##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934


For the quarter ended March 31,
2004

Commission file
number 000-50280

(iPAYMENT LOGO)

iPayment, Inc.


(Exact name of Registrant as Specified in Its
Charter)


|                                                                                                              |  |                                                       
|------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------
|Delaware(State or
    Other Jurisdiction of Incorporation or Organization)                                    |  | 62-1847043(I.R.S.
    Employer
    Identification No.)
|                                                                                                             
|40 Burton Hills Boulevard,
    Suite 415
    Nashville, Tennessee(Address of
    Principal Executive Offices) |  | 37215(Zip
    Code)                                   

Registrants Telephone
Number, Including Area Code:

(615) 665-1858


Former name, address and fiscal year, if
changed since last report:

Not Applicable


Indicate
by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.     Yes þ          No o

Indicate
by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange
Act).     Yes o          No þ

Indicate
the number of shares outstanding of each of the
registrants classes of common stock as of the latest
practicable date.

|                              |  |                              
|----------------------------- |  | -----------------------------
|Class                         |  | Outstanding at April 30, 2004
|                              |  |                              
|Common Stock, $0.01 par value |  | 16,547,820                   



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TABLE OF CONTENTS

|              |  |                                                                                                            |  |      |    | 
|------------- |  | ---------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|              |  |                                                                                                            |  | Page
|              |  |                                                                                                            |  |     
|              |  | PART I  FINANCIAL
    INFORMATION                                                                         |  |      |    | 
|Item 1        |  | Financial Statements                                                                                       |  |      |    | 
|              |  | Consolidated
    Balance Sheets as of March 31, 2004 (Unaudited) and
    December 31, 2003                 |  |      | 2  | 
|              |  | Unaudited
    Consolidated Income Statements for the three months ended
    March 31, 2004 and 2003        |  |      | 3  | 
|              |  | Unaudited
    Consolidated Statements of Cash Flows for the three months ended
    March 31, 2004 and 2003 |  |      | 4  | 
|              |  | Notes to
    Unaudited Consolidated Financial Statements                                                   |  |      | 5  | 
|Item 2        |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                  |  |      | 9  | 
|Item 3        |  | Quantitative and Qualitative
    Disclosures About Market Risk                                             |  |      | 16 | 
|Item 4        |  | Controls and Procedures                                                                                    |  |      | 16 | 
|              |  | PART II  OTHER
    INFORMATION                                                                            |  |      |    | 
|Item 1        |  | Legal Proceedings                                                                                          |  |      | 17 | 
|Item 2        |  | Changes in Securities and
    Use of Proceeds                                                              |  |      | 17 | 
|Item 3        |  | Defaults Upon Senior
    Securities                                                                        |  |      | 17 | 
|Item 4        |  | Submission of Matters to a
    Vote of Security Holders                                                    |  |      | 17 | 
|Item 5        |  | Other Information                                                                                          |  |      | 17 | 
|Item 6        |  | Exhibits and Reports on Form
    8-K                                                                       |  |      | 17 | 
|SIGNATURES    |  |                                                                                                            |  |      | 18 | 
|EXHIBITS      |  |                                                                                                            |  |      | 19 | 
|CERTIFICATION
|CERTIFICATION
|CERTIFICATION
|CERTIFICATION



1



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##### Table of Contents



PART 1.






|        |                     
|------- | --------------------
|Item 1. | Financial Statements




iPAYMENT, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)


|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |         |         | 
|---------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ------ | ------------ | ------- |  | ------ | ------- | ------- | 
|                                         |                                                                                                                                                                                                                                        | March 31,                                      |        | December 31,
|                                         |                                                                                                                                                                                                                                        | 2004                                           |        | 2003        
|                                         |                                                                                                                                                                                                                                        |                                                |        |             
|                                         |                                                                                                                                                                                                                                        | (Unaudited)                                    |        |             
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         | Cash and cash equivalents                                                                                                                                                                                                              |                                                | $      | 528          |         |  | $      | 733     |        
|                                         | Accounts receivable, net of allowance for
    doubtful accounts of $171 and $151 at March 31, 2004 and
    December 31, 2003, respectively                                                                                             |                                                |        | 14,883       |         |  |        | 13,108  |        
|                                         | Prepaid expenses and other current assets                                                                                                                                                                                              |                                                |        | 4,691        |         |  |        | 2,624   |        
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total current assets                           |        |              | 20,102  |  |        |         | 16,465  | 
|Restricted cash                          |                                                                                                                                                                                                                                        |                                                | 3,140  |              |         |  | 11,141 |        
|Property and equipment, net              |                                                                                                                                                                                                                                        |                                                | 2,661  |              |         |  | 3,333  |        
|Intangible assets, net                   |                                                                                                                                                                                                                                        |                                                | 90,772 |              |         |  | 94,593 |        
|Goodwill, net                            |                                                                                                                                                                                                                                        |                                                | 73,002 |              |         |  | 73,002 |        
|Other assets                             |                                                                                                                                                                                                                                        |                                                | 3,669  |              |         |  | 3,409  |        
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total assets                                   |        | $            | 193,346 |  |        | $       | 201,943 | 
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         | Accounts payable and accrued liabilities                                                                                                                                                                                               |                                                | $      | 12,789       |         |  | $      | 11,775  |        
|                                         | Reserve for merchant losses                                                                                                                                                                                                            |                                                |        | 1,204        |         |  |        | 1,198   |        
|                                         | Current portion of long-term debt                                                                                                                                                                                                      |                                                |        | 29           |         |  |        | 4,537   |        
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total current liabilities                      |        |              | 14,022  |  |        |         | 17,510  | 
|Long term liabilities:                   |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         | Related party long-term debt                                                                                                                                                                                                           |                                                |        | 15,677       |         |  |        | 15,591  |        
|                                         | Long-term debt                                                                                                                                                                                                                         |                                                |        | 34,008       |         |  |        | 45,008  |        
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total liabilities                              |        |              | 63,707  |  |        |         | 78,109  | 
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|Commitments and contingencies            |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|Stockholders equity:                    |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         | Preferred stock, $0.01 par value;
    17,422,800 shares authorized, no shares issued and
    outstanding at March 31, 2004 and December 31, 2003                                                                                       |                                                |        |             |         |  |        |        |        
|                                         | Common stock, $0.01 par value;
    180,000,000 shares authorized, 16,545,588 shares
    issued and outstanding at March 31, 2004;
    180,000,000 shares authorized, 16,408,052 shares
    issued and outstanding at December 31, 2003 |                                                |        | 125,863      |         |  |        | 125,060 |        
|                                         | Retained earnings (deficit)                                                                                                                                                                                                            |                                                |        | 3,776        |         |  |        | (1,226  | )      
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total stockholders equity                     |        |              | 129,639 |  |        |         | 123,834 | 
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        
|                                         |                                                                                                                                                                                                                                        | Total liabilities and stockholders
    equity |        | $            | 193,346 |  |        | $       | 201,943 | 
|                                         |                                                                                                                                                                                                                                        |                                                |        |              |         |  |        |        

See accompanying notes to consolidated financial
statements.

2



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##### Table of Contents






iPAYMENT, INC.

CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share
data)


|                                                                    |                                             |                          |        |        |        |   |        |        |        | 
|------------------------------------------------------------------- | ------------------------------------------- | ------------------------ | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                    |                                             |                         
|                                                                    |                                             | Three Months Ended      
|                                                                    |                                             | March 31,               
|                                                                    |                                             |                         
|                                                                    |                                             | 2004                     |        | 2003  
|                                                                    |                                             |                          |        |       
|                                                                    |                                             |                         
|                                                                    |                                             | (Unaudited)             
|Revenues                                                            |                                             | $                        | 79,969 |        |        | $ | 46,675 |       
|Operating expenses:                                                 |                                             |                          |        |        |        |   |        |       
|                                                                    | Interchange                                 |                          |        | 37,315 |        |   |        | 24,010 |       
|                                                                    | Other costs of services                     |                          |        | 31,702 |        |   |        | 16,277 |       
|                                                                    | Selling, general and administrative         |                          |        | 2,886  |        |   |        | 1,829  |       
|                                                                    |                                             |                          |        |        |        |   |        |       
|                                                                    |                                             | Total operating expenses |        |        | 71,903 |   |        |        | 42,116 | 
|                                                                    |                                             |                          |        |        |        |   |        |       
|                                                                    | Income from operations                      |                          |        | 8,066  |        |   |        | 4,559  |       
|Other expense (income):                                             |                                             |                          |        |        |        |   |        |       
|                                                                    | Interest expense                            |                          |        | 710    |        |   |        | 3,290  |       
|                                                                    | Other                                       |                          |        | (339   | )      |   |        |       |       
|                                                                    |                                             |                          |        |        |        |   |        |       
|                                                                    | Income before income taxes                  |                          |        | 7,695  |        |   |        | 1,269  |       
|Income tax provision                                                |                                             |                          | 2,693  |        |        |   | 381    |       
|                                                                    |                                             |                          |        |        |        |   |        |       
|                                                                    | Net income                                  |                          |        | 5,002  |        |   |        | 888    |       
|Accretion of mandatorily redeemable convertible
    preferred stock |                                             |                          |       |        |        |   | (438   | )     
|                                                                    |                                             |                          |        |        |        |   |        |       
|                                                                    | Net income allocable to common stockholders |                          | $      | 5,002  |        |   | $      | 450    |       
|                                                                    |                                             |                          |        |        |        |   |        |       
|Basic and diluted earnings per common share:                        |                                             |                          |        |        |        |   |        |       
|                                                                    | Earnings per share                          |                          |        |        |        |   |        |        |       
|                                                                    |                                             | Basic                    |        | $      | 0.30   |   |        | $      | 0.06   | 
|                                                                    |                                             | Diluted                  |        | $      | 0.28   |   |        | $      | 0.05   | 
|                                                                    | Weighted average shares outstanding         |                          |        |        |        |   |        |        |       
|                                                                    |                                             | Basic                    |        |        | 16,459 |   |        |        | 7,330  | 
|                                                                    |                                             | Diluted                  |        |        | 18,050 |   |        |        | 8,481  | 

See accompanying notes to consolidated financial
statements.

3



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##### Table of Contents






iPAYMENT, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


(Unaudited)


|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |        |       |      |  
|-------------------------------------------------------------------------- | -------------------------------------------------------------------------------------- | ------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------- | ----- | ------ | ------ | ------ | ----- | ---- | -
|                                                                           |                                                                                        |                                                                          
|                                                                           |                                                                                        | Three Months Ended                                                       
|                                                                           |                                                                                        | March 31,                                                                
|                                                                           |                                                                                        |                                                                          
|                                                                           |                                                                                        | 2004                                                                      |                                                                              | 2003   
|                                                                           |                                                                                        |                                                                           |                                                                              |        
|Cash flows from operating activities                                       |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|                                                                           | Net income                                                                             |                                                                           | $                                                                            | 5,002   |       |        | $      | 888    |      
|                                                                           | Adjustments to reconcile net income to net cash
    provided by operating activities   |                                                                           |                                                                              |         |       |        |        |        |      
|                                                                           |                                                                                        | Depreciation and amortization                                             |                                                                              |         | 4,627 |        |        |        | 1,920 |     
|                                                                           |                                                                                        | Noncash interest expense                                                  |                                                                              |         | 141   |        |        |        | 1,272 |     
|                                                                           |                                                                                        | Changes in assets and liabilities, excluding
    effects of acquisitions: |                                                                              |         |       |        |        |        |       |     
|                                                                           |                                                                                        |                                                                           | Accounts receivable                                                          |         |       | (1,775 | )      |        |       | (333 | )
|                                                                           |                                                                                        |                                                                           | Prepaid expenses and other current assets                                    |         |       | (2,067 | )      |        |       | (109 | )
|                                                                           |                                                                                        |                                                                           | Other assets                                                                 |         |       | (143   | )      |        |       | (585 | )
|                                                                           |                                                                                        |                                                                           | Accounts payable and accrued liabilities and
    reserve for merchant losses |         |       | 1,383  |        |        |       | (864 | )
|                                                                           |                                                                                        |                                                                           | Other liabilities                                                            |         |       |       |        |        |       | (13  | )
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Net cash provided by operating activities                                  |                                                                                        |                                                                           | 7,168                                                                        |         |       |        | 2,176  |       
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Cash flows from investing activities                                       |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|                                                                           | Change in restricted cash                                                              |                                                                           |                                                                              | 8,001   |       |        |        | (137   | )    
|                                                                           | Expenditures for property and equipment                                                |                                                                           |                                                                              | (97     | )     |        |        | (242   | )    
|                                                                           | Acquisitions of businesses, portfolios and other
    intangibles, net of cash acquired |                                                                           |                                                                              | (295    | )     |        |        | (1,046 | )    
|                                                                           | Deferred payment for acquisition of business                                           |                                                                           |                                                                              |        |       |        |        | (2,099 | )    
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Net cash provided by (used in) investing
    activities                    |                                                                                        |                                                                           | 7,609                                                                        |         |       |        | (3,524 | )     
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Cash flows from financing activities                                       |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|                                                                           | Net (repayments) borrowings on line of credit                                          |                                                                           |                                                                              | (11,000 | )     |        |        | 1,950  |      
|                                                                           | Repayments of debt and capital lease obligations                                       |                                                                           |                                                                              | (4,507  | )     |        |        | (1,380 | )    
|                                                                           | Proceeds from issuance of common stock                                                 |                                                                           |                                                                              | 525     |       |        |        | 83     |      
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Net cash (used in) provided by financing
    activities                    |                                                                                        |                                                                           | (14,982                                                                      | )       |       |        | 653    |       
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Net decrease in cash and cash equivalents                                  |                                                                                        |                                                                           | (205                                                                         | )       |       |        | (695   | )     
|Cash and cash equivalents, beginning of period                             |                                                                                        |                                                                           | 733                                                                          |         |       |        | 1,831  |       
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Cash and cash equivalents, end of period                                   |                                                                                        | $                                                                         | 528                                                                          |         |       | $      | 1,136  |       
|                                                                           |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|Supplemental disclosure of cash flow information:                          |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|                                                                           | Cash paid during the period for income taxes                                           |                                                                           | $                                                                            | 874     |       |        | $      | 57     |      
|                                                                           | Cash paid during the period for interest                                               |                                                                           | $                                                                            | 531     |       |        | $      | 1,184  |      
|Supplemental disclosure of noncash investing and
    financing activities: |                                                                                        |                                                                           |                                                                              |         |       |        |        |       
|                                                                           | Accretion of mandatorily redeemable convertible
    preferred stock                    |                                                                           | $                                                                            |        |       |        | $      | 438    |      

See accompanying notes to consolidated financial
statements.

4



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##### Table of Contents






(1)     Organization
and Business and Basis of Presentation



| |            
| | -----------
| | Stock split

Immediately prior to our initial public offering
(see Note 9) we effected a reverse split of our
outstanding common stock of 0.4627 shares for each share
outstanding. All shares and per share calculations included in
the accompanying unaudited consolidated financial statements of
iPayment, Inc. have been adjusted to reflect this reverse
split.



| |                          
| | -------------------------
| | Organization and Business

iPayment, Inc. (subsequently referred to as
iPayment or the Company) was originally
incorporated as iPayment Holdings, Inc. in Tennessee and
was reincorporated in Delaware under the name
iPayment, Inc. iPayment is a provider of card-based payment
processing services to small business merchants located across
the United States. We enable merchants to accept credit and
debit cards as payment for their products and services by
providing card authorization, data capture, settlement, risk
management, fraud detection and chargeback services. Our
services also include data organization and retrieval, ongoing
merchant assistance and resolution support in connection with
disputes with cardholders. We market and sell our services
primarily through independent sales organizations
(ISOs).



| |                      
| | ---------------------
| | Basis of Presentation

The accompanying unaudited consolidated financial
statements of iPayment have been prepared in accordance with
accounting principles generally accepted in the United States
and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of
the information and disclosures required by accounting
principles generally accepted in the United States for complete
financial statements. In the opinion of management, the
unaudited consolidated financial statements reflect all
adjustments considered necessary for a fair presentation,
consisting only of normal and recurring adjustments. All
significant intercompany transactions have been eliminated in
consolidation. Operating results for the three months ended
March 31, 2004 are not necessarily indicative of the
results that may be expected for the fiscal year ending
December 31, 2004. For further information, refer to the
consolidated financial statements and notes thereto for the year
ended December 31, 2003 (included in our Annual Report on
Form 10-K).

Certain prior year amounts have been reclassified
to conform to the current year presentation. Other costs of
services include costs directly attributable to our provision of
payment processing and related services to our merchants such as
residual payments to ISOs, which are commissions we pay to our
ISOs based upon a percentage of the net revenues we generate
from their merchant referrals, and assessment fees payable to
card associations, which are a percentage of the processing
volume we generate from Visa and MasterCard. In addition, other
costs of services includes telecommunications costs, personnel
costs, occupancy costs, losses due to merchant defaults, other
miscellaneous merchant supplies and services expenses,
sponsorship costs and other third-party processing costs.



| |                         
| | ------------------------
| | Stock-Based Compensation

We have adopted the disclosure-only provision of
Statement of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation, as
amended by SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure  an amendment
of FASB Statement No. 123. SFAS No. 148
requires prominent disclosures in annual and interim financial
statements regarding the method of accounting for stock-based
employee compensation and the effect of the method used on
reported results. We measure compensation expense for our stock
option awards under the intrinsic value method in accordance
with the provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees,
(APB 25) and related interpretations.
APB 25 requires compensation expense to be recognized based
on the excess, if any, of the quoted market price of the stock
at the date of the grant over the amount an employee must pay to
acquire the stock.

5



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##### Table of Contents



The following table presents the effect on net
income and basic and diluted net income per common share had we
adopted the fair value method of accounting for stock-based
compensation under SFAS No. 123 (in thousands, except
per share data):

|                                                                                                     |         |                    |       |      |  |   |      |      | 
|---------------------------------------------------------------------------------------------------- | ------- | ------------------ | ----- | ---- |  | - | ---- | ---- | 
|                                                                                                     |         |                   
|                                                                                                     |         | Three Months Ended
|                                                                                                     |         | March 31,         
|                                                                                                     |         |                   
|                                                                                                     |         | 2004               |       | 2003
|                                                                                                     |         |                    |       |     
|Net income allocable to common stockholders, as
    reported                                         |         | $                  | 5,002 |      |  | $ | 450  |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based method |         |                    | (673  | )    |  |   | (192 | )   
|                                                                                                     |         |                    |       |      |  |   |      |     
|Pro forma net income                                                                                 |         | $                  | 4,329 |      |  | $ | 258  |     
|                                                                                                     |         |                    |       |      |  |   |      |     
|Earnings per share:                                                                                  |         |                    |       |      |  |   |      |     
|As reported:                                                                                         |         |                    |       |      |  |   |      |     
|                                                                                                     | Basic   |                    | $     | 0.30 |  |   | $    | 0.06 | 
|                                                                                                     | Diluted |                    | $     | 0.28 |  |   | $    | 0.05 | 
|Pro Forma:                                                                                           |         |                    |       |      |  |   |      |     
|                                                                                                     | Basic   |                    | $     | 0.26 |  |   | $    | 0.04 | 
|                                                                                                     | Diluted |                    | $     | 0.24 |  |   | $    | 0.03 | 

The weighted-average fair value of each stock
option included in the preceding pro forma amounts was estimated
using the Black-Scholes option-pricing model and is amortized
over the vesting period of the underlying options. Because
additional options are expected to be granted each year, the
above pro forma disclosures may not be representative of pro
forma effects on reported results for future periods. The
following assumptions were applied: (i) no expected
dividend yield for all periods, (ii) expected volatility of
50% for 2004 and 2003, respectively (iii) expected lives of
2-3 years for 2004 and 2003, respectively (iv) and
risk-free interest rates ranging from 2% to 4% for all periods.

(2)     Acquisitions

The effective date of each of the acquisitions
discussed in this Note are the dates the acquisitions were
recognized in our financial statements, unless otherwise noted.



| |                             
| | ----------------------------
| | First Data Merchant Services

On December 19, 2003, we entered into an
asset purchase agreement with First Data Merchant Services to
acquire certain assets related to their agent bank portfolio
(the FDMS Portfolio) for $55.0 million in cash,
of which $1.8 million related to certain rental equipment.
The operating results of the FDMS Portfolio are included in our
consolidated income statements as of January 1, 2004, and
the $53.2 million of acquired customer relationships have
an amortization life of seven years.



| |                                
| | -------------------------------
| | CardPayment
    Solutions, Inc.

On August 5, 2003, we entered into an Asset
Purchase Agreement (the CardPayment Agreement) with
CardPayment Solutions, Inc. (CardPayment),
whereby we acquired substantially all of CardPayments
assets and assumed debt of approximately $1.0 million,
which was repaid in the third quarter of 2003, for
$12.0 million cash and 118,409 shares of our common
stock valued at $25.34 per share. CardPayment is an
integrated provider of credit card transaction processing
services. The acquisition was recorded under the purchase method.



| |                   
| | ------------------
| | Other Acquisitions

We made various other purchases of residual cash
flow streams totaling $0.3 million during the three months
ended March 31, 2004. The purchase price for these
acquisitions have been assigned to intangible

6



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##### Table of Contents



assets in the accompanying consolidated balance
sheets and are amortized over their expected useful lives of
seven years.


(3)     Intangible
Assets

As of March 31, 2004, we had the following
amortizable intangible assets (in thousands):

|                               |       |                |         |              |  |     |         |         |   |   |        |        | 
|------------------------------ | ----- | -------------- | ------- | ------------ |  | --- | ------- | ------- | - | - | ------ | ------ | 
|                               |       | Gross Carrying |         | Accumulated  |  |    
|                               |       | Amount         |         | Amortization |  | Net
|                               |       |                |         |              |  |    
|Merchant processing portfolios |       | $              | 102,278 |              |  | $   | (14,156 | )       |   | $ | 88,122 |       
|Other intangible assets        |       |                | 4,012   |              |  |     | (1,362  | )       |   |   | 2,650  |       
|                               |       |                |         |              |  |     |         |         |   |   |        |       
|                               | Total |                | $       | 106,290      |  |     | $       | (15,518 | ) |   | $      | 90,772 | 
|                               |       |                |         |              |  |     |         |         |   |   |        |       

As of December 31, 2003, we had the
following amortizable intangible assets (in thousands):

|                               |       |                |         |              |  |     |         |         |   |   |        |        | 
|------------------------------ | ----- | -------------- | ------- | ------------ |  | --- | ------- | ------- | - | - | ------ | ------ | 
|                               |       | Gross Carrying |         | Accumulated  |  |    
|                               |       | Amount         |         | Amortization |  | Net
|                               |       |                |         |              |  |    
|Merchant processing portfolios |       | $              | 102,240 |              |  | $   | (10,606 | )       |   | $ | 91,634 |       
|Other intangible assets        |       |                | 4,229   |              |  |     | (1,270  | )       |   |   | 2,959  |       
|                               |       |                |         |              |  |     |         |         |   |   |        |       
|                               | Total |                | $       | 106,469      |  |     | $       | (11,876 | ) |   | $      | 94,593 | 
|                               |       |                |         |              |  |     |         |         |   |   |        |       

For the three months ended March 31, 2004
and 2003, respectively, amortization expense related to the
merchant processing portfolios was $3,550,000 and $1,311,000 and
amortization expense related to other intangible assets was
$203,000 and $291,000.

(4)     Long-Term
Debt

In August 2003 we obtained a $30.0 million
credit facility with Bank of America as the lead bank. The
credit facility was subsequently expanded to $65.0 million
in December 2003 and to $80.0 million during the first
quarter 2004. The credit facility includes a $5.0 million
letter of credit sublimit. Interest on outstanding borrowings is
payable at a rate of LIBOR plus a margin of 2.25% to 2.75%
(currently 2.50%) depending on our ratio of consolidated debt to
EBITDA, as defined in the agreement. We have the option to
choose 1-month, 2-month, 3-month or 6-month LIBOR rates each
time we make a draw on the credit facility. In addition, the
credit facility requires us to pay unused commitment fees of up
to 0.50% (currently 0.50%) on any undrawn amounts. The credit
facility contains customary affirmative and negative covenants
including financial covenants requiring the maintenance of
specified limitations on debt-to-capitalization and
debt-to-EBITDA (as defined therein) and restrictions on
incurring liens and transactions with affiliates. We were in
compliance with all debt covenants as of March 31, 2004. At
March 31, 2004, $34.0 million was outstanding under
the credit facility, at a weighted average interest rate of
3.60%.

The credit facility replaces the previous credit
facility we had with Bank of America. All borrowings under the
credit facility are due when the facility expires on
December 31, 2006, however to the extent that we do not
consummate a financing transaction (as defined) prior to
June 30, 2004, all principal amounts outstanding under the
credit facility in excess of $20 million on that date (up
to a maximum of $35 million) will convert to a term loan.
The amount available under the revolving credit would be reduced
by the amount of the new term loan. Principal payments on the
term loan would be due quarterly beginning on October 1,
2004, and continuing through the expiration date.

In May 2003, we completed an initial public
offering (see Note 9) and used $55.7 million of
the proceeds to repay outstanding debt with a carrying value of
$52.1 million and a weighted average interest rate of
10.54%. Additionally, in conjunction with the offering we
converted $9.0 million of debt with a carrying value of
$8.2 million and an interest rate of 12.0% into
562,500 shares of common stock. These repayments and
conversions resulted in a noncash pre-tax charge of
approximately $4.4 million, which was recognized as
interest expense in the second quarter of 2003.

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(5)     Mandatorily
redeemable convertible preferred stock

As part of the initial public offering completed
in May 2003 (see Note 9), all of our Mandatorily Redeemable
Convertible Preferred Stock was converted into
1,192,470 shares of our common stock in the second quarter
of 2003.

(6)     Stockholders
Equity



| |                   
| | ------------------
| | Earnings Per Share

We report net income or loss per share in
accordance with SFAS No. 128, Earnings per
Share. Under SFAS No. 128, basic earnings per
share (EPS), which excludes dilution, is computed by
dividing net income or loss available to common stockholders by
the weighted average number of common shares outstanding for the
period. Net income or loss available to common stockholders
represents reported net income or loss less accretion of
mandatorily redeemable convertible preferred stock.

Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. Diluted EPS
includes in-the-money stock options and warrants using the
treasury stock method and also includes the assumed conversion
of preferred stock and convertible debt using the if-converted
method. During a loss period, the assumed exercise of
in-the-money stock options, warrants and conversion of
convertible securities has an anti-dilutive effect, and
therefore are excluded from the computation of diluted EPS. The
following weighted average common stock equivalents were
excluded from the computation of diluted EPS because their
inclusion would have been anti-dilutive (in thousands):

|                                                   |  |                    |   |      |  |  |           | 
|-------------------------------------------------- |  | ------------------ | - | ---- |  |  | --------- | 
|                                                   |  |                   
|                                                   |  | Three Months Ended
|                                                   |  | March 31,         
|                                                   |  |                   
|                                                   |  | 2004               |   | 2003
|                                                   |  |                    |   |     
|Stock options and warrants                         |  |                    |  |      |  |  |          | 
|Mandatorily redeemable convertible preferred stock |  |                    |  |      |  |  | 1,192,470 | 
|Convertible debt                                   |  |                    |  |      |  |  | 718,837   | 
|                                                   |  |                    |   |      |  |  |           | 
|                                                   |  |                    |  |      |  |  | 1,911,307 | 
|                                                   |  |                    |   |      |  |  |           | 

A reconciliation of basic to diluted weighted
average common shares outstanding is as follows (in thousands):

|                                |                            |                              |       |        |  |           |        |           |  |        |      |           |   |   |     |   |  |  |       |       |  |   |      |       |  
|------------------------------- | -------------------------- | ---------------------------- | ----- | ------ |  | --------- | ------ | --------- |  | ------ | ---- | --------- | - | - | --- | - |  |  | ----- | ----- |  | - | ---- | ----- | -
|                                |                            |                             
|                                |                            | Three Months Ended March 31,
|                                |                            |                             
|                                |                            |                              |       |       
|                                |                            | 2004                         |       | 2003  
|                                |                            |                              |       |       
|                                |                            | Income                       |       | Common |  | Per Share |        | Income    |  | Common |      | Per Share
|                                |                            | Available                    |       | Shares |  | Amount    |        | Available |  | Shares |      | Amount   
|                                |                            |                              |       |        |  |           |        |           |  |        |      |          
|Basic earnings per share        |                            | $                            | 5,002 |        |  |           | 16,459 |           |  | $      | 0.30 |           |   | $ | 450 |   |  |  | 7,330 |       |  | $ | 0.06 |      
|Effects of dilutive securities: |                            |                              |       |        |  |           |        |           |  |        |      |           |   |   |     |   |  |  |       |       |  |   |      |      
|                                | Stock options and warrants |                              |       |       |  |           |        | 894       |  |        |      | (0.01     | ) |   |     |  |  |  |       | 1,151 |  |   |      | (0.01 | )
|                                | Convertible debt           |                              |       | 101    |  |           |        | 662       |  |        |      | (0.01     | ) |   |     |  |  |  |       |      |  |   |      |      |  
|                                | Restricted stock           |                              |       |       |  |           |        | 35        |  |        |      |          |   |   |     |  |  |  |       |      |  |   |      |      |  
|                                |                            |                              |       |        |  |           |        |           |  |        |      |           |   |   |     |   |  |  |       |       |  |   |      |      
|Diluted earnings per share      |                            | $                            | 5,103 |        |  |           | 18,050 |           |  | $      | 0.28 |           |   | $ | 450 |   |  |  | 8,481 |       |  | $ | 0.05 |      
|                                |                            |                              |       |        |  |           |        |           |  |        |      |           |   |   |     |   |  |  |       |       |  |   |      |      

(7)     Revenue
Recognition

We follow the requirements of EITF 99-19,
Reporting Revenue Gross as a Principal versus Net as an
Agent,in determining our revenue reporting. Generally,
where we have merchant portability, credit risk and ultimate
responsibility for the merchant, revenues are reported, at the
time of sale, gross of interchange paid to card issuing banks
and assessments paid to credit card associations pursuant to
which such parties receive payments based primarily on
processing volume for particular groups of merchants. Related
interchange costs are also recognized at that time, as are bank
sponsorship fees and assessments. Revenues generated from

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certain agent bank portfolios acquired as part of
the acquisition from FDMS are reported net of interchange, as
required by EITF 99-19, where we may not have credit risk,
portability or the ultimate responsibility for the merchant
accounts.




|    |                                 
|--- | --------------------------------
|(8) | Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51(FIN 46).
FIN 46 addresses the consolidation by business enterprises
of variable interest entities as defined in the interpretation.
We do not have ownership interests in variable interest
entities, accordingly, the adoption of this statement did not
have any impact on our financial position, results of operations
or cash flows.



|    |                        
|--- | -----------------------
|(9) | Initial Public Offering

In May 2003, we completed an initial public
offering whereby we sold 5,625,000 shares of common stock
(which included underwriters overallotment) and received
net proceeds of $75.6 million (after underwriters
discount of $6.3 million and related offering expenses of
$8.1 million). During the second quarter of fiscal 2003 we
used $55.7 million of the proceeds to repay debt that had a
carrying value of $52.1 million and converted an additional
$9.0 million of debt with a carrying value of
$8.2 million into 562,500 shares of common stock. The
repayment and conversion of debt resulted in recognition of a
non-cash pre-tax charge of approximately $4.4 million in
the second quarter of 2003 due to the acceleration of interest
expense equal to the unamortized discount balance at the date of
repayment or conversion. Immediately prior to the offering we
effected a reverse split of our outstanding common stock of
0.4627 shares for each share outstanding. All shares and
per share calculations included in the accompanying unaudited
consolidated financial statements of iPayment, Inc. have
been adjusted to reflect this reverse split.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

Forward-Looking Statements May Prove
Inaccurate

This report includes various forward-looking
statements regarding the Company that are subject to risks and
uncertainties, including without limitation, the factors set
forth below and under the caption Risk Factors in
our Annual Report on Form 10-K filed with the Securities
and Exchange Commission (the Commission) on
March 30, 2004, pursuant to Rule 424(b)(4) under the
Securities Act of 1933, as amended, in connection with the
Companys Registration Statement on Form S-1 (File
No. 333-101705). Forward-looking statements include, but
are not limited to, discussions regarding our operating
strategy, growth strategy, acquisition strategy, cost savings
initiatives, industry, economic conditions, financial condition,
liquidity and capital resources and results of operations. Such
statements include, but are not limited to, statements preceded
by, followed by or that otherwise include the words
believes, expects,
anticipates, intends,
estimates or similar expressions. For those
statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.

Certain important factors, which are discussed
elsewhere in this document and in our Form 10-K filed
March 30, 2004, could affect our future financial results
and could cause actual results to differ materially from those
expressed in forward-looking statements contained or
incorporated by reference in this document.

Executive Summary

Our strategy is to grow profitably by increasing
our penetration of the expanding small merchant marketplace for
payment services. We find these merchants through our ISO and
agent bank channels of distribution and make occasional
acquisitions on an opportunistic basis in this fragmented
segment of the industry. Our operating results point to
successful execution of this strategy during the first quarter
of 2004. At March 31, 2004, we provided our payment
services to over 92,000 small merchants across the United
States. Charge volume increased to $2,863 million for the
three months ended March 31, 2004 from $1,338 million
for the three months ended March 31, 2003, and revenues
increased to $80.0 million for the three months

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ended March 31, 2004 from $46.7 million
for the three months ended March 31, 2003. While revenues
increased, our headcount declined, leading to an expansion in
our operating margin.


Overview

We are one of the fastest growing providers of
credit and debit card-based payment processing services to small
merchants. Our payment processing services enable our merchants
to process both traditional card-present, or swipe transactions,
as well as card-not-present transactions. A traditional
card-present transaction occurs whenever a cardholder physically
presents a credit or debit card to a merchant at the
point-of-sale. Card-not-present transactions occur whenever the
customer does not physically present a payment card at the
point-of-sale and may occur over the Internet or by mail, fax or
telephone.

Development of our Business

iPayment Technologies, Inc., was formed in
1992 as a California corporation. In July 2000, iPayment
Technologies purchased assets from two former affiliates in
exchange for the assumption of debt, $400,000 in cash, a
$2.0 million note and the issuance of 2,314 shares of
iPayment Technologies common stock. We refer to this as
the Caymas acquisition. In connection with the Caymas
acquisition, Caymas, LLC purchased a majority interest in
iPayment Technologies. We accounted for the Caymas acquisition
as a purchase allocating its investment to the fair value of
assets acquired and liabilities assumed and the excess basis
allocated to goodwill. The Caymas acquisition was completed in
order to transfer ownership of certain assets owned by former
affiliates of iPayment Technologies, and to separate iPayment
Technologies from its former affiliates.

In December 2000, iPayment Technologies
implemented a restructuring plan, which resulted in a reduction
in overhead costs and personnel. Expenses related to the
restructuring included severance and future lease costs, write
downs of fixed assets and leasehold improvements.

In February 2001, we were formed by the majority
stockholders of iPayment Technologies under the name iPayment
Holdings, Inc. as a holding company for iPayment
Technologies and other card processing businesses. We then
appointed Gregory Daily as our Chief Executive Officer and
Chairman of the Board. In April 2001, we acquired a 94.63%
interest in iPayment Technologies, and in July 2002, we acquired
the remaining outstanding shares of iPayment Technologies, which
then became our wholly owned subsidiary, in each case by issuing
our shares to iPayment Technologies stockholders in exchange for
iPayment Technologies shares.

In August 2002, we were reincorporated in
Delaware under the name iPayment, Inc. and in May 2003 we
completed an initial public offering of our common stock and
listing on the Nasdaq National Market.

Critical Accounting Policies

The accompanying consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States, which
require that management make numerous estimates and assumptions.
Actual results could differ from those estimates and
assumptions, impacting our reported results of operations and
financial position. The critical accounting policies described
here are those that are most important to the depiction of our
financial condition and results of operations and their
application requires managements most subjective judgment
in making estimates about the effect of matters that are
inherently uncertain.

Accounting for Goodwill and Intangible
Assets.We adopted Statement of
Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets,in the first
quarter of 2002 (certain provisions of SFAS No. 142
were adopted in the third quarter of 2001).
SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets, and
requires that goodwill is no longer subject to amortization over
its estimated useful life. Rather, goodwill is subject to at
least an annual assessment for impairment. If facts and
circumstances indicate goodwill may be impaired, we perform a
recoverability evaluation. Prior to the adoption of
SFAS No. 142 on January 1, 2002, our policy was
to compare undiscounted estimated future cash flows to the
carrying amount of our net assets, including

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goodwill, to determine if the carrying amount was
not recoverable and a write-down to fair value was required.
Effective January 1, 2002, in accordance with
SFAS No. 142, we began performing the recoverability
analysis based on fair value rather than undiscounted cash
flows. The calculation of fair value includes a number of
estimates and assumptions, including projections of future
income and cash flows, the identification of appropriate market
multiples and the choice of an appropriate discount rate.


We completed the testing for impairment of
goodwill as of July 31, 2002, using the present value of
future cash flows and determined that the fair value of the
reporting unit exceeded the carrying amount of the net assets,
including goodwill of the reporting unit. We completed our
annual goodwill impairment review as of July 31, 2003, and
determined that no impairment charge for goodwill was required.
In addition, we evaluated the remaining useful lives of
intangible assets as of December 31, 2003, and determined
them to be appropriate.

We periodically evaluate the carrying value of
long-lived assets, in relation to the respective projected
future undiscounted cash flows, to assess recoverability. An
impairment loss is recognized if the sum of the expected
undiscounted net cash flows is less than the carrying amount of
the long-lived assets being evaluated. The difference between
the carrying amount of the long-lived assets being evaluated and
the fair value, calculated as the sum of the expected cash flows
discounted at a market rate, represents the impairment loss. We
evaluated the remaining useful lives of intangible assets as of
December 31, 2003, and determined them to be appropriate.

Accounting for Stock-Based
Compensation.We have adopted the
disclosure-only provision of SFAS No. 123,
Accounting for Stock-Based Compensation, as amended by
SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure  an amendment
of SFAS No. 123. SFAS No. 148 requires
prominent disclosures in annual and interim financial statements
regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported
results. We measure compensation expense for our stock option
awards under the intrinsic value method in accordance with the
provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees,
(APB 25) and related interpretations.
APB 25 requires compensation expense to be recognized based
on the excess, if any, of the quoted market price of the stock
at the date of the grant over the amount an employee must pay to
acquire the stock.

Reserve for Merchant
Losses.Disputes between a cardholder
and a merchant periodically arise as a result of, among other
things, cardholder dissatisfaction with merchandise quality or
merchant services. Such disputes may not be resolved in the
merchants favor. In these cases, the transaction is
charged back to the merchant, which means the
purchase price is refunded to the customer through the
merchants acquiring bank and charged to the merchant. If
the merchant has inadequate funds, we or, under limited
circumstances, the acquiring bank and us, must bear the credit
risk for the full amount of the transaction. We evaluate the
merchants risk for such transactions and estimate its
potential loss for chargebacks based primarily on historical
experience and other relevant factors. At March 31, 2004,
our reserve for losses on merchant accounts totaled
$1.2 million.

Income Taxes.We
account for income taxes pursuant to the provisions of
SFAS No. 109, Accounting for Income Taxes.
Under this method, deferred tax assets and liabilities are
recorded to reflect the future tax consequences attributable to
the effects of differences between the carrying amounts of
existing assets and liabilities for financial reporting and for
income tax purposes. At December 31, 2003, we had
approximately $11.3 million of federal net operating loss
carryforwards that will be available to offset regular taxable
income through 2022, subject to annual limitations of up to
$6.5 million per year. We also have approximately
$13.4 million of state net operating loss carryforwards,
again subject to similar annual limitations, that will expire in
various states between 2011 and 2022. We have placed valuation
allowance on our net operating loss carryforwards as a result of
limitations placed on the ability to utilize the net operating
loss carryforwards due to ownership changes, which occurred
prior to our initial public offering.

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Components of Revenues and Expenses

All of our revenues are generated from fees
charged to merchants for card-based payment processing services.
We typically charge these merchants a bundled rate, primarily
based upon the merchants monthly charge volume and risk
profile. Our fees principally consist of discount fees, which
are a percentage of the dollar amount of each credit or debit
transaction. We charge all merchants higher discount rates for
card-not-present transactions than for card-present transactions
in order to compensate us for the higher risk of underwriting
these transactions. We derive the balance of our revenues from a
variety of fixed transaction or service fees, including fees for
monthly minimum charge volume requirements, statement fees,
annual fees and fees for other miscellaneous services, such as
handling chargebacks. We recognize discounts and other fees
related to payment transactions at the time the merchants
transactions are processed. We recognize revenues derived from
service fees at the time the service is performed. Generally, we
report revenues gross of amounts paid to sponsoring banks, as
well as interchange and assessments paid by us to credit card
associations pursuant to which these associations receive
payments based primarily on processing volume for particular
groups of merchants. Related interchange and assessment costs
and bank processing fees are also recognized at that time.
Revenues generated from certain agent bank portfolios acquired
as part of the acquisition from FDMS are reported net of
interchange, as required by EITF 99-19, where we may not have
credit risk, portability or the ultimate responsibility for the
merchant accounts.

The most significant component of operating
expenses is interchange fees, which are amounts we pay to the
card issuing banks. Interchange fees are based on transaction
processing volume and are recognized at the time transactions
are processed.

Other costs of services include costs directly
attributable to our provision of payment processing and related
services to our merchants such as residual payments to ISOs,
which are commissions we pay to our ISOs based upon a percentage
of the net revenues we generate from their merchant referrals,
and assessment fees payable to card associations, which is a
percentage of the processing volume we generate from Visa and
MasterCard. In addition, other costs of services includes
telecommunications costs, personnel costs, occupancy costs,
losses due to merchant defaults, other miscellaneous merchant
supplies and services expenses, bank sponsorship costs and other
third-party processing costs.

Other costs of services also includes
depreciation and amortization expenses, which are recognized on
a straight-line basis over the estimated useful life of the
asset. Amortization of intangible assets resulted from our
acquisitions of portfolios of merchant accounts or acquisitions
of a business where we allocated purchase price to the existing
merchant processing portfolio.

Selling, general and administrative expenses
consist primarily of salaries and wages and other general
administrative expenses.

From time to time, we enter into transactions
with our ISOs. Sometimes, we acquire from an ISO the right,
title and interest to a merchant portfolio, including the
residual cash flow stream for merchants the ISOs have brought to
us. The accounting for those acquisitions is dependent on the
ISOs relationship with us. If the ISO is considered an
agent, then we record prepaid commission and amortize the asset
through cost of sales. Otherwise, if we have no ongoing agent
relationship with the ISO, we will record an intangible asset
for that residual cash flow stream. Also, from time to time, we
lend money to ISOs, usually to assist the ISOs in establishing
and growing their businesses. This directly impacts the number,
quality and type of merchants these ISOs are able to bring to us.

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51(FIN 46).
We do not have variable interests in variable interest entities,
accordingly, our adoption of the interpretation had no effect on
our consolidated financial statements.

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Seasonality Trend

Our revenues and earnings are impacted by the
volume of consumer usage of credit and debit cards at the point
of sale. For example, we experience increased point of sale
activity during the traditional holiday shopping period in the
fourth quarter. Revenues during the first quarter tend to
decrease by at least 10% in comparison to the remaining three
quarters of our fiscal year on a same store basis.

Results of Operations

The following table sets forth certain financial
data for the periods indicated:

|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |       |       |  
|--------------------------------- | ----------------------------------- | ------------------------ | ------ | ---------- | ------ | ------------ | ----- | ---------- | ---- | ------ | ------ | ------ | ------ |  | ----- | ---- | ---- | - | ------ | ------ | ------ | - | ----- | ----- | ----- | -
|                                  |                                     | Three months             |        |            |        | Three months |       |            |      |       
|                                  |                                     | ended                    |        |            |        | ended        |       |            |      | Change
|                                  |                                     | March 31,                |        | % of Total |        | March 31,    |       | % of Total |      |       
|                                  |                                     | 2004                     |        | Revenue    |        | 2003         |       | Revenue    |      | Amount |        | %     
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |       
|Revenues                          |                                     | $                        | 79,969 |            |        |              | 100.0 | %          |      | $      | 46,675 |        |        |  | 100.0 | %    |      | $ | 33,294 |        |        |   | 71.3  |      
|Operating Expenses                |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|                                  | Interchange                         |                          |        | 37,315     |        |              |       | 46.7       |      |        |        | 24,010 |        |  |       | 51.4 |      |   |        | 13,305 |        |   |       | 55.4  |      
|                                  | Other costs of services             |                          |        | 31,702     |        |              |       | 39.6       |      |        |        | 16,277 |        |  |       | 34.9 |      |   |        | 15,425 |        |   |       | 94.8  |      
|                                  | Selling, general and administrative |                          |        | 2,886      |        |              |       | 3.6        |      |        |        | 1,829  |        |  |       | 3.9  |      |   |        | 1,057  |        |   |       | 57.8  |      
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|                                  |                                     | Total operating expenses |        |            | 71,903 |              |       |            | 89.9 |        |        |        | 42,116 |  |       |      | 90.2 |   |        |        | 29,787 |   |       |       | 70.7  |  
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|Income from operations            |                                     |                          | 8,066  |            |        |              | 10.1  |            |      |        | 4,559  |        |        |  | 9.8   |      |      |   | 3,507  |        |        |   | 76.9  |      
|Other expense                     |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|                                  | Interest expense                    |                          |        | 710        |        |              |       | 0.9        |      |        |        | 3,290  |        |  |       | 7.1  |      |   |        | (2,580 | )      |   |       | (78.4 | )    
|                                  | Other                               |                          |        | (339       | )      |              |       | (0.4       | )    |        |        |       |        |  |       |     |      |   |        | (339   | )      |   |       | NM    |      
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|                                  |                                     | Total other expense      |        |            | 371    |              |       |            | 0.5  |        |        |        | 3,290  |  |       |      | 7.1  |   |        |        | (2,919 | ) |       |       | (88.7 | )
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|Income (loss) before income taxes |                                     |                          | 7,695  |            |        |              | 9.6   |            |      |        | 1,269  |        |        |  | 2.7   |      |      |   | 6,426  |        |        |   | 506.4 |      
|Income tax provision              |                                     |                          | 2,693  |            |        |              | 3.4   |            |      |        | 381    |        |        |  | 0.8   |      |      |   | 2,312  |        |        |   | 606.8 |      
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      
|Net income (loss)                 |                                     | $                        | 5,002  |            |        |              | 6.2   |            |      | $      | 888    |        |        |  | 1.9   |      |      | $ | 4,114  |        |        |   | 463.3 |      
|                                  |                                     |                          |        |            |        |              |       |            |      |        |        |        |        |  |       |      |      |   |        |        |        |   |       |      



---

NM = Not meaningful



| |                                                                                                          
| | ---------------------------------------------------------------------------------------------------------
| | Three Months Ended March 31, 2004
    (2004) Compared to Three Months Ended March 31,
    2003 (2003)

Revenues.Revenues
increased $33.3 million or 71.3% to $80.0 million in
2004 from $46.7 million in 2003. This increase was
primarily attributable to our acquisition of one business and
two significant portfolios since August 2003, which resulted in
an increase in revenues of $23.5 million, representing
70.6% of our total growth in revenues over the prior period.

Interchange
Expenses.Interchange expenses
increased $13.3 million or 55.4% to $37.3 million in
2004 from $24.0 million in 2003. The increase was primarily
attributable to increased charge volume driven mainly by our
aforementioned acquisitions. Interchange expenses as a
percentage of total revenues decreased to 46.7% in 2004 from
51.4% in 2003 as we present revenue net of interchange for
certain customers included in our acquisition of agent
portfolios from First Data Merchant Services. The decrease was
also attributable to a reduction in interchange rates for
signature (off-line) debit transactions.

Other Costs of
Services.Other costs of services
increased $15.4 million or 94.8% to $31.7 million in
2004 from $16.3 million in 2003. Other costs of services as
a percentage of revenues increased to 39.6% in 2004 from 34.9%
in 2003. Other costs of services as a percentage of revenues
increased primarily due to an increase in residuals expense and
depreciation and amortization as a result of the acquisitions.

13



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##### Table of Contents



Selling, General and
Administrative.Selling, general and
administrative expenses increased $1.1 million or 57.8% to
$2.9 million in 2004 from $1.8 million in 2003. The
increase was primarily due to an increase in personnel related
costs and an increase in professional fees for legal and
accounting services. Selling, general and administrative
expenses as a percentage of revenues remained relatively
consistent, declining slightly to 3.6% in 2004 from 3.9% in 2003.

Other Expense.Other
expense in 2004 consisted of $0.7 million of interest
expense partially offset by net proceeds from a legal settlement
of $0.3 million. Other expense decreased $2.9 million
or 88.7% from $3.3 million in 2003, primarily due to a
reduction in interest expense resulting from the repayment of
$55.7 million of debt in the second quarter of 2003 using
proceeds from our initial public offering.

Income Tax.Income
tax expense increased $2.3 million to $2.7 million in
2004 from $0.4 million in 2003 due to an increase in
taxable income and an increase in our effective tax rate. Income
tax expense as a percentage of income before taxes was 35.0% in
2004 compared to 30.0% in 2003. The increase in the effective
tax rate results from the utilization of previously unrecognized
net operating loss carryforwards being proportionately greater
in 2003.

Liquidity and Capital Resources

Prior to our initial public offering, we funded
our principal operations through private placements of debt and
equity securities to executive officers, directors, principal
stockholders, third parties and a credit facility from Bank of
America. In May 2003, we raised net proceeds of
$75.6 million through an initial public offering of our
common stock. As of March 31, 2004, we had cash and cash
equivalents totaling $0.5 million, compared to
$0.7 million as of December 31, 2003. We had net
working capital (current assets in excess of current
liabilities) of $6.1 million as of March 31, 2004
compared to a net working capital deficit of $1.0 million
as of December 31, 2003. We believe that funds from future
operations and proceeds from borrowings under our credit
facility will be sufficient to settle our current obligations.



| |                     
| | --------------------
| | Operating activities

Net cash provided by operating activities was
$7.2 million in 2004, consisting of net income of
$5.0 million and depreciation and amortization of
$4.6 million, partially offset by a net unfavorable change
in operating assets and liabilities of $2.6 million. The
net unfavorable change in operating assets and liabilities was
primarily caused by an increase in prepaid expenses due to the
advance payment of monthly interchange expenses to a new sponsor
bank and by an increase in accounts receivable due to the
addition of net revenues from the First Data portfolio as of
January 1, 2004, partially offset by an increase in income
taxes payable.

Net cash provided by operating activities was
$2.2 million in 2003. Net income of $0.9 million,
depreciation and amortization of $1.9 million and noncash
interest of $1.3 million related to amortization of debt
discounts were partially offset by $1.9 million of changes
in operating assets and liabilities. Such changes principally
included losses of $0.8 million attributable to one
merchant and a litigation settlement of $0.7 million.



| |                     
| | --------------------
| | Investing activities

Net cash provided by investing activities was
$7.6 million in 2004. Net cash provided by investing
activities primarily consisted of $8.0 million held on
deposit by a former sponsor bank that was returned to us. We
currently have no significant capital spending or purchase
commitments, but expect to continue to engage in capital
spending in the ordinary course of business.

Net cash used in investing activities was
$3.5 million in 2003. During 2003, we paid
$2.1 million for the final installment of the cash purchase
price of a business acquisition, which occurred in the third
quarter of 2002. We also paid a total of $1.0 million for
various portfolio acquisitions from agents. Total capital
expenditures for 2003 were $0.2 million.

14



---



##### Table of Contents





| |                     
| | --------------------
| | Financing activities

Net cash used in financing activities was
$15.0 million in 2004, primarily consisting of net
repayments on our credit facility of $11.0 million and
repayments of debt to our Chairman and Chief Executive Officer
totaling $4.5 million, partially offset by
$0.5 million of proceeds from stock option exercises.

Net cash provided by financing activities was
$0.7 million in 2003. During 2003 we paid an aggregate
principal amount of $1.4 million on outstanding debt
balances, offset by net borrowings of $2.0 million under
our line of credit.

As of March 31, 2004, we had notes, capital
lease obligations and a credit facility arrangement outstanding
in an aggregate principal amount of $49.7 million,
consisting of $34.0 million outstanding under our credit
facility and $15.7 million of convertible subordinated
promissory notes (including $0.7 million of accrued
interest, of which approximately $0.4 million is
convertible). The convertible notes may be converted into
662,079 shares of our common stock at the discretion of the
holders at a price of $23.16 per share. Our weighted
average interest rate was approximately 4% as of March 31,
2004, excluding amortization of finance costs.

In August 2003 we obtained a $30.0 million
credit facility with Bank of America as the lead bank. The
credit facility was subsequently expanded to $80.0 million
during the first quarter of 2004. The credit facility includes a
$5.0 million letter of credit sublimit. Interest on
outstanding borrowings is payable at a rate of LIBOR plus a
margin of 2.25% to 2.75% (currently 2.50%) depending on our
ratio of consolidated debt to EBITDA, as defined in the
agreement. We have the option to choose 1-month, 2-month,
3-month or 6-month LIBOR rates each time we make a draw on the
credit facility. In addition, the credit facility requires us to
pay unused commitment fees of up to 0.50% (currently 0.50%) on
any undrawn amounts. The credit facility contains customary
affirmative and negative covenants including financial covenants
requiring the maintenance of specified limitations on
debt-to-capitalization and debt-to-EBITDA (as defined therein)
and restrictions on incurring liens and transactions with
affiliates. We were in compliance with all debt covenants as of
March 31, 2004. The credit facility replaces the previous
credit facility we had with Bank of America and expires on
December 31, 2006.

The following table of our material contractual
obligations as of March 31, 2004, summarizes the aggregate
effect that these obligations are expected to have on our cash
flows in the periods indicated: (in thousands)

|                                               |                               |                        |        |           |  |           |       |           |  |         |        |        |  |  |        |        |  |  |     |     | 
|---------------------------------------------- | ----------------------------- | ---------------------- | ------ | --------- |  | --------- | ----- | --------- |  | ------- | ------ | ------ |  |  | ------ | ------ |  |  | --- | --- | 
|                                               |                               |                       
|                                               |                               | Payments due by period
|                                               |                               |                       
|                                               |                               |                        |        | Less than |  |           |       | More than
|Contractual Obligations                        |                               | Total                  |        | 1 year    |  | 1-3 years |       | 3-5 years |  | 5 years
|                                               |                               |                        |        |           |  |           |       |           |  |        
|Credit facility                                |                               |                        | 34,000 |           |  |           |      |           |  |         | 34,000 |        |  |  |       |        |  |  |    |    
|Convertible notes (including accrued interest) |                               |                        | 15,677 |           |  |           |      |           |  |         |       |        |  |  | 15,677 |        |  |  |    |    
|Capital lease obligations                      |                               |                        | 29     |           |  |           | 29    |           |  |         |       |        |  |  |       |        |  |  |    |    
|Operating lease obligations                    |                               |                        | 2,040  |           |  |           | 759   |           |  |         | 723    |        |  |  | 431    |        |  |  | 127 |    
|Purchase obligations(1)                        |                               |                        | 19,460 |           |  |           | 4,835 |           |  |         | 9,355  |        |  |  | 5,270  |        |  |  |    |    
|                                               |                               |                        |        |           |  |           |       |           |  |         |        |        |  |  |        |        |  |  |     |    
|                                               | Total contractual obligations |                        | $      | 71,206    |  |           | $     | 5,623     |  |         | $      | 44,078 |  |  | $      | 21,378 |  |  | $   | 127 | 
|                                               |                               |                        |        |           |  |           |       |           |  |         |        |        |  |  |        |        |  |  |     |    



---



|    |                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Purchase obligations represent costs of
    contractually guaranteed minimum processing volumes with certain
    of our third-party transaction processors.

In May 2003, we completed an initial public
offering and used $55.7 million of the proceeds to repay
outstanding debt with a carrying value of $52.1 million.
Additionally, in conjunction with the offering we converted
$9.0 million of debt with a carrying value of
$8.2 million into 562,500 shares of common stock.
These repayments and conversions resulted in a noncash pre-tax
charge of approximately $4.4 million which was recognized
as interest expense in the second quarter of 2003.

15



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##### Table of Contents



We expect to be able to fund our operations,
capital expenditures and contractual obligations above using our
cash from operations. We intend to use our credit facility
primarily to fund additional acquisition opportunities as they
arise. To the extent we are unable to fund our operations,
capital expenditures and contractual obligations using cash from
operations, we intend to use borrowings under our credit
facility or future debt or equity financings. In addition, we
may seek to sell additional equity or arrange debt financing to
give us financial flexibility to pursue opportunities that may
arise in the future if an opportunity that we consider
attractive arises to raise additional funding. If we raise
additional funds through the sale of equity or convertible debt
securities, these transactions may dilute the value of our
outstanding common stock. We may also decide to issue
securities, including debt securities, which have rights,
preferences and privileges senior to our common stock. If future
financing is not available or is not available on acceptable
terms, we may not be able to fund our future needs, which may
prevent us from increasing our market share, capitalizing on new
business opportunities or remaining competitive in our industry.

Effects of Inflation

Our monetary assets, consisting primarily of cash
and receivables, are not significantly affected by inflation.
Our non-monetary assets, consisting primarily of intangible
assets and goodwill, are not affected by inflation. We believe
that replacement costs of equipment, furniture and leasehold
improvements will not materially affect our operations. However,
the rate of inflation affects our expenses, such as those for
employee compensation and telecommunications, which may not be
readily recoverable in the price of services offered by us.






|        |                                                              
|------- | -------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosure
    about Market Risk

We transact business with merchants exclusively
in the United States and receive payment for our services
exclusively in United States dollars. As a result, our financial
results are unlikely to be affected by factors such as changes
in foreign currency exchange rates or weak economic conditions
in foreign markets.

Our interest expense is sensitive to changes in
the general level of interest rates in the United States,
because a majority of our indebtedness is at variable rates. At
March 31, 2004, $34.0 million of our outstanding
indebtedness was at variable interest rates based on LIBOR. A
rise in LIBOR rates of one percentage point would result in
additional interest expense of $0.3 million.

We do not hold derivative financial or commodity
instruments, nor do we engage in any foreign currency
denominated transactions, and all of our cash and cash
equivalents are held in money market and checking funds.






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

Evaluation of disclosure controls and
procedures.An evaluation was
conducted under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of
March 31, 2004. Based on that evaluation, our principal
executive officer and principal financial officer have concluded
that our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended, (the Exchange Act)) were
effective as of such date to ensure that information required to
be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange
Commission rules and forms.

Changes in internal control over financial
reporting.There was no change in our
internal control over financial reporting during our first
fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.

16



---



##### Table of Contents



PART II  OTHER
INFORMATION






|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

We are party to various legal proceedings in the
normal course of business. Please see the description under the
caption Legal Proceedings in the Companys
Annual Report on Form 10-K filed with the Commission on
March 30, 2004, pursuant to Rule 424(b)(4) under the
Securities Act (File No. 000-50280).






|        |                                              
|------- | ---------------------------------------------
|Item 2. | Changes in Securities and Use of
    Proceeds

(a) None

(b) None

(c) None

(d) None

(e) None






|        |                                    
|------- | -----------------------------------
|Item 3. | Defaults Upon Senior
    Securities

None






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

None






|        |                  
|------- | -----------------
|Item 5. | Other Information

None






|        |                                     
|------- | ------------------------------------
|Item 6. | Exhibits and Reports on
    Form 8-K

(a) Exhibits

The exhibits to this report are listed in the
Exhibit Index.

(b) Reports on Form 8-K

|            |                   |             |  |                                                                                                                               
|----------- | ----------------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------
|Report Date |                   |            
|            |                   | Description
|            | February 18, 2004 |             |  | The Company filed a current report on Form 8-K
    under Item 12 to announce its 2003 fourth-quarter and
    year-end results.

17



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities
and Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned party duly
authorized.



| |               
| | --------------
| | iPAYMENT, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ GREGORY S. DAILY

| |                              
| | -----------------------------
| |                              
| | Gregory S. Daily             
| | Chief Executive Officer      
| | (Principal Executive Officer)

Date: May 13, 2004



| |     |                    
| | --- | -------------------
| | By: | /s/ CLAY M. WHITSON

| |                                                 
| | ------------------------------------------------
| |                                                 
| | Clay M. Whitson                                 
| | Chief Financial Officer                         
| | (Principal Financial and Accounting
    Officer)

Date: May 13, 2004

18



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##### Table of Contents






EXHIBIT INDEX

|            |    |             |  |                                                                                                                                                                                                                  
|----------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |    | Description
|            |    |            
|            | 31 | .1          |  | Certification of Chief Executive Officer pursuant
    to Securities Exchange Act Rule 13a-14(a) (as adopted
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002),
    filed herewith                   
|            | 31 | .2          |  | Certification of Chief Financial Officer pursuant
    to Securities Exchange Act Rule 13a-14(a) (as adopted
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002),
    filed herewith                   
|            | 32 | .1          |  | Certification of Chief Executive Officer pursuant
    to Securities Exchange Act Rule 13a-14(b) and
    18 U.S.C. 1350 (as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002), filed herewith
|            | 32 | .2          |  | Certification of Chief Financial Officer pursuant
    to Securities Exchange Act Rule 13a-14(b) and
    18 U.S.C. 1350 (as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002), filed herewith

19