##### 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 September 30, 2003

Commission file number 000-50280

(IPAYMENT INC. LOGO)
iPayment, Inc.
(Exact Name of Registrant as Specified in Its Charter)

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 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 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 October 31, 2003Common Stock, $0.01 par value
    
    
    16,363,907


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|                                   |                                                                                               |                                            |  |  |  |  |  | 
|---------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|Part 1.                           
|                                   | Item 1. Financial Statements                                                                 
|                                   |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                                   |                                                                                               | CONSOLIDATED STATEMENTS of OPERATIONS     
|                                   |                                                                                               | CONSOLIDATED STATEMENTS of CASH FLOWS     
|                                   |                                                                                               | NOTES to CONSOLIDATED FINANCIAL STATEMENTS
|                                   | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                   | Item 3. Quantitative and Qualitative Disclosure about Market Risk                            
|                                   | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION       
|                                   | Item 1. Legal Proceedings                                                                    
|                                   | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                        
|EXHIBIT INDEX                     
|EX-31.1: SECTION 302 CERTIFICATION
|EX-32.2: SECTION 302 CERTIFICATION
|EX-32.1: SECTION 906 CERTIFICATION
|EX-32.2: SECTION 906 CERTIFICATION



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INDEX

iPAYMENT, INC. and SUBSIDIARIES

PagePART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets as of September 30, 2003 (Unaudited) and December 31, 2002
    
    
    3Unaudited Consolidated Statements of Operations for the three and nine months ended
September 30, 2003 and 2002
    
    
    4Unaudited Consolidated Statements of Cash Flows for the nine months ended September
30, 2003 and 2002
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosure about Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    20PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    21Item 2. Changes in Securities and Use of Proceeds
    
    
    21Item 6. Exhibits and Reports on Form 8-K
    
    
    22SIGNATURES
    
    
    22EXHIBITS
    
    
    23


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Part 1.




Item 1. Financial Statements




iPAYMENT, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |              |         |  |  | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ----------------------------------------------- | ---------------------------------------- | ------- | ------------- | ------- | ------------ | ------- |  |  | 
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         | September 30, |         | December 31,
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         | 2003          |         | 2002        
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         | (Unaudited)   |         |              |         | 
|ASSETS                                                                                                                                                                                                                                                           |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|Current assets:                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 | Cash and cash equivalents                                                                                                                                                                                                 |                            | $                                               | 11,691                                   |         |               | $       | 1,831        |        
|                                                                                                                                                                                                                                                                 | Accounts receivable, net of allowance for doubtful accounts of $53 and $93 at
September 30, 2003 and December 31, 2002, respectively                                                                                      |                            |                                                 | 10,400                                   |         |               |         | 6,687        |        
|                                                                                                                                                                                                                                                                 | Prepaid expenses and other current assets                                                                                                                                                                                 |                            |                                                 | 2,028                                    |         |               |         | 1,287        |        
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           | Total current assets       |                                                 |                                          | 24,119  |               |         |              | 9,805   | 
|Restricted cash                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                           |                            | 9,579                                           |                                          |         |               | 3,070   |             
|Property and equipment, net                                                                                                                                                                                                                                      |                                                                                                                                                                                                                           |                            | 1,654                                           |                                          |         |               | 1,610   |             
|Intangible assets, net                                                                                                                                                                                                                                           |                                                                                                                                                                                                                           |                            | 32,313                                          |                                          |         |               | 31,758  |             
|Goodwill, net                                                                                                                                                                                                                                                    |                                                                                                                                                                                                                           |                            | 74,069                                          |                                          |         |               | 60,790  |             
|Other assets                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                           |                            | 6,918                                           |                                          |         |               | 9,948   |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           | Total assets               |                                                 | $                                        | 148,652 |               |         | $            | 116,981 | 
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            | LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE |                                          |         |               |         |              |         |  | 
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 | PREFERRED STOCK and STOCKHOLDERS EQUITY |         |               |         |              |         |  |  | 
|Current liabilities:                                                                                                                                                                                                                                             |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 | Reserve for merchant losses                                                                                                                                                                                               |                            | $                                               | 3,144                                    |         |               | $       | 4,411        |        
|                                                                                                                                                                                                                                                                 | Accounts payable and accrued liabilities                                                                                                                                                                                  |                            |                                                 | 10,810                                   |         |               |         | 12,192       |        
|                                                                                                                                                                                                                                                                 | Current portion of long-term debt to a related party                                                                                                                                                                      |                            |                                                 | 5,044                                    |         |               |         | 7,383        |        
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           | Total current liabilities  |                                                 |                                          | 18,998  |               |         |              | 23,986  | 
|Long term liabilities:                                                                                                                                                                                                                                           |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 | Long-term debt                                                                                                                                                                                                            |                            |                                                 | 15,538                                   |         |               |         | 70,688       |        
|                                                                                                                                                                                                                                                                 | Other long-term liabilities                                                                                                                                                                                               |                            |                                                 | 666                                      |         |               |         | 2,118        |        
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           | Total liabilities          |                                                 |                                          | 35,202  |               |         |              | 96,792  | 
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|Commitments
and contingencies                                                                                                                                                                                                                                    |                                                                                                                                                                                                                           |                            |                                                
|Series A mandatorily redeemable convertible preferred stock, no par value; 2,577,200
shares authorized and issued at September 30, 2003 and December 31,
2002; no shares
outstanding at September 30, 2003 and 2,577,200 shares outstanding at December 31, 2002 |                                                                                                                                                                                                                           |                            |                                                |                                          |         |               | 6,670   |             
|Stockholders equity:                                                                                                                                                                                                                                            |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 | Preferred stock, $0.01 par value; 17,422,800 shares authorized,
no shares issued and outstanding at September 30, 2003 and December 31, 2002                                                                              |                            |                                                 |                                         |         |               |         |             |        
|                                                                                                                                                                                                                                                                 | Common stock, $0.01 par value; 180,000,000 shares authorized, 16,363,027 shares
issued and outstanding at September 30, 2003; 130,000,000 shares authorized,
6,736,075 shares issued and outstanding at December 31, 2002 |                            |                                                 | 124,902                                  |         |               |         | 29,736       |        
|                                                                                                                                                                                                                                                                 | Accumulated deficit                                                                                                                                                                                                       |                            |                                                 | (11,452                                  | )       |               |         | (16,217      | )      
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           | Total stockholders equity |                                                 |                                          | 113,450 |               |         |              | 13,519  | 
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             
|Total liabilities and stockholders equity                                                                                                                                                                                                                       |                                                                                                                                                                                                                           | $                          | 148,652                                         |                                          |         | $             | 116,981 |             
|                                                                                                                                                                                                                                                                 |                                                                                                                                                                                                                           |                            |                                                 |                                          |         |               |         |             

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.
CONSOLIDATED STATEMENTS of OPERATIONS
(In thousands, except per share data)
(Unaudited)

Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Revenues
    
    $
    59,847
    
    
    $
    29,249
    
    
    $
    160,830
    
    
    $
    67,268Operating expenses:Interchange
    
    
    30,302
    
    
    
    13,329
    
    
    
    82,648
    
    
    
    27,672Other costs of services
    
    
    20,765
    
    
    
    11,229
    
    
    
    55,571
    
    
    
    30,821Selling, general and administrative
    
    
    2,071
    
    
    
    1,918
    
    
    
    5,809
    
    
    
    4,488Total operating expenses
    
    
    53,138
    
    
    
    26,476
    
    
    
    144,028
    
    
    
    62,981Income from operations
    
    
    6,709
    
    
    
    2,773
    
    
    
    16,802
    
    
    
    4,287Other expense (income)Interest expense
    
    
    186
    
    
    
    1,416
    
    
    
    9,741
    
    
    
    3,915Other
    
    
    165
    
    
    
    (12
    )
    
    
    266
    
    
    
    Income before income taxes
    
    
    6,358
    
    
    
    1,369
    
    
    
    6,795
    
    
    
    372Income tax provision
    
    
    1,272
    
    
    
    156
    
    
    
    1,403
    
    
    
    466Net income (loss)
    
    
    5,086
    
    
    
    1,213
    
    
    
    5,392
    
    
    
    (94
    )Accretion of mandatorily redeemable convertible preferred stock
    
    
    
    
    
    
    (393
    )
    
    
    (652
    )
    
    
    (1,096
    )Net income (loss) allocable to common stockholders
    
    $
    5,086
    
    
    $
    820
    
    
    $
    4,740
    
    
    $
    (1,190
    )Basic and diluted earnings (loss) per common share:Earnings (loss) per shareBasic
    
    $
    0.31
    
    
    $
    0.15
    
    
    $
    0.39
    
    
    $
    (0.25
    )Diluted
    
    $
    0.29
    
    
    $
    0.12
    
    
    $
    0.35
    
    
    $
    (0.25
    )Weighted average shares outstandingBasic
    
    16,323
    
    
    
    5,311
    
    
    
    12,045
    
    
    
    4,760Diluted
    
    
    17,809
    
    
    
    6,848
    
    
    
    13,437
    
    
    
    4,760


See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.
CONSOLIDATED STATEMENTS of CASH FLOWS
(In thousands)
(Unaudited)

Nine months endedSeptember 30,2003
    
    2002Cash flows from operating activities:Net income (loss)
    
    $
    5,392
    
    
    $
    (94
    )Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization
    
    
    5,891
    
    
    
    3,833Noncash interest expense
    
    
    6,372
    
    
    
    852Changes in assets and liabilities, excluding effects of acquisitions:Accounts receivable
    
    
    (3,287
    )
    
    
    (2,519
    )Prepaid expenses and other current assets
    
    
    (731
    )
    
    
    (444
    )Other assets
    
    
    2,601
    
    
    
    (3,141
    )Reserve for merchant losses, accounts payable and accrued liabilities
    
    
    (3,167
    )
    
    
    1,665Other liabilities
    
    
    34
    
    
    
    179Net cash provided by operating activities
    
    
    13,105
    
    
    
    331Cash flows from investing activities:Change in restricted cash
    
    
    (6,288
    )
    
    
    (2,751
    )Expenditures for property and equipment
    
    
    (473
    )
    
    
    (188
    )Acquisitions of businesses, portfolios and other intangibles, net of cash acquired
    
    
    (14,415
    )
    
    
    (5,270
    )Payments related to businesses previously aquired
    
    
    (2,099
    )
    
    
    Net cash used in investing activities
    
    
    (23,275
    )
    
    
    (8,209
    )Cash flows from financing activities:Issuances of debt
    
    
    
    
    
    
    14,203Repayments of debt
    
    
    (54,759
    )
    
    
    (5,228
    )Net repayments on line of credit
    
    
    (1,050
    )
    
    
    Proceeds from issuance of common stock
    
    
    75,839
    
    
    
    Net cash provided by financing activities
    
    
    20,030
    
    
    
    8,975Net increase in cash and cash equivalents
    
    
    9,860
    
    
    
    1,097Cash and cash equivalents, beginning of period
    
    
    1,831
    
    
    
    290Cash and cash equivalents, end of period
    
    $
    11,691
    
    
    $
    1,387


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iPAYMENT, INC.
CONSOLIDATED STATEMENTS of CASH FLOWS  (Continued)
(In thousands)
(Unaudited)

Supplemental disclosure of cash flow information:Cash paid during the period for income taxes
    
    $
    261
    
    
    $
    7Cash paid during the period for interest
    
    $
    3,402
    
    
    $
    2,975Supplemental disclosure of noncash investing and financing activities:Accretion of mandatorily redeemable convertible preferred stock
    
    $
    652
    
    
    $
    1,096Conversion of debt to common stock
    
    $
    9,000
    
    
    $
    Conversion of mandatorily redeemable convertible preferred stock to common stock
    
    $
    7,322
    
    
    $
    Acquisition of businesses funded with:Debt
    
    $
    
    
    
    $
    22,099Common stock
    
    $
    3,000
    
    
    $
    17,355Non-cash increase in assets and liabilities from acquisitions:Restricted cash
    
    $
    221
    
    
    $
    1,555Accounts receivable
    
    $
    426
    
    
    $
    2,323Other assets
    
    $
    1,287
    
    
    $
    1,972Plant and equipment
    
    $
    51
    
    
    $
    768Intangible assets
    
    $
    4,980
    
    
    $
    13,290Goodwill
    
    $
    13,117
    
    
    $
    45,409Accounts payable, accrued liabilities and merchant loss reserve
    
    $
    (1,676
    )
    
    $
    (11,159
    )Short and long-term debt
    
    $
    (991
    )
    
    $
    (10,428
    )


See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED

(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 of America 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 of America 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 and nine months ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 2003. For further information, refer to the consolidated
financial statements and notes thereto for the year ended December 31, 2002
(included in our Registration Statement on Form S-1).

Certain prior year amounts have been reclassified to conform to the
current year presentation, including separate presentation of interchange fees
and classification of all depreciation and amortization expense as other cost
of services in the consolidated statement of operations. Interchange fees had
previously been included in cost of services and were $6.7 million, $7.6
million, $13.3 million and $24.2 million for the three months ended March 31,
June 30, September 30, and December 31, 2002, respectively. 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. The following table presents the effect
on net income (loss) and basic and diluted net income (loss) per common share
had the Company adopted the fair value method of accounting for stock-based
compensation under SFAS No. 123 (in thousands, except per share data):

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,2003
    
    2002
    
    2003
    
    2002Net income (loss) allocable to common stockholders, as reported
    
    $
    5,086
    
    
    $
    820
    
    
    $
    4,740
    
    
    $
    (1,190
    )Deduct: Total stock-based employee compensation expense
determined under fair-value-based method
    
    
    (352
    )
    
    
    (119
    )
    
    
    (820
    )
    
    
    (357
    )Pro forma net income (loss)
    
    $
    4,734
    
    
    $
    701
    
    
    $
    3,920
    
    
    $
    (1,547
    )Earnings (loss) per share:As reported:Basic
    
    $
    0.31
    
    
    $
    0.15
    
    
    $
    0.39
    
    
    $
    (0.25
    )Diluted
    
    $
    0.29
    
    
    $
    0.12
    
    
    $
    0.35
    
    
    $
    (0.25
    )Pro Forma:Basic
    
    $
    0.29
    
    
    $
    0.13
    
    
    $
    0.33
    
    
    $
    (0.33
    )Diluted
    
    $
    0.27
    
    
    $
    0.10
    
    
    $
    0.29
    
    
    $
    (0.33
    )


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%
and 100% for 2003 and 2002, respectively (iii) expected lives of 3 years for
all periods, (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.

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 $25.34. 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 statements of operations of the Company.

CardSync Processing, Inc.

On September 5, 2002, we entered into an Agreement and Plan of Merger (the
CardSync Agreement) with CardSync Processing, Inc. (CardSync), whereby
CardSync merged with a wholly owned subsidiary of the Company. CardSync is an
integrated provider of credit card transaction processing services. Under the
terms of the CardSync Agreement, we purchased CardSync for $1.1 million cash
and 670,915 shares of our common stock. The acquisition was accounted for as a
purchase. Debt assumed in the acquisition is pursuant to a settlement of
litigation between CardSync and NOVA Corporation (NOVA) under which CardSync
was required to pay NOVA $8.0 million. The debt was repaid in the second
quarter of 2003 using proceeds from our initial public offering (see Note 9).

First Merchants Bancard Services, Inc

On August 28, 2002, we entered into an Agreement and Plan of Merger (the
FMBS Agreement) with First Merchants Bancard Services, Inc. (FMBS), whereby
FMBS merged into a wholly owned subsidiary of the Company. FMBS is an
integrated provider of credit card transaction processing services. Under the
terms of the FMBS Agreement,

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

we purchased FMBS for $3.4 million cash and 740,320 shares of our common
stock. The acquisition was accounted for as a purchase. Debt assumed in the
acquisition included a note payable for $1.9 million (which also contained a
one-time $250,000 loan fee due upon the repayment of the note). The note was
repaid in the second quarter of 2003 using proceeds from our initial public
offering (see Note 9).

Online Data Corporation

On August 22, 2002, we entered into an Agreement and Plan of Merger (the
Online Agreement) with Online Data Corporation (Online), whereby Online
merged with a wholly owned subsidiary of the Company. Online is an integrated
provider of credit card transaction processing services. Under the terms of
the Online Agreement, we purchased Online for $2.0 million cash, a note for
$5.0 million (the Online Note) and 844,428 shares of our common stock, as
well as a deferred cash payment of $2.1 million which was paid in February
2003. The acquisition was accounted for as a purchase. Debt assumed in the
acquisition included a note payable to Blueline Data Corporation (the Blueline
Note) for $1.3 million. The Online Note and the Blueline Note were repaid in
the second quarter of 2003 using proceeds from our initial public offering (see
Note 9).

E-Commerce Exchange

On March 19, 2002, we entered into an Agreement and Plan of Merger (the
ECX Agreement) with ECX, a card-payment processor, whereby ECX merged into a
wholly owned subsidiary of the Company. ECX is a provider of an end-to-end
solution which enables merchants to accept credit card payments via the
Internet. Under the terms of the ECX Agreement, we issued a series of
convertible notes (the ECX Notes) to the prior Series A Preferred
Stockholders of ECX (ECX Preferred Stockholders) in the aggregate amount of
$15.0 million in exchange for all of the outstanding common shares of ECX.
Subject to certain restrictions, such ECX Notes are convertible into 663,184
shares of our common stock, and the notes bear interest at 4.5 percent and are
due March 2007. The acquisition was accounted for as a purchase.

Other Acquisitions of Portfolios
and Residual Cash Flow Streams

We made
various other purchases of residual cash flow streams totaling
$3.8 million during the nine months ended September 30,
2003. These purchases are accounted for as other assets in the
accompanying consolidated balance sheets and are amortized over their expected
useful lives of seven years.

(3) Intangible Assets

As of September 30, 2003, we had the following amortizable intangible
assets (in thousands):

GrossCarrying
    
    AccumulatedAmount
    
    Amortization
    
    NetMerchant processing portfolios
    
    $
    39,006
    
    
    
    (9,018
    )
    
    $
    29,988Acquired software
    
    
    1,351
    
    
    
    (570
    )
    
    
    781Bank contract costs and other
    
    
    2,079
    
    
    
    (535
    )
    
    
    1,544Total
    
    $
    42,436
    
    
    $
    (10,123
    )
    
    $
    32,313


As of December 31, 2002, we had the following amortizable intangible
assets (in thousands):

GrossCarrying
    
    AccumulatedAmount
    
    Amortization
    
    NetMerchant processing portfolios
    
    $
    34,236
    
    
    
    (4,975
    )
    
    $
    29,261Acquired software
    
    
    2,593
    
    
    
    (1,973
    )
    
    
    620Bank contract costs and other
    
    
    5,174
    
    
    
    (3,297
    )
    
    
    1,877Total
    
    $
    42,003
    
    
    $
    (10,245
    )
    
    $
    31,758


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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

For the three months ended September 30, 2003 and 2002, respectively,
amortization expense related to the merchant processing portfolios was
$1,415,000 and $899,000, amortization expense related to acquired software was
$127,000 and $187,000, and amortization expense related to bank contract costs
and other was $70,000 and $72,000. For the nine months ended September 30,
2003 and 2002, respectively, amortization expense related to the merchant
processing portfolios was $4,042,000 and $2,387,000, amortization expense
related to acquired software was $620,000 and $669,000, and amortization
expense related to bank contract costs and other was $183,000 and $345,000.

(4) Long-Term Debt

In
August, 2003 we obtained a $20.0 million revolving credit
from Bank of America which was subsequently expanded to $30.0 million in
October 2003. The revolving credit includes a $3.0 million letter of credit
sublimit. Interest is payable at an adjusted LIBOR rate (LIBOR Rate plus
2.25%, each as in effect at such time). The revolving credit contains certain
financial and nonfinancial covenants (as defined therein) and replaces the
previous line of credit we had with Bank of America. The revolving credit
expires on August 1, 2006. We were in compliance with all debt covenants as of
September 30, 2003 and we currently have no borrowings.

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. 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.

(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):

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Stock options and warrants
    
    
    
    
    
    
    69
    
    
    
    
    
    
    
    1,319Mandatorily redeemable convertible preferred stock
    
    
    
    
    
    
    1,192
    
    
    
    572
    
    
    
    1,192Convertible debt
    
    
    
    
    
    
    725
    
    
    
    697
    
    
    
    539
    
    
    
    1,986
    
    
    
    1,269
    
    
    
    3,050


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

Three months ended September 30,2003
    
    2002Income
    
    Common
    
    Per Share
    
    Income
    
    Common
    
    Per ShareAvailable
    
    Shares
    
    Amount
    
    Available
    
    Shares
    
    AmountBasic earnings per share
    
    $
    5,086
    
    
    
    16,323
    
    
    $
    0.31
    
    
    $
    820
    
    
    
    5,311
    
    
    $
    0.15Effects of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    823
    
    
    
    (0.01
    )
    
    
    
    
    
    
    1,538
    
    
    
    (0.03
    )Convertible debt
    
    
    118
    
    
    
    663
    
    
    
    (0.01
    )
    
    
    
    
    
    
    
    
    
    
    Diluted earnings per share
    
    $
    5,204
    
    
    
    17,809
    
    
    $
    0.29
    
    
    $
    820
    
    
    
    6,849
    
    
    $
    0.12


Nine months ended September 30,2003
    
    2002Income
    
    Common
    
    Per Share
    
    Income
    
    Common
    
    Per ShareAvailable
    
    Shares
    
    Amount
    
    Available
    
    Shares
    
    AmountBasic earnings per share
    
    $
    4,740
    
    
    
    12,045
    
    
    $
    0.39
    
    
    $
    (1,190
    )
    
    
    4,760
    
    
    $
    (0.25
    )Effects of dilutive securities:Stock options and warrants
    
    
    
    
    
    
    1,392
    
    
    
    (0.04
    )
    
    
    
    
    
    
    
    
    
    
    Convertible debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Diluted earnings per share
    
    $
    4,740
    
    
    
    13,437
    
    
    $
    0.35
    
    
    $
    (1,190
    )
    
    
    4,760
    
    
    $
    (0.25
    )


(7) Revenue Recognition

Revenues are reported gross of amounts paid to association banks as well
as interchange and assessments paid by us 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, which are included
in other costs of services.

(8) Recent Accounting Pronouncements

In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others, an

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

interpretation of SFAS Nos. 5, 57 and 107 and a rescission of FASB
Interpretation No. 34(FIN 45). Effective January 1, 2003, the Company
adopted FIN 45, which requires the recognition of a liability for the amount of
the fair value of a guarantee. A liability is required to be maintained until
the settlement or expiration of the guarantee for transactions occurring after
December 31, 2002. The Company recognizes a reserve for its merchant credit
risk, which is partially mitigated by the collateral the Company obtains from
those merchants considered at risk. Based on historical experience, ongoing
credit risk assessments, and the collateral held, the fair value of the
guarantee approximates the credit loss reserves. We adopted this statement and
its adoption did not have a material impact on our financial position, results
of operations or cash flows.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment of FASB Statement No.
123. This statement amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirement of
SFAS No. 123 to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We adopted
this statement and its adoption did not have any impact on our financial
position, results of operations or cashflows (see Note 1).

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. FIN 46 applies immediately to
variable interests in variable interest entities created after January 31,
2003, and to variable interests in variable interest entities obtained after
January 31, 2003. FIN 46 requires certain disclosures
in financial statements issued after January 31, 2003 if it is reasonably
possible that we will consolidate or disclose information about variable
interest entities when the interpretation becomes effective. We do not have
ownership interests in variable interest entities, accordingly, the adoption of
this statement did not have a material impact on our financial position,
results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity.
This statement establishes standards for classifying and measuring as
liabilities certain financial instruments that embody obligations of the issuer
and have characteristics of both liabilities and equity, including mandatorily
redeemable equity instruments. The Statement is effective for all interim
periods beginning after June 15, 2003. We have classified our mandatorily
redeemable convertible equity instruments in the mezzanine level between
liabilities and stockholders equity on its balance sheet. However, all of our
mandatorily redeemable convertible equity instruments were converted to common
stock in conjunction with the initial public offering in May 2003 (see Note 9)
and therefore, the adoption of this statement 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 $75.7 million (after underwriters discount of
$6.3 million and related offering expenses of $8.0 million). As described in
Note 4, 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

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iPAYMENT, INC.
NOTES to CONSOLIDATED FINANCIAL STATEMENTS (continued)
UNAUDITED

During the third quarter, we completed a study of our available federal
and state net operating loss carryforwards. At December 31, 2002, we had
approximately $18.1 million of federal net operating loss carryforwards that
will be available to offset regular taxable income through 2022, subject to
annual limitations of approximately $9.8 million in 2003 and up to $6.5 million
per year thereafter. We also have approximately $15.6 million of state net
operating loss carryforwards, again subject to similar annual limitations, that
will expire in various states between 2013 and 2022. As a result of the study,
we have adjusted our tax provision to reflect the anticipated effective rate
for the year.

(11) Subsequent Events

In October 2003, we acquired a merchant portfolio from NPMG, Inc. of
Phoenix, Arizona. The merchant portfolio, currently located at JP Morgan Chase
Bank, consists of approximately 1,500 merchants.

In October 2003, we repaid $0.5 million of principal on an existing note
payable owed to an officer of the Company. The remaining principal balance of
$4.5 million is due in January 2004.

On October 1, 2003, we amended our Credit Agreement with Bank of America,
dated August 1, 2003 to increase our revolving credit in the amount of $10.0
million, from $20.0 million to $30.0 million in October
2003, under the terms and conditions of
this Revolving Credit Facility. All of the terms, conditions and covenants of
the Credit Agreement are expressly made a part of this Revolving Credit
Facility and reference is made to the Credit Agreement for provisions relating
to the interest rate, maturity, payment, prepayment, acceleration and other
terms affecting this Revolving Credit Facility.

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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
the prospectus filed with the Securities and Exchange Commission (the
Commission) on May 13, 2003, 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 prospectus filed May 13, 2003, 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.

Overview

We are one of the fastest growing providers of credit and debit card-based
payment processing services to small merchants. We currently provide our
services to over 70,000 active small merchants located across the United
States, and our merchant processing volume was $1,729 million
and $4,624
million for the three and nine months ended September 30, 2003, respectively
(compared to $736 million and $1,506 million for the three and nine months
ended September 30, 2002, respectively). The small merchants we serve typically
generate less than $250,000 of charge volume per year and have an average
transaction value of approximately $75. These merchants have traditionally been
underserved by larger payment processors due to the difficulty in identifying,
servicing and managing the risks associated with these merchants. As a result,
these merchants have historically paid higher transaction fees than larger
merchants.

Our payment processing services enable merchants to process both
traditional card-present, or swipe, transactions, as well as card-not-present
transactions. A card-not-present transaction occurs whenever a 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. Our processing services include
evaluation and acceptance of card numbers, detection of fraudulent
transactions, receipt and settlement of funds and service and support. By
outsourcing some of these services to third parties, including the evaluation
and acceptance of card numbers and receipt and settlement of funds, we maintain
an efficient operating structure, which allows us to easily expand our
operations without significantly increasing our fixed costs. We derive the
majority of our revenues from fee income related to transaction processing,
which is primarily comprised of a percentage of the dollar amount of each
transaction we process, as well as a flat fee per transaction. In the event we
have outsourced any of the services provided in the transaction, we remit a
portion of the fee income to the third parties that have provided these
services.

We believe our experience and knowledge in providing payment processing
services to small merchants gives us the ability to effectively identify,
evaluate and manage the payment processing needs and risks that are unique to
small businesses.

We market and sell our services primarily through our relationships with
over 500 independent sales organizations, or ISOs, which we define as any party
that sells card-based payment processing services to merchants. ISOs act as a
non-employee, external sales force in communities throughout the United States.
By providing the same high level of service and support to our ISOs as we do to
our merchant customers, we maintain our access to an experienced sales force of
approximately 2,000 sales professionals who will market our services, with
minimal direct investment in sales infrastructure and management. After an ISO
refers a merchant to us and we execute a processing agreement with that
merchant, we pay the referring ISO a percentage of the revenues generated by
that merchant. Although our relationships with ISOs are mutually non-exclusive,
we believe that our understanding of the unique payment processing needs of
small merchants enables us to develop compelling incentives for ISOs to
continue to refer newly identified merchants to us. We also maintain an open
dialogue with our ISOs, allowing us to quickly address their concerns and any
problems facing the merchants they refer to us.

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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. Our significant
accounting policies are more fully described in Note 3 of our financial
statements included in our prospectus filed with the Commission on May 13,
2003. 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.

Restricted
Cash

Restricted
cash represents funds held-on-deposit with processing banks pursuant
to agreements to cover potential merchant losses, and funds held by
lending institutions pursuant to loan agreements to provide
additional collateral.

Goodwill

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 utilizing the fair value approach. If
facts and circumstances indicate goodwill may be impaired, we perform a
recoverability evaluation. 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.

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, together with the
acquiring bank, must bear the credit risk for the full amount of the
transaction. We evaluate the merchants risk for such transaction and estimate
its potential loss for chargebacks based primarily on historical experience and
other relevant factors. At September 30, 2003, our reserve for losses on
merchant accounts totaled $3.1 million, of which approximately $1.3 million
related to reserves from one merchant.

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. We have placed
a valuation allowance on our net deferred tax asset as a result of certain
limitations.

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. 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.

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.

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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 November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others, an
interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB
Interpretation No. 34(FIN 45). Effective January 1, 2003, the Company
adopted FIN 45, which requires the recognition of a liability for the amount of
the fair value of a guarantee. A liability is required to be maintained until
the settlement or expiration of the guarantee for transactions occurring after
December 31, 2002. The Company recognizes a reserve for its merchant credit
risk, which is partially mitigated by the collateral the Company obtains from
those merchants considered at risk. Based on historical experience, ongoing
credit risk assessments, and the collateral held, the fair value of the
guarantee approximates the credit loss reserves. We adopted this statement and
its adoption did not have a material impact on our financial position, results
of operations or cash flows.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an amendment of FASB Statement No.
123. This statement amends SFAS No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirement of
SFAS No. 123 to require prominent disclosure in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We adopted
this statement and its adoption did not have a material impact on our financial
position, results of operations or cash flows (see Note 1).

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. FIN 46 applies immediately to
variable interests in variable interest entities created after January 31,
2003, and to variable interests in variable interest entities obtained after
January 31, 2003. FIN 46 requires certain disclosures in financial statements
issued after January 31, 2003 if it is reasonably possible that we will
consolidate or disclose information about variable interest entities when the
interpretation becomes effective. We do not have variable interests in variable
interest entities.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of

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both Liabilities and Equity. This statement establishes standards for
classifying and measuring as liabilities certain financial instruments that
embody obligations of the issuer and have characteristics of both liabilities
and equity, including mandatorily redeemable equity instruments. The Statement
is effective for all interim periods beginning after June 15, 2003. We have
classified our mandatorily redeemable equity instruments in the mezzanine level
between liabilities and stockholders equity on its balance sheet. However,
all of our mandatorily redeemable equity instruments were converted to common
stock in conjunction with the initial public offering in May 2003 (see Note 9)
and we, therefore, do not anticipate this Statement will have a material effect
on our consolidated financial statements.

Results of Operations

The following table sets forth certain financial data as a percentage of
revenues for the periods indicated:

Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    
    
    
    
    
    
    
    
    2003
    
    2002(Unaudited)
    
    (Unaudited)Revenues
    
    
    
    
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    
    
    
    
    
    
    
    
    100.0
    %
    
    
    100.0
    %Operating expenses:Interchange
    
    
    
    
    
    
    50.6
    
    
    
    45.5
    
    
    
    
    
    
    
    
    
    
    
    51.4
    
    
    
    41.1Other costs of services
    
    
    
    
    
    
    34.7
    
    
    
    38.4
    
    
    
    
    
    
    
    
    
    
    
    34.6
    
    
    
    45.8Selling, general and administrative
    
    
    
    
    
    
    3.5
    
    
    
    6.6
    
    
    
    
    
    
    
    
    
    
    
    3.6
    
    
    
    6.7Total operating expenses
    
    
    
    
    
    
    88.8
    
    
    
    90.5
    
    
    
    
    
    
    
    
    
    
    
    89.6
    
    
    
    93.6Income from operations
    
    
    
    
    
    
    11.2
    
    
    
    9.5
    
    
    
    
    
    
    
    
    
    
    
    10.4
    
    
    
    6.4Other expense, net
    
    
    
    
    
    
    0.6
    
    
    
    4.8
    
    
    
    
    
    
    
    
    
    
    
    6.2
    
    
    
    5.8Income before income taxes
    
    
    
    
    
    
    10.6
    
    
    
    4.7
    
    
    
    
    
    
    
    
    
    
    
    4.2
    
    
    
    0.6Income tax provision
    
    
    
    
    
    
    2.1
    
    
    
    0.5
    
    
    
    
    
    
    
    
    
    
    
    0.9
    
    
    
    0.7Net income (loss)
    
    
    
    
    
    
    8.5
    
    
    
    4.2
    
    
    
    
    
    
    
    
    
    
    
    3.3
    
    
    
    (0.1
    )


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Three Months Ended September 30, 2003 (2003) Compared to Three Months Ended September 30, 2002 (2002)

Revenues.Revenues increased $30.6 million or 104.6% to $59.8 million in
2003 from $29.2 million in 2002. This increase was primarily attributable to
our acquisitions of five businesses since August 2002, which resulted in an
increase in revenues of $23.7 million, representing 77.4% of our total growth
in revenues over the prior period.

Interchange Expenses. Interchange expenses increased $17.0 million or
127.3% to $30.3 million in 2003 from $13.3 million in 2002. The increase was
primarily attributable to increased charge volume driven mainly by our
aforementioned acquisitions. Interchange expenses as a percentage of total
revenues increased to 50.6% in 2003 from 45.6% in 2002 as the portfolios
acquired through the acquisitions had higher average costs as a percentage of
revenues than our existing mix of business.

Other Costs of Services.Other costs of services increased $9.6 million or
84.9% to $20.8 million in 2003 from $11.2 million in 2002. The increase was due
primarily to costs associated with increased processing volume and salaries and
other costs associated with the addition of personnel as a result of our
acquisitions. Other costs of services as a percentage of revenues declined to
34.7% in 2003 from 38.4% in 2002. Other costs of services as a percentage of
revenues decreased primarily due to a decrease in personnel costs, merchant
losses and depreciation and amortization, which were also lower as a percentage
of revenues.

Selling, General and Administrative.Selling, general and administrative
expenses increased $0.2 million or 8.0% to $2.1 million in 2003 from $1.9
million in 2002. The increase was primarily due to an increase in personnel
cost resulting from our acquisitions. Selling, general and administrative
expenses as a percentage of revenues declined to 3.5% in 2003 from 6.6% in
2002, primarily due to the consolidation of the operations of acquired
entities, which allowed employee headcount to remain steady while revenues
increased.

Other
Expense (income).Other expense (income) consisted of $186,000
of interest expense and $165,000 of expenses related to an acquisition that was
not consummated. Other expense (income) decreased $1.0 million or 75.1% to
$0.4 million in 2003 from $1.4 million in 2002, primarily due to a reduction in
interest expense resulting from the repayment of $55.8 million of
debt in the second quarter of 2003 using proceeds from the initial public
offering.

Income Tax. Income tax expense increased $1.1 million to $1.3 million in
2003 from $0.2 million in 2002 due to an increase in taxable income. Income tax
expense as a percentage of income before taxes was 20.0 % in 2003. This rate
differs from our statutory rate, primarily as a result of the utilization of
previously unrecognized net operating loss carryforwards (see Note 11).

Nine Months Ended September 30, 2003 (2003) Compared to Nine Months Ended September 30, 2002 (2002)

Revenues.Revenues increased $93.5 million or 139.1% to $160.8 million in
2003 from $67.3 million in 2002. This increase was primarily attributable to
our acquisitions of six businesses since March 2002, which resulted in an
increase in revenues of $78.7 million, representing 84.2% of our total growth
in revenues over the prior period.

Interchange Expenses. Interchange expenses increased $54.9 million or
198.7% to $82.6 million in 2003 from $27.7 million in 2002. The increase was
primarily attributable to increased charge volume driven mainly by our
aforementioned acquisitions. Interchange expenses as a percentage of total
revenues increased to 51.4% in 2003 from 41.1% in 2002 as the portfolios
acquired through the acquisitions had higher average costs as a percentage of
revenues than our existing mix of business.

Other Costs of Services.Other costs of services increased $24.8 million
or 80.3% to $55.6 million in 2003 from $30.8 million in 2002. The increase was
due primarily to costs associated with increased processing volume and salaries
and other costs associated with the addition of personnel as a result of our
acquisitions. Other costs of services as a percentage of revenues declined to
34.6% in 2003 from 45.8% in 2002. Other costs of services as a percentage of
revenues decreased primarily due to a $3.3 million loss recognized in 2002
attributable to chargebacks relating to one merchant. Personnel costs,
processing costs and depreciation and amortization were also lower as a
percentage of

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revenues.

Selling, General and Administrative.Selling, general and administrative
expenses increased $1.3 million or 29.4 % to $5.8 million in 2003 from $4.5
million in 2002. The increase was primarily due to an increase in personnel
costs resulting from our acquisitions. Selling, general and administrative
expenses as a percentage of revenues declined to 3.6% in 2003 from 6.7% in 2002
primarily due to the consolidation of the operations of acquired entities,
which allowed employee headcount to remain steady while revenues increased.

Other
Expense (income).Other expense (income) increased $6.1 million
or 155.6% to $10.0 million in 2003 from $3.9 million in 2002. This increase was
primarily due to a $4.4 million charge resulting from early extinguishment of
certain debt.

Income Tax. Income tax expense increased $0.9 million to $1.4 million in
2003 from $0.5 million in 2002, primarily as a result of an increase in taxable
income. Income tax expense as a percentage of income before taxes was 20.6 %
in 2003. This rate differs from our statutory rate due to recognition of the
net operating losses as previously discussed.

Liquidity and Capital Resources

At September 30, 2003, we had cash and cash equivalents totaling $11.7
million, compared to $1.8 million at December 31, 2002.

Net cash provided by operating activities was $13.1 million in the first
nine months of 2003 (2003). Net income of $5.4 million, depreciation and
amortization of $5.9 million and noncash interest of $6.4 million were
partially offset by $4.7 million of changes in operating assets and
liabilities. Such changes principally included increases in accounts receivable
of $3.3 million and cash losses of $1.1 million previously
expensed attributable to one merchant. Net
cash provided by operating activities was $0.3 million in the first nine months
of 2002 (2002), primarily representing a net loss of $0.1 million and an
unfavorable change in operating assets and liabilities of $4.3 million which
were offset by $3.8 million of depreciation and amortization, $0.9 million of
noncash interest.

Net cash used in investing activities was $23.3 million for 2003 which was
primarily comprised of a $12.0 million payment for the acquisition of a
business, $5.5 million of deposits for a new sponsor bank and a $2.1 million
payment for the final installment of the cash purchase price of a business
acquisition which occurred in the third quarter of 2002. During 2002,
investing activities used net cash of $8.2 million, including $5.3 million for
the acquisition of four businesses and $2.8 million for deposits. Total
capital expenditures for 2003 and 2002 were $0.5 million and $0.2 million,
respectively, which were primarily related to the purchase of computers and
other equipment. 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 provided by financing activities was $20.0 million in 2003,
compared to $9.0 million in 2002. During 2003 and 2002, we paid an aggregate
principal amount of $55.8 million and $5.2 million, respectively, on
outstanding debt balances (including net changes in our line of credit). This
was offset by net proceeds from issuance of common stock in connection with our
IPO of $75.8 million in 2003, and by proceeds of $14.2 million from the
issuance of long-term debt in 2002.

As of September 30, 2003, we had notes, capital lease obligations and a
revolving credit arrangement outstanding in an aggregate principal amount of
$20.6 million, owed to executive officers and third parties. $15.0 million of
the notes and $0.4 million of accrued interest are convertible into 663,184
shares of our common stock at the discretion of the holders at a price per
share of $23.16. Our notes mature between August 2003 and August 2007. These
notes bear interest at rates ranging from 0% to 6%, and the weighted average
interest rate of these notes was 4.8% as of September 30, 2003.

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On August 1, 2003 we obtained a $20.0 million revolving credit
from Bank of America which was subsequently expanded to $30.0 million in
October 2003. The revolving credit includes a $3.0 million letter of credit
sublimit. Interest is payable at an adjusted LIBOR rate (LIBOR Rate plus the
Applicable Margin for LIBOR, each as in effect at such time). The
revolving
credit contains certain financial and nonfinancial covenants (as defined
therein) and replaces the previous line of credit we had with Bank of America.
The revolving credit expires on August 1, 2006. We were in compliance with all
debt covenants as of September 30, 2003.

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 have historically funded our principal operations through private
placements of debt and equity securities to executive officers, directors and
third parties. We also received funds from our initial public equity
offering in May 2003, and we have a revolving credit from Bank of
America.

We
expect that based on our current business plan our current cash and
cash equivalents, anticipated net
positive cash flows from operations and revolving credit will satisfy working capital, financing and
capital expenditure requirements for the next 12 months.




Item 3. Quantitative and Qualitative Disclosure about Market Risk

There have been no material changes in market risk from the information
provided under the caption Disclosures about Market Risk in Managements
Discussion and Analysis of Financial Condition and Results of Operations
included in our final prospectus filed with the Commission on May 13, 2003.




Item 4. Controls and Procedures

We have evaluated the
effectiveness of our disclosure controls and procedures, as defined in Exchange
Act Rules 13a-14(c) and 15d-14(c), as of the end of the period
covered by this Form 10-Q. This evaluation was done under the
supervision and with the participation of management, including our
Chief Executive Office and Chief Financial Officer. Based on this evaluation, they have concluded that
those disclosure controls and procedures were adequate. There have been no
significant changes in our internal controls or in other factors that could
significantly affect these controls subsequent to the date of this evaluation.

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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 prospectus filed with the Commission on May 13, 2003 pursuant to Rule
424(b)(4) under the Securities Act in connection with the Companys
Registration Statement on Form S-1 (File No. 333-101705)

Item 2. Changes in Securities and Use of Proceeds.



|(a) |  | None.
|--- |  | -----



|(b) |  | None.
|--- |  | -----



|(c) |  | In connection with our acquisition of CardPayment
Solutions, Inc. on August 5, 2003, pursuant to the exemption
from registration provided in Section 4(2) of the Securities Act
of 1933 we issued 118,409 shares of our common stock to CardPayment
Solutions, Inc. with a fair market value of $3.0 million which
constituted part of the total consideration of $15.0 million paid
in consideration for the acquisition for substantially all of the
assets and assumed debt of $1.0 million of CardPayment
Solutions, Inc.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) |  | On May 15, 2003, we consummated the initial public offering of our common
stock, $0.01 par value. The managing underwriters were Bear, Stearns & Co.
Inc, Thomas Weisel Partners LLC and Wachovia Securities. The shares of
common stock sold in the offering were registered under the Securities Act
of 1933, as amended on a Registration Statement (Registration No.
333-101705) that was declared effective by the Securities and Exchange
Commission on May 8, 2003 (a post-effective amendment to which was
declared effective on May 12, 2003) and a Registration Statement
(Registration No. 333-105165) filed pursuant to Rule 462(b) under the
Securities Act of 1933. All 5,625,000 shares of common stock registered
under the registration statement, including an aggregate of 625,000 shares
of common stock covered by an over-allotment option granted to the
underwriters, were sold at a price to the public of $16.00 per share. All
of the shares of common stock were sold by us and there were no selling
stockholders in the offering. The offering did not terminate until after
the sale of all of the securities registered on the Registration
Statement. The aggregate gross proceeds from the shares of common stock
sold by us were $90.0 million. The aggregate net proceeds to us from the
offering were approximately $75.7 million after deducting an aggregate of
$6.3 million in underwriting discounts and commissions paid to the
underwriters and an estimated $8.0 million in other expenses incurred in
connection with the offering.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | We used $55.7 million of the net proceeds to repay debt that had a carrying
value of $52.1 million, including $11.4 million to repay in full promissory
notes held by our director, David Vandewater, and entities affiliated with
our directors, John Harrison, David Vandewater and David Wilds. We invested
the remaining net proceeds in short-term, investment-grade, interest bearing
instruments, pending their use to fund working capital, acquisitions and
capital expenditures.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002)31.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002)32.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)32.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)


(b) Reports on Form 8-K

None.

Report Date
    
    DescriptionAugust 7, 2003
    
    The Company filed a
current report on Form 8-K under items 2 and 12 regarding
its acquisition of Card Payment Solutions, Inc. and to report its
financial results for the period ended June 30, 2003.





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: November 14, 2003
    
    By: /s/ Gregory S. DailyGregory S. DailyChief Executive Officer(Principal Executive Officer)Date: November 14, 2003
    
    By: /s/ Clay M. WhitsonClay M. WhitsonChief Financial Officer(Principal Financial and Accounting Officer)


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EXHIBIT INDEX

Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002)31.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350 (Section 302 of the Sarbanes-Oxley Act of 2002)32.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)32.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002)


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