, and no lender will have direct recourse to the Company for any loans made under the SPV Facility. We expect the SPV to conduct periodic sales of the purchased participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases of participations to be financed through the SPV Facility. To the extent that such sales occur, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. The Company expects the SPV Facility to be operational inMay 2020 . •We continue to work with multiple institutional investors, including a leading institutional asset manager, on both a whole loan sales program and a material forward flow financing arrangement (collectively, "New Institutional Financings"). We would expect to close on one or more of these transactions in the second half of 2020. •EffectiveApril 30, 2020 , one of ourBank Partners adjusted its funding commitment from$3 billion to$2 billion , which, because the funding level by the Bank Partner at the time of the change was near the Bank Partner's maximum, had only a nominal impact on our current funding position. Refer to "Liquidity and Capital Resources" in this Part I, Item 2 for discussion of the potential impact on our escrow. Strategic Alternatives Review Process. As announced inAugust 2019 , the Company's Board of Directors (the "Board"), working together with its senior management team and legal and financial advisors, has commenced a process to explore, review and evaluate a range of potential strategic alternatives focused on maximizing stockholder value. The Board's review is ongoing, and the Company does not intend to make further public comment regarding these matters unless and until the Board has approved a specific transaction or alternative or otherwise concludes its review. We would expect to make an announcement in this regard no later than the reporting of the Company's second quarter 2020 financial results. First Quarter 2020 Results As of and for the three months endedMarch 31, 2020 , we achieved growth in many of our key business metrics and financial measures: •Transaction volume (as defined below) was$1.37 billion during the three months endedMarch 31, 2020 compared to$1.24 billion during the three months endedMarch 31, 2019 , an increase of 10%; •The outstanding balance of loans serviced by our platform totaled$9.26 billion as ofMarch 31, 2020 compared to$7.61 billion as ofMarch 31, 2019 , an increase of 22%; •Active merchants totaled 17,761 as ofMarch 31, 2020 compared to 15,745 as ofMarch 31, 2019 , an increase of 13%; •We maintained a strong consumer profile. For all loans originated on our platform during the three months endedMarch 31, 2020 , the credit-line weighted average GreenSky program borrower credit score was 773. Furthermore, GreenSky program borrowers with credit scores over 780 comprised 37% of the loan servicing portfolio as ofMarch 31, 2020 , and over 85% of the loan servicing portfolio as ofMarch 31, 2020 consisted of GreenSky program borrowers with credit scores over 700; •The 30-day delinquencies during the three months endedMarch 31, 2020 were 1.23%, an improvement of 8 basis points over the three months endedMarch 31, 2019 ; •Incentive payments we receive from ourBank Partners , which favorably impact our cost of revenue, increased 77% during the three months endedMarch 31, 2020 compared to the same period in 2019 due to the combination of lower agreed-upon Bank Partner portfolio yield and strong credit performance across the portfolio; and 45 -------------------------------------------------------------------------------- Table of
Contents
•Total revenue of$121.2 million during the three months endedMarch 31, 2020 increased 17% from$103.7 million during the three months endedMarch 31, 2019 . We had a net loss of$10.9 million during the three months endedMarch 31, 2020 compared to net income of$7.4 million during the three months endedMarch 31, 2019 . The lower earnings in the 2020 period were primarily due to a$18.4 million non-cash charge to financial guarantee expense in the 2020 period in accordance with the provisions of ASU 2016-13 (referred to as "CECL"), which we adopted onJanuary 1, 2020 . Refer to "Three Months EndedMarch 31, 2020 and 2019-Financial guarantee" in this Part I, Item 2 as well as Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional discussion of our financial guarantee. In addition, during the first quarter of 2020, we ceased transfers of our rights to Charged-Off Receivables (as defined in Note 3 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1), for which we recognized a$7.4 million gain in the three months endedMarch 31, 2019 . To the extent that we do not transfer our rights to Charged-Off Receivables, we expect to benefit from the retained recoveries over time to achieve overall higher cash returns. Adjusted EBITDA (as defined below) of$19.4 million during the three months endedMarch 31, 2020 increased from$18.4 million during the three months endedMarch 31, 2019 . The increase in Adjusted EBITDA during the three months endedMarch 31, 2020 was primarily attributable to our strong earnings on our growth in transaction volume and increases to the contractual fixed servicing fees for certainBank Partners that were amended in the second half of 2019. These increases were partially offset by the increase in the fair value change in finance charge reversal liability due to a combination of: (i) growth in our loan servicing portfolio, (ii) the aforementioned increase in the contractual servicing fee, which directly reduces incentive payments, and (iii) the cessation of transfers of Charged-Off Receivables in the 2020 period. In addition, we experienced higher servicing and operating expenses in the 2020 period to support our growth. Information regarding our use of Adjusted EBITDA, a non-GAAP measure, and a reconciliation of Adjusted EBITDA to net income (loss), the most comparable GAAP (as defined below) measure, is included in "Non-GAAP Financial Measure." Seasonality. Historically, our business has generally been subject to seasonality in consumer spending and payment patterns. We cannot yet predict the impacts of COVID-19 on the seasonality of our business for the remainder of 2020 or future periods. Given that our home improvement vertical is a significant contributor to our overall revenue, our revenue growth generally has been higher during the second and third quarters of the year as the weather improves, the residential real estate market becomes more active and consumers begin home improvement projects. During these periods, we have typically experienced increased loan applications and, in turn, transaction volume. Conversely, our revenue growth generally has been relatively slower during the first and fourth quarters of the year, as consumer spending on home improvement projects tends to slow leading up to the holiday season and through the winter months. As a result, the volume of loan applications and transactions has also tended to slow during these periods. Historically, the elective healthcare vertical has been susceptible to seasonality during the fourth quarter of the year, as the licensed healthcare providers take more vacation time around the holiday season. During this period, the volume of elective healthcare procedures and our resulting revenue have typically been slower relative to other periods throughout the year. Our seasonality trends may vary in the future as we introduce our program to new industry verticals and become less concentrated in the home improvement industry. The origination related and finance charge reversal components of our cost of revenue also have been subject to these same seasonal factors, while the servicing related component of cost of revenue, in particular customer service staffing, printing and postage costs, has not been as closely correlated to seasonal volume patterns. As transaction volume increases, the transaction volume related personnel costs, as well as costs related to credit and identity verification, among other activities, increase as well. Further, finance charge reversal settlements are positively correlated with transaction volume in the same period of the prior year. As prepayments on deferred interest loans, which trigger finance charge reversals, typically are highest towards the end of the promotional period, and promotional periods are most commonly 12, 18 or 24 months, finance charge reversal settlements follow a similar seasonal pattern as transaction volumes over the course of a calendar year. 46 -------------------------------------------------------------------------------- Table of
Contents
Lastly, we historically have observed seasonal patterns in consumer credit, driven to an extent by income tax refunds, which results in lower charge-offs during the second and third quarters of the year. Credit improvement during these periods has a positive impact on the incentive payments we receive from ourBank Partners . Conversely, during the first and fourth quarters of the year, when credit performance is comparably lower, our incentive payment receipts are negatively impacted, which in turn has a negative impact on our cost of revenue. Non-GAAP Financial Measure In addition to financial measures presented in accordance withUnited States generally accepted accounting principles ("GAAP"), we monitor Adjusted EBITDA to manage our business, make planning decisions, evaluate our performance and allocate resources. We define "Adjusted EBITDA" as net income (loss) before interest expense, taxes, depreciation and amortization, adjusted to eliminate equity-based compensation and payments and certain non-cash and non-recurring expenses. We believe that Adjusted EBITDA is one of the key financial indicators of our business performance over the long term and provides useful information regarding whether cash provided by operating activities is sufficient to maintain and grow our business. We believe that this methodology for determining Adjusted EBITDA can provide useful supplemental information to help investors better understand the economics of our business. Management removed the following EBITDA adjustments beginning in the second quarter of 2019: •the non-cash impact of the initial recognition and subsequent fair value changes in our servicing liabilities, as the fair value measurements of our servicing rights are becoming a more significant component of our core business model. The Adjusted EBITDA measure for the three months endedMarch 31, 2019 was adjusted accordingly, which resulted in a decrease of the measure by$181 thousand ; and •non-corporate tax expenses, which are recorded within general and administrative expenses in our Unaudited Condensed Consolidated Statements of Operations, to align the adjustment with our corporate income tax expense. The Adjusted EBITDA measure for the three months endedMarch 31, 2019 was adjusted accordingly, which resulted in a decrease of the measure by$97 thousand . Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation from, or as a substitute for, the analysis of other GAAP financial measures, such as net income (loss). Some of the limitations of Adjusted EBITDA include: •It does not reflect our current contractual commitments that will have an impact on future cash flows; •It does not reflect the impact of working capital requirements or capital expenditures; and •It is not a universally consistent calculation, which limits its usefulness as a comparative measure. 47 -------------------------------------------------------------------------------- Table of
Contents
Management compensates for the inherent limitations associated with using the
measure of Adjusted EBITDA through disclosure of such limitations, presentation
of our financial statements in accordance with GAAP and reconciliation of
Adjusted EBITDA to the most directly comparable GAAP measure, net income (loss),
as presented below.
Three Months Ended
March 31,
2020 2019
Net income (loss) $ (10,919) $ 7,401
Interest expense 5,620 6,243
Income tax expense (benefit) (895) (595)
Depreciation and amortization 2,445 1,467
Equity-based compensation expense(1) 3,499 2,668
Change in financial guarantee liability(2) 18,408 -
Transaction expenses(3) 262 -
Non-recurring expenses(4) 971 1,216
Adjusted EBITDA $ 19,391 $ 18,400
(1)Includes equity-based compensation to employees and directors, as well as
equity-based payments to non-employees.
(2)Includes non-cash charges related to our financial guarantee arrangements
with our ongoing Bank Partners , which are primarily a function of new loans
facilitated on our platform during the period increasing the contractual escrow
balance and the associated financial guarantee liability.
(3)For the three months ended March 31, 2020 , includes professional fees
associated with our strategic alternatives review process.
(4)For the three months ended March 31, 2020 , includes legal fees associated
with IPO related litigation. For the three months ended March 31, 2019 , includes
the following: (i) legal fees associated with IPO related litigation of $435
thousand , (ii) one-time tax compliance fees related to filing the final tax
return for the Former Corporate Investors associated with the Reorganization
Transactions of $160 thousand , and (iii) lien filing expenses related to certain
Bank Partner solar loans of $621 thousand .
Business Metrics
We review a number of operating and financial metrics to evaluate our business,
measure our performance, identify trends, formulate plans and make strategic
decisions, including the following.
Three Months Ended
March 31,
2020 2019
Transaction Volume
Dollars (in millions) $ 1,372 $ 1,242
Percentage increase 10 %
Loan Servicing Portfolio
Dollars (in millions, at end of period) $ 9,260 $ 7,612
Percentage increase 22 %
Active Merchants
Number (at end of period) 17,761 15,745
Percentage increase 13 %
Cumulative Consumer Accounts
Number (in millions, at end of period) 3.21 2.41
Percentage increase 33 %
48
--------------------------------------------------------------------------------
Table of Contents
Transaction Volume. We define transaction volume as the dollar value of loans facilitated on our platform during a given period. Transaction volume is an indicator of revenue and overall platform profitability and has grown substantially in the past several years. Loan Servicing Portfolio. We define our loan servicing portfolio as the aggregate outstanding consumer loan balance (principal plus accrued interest and fees) serviced by our platform at the date of measurement. Our loan servicing portfolio is an indicator of our servicing activities. The average loan servicing portfolio for the three months endedMarch 31, 2020 and 2019 was$9,214 million and$7,477 million , respectively. Active Merchants. We define active merchants as home improvement merchants and healthcare providers that have submitted at least one consumer application during the twelve months ended at the date of measurement. Because our transaction volume is a function of the size, engagement and growth of our merchant network, active merchants, in aggregate, are an indicator of future revenue and profitability, although they are not directly correlated. The comparative measures can also be impacted by disciplined corrective action taken by the Company to remove merchants from our program who do not meet our customer satisfaction standards. Cumulative Consumer Accounts. We define cumulative consumer accounts as the aggregate number of consumer accounts approved on our platform since our inception, including accounts with both outstanding and zero balances. Although not directly correlated to revenue, cumulative consumer accounts is a measure of our brand awareness among consumers, as well as the value of the data we have been collecting from such consumers since our inception. We may use this data to support future growth by cross-marketing products and delivering potential additional customers to merchants that may not have been able to source those customers themselves. Factors Affecting our Performance Network of Active Merchants and Transaction Volume. We have a robust network of active merchants, upon which our transaction volumes rely. Our revenues and financial results are heavily dependent on our transaction volume, which represents the dollar amount of loans funded on our platform and, therefore, influences the fees that we earn and the per-unit cost of the services that we provide. Our transaction volume depends on our ability to retain our existing platform participants, add new participants and expand to new industry verticals. We engage new merchants through both direct sales channels, as well as affiliate channel partners, such as manufacturers, software companies and other entities that have a network of merchants that would benefit from consumer financing. Once onboarded, merchant relationships are maintained and grown by direct account management, as well as regular product enhancements that facilitate merchant growth. Bank Partner Relationships; Other Funding. "Bank Partners " are the federally insured banks that originate loans under the consumer financing and payments program that we administer for use by merchants on behalf of such banks in connection with which we provide point-of-sale financing and payments technology and related marketing, servicing, collection and other services (the "GreenSky program" or "program"). Our ability to generate and increase transaction volume and expand our loan servicing portfolio is, in part, dependent on (a) retaining our existingBank Partners and having them renew and expand their commitments, (b) adding newBank Partners , and/or (c) adding complementary funding arrangements to increase funding capacity. Our failure to do so could materially and adversely affect our business and our ability to grow. A Bank Partner's funding commitment typically has an initial multi-year term, after which the commitment is either renewed (typically on an annual basis) or expires. No assurance is given that any of the current funding commitments of ourBank Partners will be renewed. As ofMarch 31, 2020 , we had aggregate funding commitments from our ongoingBank Partners of approximately$9.0 billion , of which approximately$1.6 billion was unused. These funding commitments are "revolving" and replenish as outstanding loans are paid down. As a result of loan pay downs, we anticipate approximately$3.4 billion of additional funding capacity will become available through 2021. As we add newBank Partners , their full commitments are typically subject to a mutually-agreed-upon onboarding schedule. As previously disclosed, one of ourBank Partners adjusted its funding commitment effectiveApril 30, 2020 from$3 billion to$2 billion , which adjustment is reflected in the incremental funding capacity noted above. The adjustment of the Bank Partner's funding commitment had only a nominal impact on our current funding position, because the funding level by the Bank Partner at the time of the change was near the Bank Partner's maximum. 49 -------------------------------------------------------------------------------- Table of
Contents
In addition to customary expansion of commitments from existingBank Partners and the periodic addition of newBank Partners to our funding group, we are working to diversify the funding for loans originated by ourBank Partners to also include alternative structures with one or more institutional investors, financial institutions or other financing sources. To that end, as noted above under "Executive Summary," we established the SPV Facility withJPMorgan Chase Bank, N.A . to finance purchases by the SPV of participations in loans originated through the GreenSky program. The SPV Facility provides committed financing of$300 million . The SPV Facility also permits up to$200 million in additional financing, subject to satisfying certain conditions specified in the SPV Facility and obtaining the consent of the lenders. The Company is in the final stages of finalizing an agreement governing the participation sales with an existing Bank Partner necessary to access funding under the SPV Facility. We expect the SPV to conduct periodic sales of the loan participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases to be financed through the SPV Facility. To the extent that such sales occur, the SPV Facility could facilitate substantial incremental GreenSky program loan volume. Additionally, we are continuing to work with multiple institutional investors, including a leading institutional asset manager, on both a whole loan sales program and a material forward flow financing arrangement. We would expect to close on one or more of these transactions in the second half of 2020. If we do not timely consummate forward flow arrangements or other alternative structures, or if the funding commitments from ourBank Partners and forward flow arrangements or other alternative structures (should they be consummated) are not sufficient to support expected originations, it would limit our ability for loans to be originated or our ability to generate revenue at or above current levels. Performance of the Loans our Bank Partners Originate. While ourBank Partners bear substantially all of the credit risk on their wholly-owned loan portfolios, Bank Partner credit losses and prepayments impact our profitability as follows: •Our contracts with ourBank Partners entitle us to incentive payments when the finance charges billed to borrowers exceed the sum of an agreed-upon portfolio yield, a fixed servicing fee and realized credit losses. This incentive payment varies from month to month, primarily due to the amount of realized credit losses. •With respect to deferred interest loans, we bill the GreenSky program borrower for interest throughout the deferred interest promotional period, but the GreenSky program borrower is not obligated to pay any interest if the loan is repaid in full before the end of the promotional period. We are obligated to remit this accumulated billed interest to ourBank Partners to the extent the loan principal balances are paid off within the promotional period (each event, a finance charge reversal or "FCR") even though the interest billed to the GreenSky program borrower is reversed. Our maximum FCR liability is limited to the gross amount of finance charges billed during the promotional period, offset by (i) the collection of incentive payments from ourBank Partners during such period, (ii) proceeds received from transfers of Charged-Off Receivables, and (iii) recoveries on unsold charged-off receivables. Our profitability is impacted by the difference between the cash collected from these items and the cash to be remitted on a future date to settle our FCR liability. Our FCR liability quantifies our expected future obligation to remit previously billed interest with respect to deferred interest loans. •If credit losses exceed an agreed-upon threshold, we make limited payments to ourBank Partners . Our maximum financial exposure is contractually limited to the escrow that we establish with each Bank Partner, which represented a weighted average target rate of 2.2% of the total outstanding loan balance as ofMarch 31, 2020 . Cash set aside to meet this requirement is classified as restricted cash in our Unaudited Condensed Consolidated Balance Sheets. As ofMarch 31, 2020 , the financial guarantee liability associated with our escrow arrangements recognized in accordance with ASU 2016-13 represents over 90% of the contractual escrow that we have established with each Bank Partner. For further discussion of our sensitivity to the credit risk exposure of ourBank Partners , see Part I, Item 3 "Quantitative and Qualitative Disclosures About Market Risk-Credit risk." InJanuary 2020 , ourBank Partners also became subject to ASU 2016-13, which may affect how they reserve for losses on loans. 50 -------------------------------------------------------------------------------- Table of
Contents
General Economic Conditions and Industry Trends. Our results of operations are impacted by the relative strength of the overall economy and its effect on unemployment, consumer spending behavior and consumer demand for our merchants' products and services. As general economic conditions improve or deteriorate, the amount of consumer disposable income tends to fluctuate, which, in turn, impacts consumer spending levels and the willingness of consumers to take out loans to finance purchases. Specific economic factors, such as interest rate levels, changes in monetary and related policies, market volatility, consumer confidence and, particularly, unemployment rates, also influence consumer spending and borrowing patterns. In addition, trends within the industry verticals in which we operate affect consumer spending on the products and services our merchants offer in those industry verticals. For example, the strength of the national and regional real estate markets and trends in new and existing home sales impact demand for home improvement goods and services and, as a result, the volume of loans originated to finance these purchases. In addition, trends in healthcare costs, advances in medical technology and increasing life expectancy are likely to impact demand for elective medical procedures and services. Refer to "Executive Summary" above for a discussion of the expected impacts on our business from the COVID-19 pandemic. Components of Results of Operations There were no significant changes to the components of our results of operations as disclosed in Part II, Item 7 of our 2019 Form 10-K, except as noted below. Financial guarantee. Upon our adoption of the provisions of ASU 2016-13 onJanuary 1, 2020 , our financial guarantee liability associated with our escrow arrangements with ourBank Partners was recognized in accordance with ASC 326, Financial Instruments-Credit Losses (CECL). Changes in the financial guarantee liability each period as measured under CECL are recorded as non-cash charges in the statement of operations. 51 -------------------------------------------------------------------------------- Table of
Contents
Results of Operations Summary
Three Months Ended
2020 2019 $ Change % Change
Revenue
Transaction fees $ 89,884 $ 84,048 $ 5,836 7 %
Servicing and other 31,286 19,652 11,634 59 %
Total revenue 121,170 103,700 17,470 17 %
Costs and expenses
Cost of revenue (exclusive of depreciation and
amortization shown separately below) 71,775 58,037 13,738 24 %
Compensation and benefits 22,434 19,633 2,801 14 %
Sales and marketing 789 1,203 (414) (34) %
Property, office and technology 4,022 4,414 (392) (9) %
Depreciation and amortization 2,445 1,467 978 67 %
General and administrative 6,711 5,700 1,011 18 %
Financial guarantee 18,408 1,222 17,186 1,406 %
Related party 477 536 (59) (11) %
Total costs and expenses 127,061 92,212 34,849 38 %
Operating profit (loss) (5,891) 11,488 (17,379) (151) %
Other income (expense), net (5,923) (4,682) (1,241) 27 %
Income (loss) before income tax expense (benefit) (11,814) 6,806 (18,620) (274) %
Income tax expense (benefit) (895) (595) (300) 50 %
Net income (loss) $ (10,919) $ 7,401 $ (18,320) (248) %
Less: Net income (loss) attributable to
noncontrolling interests (7,585) 4,502 (12,087) (268) %
Net income (loss) attributable to GreenSky, Inc. $ (3,334) $ 2,899 $ (6,233) (215) %
Earnings (loss) per share of Class A common stock
Basic $ (0.05) $ 0.05
Diluted $ (0.05) $ 0.05
Three Months Ended March 31, 2020 and 2019
Total Revenue
During the three months ended March 31, 2020 , total revenue increased $17.5
million , or 17%, compared to the same period in 2019. Transaction fees increased
7%, which was largely commensurate with an increase in transaction volume of
10%. The impact of higher transaction volume was slightly offset by price
concessions for a significant merchant group, which reduced transaction fees by
$2.4 million during the three months ended March 31, 2020 compared to $3.5
million offered to the same merchant group during the same period in 2019.
Transaction fees earned per dollar originated were 6.55% during the three months
ended March 31, 2020 compared to 6.77% during the same period in 2019. The year
over year transaction fee rate decline is primarily related to the mix of
promotional terms of loans originated on our platform. Loans with lower interest
rates, longer stated maturities and longer promotional periods generally carry
relatively higher transaction fee rates. Conversely, loans with higher interest
rates, shorter stated terms and shorter promotional periods generally carry
relatively lower transaction fee rates. The mix of loans offered by merchants
generally varies by merchant category, and is dependent on merchant and consumer
preference. Therefore, shifts in merchant mix have a direct impact on our
transaction fee rates. During the three months ended March 31, 2020 relative to
the same period in 2019, we experienced small shifts in loan originations from
different merchant categories, which resulted in the 0.22% decrease in
transaction fees earned per dollar originated.
During the three months ended March 31, 2020 , servicing and other revenue
increased $11.6 million , or 59%, compared to the same period in 2019, which was
primarily attributable to the increase in our average loan
52
--------------------------------------------------------------------------------
Table of Contents
servicing portfolio of 23% combined with the receipt of higher fixed servicing fees associated with increases to the contractual fixed servicing fees for certainBank Partners in the second half of 2019. The average servicing fee increased to 1.29% of the average loan servicing portfolio in the three months endedMarch 31, 2020 from 1.05% in the same period in 2019. An additional increase of$1.8 million was related to the fair value change in our servicing asset associated with the growth in Bank Partner loan servicing portfolios. Cost of Revenue (exclusive of depreciation and amortization expense) Three Months Ended March 31, 2020 2019 Origination related$ 6,457 $ 8,535 Servicing related 12,814 10,737 Fair value change in FCR liability 52,504
38,765
Total cost of revenue (exclusive of depreciation and amortization expense)$ 71,775 $ 58,037 Origination related Origination related expenses typically include costs associated with our customer service staff that supports Bank Partner loan originations, credit and identity verification, loan document delivery, transaction processing and customer protection expenses. During the three months endedMarch 31, 2020 , origination related expenses decreased 24% compared to the same period in 2019 despite our 10% period over period transaction volume growth. The lower expenses were largely driven by lower customer protection expenses of$1.8 million during the three months endedMarch 31, 2020 compared to the same period in 2019, which are incurred when the Company determines that a merchant did not fulfill its obligation to the end consumer and compensates a Bank Partner for the applicable portion of the loan principal balance. Additionally, we achieved operational efficiencies with loan processing expenses, partially offset by higher personnel costs in the 2020 period. Servicing related Servicing related expenses are primarily reflective of the cost of our personnel (including dedicated call center personnel), printing and postage. During the three months endedMarch 31, 2020 , servicing related expenses increased 19% compared to the same period in 2019, which resulted from our 23% period over period average loan servicing portfolio growth. The increases in servicing related expenses associated with the increase in loans serviced were primarily for personnel costs within our customer service, collections and quality assurance functions. 53 -------------------------------------------------------------------------------- Table of
Contents
Fair value change in FCR liability
The following table reconciles the beginning and ending measurements of our FCR
liability and highlights the activity that drove the fair value change in FCR
liability included in our cost of revenue.
Three Months Ended
March 31,
2020 2019
Beginning balance $ 206,035 $ 138,589
Receipts (1) 44,708 32,123
Settlements (2) (90,089) (59,879)Fair value changes recognized in cost of revenue (3) 52,504
38,765
Ending balance $ 213,158 $ 149,598
(1)Includes: (i) incentive payments from Bank Partners , which is the surplus of
finance charges billed to borrowers over an agreed-upon portfolio yield, a fixed
servicing fee and realized net credit losses, (ii) cash received from recoveries
on previously charged-off Bank Partner loans, and (iii) the proceeds received
from transferring our rights to Charged-Off Receivables attributable to
previously charged-off Bank Partner loans. We consider all monthly incentive
payments from Bank Partners during the period to be related to billed finance
charges on deferred interest products until monthly incentive payments exceed
total billed finance charges on deferred products, which did not occur during
the periods presented.
(2)Represents the reversal of previously billed finance charges associated with
deferred payment loan principal balances that were repaid within the promotional
period.
(3)A fair value adjustment is made based on the expected reversal percentage of
billed finance charges (expected settlements), which is estimated at each
reporting date. The fair value adjustment is recognized in cost of revenue in
the Unaudited Condensed Consolidated Statements of Operations.
Further detail regarding our receipts is provided below for the periods
indicated.
Three Months Ended
March 31,
2020 2019
Incentive payments $ 42,453 $ 23,937 Proceeds from Charged-Off Receivables transfers (1) - 7,355 Recoveries on unsold charged-off receivables (2) 2,255
831 Total receipts$ 44,708 $ 32,123 (1)We collected recoveries on previously charged-off and transferred Bank Partner loans on behalf of our Charged-Off Receivables investors of$5.8 million and$5.1 million during the three months endedMarch 31, 2020 and 2019, respectively. These collected recoveries are excluded from receipts, as they do not impact our fair value change in FCR liability. (2)Represents recoveries on previously charged-off Bank Partner loans. The increase of$13.7 million , or 35%, in the fair value change in FCR liability recognized in cost of revenue during the three months endedMarch 31, 2020 compared to the same period in 2019 was primarily a function of the growth of deferred interest loans in the loan servicing portfolio (and billed finance charges on loans in promotional status) combined with the absence of proceeds from Charged-Off Receivables transfers in the three months endedMarch 31, 2020 compared to proceeds of$7.4 million in the same period in 2019. Excluding the impact of the proceeds from Charged-Off Receivables transfers, the increase in the fair value change in FCR liability was 14% relative to our 22% growth in the loan servicing portfolio, as we benefited from a 77% increase in incentive payments resulting from the combination of lower agreed upon Bank Partner portfolio yield and lower Bank Partner portfolio credit losses. Compensation and benefits During the three months endedMarch 31, 2020 , compensation and benefits expense increased$2.8 million , or 14%, compared to the same period in 2019 due to continued investment in our information technology, credit and sales infrastructure and increased share-based compensation expense of$0.8 million . 54 -------------------------------------------------------------------------------- Table of
Contents
Sales and marketing During the three months endedMarch 31, 2020 , sales and marketing expense, which excludes compensation and benefits, decreased$0.4 million , or 34%, compared to the same period in 2019 primarily due to decreases in trade show attendance, advertising fees and marketing related travel expenses largely related to impacts of the COVID-19 pandemic. Property, office and technology During the three months endedMarch 31, 2020 , property, office and technology expense decreased$0.4 million , or 9%, compared to the same period in 2019 primarily due to a decrease of$0.7 million in consulting expenses associated with additional technology process innovation costs in the 2019 period, partially offset by increases in software, hardware and hosting costs of$0.1 million and operating lease costs of$0.2 million . Depreciation and amortization During the three months endedMarch 31, 2020 , depreciation and amortization expense increased$1.0 million , or 67%, compared to the same period in 2019 primarily driven by increases over time in capitalized internally-developed software. General and administrative During the three months endedMarch 31, 2020 , general and administrative expense increased$1.0 million , or 18%, compared to the same period in 2019 primarily related to professional fees for litigation and compliance matters of$0.7 million and increases in advisory and insurance costs of$0.3 million . Financial guarantee During the three months endedMarch 31, 2020 , non-cash financial guarantee expenses recognized subsequent to our adoption of ASU 2016-13 onJanuary 1, 2020 totaled$18.4 million , representing the estimated increase in the financial guarantee liability. As measured in accordance with the new standard, the increase in the financial guarantee liability was primarily associated with new Bank Partner loans facilitated during the quarter, which increased the required escrow balance, and, to a lesser degree, due to decreased expectations of Bank Partner loan credit performance under the current economic environment. See Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for additional information regarding the measurement of our financial guarantees under the new standard. Under this guidance, we are precluded from including future loan originations by ourBank Partners in measuring our financial guarantee liability. Consistent with the modeling of loan losses for any consumer loan portfolio assumed to go into "run-off," our recognized financial guarantee liability under this model represents a significant portion of the contractual escrow that we establish with each Bank Partner and typically increases each period, with a corresponding non-cash charge to the statement of operations, as new loans facilitated on our platform during the period increase the contractual escrow balance. Historically, our actual cash payments required under the financial guarantee arrangements have been immaterial for ongoing Bank Partner portfolios into which we continue originating loans, and we expect this to continue to be the case subject to the accuracy of our assumptions around the performance of the loan portfolios. During the three months endedMarch 31, 2019 , financial guarantee expenses recognized in accordance with legacy guidance in ASC 450, Contingencies, were$1.2 million , representing expected escrow usage in future periods associated with Bank Partner loan credit performance that was determined to be probable of occurring. Related party During the three months endedMarch 31, 2020 , related party expenses decreased$0.1 million , or 11%, compared to the same period in 2019, which was primarily due to fees incurred in the 2019 period to a placement agent in connection with certain Charged-Off Receivables transfers, of which there were none in the 2020 period. 55 -------------------------------------------------------------------------------- Table of
Contents
Other income (expense), net The$1.2 million , or 27%, increase in other expense, net during the three months endedMarch 31, 2020 compared to the same period in 2019 was primarily due to: (i) higher loan loss reserves associated with loan receivables held for sale of$2.4 million , and (ii) lower income generated from cash and cash equivalents of$0.3 million , partially offset by (iii) lower interest expense of$0.6 million due primarily to a lower effective interest rate, (iv) a decrease in the fair value change in servicing liability of$0.7 million , and (v) higher interest income generated from loan receivables held for sale of$0.3 million due to a higher average balance. Income tax expense (benefit) Income tax benefit recorded during the three months endedMarch 31, 2020 of$0.9 million reflected the expected income tax benefit of$1.1 million on the net loss for the period related toGreenSky, Inc.'s economic interest inGS Holdings , partially offset by$0.2 million of tax expense arising from discrete items, which primarily consisted of a stock-based compensation shortfall as a result of restricted stock awards vesting during the period. Income tax benefit recorded during the three months endedMarch 31, 2019 of$0.6 million reflected the expected income tax expense of$0.5 million on the net earnings for the period related toGreenSky, Inc.'s economic interest inGS Holdings , which was offset by a$1.1 million tax benefit arising from discrete items, which primarily consisted of warrant and stock-based compensation deductions during the period. The decrease in the income tax expense was primarily related to the decrease in overall net earnings attributable toGreenSky, Inc.'s economic interest inGS Holdings compared to the 2019 period, partially offset by an increase in the statutory tax rate. Net income (loss) attributable to noncontrolling interests Net income (loss) attributable to noncontrolling interests for the three months endedMarch 31, 2020 and 2019 reflects income (loss) attributable to the Continuing LLC Members for the entire periods based on their weighted average ownership interest inGS Holdings , which was 63.8% and 67.8%, respectively. Financial Condition Summary Changes in the composition and balance of our assets and liabilities as ofMarch 31, 2020 compared toDecember 31, 2019 were principally attributable to the following: •a$3.8 million increase in cash and cash equivalents and restricted cash. See "Liquidity and Capital Resources" in this Part I, Item 2 for further discussion of our cash flow activity; •a$30.9 million decrease in loan receivables held for sale, net, primarily due to proceeds of$24.1 million from aJanuary 2020 sale and customer payments; •a$7.1 million increase in the FCR liability, which was indicative of a larger balance of deferred interest loans. This activity is analyzed in further detail throughout this Part I, Item 2; •the impact of ourJanuary 1, 2020 adoption of ASU 2016-13, which resulted in an additional financial guarantee liability of$118.0 million and a corresponding cumulative-effect adjustment to equity at the adoption date, including$32.2 million to retained earnings, net of the impact of a$10.4 million increase in deferred tax assets, and$75.4 million to noncontrolling interest. The estimated value of the financial guarantee increased an additional$18.4 million based on our subsequent measurement during the three months endedMarch 31, 2020 . See Note 1 and Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for further discussion of the new standard; •a$7.9 million increase in accounts payable primarily due to monthly settlements withBank Partners related to their portfolio activity; •a$12.9 million increase in the interest rate swap liability due to the significantly decreased interest rate environment. See Note 8 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional information; 56 -------------------------------------------------------------------------------- Table of
Contents
•a$7.9 million decrease in transaction processing liabilities, which is reflective of the reduction in custodial in-transit loan funding requirements; and •a decrease in total equity of$158.6 million primarily due to: (i) the measurement of our financial guarantee liability under ASU 2016-13, as discussed above, (ii) distributions of$31.1 million , which were primarily tax distributions, and (iii) other comprehensive loss of$11.7 million associated with our interest rate swap, as discussed above. These decreases were partially offset by share-based compensation of$3.5 million . Liquidity and Capital Resources We are a holding company with no operations and depend on our subsidiaries for cash to fund all of our consolidated operations, including future dividend payments, if any. We depend on the payment of distributions by our current subsidiaries, includingGS Holdings and GSLLC, which distributions may be restricted as a result of regulatory restrictions, state law regarding distributions by a limited liability company to its members, or contractual agreements, including agreements governing their indebtedness. For a discussion of those restrictions, refer to Part II, Item 1A "Risk Factors - Risks Related to Our Organizational Structure." In particular, the Credit Facility (as defined below) contains certain negative covenants prohibitingGS Holdings and GSLLC from making cash dividends or distributions unless certain financial tests are met. In addition, while there are exceptions to these prohibitions, such as an exception that permitsGS Holdings to pay our operating expenses, these exceptions apply only when there is no default under the Credit Facility. We currently anticipate that such restrictions will not impact our ability to meet our cash obligations. Our principal source of liquidity is cash generated from operations. Our transaction fees are the most substantial source of our cash flows and follow a relatively predictable, short cash collection cycle. To the extent that the impact from the COVID-19 pandemic on consumer spending behavior results in a decline in our transaction volume compared to prior periods, our transaction fees would be similarly impacted. Our short-term liquidity needs primarily include setting aside restricted cash for Bank Partner escrow balances and interest payments onGS Holdings' Credit Facility, which consists of the term loan and revolving loan facility under the Amended Credit Agreement, as defined and discussed in Note 7 to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1. Further, we do not anticipate any major capital expenditures. We currently generate sufficient cash from our operations to meet these short-term needs. In addition, we expect to use cash for: (i) FCR liability settlements, which are not fully funded by the incentive payments we receive from ourBank Partners , but for which$91.1 million is held for certainBank Partners in restricted cash as ofMarch 31, 2020 , and (ii) payments under our financial guarantee related to our portfolio with a Bank Partner that did not renew its loan origination agreement in late 2019 and our portfolio with a Bank Partner that adjusted its funding commitment effectiveApril 30, 2020 and into which loans will not be originated until the balance of the portfolio is below the adjusted funding commitment. Our$100 million revolving loan facility is also available to supplement our cash flows from operating activities in satisfying our short-term liquidity needs. As noted above under "Executive Summary," onMay 11, 2020 , we established the SPV Facility to finance purchases by the SPV of participations in loans originated through the GreenSky program. The SPV Facility provides committed financing of$300 million . The SPV Facility also permits up to$200 million in additional financing, subject to satisfying certain conditions specified in the SPV Facility and obtaining the consent of the lenders. The Company is in the final stages of finalizing an agreement governing the participation sales with an existing Bank Partner necessary to access funding under the SPV Facility. The Company currently expects that the SPV Facility will provide financing for approximately 70% of the purchase price for such participations (on average), and the Company will fund the remainder. We expect that the Company will from time to time purchase participations in loans that have future funding obligations. Such future funding obligations will be funded by the Bank Partner that owns the loan; however, the Company will be required to purchase a participation in the future funding amount, which the Company would intend to finance through the SPV Facility at similar rates. In addition, we expect the SPV to conduct periodic sales of the loan participations or issue asset-backed securities to third parties, which sales or issuances would allow additional purchases to be financed at similar rates. Our most significant long-term liquidity need involves the repayment of our term loan upon maturity inMarch 2025 , which assuming no prepayments, will have an expected remaining unpaid principal balance of$373 57 -------------------------------------------------------------------------------- Table of
Contents
million at that time. Assuming no extended impact of the COVID-19 pandemic, we anticipate that our significant cash generated from operations will allow us to service this debt both for quarterly principal repayments and the balloon payment at maturity. Should operating cash flows be insufficient for this purpose, we will pursue other financing options. We have not made any material commitments for capital expenditures other than those disclosed in the "Contractual Obligations" table in Part II, Item 7 of our 2019 Form 10-K, which did not change materially during the three months endedMarch 31, 2020 . Significant Changes in Capital Structure There were no significant changes in the Company's capital structure during the three months endedMarch 31, 2020 . During the three months endedMarch 31, 2019 , we purchased 4.3 million shares of Class A common stock at a cost of$51.0 million under our share repurchase program, which are held in treasury. See Note 11 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for further discussion of our treasury stock. Cash flows We prepare our Unaudited Condensed Consolidated Statements of Cash Flows using the indirect method, under which we reconcile net income (loss) to cash flows provided by operating activities by adjusting net income (loss) for those items that impact net income (loss), but may not result in actual cash receipts or payments during the period. The following table provides a summary of our operating, investing and financing cash flows for the periods indicated. Three Months EndedMarch 31, 2020
2019
Net cash provided by operating activities$ 41,047 $ 43,455
Net cash used in investing activities
Cash and cash equivalents and restricted cash totaled$449.7 million as ofMarch 31, 2020 , an increase of$3.8 million fromDecember 31, 2019 . Restricted cash, which had a balance of$273.0 million as ofMarch 31, 2020 compared to a balance of$250.1 million as ofDecember 31, 2019 , is not available to us to fund operations or for general corporate purposes. Cash flow activities for the three months endedMarch 31, 2020 consisted of$41.0 million of cash generated from operations, partially offset by$3.4 million of cash used for investing activities and$33.9 million of cash used for financing activities. Financing activity outflows were highlighted by distributions toGS Holdings' members, payment of withholding taxes associated with stock option exercises, and repayments of the principal balance of our term loan. Our restricted cash balances as ofMarch 31, 2020 andDecember 31, 2019 were comprised of three components: (i)$165.0 million and$150.4 million , respectively, which represented the amounts that we have escrowed withBank Partners as limited protection to theBank Partners in the event of excess Bank Partner portfolio credit losses; (ii)$91.1 million and$75.0 million , respectively, which represented an additional restricted cash balance that we maintained for certainBank Partners related to our FCR liability; and (iii)$16.9 million and$24.7 million , respectively, which represented certain custodial in-transit loan funding and consumer borrower payments that we were restricted from using for our operations. The restricted cash balances related to our FCR liability and our custodial balances are not included in our evaluation of restricted cash usage, as these balances are not held as part of a financial guarantee arrangement. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for additional information on our restricted cash held as escrow withBank Partners . 58 -------------------------------------------------------------------------------- Table of
Contents
Cash provided by operating activities Three Months EndedMarch 31, 2020 . Cash flows provided by operating activities were$41.0 million during the three months endedMarch 31, 2020 . Net loss of$10.9 million was adjusted favorably for certain non-cash items of$21.5 million , which were predominantly related to financial guarantee losses, depreciation and amortization, and equity-based expense, partially offset by the fair value changes in servicing assets and liabilities and deferred tax benefit. Primary sources of operating cash during the three months endedMarch 31, 2020 were: (i) an excess of proceeds from sales of loan receivables compared to purchases, (ii) an increase in billed finance charges on deferred interest loans that are expected to reverse in future periods, and (iii) an increase in accounts payable largely driven by Bank Partner settlements related to their portfolio activity and payables for price concessions to a significant merchant group. These increases were offset by uses of cash associated with transaction processing liabilities, which is reflective of the reduction in custodial in-transit loan funding requirements. Three Months EndedMarch 31, 2019 . Cash flows provided by operating activities were$43.5 million during the three months endedMarch 31, 2019 . Net income of$7.4 million was adjusted favorably for certain non-cash items of$4.4 million , which were predominantly related to depreciation and amortization, equity-based expense, financial guarantee losses and fair value changes in servicing liabilities, partially offset by deferred tax benefit. Primary sources of operating cash during the three months endedMarch 31, 2019 were: (i) earnings, (ii) an increase in billed finance charges on deferred interest loans that are expected to reverse in future periods, (iii) an increase in accounts payable largely driven by Bank Partner settlements related to their portfolio activity and payables for price concessions to a significant merchant group, (iv) an increase in transaction processing liabilities primarily driven by the timing of transaction processing liability settlements, and (v) an excess of proceeds from sales of loan receivables held for sale compared to purchases. Cash used in investing activities Detail of the cash used in investing activities is included below for each period (dollars in millions). Three Months Ended March 31, 2020 2019 Software$ 3.0 $ 2.3 Computer hardware 0.3 0.7 Leasehold improvements - 0.2 Furniture 0.1 0.2 Purchases of property, equipment and software$ 3.4 $ 3.4 The spend on investing activities during the three months endedMarch 31, 2020 was flat compared to the same period in 2019. The increase in capitalized costs associated with various internally-developed software projects, such as mobile application development and transaction processing, were offset by lower hardware costs associated with higher infrastructure needs in the 2019 period and lower leasehold improvement costs. Cash used in financing activities Our financing activities in the periods presented consisted of equity and debt related transactions and distributions.GS Holdings makes tax distributions based on the estimated tax payments that its members are expected to have to make during any given period (based upon various tax rate assumptions), which are typically paid in January, April, June and September of each year. We had net cash used in financing activities of$33.9 million during the three months endedMarch 31, 2020 compared to$55.9 million during the same period in 2019. In the 2020 period, our use of cash was primarily related to tax and non-tax distributions to members of$31.1 million and$1.7 million , respectively, and repayments of the principal balance of our term loan (net of original issuance discount) of$1.0 million . In the 2019 period, our use of 59 -------------------------------------------------------------------------------- Table of
Contents
cash was primarily related to: (i) our$51.0 million repurchase of Class A common stock, (ii) distributions of$2.7 million , (iii) repayments of the principal balance of our term loan (net of original issuance discount) of$1.0 million , and (iv) equity activity of$1.1 million consisting of Holdco Unit exchanges and option exercises. Borrowings See Note 7 to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 for further information about our borrowings, including the use of term loan proceeds, as well as our interest rate swap. OnMarch 29, 2018 ,GS Holdings amended itsAugust 25, 2017 Credit Agreement ("Amended Credit Agreement"). The Amended Credit Agreement provides for a$400.0 million term loan, the proceeds of which were used, in large part, to settle the outstanding principal balance on the$350.0 million term loan previously executed under the Credit Agreement inAugust 2017 , and includes a$100.0 million revolving loan facility. The revolving loan facility also includes a$10.0 million letter of credit. The Credit Facility is guaranteed byGS Holdings' significant subsidiaries, including GSLLC, and is secured by liens on substantially all of the assets ofGS Holdings and the guarantors. Interest on the loans can be based either on a "Eurodollar rate" or a "base rate" and fluctuates depending upon a "first lien net leverage ratio." The Amended Credit Agreement contains a variety of covenants, certain of which are designed to limit the ability ofGS Holdings to make distributions on, or redeem, its equity interests unless, in general, either (a) its "first lien net leverage ratio" is no greater than 2.00 to 1.00, or (b) the funds used for the payments come from certain sources (such as retained excess cash flow and the issuance of new equity) and its "total net leverage ratio" is no greater than 3.00 to 1.00. In addition, during any period when 25% or more of our revolving facility is utilized,GS Holdings is required to maintain a "first lien net leverage ratio" no greater than 3.50 to 1.00. There are various exceptions to these restrictions, including, for example, exceptions that enable us to pay our operating expenses and to make certainGS Holdings tax distributions. The$400.0 million term loan matures onMarch 29, 2025 , and the revolving loan facility matures onMarch 29, 2023 . There was no amount outstanding under our revolving loan facility as ofMarch 31, 2020 , which is available to fund future needs ofGS Holdings' business. The use of the London Interbank Offered Rate ("LIBOR") is expected to be phased out by the end of 2021. LIBOR is currently used as a reference rate for certain of our financial instruments, including our$400.0 million term loan under the Amended Credit Agreement and the related interest rate swap agreement, both of which are set to mature after the expected phase out of LIBOR. At this time, there is no definitive information regarding the future utilization of LIBOR or of any particular replacement rate; however, we continue to monitor the efforts of various parties, including government agencies, seeking to identify an alternative rate to replace LIBOR. We will work with our lenders and counterparties to accommodate any suitable replacement rate where it is not already provided under the terms of the financial instruments and, going forward, we will use suitable alternative reference rates for our financial instruments. We will continue to assess and plan for how the phase out of LIBOR will affect the Company; however, while the LIBOR transition could adversely affect the Company, we do not currently perceive any material risks and do not expect the impact to be material to the Company. Tax Receivable Agreement Our purchase of Holdco Units from the Exchanging Members using a portion of the net proceeds from the IPO, our acquisition of the equity of certain of theFormer Corporate Investors , and any future exchanges of Holdco Units for our Class A common stock pursuant to the Exchange Agreement (as such terms are defined in the 2019 Form 10-K) are expected to result in increases in our allocable tax basis in the assets ofGS Holdings . These increases in tax basis are expected to increase (for tax purposes) depreciation and amortization deductions allocable to us and, therefore, reduce the amount of tax that we otherwise would be required to pay in the future. This increase in tax basis may also decrease gain (or increase loss) on future dispositions of certain assets to the extent tax basis is allocated to those assets.We and GS Holdings entered into a Tax Receivable Agreement ("TRA") with the "TRA Parties" (the equity holders of theFormer Corporate Investors , the Exchanging Members, the Continuing LLC Members and any other parties receiving benefits under the TRA, as those parties are defined in the 2019 Form 10-K), whereby we agreed 60 -------------------------------------------------------------------------------- Table of
Contents
to pay to those parties 85% of the amount of cash tax savings, if any, inUnited States federal, state and local taxes that we realize or are deemed to realize as a result of these increases in tax basis, increases in basis from such payments, and deemed interest deductions arising from such payments. Due to the uncertainty of various factors, the likely tax benefits we will realize as a result of our purchase of Holdco Units from the Exchanging Members, our acquisition of the equity of certain of theFormer Corporate Investors or any future exchanges of Holdco Units for our Class A common stock pursuant to the Exchange Agreement, or the resulting amounts we are likely to pay out to the TRA Parties pursuant to the TRA are also uncertain. However, we expect that such payments will be substantial and may substantially exceed the tax receivable liability of$312.3 million as ofMarch 31, 2020 . Because we are the managing member ofGS Holdings , which is the managing member of GSLLC, we have the ability to determine when distributions (other than tax distributions) will be made by GSLLC toGS Holdings and the amount of any such distributions, subject to limitations imposed by applicable law and contractual restrictions (including pursuant to our Amended Credit Agreement or other debt instruments). Any such distributions will be made to all holders of Holdco Units, including us, pro rata based on the number of Holdco Units. The cash received from such distributions will first be used by us to satisfy any tax liability and then to make any payments required under the TRA. We expect that such distributions will be sufficient to fund both our tax liability and the required payments under the TRA. In the event that we do not make timely payment of all or any portion of a tax benefit payment due under the TRA on or before a final payment date, LIBOR is the base for the default rate used to calculate the required interest. The TRA is anticipated to remain in effect after the expected phase out of LIBOR in 2021. See Part I, Item 2 "Liquidity and Capital Resources-Borrowings" for further discussion of the LIBOR phase out. Contingencies From time to time, we may become a party to civil claims and lawsuits in the ordinary course of business. We record a provision for a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated, which requires management judgment. As ofMarch 31, 2020 andDecember 31, 2019 , we did not record any provision for liability. Should any of our estimates or assumptions change or prove to be incorrect, it could have a material adverse impact on our consolidated financial condition, results of operations or cash flows. See Note 14 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for discussion of certain legal proceedings and other contingent matters. Recently Adopted or Issued Accounting Standards See "Recently Adopted Accounting Standards" and "Accounting Standards Issued, But Not Yet Adopted" in Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for additional information. Critical Accounting Policies and Estimates The accounting policies and estimates that we believe are the most critical to an understanding of our results of operations and financial condition as disclosed in our Management's Discussion and Analysis of Financial Condition and Results of Operations as filed in our 2019 Form 10-K include those related to our accounting for finance charge reversals, servicing assets and liabilities, financial guarantees and income taxes. In the preparation of our Unaudited Condensed Consolidated Financial Statements as of and for the three months endedMarch 31, 2020 , there have been no significant changes to the accounting policies and estimates related to our accounting for finance charge reversals, servicing assets and liabilities and income taxes. OnJanuary 1, 2020 , we adopted the provisions of ASU 2016-13, which impacted our accounting for the contingent aspect of our financial guarantees. Historical periods prior toJanuary 1, 2020 continue to reflect the measurement of the contingent aspect of our financial guarantees under legacy guidance in ASC 450. Refer to Note 1 to the Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 for discussion of our adoption of ASU 2016-13 and its impact on our consolidated financial statements and for the revised accounting policy. 61 -------------------------------------------------------------------------------- Table of
Contents
© Edgar Online, source
