##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 2004 Commission file number 000-50280 (iPAYMENT LOGO) iPayment, Inc.  Delaware
    
    62-1847043(State or Other Jurisdiction of Incorporation
or Organization)
    
    (I.R.S. Employer Identification No.)40 Burton Hills Boulevard, Suite 415Nashville, Tennessee
    
    37215(Address of Principal Executive Offices)
    
    (Zip Code)Registrants Telephone Number, Including Area Code:
    
    (615) 665-1858Former 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 [X] NO [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [  ] NO[X] 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 July 31, 2004Common Stock, $0.01 par value
    
    
    16,594,196
 Page 1 of 20




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PagePART I  FINANCIAL INFORMATIONItem 1 Financial StatementsConsolidated Balance Sheets as of June 30, 2004 (Unaudited) and December 31, 2003
    
    
    3Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    6Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
    
    
    12Item 3 Quantitative and Qualitative Disclosures About Market Risk
    
    
    18Item 4 Controls and Procedures
    
    
    19PART II  OTHER INFORMATIONItem 1 Legal Proceedings
    
    
    19Item 2 Changes in Securities and Use of Proceeds
    
    
    19Item 3 Defaults Upon Senior Securities
    
    
    19Item 4 Submission of Matters to a Vote of Security Holders
    
    
    19Item 5 Other Information
    
    
    19Item 6 Exhibits and Reports on Form 8-K
    
    
    20SIGNATURES
    
    
    20EXHIBITS
    
    
    21EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO
  Page 2 of 20




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##### Table of Contents



Part 1. 
 Item 1. Financial Statements iPAYMENT, INC. 
 CONSOLIDATED BALANCE SHEET
  June 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    877
    
    
    $
    733Accounts receivable,net of allowance for doubtful
accounts of $234 and $151 at
June 30, 2004, and December 31, 2003,
respectively
    
    
    14,172
    
    
    
    13,108Prepaid expenses and other current assets, net
    
    
    5,017
    
    
    
    2,624Total current assets
    
    
    20,066
    
    
    
    16,465Restricted cash
    
    
    3,344
    
    
    
    11,141Property and equipment, net
    
    
    2,095
    
    
    
    3,333Intangible assets, net
    
    
    90,292
    
    
    
    94,593Goodwill, net
    
    
    74,554
    
    
    
    73,002Other assets, net
    
    
    3,453
    
    
    
    3,409Total assets
    
    $
    193,804
    
    
    $
    201,943LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued liabilities
    
    $
    16,648
    
    
    $
    11,775Reserve for merchant losses
    
    
    1,199
    
    
    
    1,198Current portion of long-term debt
    
    
    7
    
    
    
    4,537Total current liabilities
    
    
    17,854
    
    
    
    17,510Long term liabilities:Related party long-term debt
    
    
    15,763
    
    
    
    15,591Long-term debt
    
    
    23,508
    
    
    
    45,008Total liabilities
    
    
    57,125
    
    
    
    78,109Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value; 17,422,800 shares
authorized,
no shares issued and outstanding at June 30,
2004, and December 31, 2003
    
    
    
    
    
    
    Common stock, $0.01 par value; 180,000,000 shares
authorized, 16,593,322 shares
issued and outstanding at June 30, 2004;
180,000,000 shares authorized, 16,408,052
shares issued and outstanding at December 31,
2003
    
    
    127,226
    
    
    
    125,060Retained earnings (deficit)
    
    
    9,453
    
    
    
    (1,226
    )Total stockholders equity
    
    
    136,679
    
    
    
    123,834Total liabilities and stockholders equity
    
    $
    193,804
    
    
    $
    201,943
 See accompanying notes to consolidated financial statements. Page 3 of 20




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iPAYMENT, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS
   Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    89,384
    
    
    $
    54,308
    
    
    $
    169,353
    
    
    $
    100,983Operating expenses:Interchange
    
    
    43,513
    
    
    
    28,336
    
    
    
    80,828
    
    
    
    52,346Other costs of services
    
    
    33,683
    
    
    
    18,529
    
    
    
    65,385
    
    
    
    34,806Selling, general and administrative
    
    
    2,796
    
    
    
    1,909
    
    
    
    5,682
    
    
    
    3,738Total operating expenses
    
    
    79,992
    
    
    
    48,774
    
    
    
    151,895
    
    
    
    90,890Income from operations
    
    
    9,392
    
    
    
    5,534
    
    
    
    17,458
    
    
    
    10,093Other expense (income):Interest expense
    
    
    649
    
    
    
    6,301
    
    
    
    1,359
    
    
    
    9,556Other
    
    
    
    
    
    
    65
    
    
    
    (339
    )
    
    
    100Income (loss) before income taxes
    
    
    8,743
    
    
    
    (832
    )
    
    
    16,438
    
    
    
    437Income tax provision
    
    
    3,066
    
    
    
    (250
    )
    
    
    5,759
    
    
    
    131Net income (loss)
    
    
    5,677
    
    
    
    (582
    )
    
    
    10,679
    
    
    
    306Accretion of mandatorily redeemable convertible preferred stock
    
    
    
    
    
    
    (214
    )
    
    
    
    
    
    
    (652
    )Net income (loss) allocable to common stockholders
    
    $
    5,677
    
    
    $
    (796
    )
    
    $
    10,679
    
    
    $
    (346
    )Basic and diluted earnings (loss) per common share:Earnings (loss) per shareBasic
    
    $
    0.34
    
    
    $
    (0.06
    )
    
    $
    0.65
    
    
    $
    (0.04
    )Diluted
    
    $
    0.32
    
    
    $
    (0.06
    )
    
    $
    0.60
    
    
    $
    (0.04
    )Weighted average shares outstandingBasic
    
    
    16,527
    
    
    
    12,383
    
    
    
    16,493

    
    
    
    9,870Diluted
    
    
    18,113
    
    
    
    12,383
    
    
    
    18,083
    
    
    
    9,870
 See accompanying notes to consolidated financial statements. Page 4 of 20




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##### Table of Contents



iPAYMENT, INC. 
 CONSOLIDATED STATEMENTS of CASH FLOWS
 
 Six Months Ended June 30,2004

    
    2003Cash flows from operating activitiesNet income
    
    $
    10,679
    
    
    $
    306Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    9,576
    
    
    
    3,925Noncash interest expense
    
    
    321
    
    
    
    6,366Changes in assets and liabilities, excluding effects of acquisitions:Accounts receivable
    
    
    (1,064
    )
    
    
    (2,465
    )Prepaid expenses and other current assets
    
    
    (2,389
    )
    
    
    (520
    )Other assets
    
    
    (181
    )
    
    
    4,097Accounts payable and accrued liabilities and reserve for merchant losses
    
    
    4,392
    
    
    
    (3,754
    )Other liabilities
    
    
    
    
    
    
    13Net cash provided by operating activities
    
    
    21,334
    
    
    
    7,968Cash flows from investing activitiesChange in restricted cash
    
    
    7,797
    
    
    
    (1,649
    )Expenditures for property and equipment
    
    
    (149
    )
    
    
    (380
    )Acquisitions of businesses, portfolios and other intangibles, net of cash acquired
    
    
    (3,760
    )
    
    
    (1,546
    )Deferred payment for acquisition of business
    
    
    
    
    
    
    (2,099
    )Net cash provided by (used in) investing activities
    
    
    3,888
    
    
    
    (5,674
    )Cash flows from financing activitiesNet repayments on line of credit
    
    
    (21,500
    )
    
    
    (1,050
    )Repayments of debt and capital lease obligations
    
    
    (4,515
    )
    
    
    (53,728
    )Proceeds from issuance of common stock
    
    
    937
    
    
    
    75,913Net cash (used in) provided by financing activities
    
    
    (25,078
    )
    
    
    21,135Net increase in cash and cash equivalents
    
    
    144
    
    
    
    23,429Cash and cash equivalents, beginning of period
    
    
    733
    
    
    
    1,831Cash and cash equivalents, end of period
    
    $
    877
    
    
    $
    25,260Supplemental disclosure of cash flow information:Cash paid during the period for income taxes
    
    $
    1,975
    
    
    $
    57Cash paid during the period for interest
    
    $
    848
    
    
    $
    3,262Supplemental disclosure of noncash investing and financing activities:Accretion of mandatorily redeemable convertible preferred stock
    
    $
    
    
    
    $
    652Conversion of debt to common stock
    
    $
    
    
    
    $
    9,000Conversion of mandatorily redeemable convertible preferred stock to common stock
    
    $
    
    
    
    $
    7,322
 See accompanying notes to consolidated financial statements. Page 5 of 20




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##### Table of Contents



iPAYMENT, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 (1) Organization and Business and Basis of Presentation 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). 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 consolidated financial statements of iPayment, Inc. have been
adjusted to reflect this reverse split. 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 and
reclassifications considered necessary for a fair presentation of the results
of operations and financial condition for the interim periods. All significant
intercompany transactions have been eliminated in consolidation. These
statements should be read in conjunction with the audited consolidated
financial statements and related notes included in our 2003 Annual Report on
Form 10-K. Operating results for the three and six months ended June 30, 2004
are not necessarily indicative of the results that may be expected for the
fiscal year ending December 31, 2004. Certain prior year amounts have been reclassified to conform to the
current year presentation. Other costs of services include costs directly
attributable to our providing 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. Use of Estimates The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. Estimates and assumptions also affect the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. 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 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. 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): Page 6 of 20




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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) allocable to common stockholders, as reported
    
    $
    5,677
    
    
    $
    (796
    )
    
    $
    10,679
    
    
    $
    (346
    )Deduct: Total stock-based employee compensation expense
determined under fair-value-based method
    
    
    (561
    )
    
    
    (276
    )
    
    
    (1,234
    )
    
    
    (468
    )Pro forma net income (loss)
    
    $
    5,116
    
    
    $
    (1,072
    )
    
    $
    9,445
    
    
    $
    (814
    )Earnings per share:As reported:Basic
    
    $
    0.34
    
    
    $
    (0.06
    )
    
    $
    0.65
    
    
    $
    (0.04
    )Diluted
    
    $
    0.32
    
    
    $
    (0.06
    )
    
    $
    0.60
    
    
    $
    (0.04
    )Pro Forma:Basic
    
    $
    0.31
    
    
    $
    (0.09
    )
    
    $
    0.57
    
    
    $
    (0.08
    )Diluted
    
    $
    0.29
    
    
    $
    (0.09
    )
    
    $
    0.53
    
    
    $
    (0.08
    )
 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 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. There were no acquisitions of businesses during 2003 and 2004
that would require pro forma disclosure. 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 were not included in our consolidated income statements until January
1, 2004. The $53.2 million of acquired customer relationships have an
amortization life of seven years, and are deductible over fifteen years for
income tax purposes. Revenues generated from certain agent bank portfolios
acquired as part of the FDMS acquisition 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. 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 the 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, plus a contingent payment based upon performance, which CardPayment has
achieved and as a result has been recorded as a liability as of June 30, 2004. CardPayment
is an integrated provider of credit card transaction processing services. The
acquisition was recorded under the purchase method. The operating results of
CardPayment from August 1, 2003 are included in our consolidated income
statements. Other Acquisitions We made various other purchases of certain residual cash flow streams and
merchant processing portfolios totaling $3.8 million Page 7 of 20




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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) during the six months
ended June 30, 2004. The purchase price for these acquisitions have been
assigned to intangible assets in the
accompanying consolidated balance sheets and are amortized over their
expected useful lives of seven years. (3) Intangible Assets As of June 30, 2004, we had the following amortizable intangible assets
(in thousands): Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    NetMerchant processing portfolios
    
    $
    105,630
    
    
    $
    (17,863
    )
    
    $
    87,767Other intangible assets
    
    
    4,095
    
    
    
    (1,570
    )
    
    
    2,525Total
    
    $
    109,725
    
    
    $
    (19,433
    )
    
    $
    90,292
 As of December 31, 2003, we had the following amortizable intangible
assets (in thousands): Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    NetMerchant processing portfolios
    
    $
    102,240
    
    
    $
    (10,606
    )
    
    $
    91,634Other intangible assets
    
    
    4,229
    
    
    
    (1,270
    )
    
    
    2,959Total
    
    $
    106,469
    
    
    $
    (11,876
    )
    
    $
    94,593
 For the three months ended June 30, 2004 and 2003, respectively,
amortization expense related to the merchant processing portfolios was
$3,819,000 and $1,315,000 and amortization expense related to other intangible
assets was $200,000 and $322,000. For the six months ended June 30, 2004 and
2003, respectively, amortization expense related to the merchant processing
portfolios was $7,639,000 and $2,627,000 and amortization expense related to
other intangible assets was $401,000 and $613,000. (4) Long-Term Debt As of June 30, 2004, we had notes, capital lease obligations and a
revolving credit facility arrangement outstanding in an aggregate principal
amount of $39.3 million, consisting of $23.5 million outstanding under our
revolving credit facility and $15.8 million of convertible subordinated
promissory notes (including $0.8 million of accrued interest, of which $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. We have an $80.0 million revolving credit facility with Bank of America as
the lead bank. 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 2.25%) 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 0.375%) 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 June 30, 2004. At June 30, 2004,
$23.5 million was outstanding under the credit facility, at a weighted average
interest rate of 3.60%. All borrowings under the credit facility are due when the facility expires
on December 31, 2006. The credit facility initially contained provisions that
would have required all principal amounts outstanding in excess of $20 million
on June 30, 2004 (up to a maximum of $35 million) to convert to a term loan if
we did not consummate a financing transaction (as defined) prior to that date.
This provision was amended during the second quarter of 2004 to increase the
limit from $20 million to $25 million. Accordingly, none of the outstanding
principal was converted to a term loan on June 30, 2004. 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 10.5%. 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 Page 8 of 20




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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 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. (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. (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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Stock options and warrants
    
    
    20
    
    
    
    1,212
    
    
    
    15
    
    
    
    1,665Mandatorily redeemable convertible preferred stock
    
    
    
    
    
    
    537
    
    
    
    
    
    
    
    863Convertible debt
    
    
    
    
    
    
    698
    
    
    
    
    
    
    
    71520
    
    
    
    2,447
    
    
    
    15
    
    
    
    3,243
 A reconciliation of basic to diluted weighted average common shares outstanding
is as follows (in thousands except per share data): Three Months Ended June 30,2004
    
    2003Per
    
    
    
    
    
    
    
    
    
    PerIncome
    
    Common
    
    Share
    
    Income
    
    Common
    
    ShareAvailable
    
    Shares
    
    Amount
    
    Available
    
    Shares
    
    AmountBasic earnings per share
    
    $
    5,677
    
    
    
    16,527
    
    
    $
    0.34
    
    
    $
    (796
    )
    
    
    12,383
    
    
    $
    (0.06
    )Effects of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    884
    
    
    
    (0.01
    )
    
    
    
    
    
    
    
    
    
    
    Convertible debt
    
    
    101
    
    
    
    662
    
    
    
    (0.01
    )
    
    
    
    
    
    
    
    
    
    
    Restricted stock
    
    
    
    
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted earnings per share
    
    $
    5,778
    
    
    
    18,113
    
    
    $
    0.32
    
    
    $
    (796
    )
    
    
    12,383
    
    
    $
    (0.06
    )
 Page 9 of 20




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##### Table of Contents



iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Six Months Ended June 30,2004
    
    2003Per
    
    
    
    
    
    
    
    
    
    PerIncome
    
    Common
    
    Share
    
    Income
    
    Common
    
    ShareAvailable
    
    Shares
    
    Amount
    
    Available
    
    Shares
    
    AmountBasic earnings per share
    
    $
    10,679
    
    
    
    16,493
    
    
    $
    0.65
    
    
    $
    (346
    )
    
    
    9,870
    
    
    $
    (0.04
    )Effects of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    891
    
    
    
    (0.03
    )
    
    
    
    
    
    
    
    
    
    
    Convertible debt
    
    
    202
    
    
    
    662
    
    
    
    (0.02
    )
    
    
    
    
    
    
    
    
    
    
    Restricted stock
    
    
    
    
    
    
    37
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted earnings per share
    
    $
    10,881
    
    
    
    18,083
    
    
    $
    0.60
    
    
    $
    (346
    )
    
    
    9,870
    
    
    $
    (0.04
    )
 (7) Segment Information and Geographical Information We consider our business activities to be in a single reporting segment as
we derive greater than 90% of our revenue and results of operations from
processing revenues and other fees from card-based payments. During 2004 and
2003, we had no single customer that represented 2% or more of revenues.
Substantially all revenues are generated in the United States. (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 in
fiscal year 2003, did not have a material 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. (10) Income Taxes We account for income taxes pursuant to the provisions of SFAS No. 109,
Accounting for Income Taxes. Our effective income tax rate differs from
statutory income tax rates due to the utilization of net operating loss
carryforwards in 2004. Page 10 of 20




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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) (11) Commitments and Contingencies We are subject to claims and litigation and contractual obligations that
arise in the normal course of business. We believe that such matters will not
have a material adverse effect on our results of operations, liquidity or
financial condition. Page 11 of 20




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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 second quarter of 2004. We provide our payment services to
approximately 95,000 small merchants across the United States. Charge volume
increased to $3,181 million and $6,044 million for the three and six months
ended June 30, 2004, respectively, from $1,557 million and $2,895 million for
the three and six months ended June 30, 2003 respectively. Revenues also increased to $89.4
million and $169.4 million for the three and six months ended June 30, 2004,
respectively, from $54.3 million and $101.0 million for the three and six
months ended June 30, 2003 respectively. 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, as well as
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. In July
2002, we acquired the remaining outstanding shares of iPayment Technologies,
which then became our wholly owned subsidiary. In each case we issued 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, which is listed on the Nasdaq National Market. Page 12 of 20




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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 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 last completed our annual goodwill impairment review as of July 31,
2003, 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, and, therefore, concluded that no impairment
charge to goodwill was required. 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 net
undiscounted 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 June 30, 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 a
significant 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. Page 13 of 20




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Components of Revenues and Expenses Substantially 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. Related interchange and
assessment costs are also recognized at that time. 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 on a
gross basis equal to the full amount of the discount charged to the merchant.
This amount includes 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. Revenues generated from certain agent bank portfolios
acquired as part of the FDMS acquisition 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 include 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 include depreciation and amortization
expenses, which are recognized on a straight-line basis over the estimated
useful life of the asset. Amortization of intangible assets results from our
acquisitions of portfolios of merchant accounts or acquisitions of a business
where we allocated a portion of the purchase price to the existing merchant
processing portfolio. Selling, general and administrative expenses consist primarily of salaries
and wages and other general administrative expenses. 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, our adoption of the interpretation
had no effect on our consolidated financial statements. 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 usually decrease by at
least 10% in comparison to the remaining two quarters of our fiscal year on a
same store basis. Page 14 of 20




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Results of Operations Three Months Ended June 30, 2004 (2004) Compared to Three Months Ended June 30, 2003 (2003) In thousands (Unaudited) ChangeThree months ended
    
    % of Total
    
    Three months ended
    
    % of TotalJune 30, 2004
    
    Revenue
    
    June 30, 2003
    
    Revenue
    
    Amount
    
    %Revenues
    
    $
    89,384
    
    
    
    100.0
    %
    
    $
    54,308
    
    
    
    100.0
    %
    
    $
    35,076
    
    
    
    64.6
    %Operating ExpensesInterchange
    
    
    43,513
    
    
    
    48.7
    
    
    
    28,336
    
    
    
    52.2
    
    
    
    15,177
    
    
    
    53.6Other costs of services
    
    
    33,683
    
    
    
    37.7
    
    
    
    18,529
    
    
    
    34.1
    
    
    
    15,154
    
    
    
    81.8Selling, general and administrative
    
    
    2,796
    
    
    
    3.1
    
    
    
    1,909
    
    
    
    3.5
    
    
    
    887
    
    
    
    46.5Total operating expenses
    
    
    79,992
    
    
    
    89.5
    
    
    
    48,774
    
    
    
    89.8
    
    
    
    31,218
    
    
    
    64.0Income from operations
    
    
    9,392
    
    
    
    10.5
    
    
    
    5,534
    
    
    
    10.2
    
    
    
    3,858
    
    
    
    69.7Other expenseInterest expense
    
    
    649
    
    
    
    0.7
    
    
    
    6,301
    
    
    
    11.6
    
    
    
    (5,652
    )
    
    
    (89.7
    )Other
    
    
    
    
    
    
    
    
    
    
    65
    
    
    
    0.1
    
    
    
    (65
    )
    
    
    Total other expense
    
    
    649
    
    
    
    0.7
    
    
    
    6,366
    
    
    
    11.7
    
    
    
    (5,717
    )
    
    
    (89.8
    )Income (loss) before income taxes
    
    
    8,743
    
    
    
    9.8
    
    
    
    (832
    )
    
    
    (1.5
    )
    
    
    9,575
    
    
    NMIncome tax provision
    
    
    3,066
    
    
    
    3.4
    
    
    
    (250
    )
    
    
    (0.4
    )
    
    
    3,316
    
    
    NMNet income (loss)
    
    $
    5,677
    
    
    
    6.4
    
    
    $
    (582
    )
    
    
    (1.1
    )
    
    $
    6,259
    
    
    NM
 NM = Not meaningful Revenues.Revenues increased $35.1 million or 64.6% to $89.4 million in
2004 from $54.3 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 $26.0 million, representing
74.1% of our total growth in revenues over the prior period. Interchange Expenses. Interchange expenses increased $15.2 million or
53.6% to $43.5 million in 2004 from $28.3 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 48.7% in 2004 from 52.2% 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
card transactions. Other Costs of Services.Other costs of services increased $15.2 million
or 81.8% to $33.7 million in 2004 from $18.5 million in 2003. Other costs of
services as a percentage of revenues increased to 37.7% in 2004 from 34.1% 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 described above. Selling, General and Administrative.Selling, general and administrative
expenses increased $0.9 million or 46.5% to $2.8 million in 2004 from $1.9
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 decreased to 3.1% in 2004 from 3.5% in 2003, principally due to lower
personnel-related costs, as a percentage of revenues. Other Expense.Other expense in 2004 consisted of $0.6 million of interest
expense. Other expense decreased $5.7 million or 89.7% from $6.4 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 the initial public offering. This repayment resulted in a $4.4 million
charge in the second quarter of 2003 due to the early extinguishment of certain
debt. Income Tax. Income tax expense increased $3.3 million to $3.1 million in
2004 from an income tax benefit of $0.2 million in 2003 due to an increase in
taxable income. Income tax expense as
a percentage of income before taxes was 35.0% in 2004. This rate
differs from our statutory rate, primarily as a result of the
utilization of previously unrecognized net operating losses. Page 15 of 20




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Six Months Ended June 30, 2004 (2004) Compared to Six Months Ended June 30, 2003 (2003) In thousands (Unaudited) ChangeSix months ended
    
    % of Total
    
    Six months ended
    
    % of TotalJune 30, 2004
    
    Revenue
    
    June 30, 2003
    
    Revenue
    
    Amount
    
    %Revenues
    
    $
    169,353
    
    
    
    100.0
    %
    
    $
    100,983
    
    
    
    100.0
    %
    
    $
    68,370
    
    
    
    67.7
    %Operating ExpensesInterchange
    
    
    80,828
    
    
    
    47.7
    
    
    
    52,346
    
    
    
    51.8
    
    
    
    28,482
    
    
    
    54.4Other costs of services
    
    
    65,385
    
    
    
    38.6
    
    
    
    34,806
    
    
    
    34.5
    
    
    
    30,579
    
    
    
    87.9Selling, general and administrative
    
    
    5,682
    
    
    
    3.4
    
    
    
    3,738
    
    
    
    3.7
    
    
    
    1,944
    
    
    
    52.0Total operating expenses
    
    
    151,895
    
    
    
    89.7
    
    
    
    90,890
    
    
    
    90.0
    
    
    
    61,005
    
    
    
    67.1Income from operations
    
    
    17,458
    
    
    
    10.3
    
    
    
    10,093
    
    
    
    10.0
    
    
    
    7,365
    
    
    
    73.0Other expenseInterest expense
    
    
    1,359
    
    
    
    0.8
    
    
    
    9,556
    
    
    
    9.5
    
    
    
    (8,197
    )
    
    
    (85.8
    )Other
    
    
    (339
    )
    
    
    (0.2
    )
    
    
    100
    
    
    
    0.1
    
    
    
    (439
    )
    
    
    Total other expense
    
    
    1,020
    
    
    
    0.6
    
    
    
    9,656
    
    
    
    9.6
    
    
    
    (8,636
    )
    
    
    (89.4
    )Income (loss) before income taxes
    
    
    16,438
    
    
    
    9.7
    
    
    
    437
    
    
    
    0.4
    
    
    
    16,001
    
    
    NMIncome tax provision
    
    
    5,759
    
    
    
    3.4
    
    
    
    131
    
    
    
    0.1
    
    
    
    5,628
    
    
    NMNet income (loss)
    
    $
    10,679
    
    
    
    6.3
    
    
    $
    306
    
    
    
    0.3
    
    
    $
    10,373
    
    
    NM
 NM = Not meaningful Revenues.Revenues increased $68.4 million or 67.7% to $169.4 million in
2004 from $101.0 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 $49.5 million, representing
72.4% of our total growth in revenues over the prior period. Interchange Expenses. Interchange expenses increased $28.5 million or
54.4% to $80.8 million in 2004 from $52.3 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 47.7% in 2004 from 51.8% 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
card transactions. Other Costs of Services.Other costs of services increased $30.6 million
or 87.9% to $65.4 million in 2004 from $34.8 million in 2003. Other costs of
services as a percentage of revenues increased to 38.6% in 2004 from 34.5% 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 described above. Selling, General and Administrative.Selling, general and administrative
expenses increased $2.0 million or 52.0% to $5.7 million in 2004 from $3.7
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 decreased to 3.4% in 2004 from 3.7% in 2003, principally due to lower
personnel-related costs as a percentage of revenues. Other Expense.Other expense in 2004 consisted of $1.4 million of interest
expense partially offset by net proceeds from a legal settlement of $0.3
million. Other expense decreased $8.6 million or 89.4% from $9.7 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 the initial public offering. This repayment resulted in a $4.4 million
charge in the second quarter of 2003 due to the early extinguishment of certain
debt. Income Tax. Income tax expense increased $5.7 million to $5.8 million in
2004 from $0.1 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. This rate differs from our
statutory rate, primarily as a result of the utilization of
previously unrecognized net operating losses. Page 16 of 20




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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 and third parties, as well as through a
revolving 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 June 30, 2004, we had cash and cash equivalents totaling $0.9
million, compared to $0.7 million as of December 31, 2003. We had net working
capital (current assets in excess of current liabilities) of $2.2 million as of
June 30, 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 $21.3 million for the six
months ended June 30, 2004, primarily consisting of net income of $10.7 million
and depreciation and amortization of $9.6 million and a net favorable change in
operating assets and liabilities of $0.8 million. The net favorable change in
operating assets and liabilities was primarily caused by an increase in income
taxes payable, partially offset by an increase in prepaid expenses due to
monthly interchange expenses to a new sponsor bank and by an increase in
accounts receivable due to the addition of net revenues from the FDMS portfolio
as of January 1, 2004. Net cash provided by operating activities was $8.0 million for the six
months ended June 30, 2003. Net income of $0.3 million, depreciation and
amortization of $3.9 million and noncash interest of $6.4 million related to
amortization of debt discounts and isuance costs were partially offset by $2.6
million of unfavorable changes in operating assets and liabilities. Such
changes principally included increases in accounts receivable of $2.5 million. Investing activities Net cash provided by investing activities was $3.9 million for the six
months ended June 30, 2004. Net cash provided by investing activities primarily
consisted of $7.8 million held on deposit by a former sponsor bank that was
returned to us, partially offset by $3.8 million of purchases of residual cash
flow streams and merchant portfolios. 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 $5.7 million for the six months
ended June 30, 2003. During that period, 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 $1.5 million for various residual
cash flow streams and merchant portfolios and paid a $1.5 million deposit to a
new sponsor bank. Financing activities Net cash used in financing activities was $25.1 million for the six months
ended June 30, 2004, consisting of $26.0 million of principal payments on
outstanding debt (including net repayments on our credit facility of $21.5
million) partially offset by $0.9 million of proceeds from stock option
exercises. Net cash provided by financing activities was $21.1 million for the six
months ended June 30, 2003. During that period, we received net proceeds from
issuance of common stock in connection with our IPO of $75.6 million, partially
offset by payments of aggregate principal amounts of $54.8 million on
outstanding debt balances (including net changes in our line of credit). As of June 30, 2004, we had notes, capital lease obligations and a
revolving credit facility arrangement outstanding in an aggregate principal
amount of $39.3 million, consisting of $23.5 million outstanding under our
revolving credit facility and $15.8 million of convertible subordinated
promissory notes (including $0.8 million of accrued interest, of which $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
June 30, 2004, excluding amortization of finance costs. We have an $80.0 million revolving credit facility with Bank of America as
the lead bank. 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 2.25%) 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 0.375%) 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 June 30, 2004. The credit facility
replaces the previous credit facility we had with Bank of America and expires
on December 31, 2006. Page 17 of 20




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The following table of our material contractual obligations as of June 30,
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 periodLess than 1
    
    
    
    
    
    
    
    
    
    More than 5Contractual Obligations
    
    Total
    
    year
    
    1-3 years
    
    3-5 years
    
    yearsCredit facility
    
    $
    23,500
    
    
    $
    
    
    
    $
    23,500
    
    
    $
    
    
    
    $
    Convertible notes (including accrued interest)
    
    
    15,763
    
    
    
    
    
    
    
    
    
    
    
    15,763
    
    
    
    Capital lease obligations
    
    
    15
    
    
    
    7
    
    
    
    8
    
    
    
    
    
    
    
    Operating lease obligations
    
    
    1,817
    
    
    
    646
    
    
    
    695
    
    
    
    391
    
    
    
    85Purchase obligations (1)
    
    
    18,362
    
    
    
    5,079
    
    
    
    8,765
    
    
    
    4,518
    
    
    
    Total contractual obligations
    
    $
    59,457
    
    
    $
    5,732
    
    
    $
    32,968
    
    
    $
    20,672
    
    
    $
    85
 (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. 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 above 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 June 30, 2004, $23.5 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 annual interest
expense of $0.2 million based on our current debt balance. We do not hold derivative financial or commodity instruments, nor engage
in any foreign currency denominated transactions, and all of our cash and cash
equivalents are held in money market and checking funds. Page 18 of 20




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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 June 30, 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 second fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting. 
 PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings A
press release issued on August 6, 2004, states that a complaint
has been filed in the United States Bankruptcy Court on behalf of a
U.S. Bankruptcy Court Trustee against the Company, certain of its
officers and directors and other non-affiliated entities, whereby the
Debtor is alleging that it was fraudulently induced to enter into a
transaction with the Company. According to the press release, the
complaintant is seeking treble damages totaling $151 million. The Company believes that this complaint and the underlying
allegations are without merit and intends to vigorously defend
against them. The Company believes that there are a number of
defenses available, including the existence of a release agreement
previously signed by the Debtor. 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 The following matters were voted upon at the annual meeting of stockholders held on June 10, 2004: (a) Election of eight directors (b) The ratification of the selection of Ernst & Young LLP as independent auditors of the Company for the
fiscal year ending December 31, 2004 All matters voted on at the annual meeting were approved. The voting results were as follows: For
    
    WithheldElection of Directors:Peter Y. Chung
    
    
    12,456,169
    
    
    
    193,164Gregory S. Daily
    
    
    12,367,820
    
    
    
    281,513John C. Harrison
    
    
    12,456,169
    
    
    
    193,164Donald McLemore, Jr.
    
    
    12,278,872
    
    
    
    370,461Jennie Carter Thomas
    
    
    12,278,784
    
    
    
    370,549David T. Vandewater
    
    
    12,264,483
    
    
    
    384,850Clay M. Whitson
    
    
    12,407,269
    
    
    
    242,064David M. Wilds
    
    
    12,456,169
    
    
    
    193,164BrokerFor
    
    Against
    
    Abstain
    
    Non-VotesRatification of Auditors
    
    
    12,599,919
    
    
    
    60
    
    
    
    34,139
 There were no broker non-votes included in the results of the election of directors or the ratification of appointment of auditors. 
 Item 5. Other Information None Page 19 of 20




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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
    
    DescriptionMay 5, 2004
    
    The Company filed a current report on Form 8-K under item 12
to announce its 2004 first-quarter results.
 
 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.Date:
August 16, 2004
    
    By: /s/ Gregory S. DailyGregory S. DailyChief Executive Officer(Principal Executive Officer)Date: August 16, 2004
    
    By: /s/ Clay M. WhitsonClay M. WhitsonChief Financial Officer(Principal Financial and Accounting Officer)
 
 EXHIBIT INDEX Exhibit No.
    
    Description31.1
    
    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 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(a) 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(a) and 18 U.S.C. 1350 (as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002), filed herewith.
 Page 20 of 20