UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 PIPELINE DATA INC.   Form 10-KSB    xANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the fiscal year ended December 31, 2006  o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the transition period from __________ to __________
  Delaware
        
        13-3953764(State or other jurisdiction of
        
        (I.R.S. Employerincorporation or organization)
        
        Identification No.)
  1515 Hancock Street, Suite 301, Hancock Plaza, Quincy, Massachusetts 02169-5243 (Address of principal executive offices) (Zip Code)  Issuers telephone number: (617) 405-2600 Securities registered under Section 12(g) of the Exchange Act: Common Stock $0.001 par value  Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. [X[ Yes No o  Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.x State issuers revenues for its most recent fiscal year: $41,814,000 State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of a specified date within the past 60 days. (See definition of affiliate in Rule 12b-2 of the Exchange Act.) As of March 20, 2007, there were 48,088,995 shares of the registrants common stock, par value $0.001 issued and outstanding. As of March 20, 2007, the market value of securities held by non-affiliates is $27,328,796 based on the average of the high and low bid prices as reported by Yahoo.com. These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not reflect actual transactions.    DOCUMENTS INCORPORATED BY REFERENCE



The following documents are incorporated by reference, briefly describe them and identify the part of the Form 10-KSB (e.g., Part I, Part II, etc.) into which the document is incorporated: the proxy information statement for the year ended December 31, 2006.






Transitional Small Business Disclosure Format (Check one): Yes o ; No x







TABLE OF CONTENTS






Item
            Number and CaptionPART
            IITEM
            1. Business
        1ITEM
            2. Properties
        29ITEM
            3. Legal Proceedings
        30ITEM
            4. Submission of Matters to a Vote of Security Holders
        30PART
            IIITEM
            5. Market for Common Equity and Related Stockholder Matters
        30ITEM
            6. Managements Discussion and Analysis of Financial Condition
            andResults
            of Operations
        32ITEM
            7. Financial Statements
        43ITEM
            8. Changes in and Disagreements with Accountants onAccounting
            and Financial Matters
        70ITEM
            8A Controls and Procedures
        70ITEM
            8B Other Information
        70PART
            IIIITEM
            9. Directors and Executive Officers
        71ITEM
            10. Executive Compensation
        71ITEM
            11. Security Ownership of Certain Beneficial Ownersand
            Management and Related Stockholder Matters
        71ITEM
            12. Certain Relationships and Related Transactions, and Director Independence
        71ITEM
            13. Exhibits
        71ITEM
            14.Principal Accountant Fees and Services
        71








ANNUAL REPORT ON FORM 10KSB FOR PIPELINE DATA INC.



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS



To the extent that the information  presented in this Annual Report on Form 10-KSB for the year ended  December 31, 2006 discusses financial projections, information or expectations about the products or markets of our company,  or otherwise   makes   statements   about  future  events,   such   statements  are forward-looking. We are making these forward-looking statements in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Although  we  believe   that  the   expectations   reflected   in  these forward-looking  statements  are based on  reasonable  assumptions,  there are a number of risks and  uncertainties  that could  cause  actual  results to differ materially from such forward-looking statements. These risks and uncertainties are described, among other places in this Annual Report, in Managements Discussion and
Analysis. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. In addition, we disclaim any obligations to update any forward-looking statements to reflect events or circumstances after the date of this Annual Report. When considering  such  forward-looking  statements,  readers should keep in mind the risks  referenced  above  and the other  cautionary  statements  in this  Annual Report.






PART I



  **Item
    1. Business**.



BUSINESS

Overview of our Business and our Development

  We
    are a value-added provider of merchant payment processing services and other
    related software products.
We provide credit and debit card-based payment processing solutions and services to small to medium-sized merchants who operate
either in a physical brick and mortar  business environment or over the Internet.
 Our payment processing services enable merchants
    to process both traditional card-present, or swipe, transactions,
    as well as card-not-present transactions. A traditional card-present transaction
    occurs whenever a cardholder physically presents a credit or debit card to
    a merchant at the point-of-sale. Card-not-present transactions occur whenever
    the customer does not physically present a payment card at the point-of-sale,
    including over the Internet or by mail, fax or telephone.

Our primary customer base consists of small to medium-sized merchants. We estimate that there are approximately 4.9 million merchants in the United States, representing 6.1 million locations, of which we estimate there to be 3.2 million small to medium-sized merchants currently accepting Visa and MasterCard credit cards. Additionally, a little under 600,000 new businesses open every year in the United States. We believe that the small to medium-sized merchant market offers us significant growth opportunities for the first time installation and subsequent servicing of credit card authorization and payment systems.

We market and sell our services primarily through three lines of distribution: the Internet, banks and ISOs/VARs (Independent Sales Organizations/Value Added Resellers), which we define as any non-bank party that sells card-based payment processing services to merchants. We have contractual relationships with 50 banks, comprising over 400 bank branch locations, and with 48 credit unions that serve as referral sources for our products and services. We also have relationships with over 30 ISOs/VARs that act as a non-employee, external sales force in communities throughout the United States. We also market over the Internet, targeting small to medium-sized e-commerce businesses.

Our revenues are derived primarily from the electronic processing of credit, charge and debit card transactions that are authorized and captured through third-party networks. Typically, fees charged to merchants for these processing services are based on a variable percentage of the dollar amount of each transaction, as well as an additional pre-determined transaction fee; we refer to these fees as interchange fees in this prospectus. Merchant customers may also be charged miscellaneous fees, including statement fees, annual fees, monthly minimums fees, fees for handling payment chargebacks, gateway fees and other miscellaneous services. Revenues are reported gross of amounts paid to sponsor banks, as well as interchange and assessments paid to credit card associations (such as MasterCard and Visa) under revenue sharing agreements pursuant to which such parties receive payments based primarily on processing
volume for particular groups of merchants. We have outsourced a portion of our services to third-party processors including, but not limited to, CTS Holdings, Inc. (a wholly owned subsidiary of First Data Corp), Nova Information Systems, Inc. and Wells Fargo Bank, to whom, in each case, we remit a portion of the fee income for services they provide.

We operate through several wholly owned subsidiaries:



        SecurePay.com, Inc., which we refer to herein as SecurePay;




        Northern Merchant Services, Inc., which we refer to herein as NMSI;




        Pipeline Data Processing, Inc., which we refer to herein as PDP;




        Pipeline Data Portfolio Acquisitions, Inc., which we refer to herein as Pipeline Acquisitions;




        Charge.com, Inc., which we refer to herein as Charge.com;




        CardAccept, Inc., which we refer to herein as CardAccept;





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
        Aircharge, Inc., which we refer to herein as Aircharge;




        Valadata, Inc., which we refer to herein as Valadata; and




        Paynet Systems, Inc., which we refer to herein as Paynet Systems.

On January 12, 2006, our stockholders approved a reverse stock split. The reverse stock split, however, has not yet been implemented. Readers should note that unless otherwise indicated all share information in this Business section is presented on a pre-reverse stock split basis. Readers should also note that when we use the term recurring revenue payments herein, we do not mean to imply that such revenue payments are guaranteed, but rather that services for which payments are made are provided continually over a period of time, as opposed to on a one-time basis.

Small to medium-sized merchants generally have a lower volume of credit card transactions, are difficult to identify and have traditionally been underserved by credit card processors. We expect the small to medium-sized merchants we target to increasingly accept and benefit from the increased usage of card-based payment systems. According to the Nilson Report, there are approximately 4.9 million merchants in the United States, representing 6.1 million locations. The Nilson Report  forecasts that purchases by U.S. consumers using credit cards will grow from $1.89 trillion in 2003 to $2.81 trillion in 2008 (8% CAGR). Credit cards will comprise 47.7% of all transactions by 2009, up from 38.8% in 2004. The Federal Services Policy Committee of the Federal Reserve System reported that the year 2003 marked the first time in United States history that electronic payment transactions (44.5 billion) exceeded the number
of check transactions (36.7 billion). This expected shift in electronic payments is likely to continue for the foreseeable future and reflects the expanding role of technology and its impact on consumer spending within retail, financial and banking businesses. As a result, many small to medium-sized businesses are seeking, and we expect many new small to medium-sized businesses to seek, to provide customers with the ability to pay for merchandise and services using credit or debit cards, including those in industries that have historically accepted cash and checks as the only forms of payment for their merchandise and services. Our historic and continuing strategy is to expand our company by aggressively growing the number of merchant accounts serviced and by creating a processing and servicing operation that is efficient and scalable. We believe this will allow us to more easily expand our operations without significantly increasing our fixed costs. We also intend to grow the number
of accounts we service through a combination of external acquisitions and internal sales efforts. We have created an efficient and scalable processing and servicing operation by employing talented team members, utilizing state-of-the-art technology and differentiating between what should be serviced in house and what should be outsourced, in order to maximize resources while providing better service to our clients. We believe that the development of our company to date demonstrates how we have implemented our strategy.

Our wholly owned subsidiary, SecurePay, is a custom credit card transaction processor serving as a gateway intermediary between the customer and the financial networks for the acceptance of card payments by merchants. Most card transactions worldwide are processed by a third-party working in conjunction with the financial networks. SecurePay processes all major card types including Visa, MasterCard, American Express, Discover and JCB. Presently, SecurePays solutions include: payment gateway solutions, virtual credit card terminals, proprietary shopping carts and wireless applications operating on cell phone networks to support mobile merchant card acceptance.

Our wholly-owned subsidiary, NMSI, is an Independent Sales Organization, or ISO, which we define as any non-bank party that sells card-based payment processing services to merchants. In accordance with our overall operating and growth strategies, NMSI seeks to enlarge its customer base of small to medium-sized merchants through merchant portfolio acquisitions, as well as through bank referrals, direct sales, independent sales agents and trade association affiliations. It seeks to retain its customer base through efficient operations and superior customer service.

To further our internal growth strategy, we formed PDP as our wholly-owned wholesale processing division in July 2004. Our primary objective with the formation of PDP is to grow the number of merchant accounts serviced by targeting the wholesale processing industry. PDP conducts underwriting and risk management operations in-house. We consider underwriting and risk management highly important to our operations. We outsource our remaining processing services to third parties, including the evaluation and acceptance of card numbers and receipt and settlement of funds. By outsourcing these non-core services, we believe we can achieve lower costs per transaction through higher volume purchasing.

Our acquisitions have enhanced our revenues and increased our portfolio of merchant accounts. To this end, we formed Pipeline Acquisitions in November 2004 to locate merchant portfolios that complement our existing customer base of small to medium-sized merchants. Pipeline Acquisitions performs an extensive review of the cash flow characteristics of each portfolio, the types of business conducted therein, the credit status of the merchants in the portfolio, our ability to control



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attrition of the portfolio and the opportunities the portfolio provides for revenue enhancement and cost reduction. Pipeline Acquisitions then determines a valuation of each portfolio acquisition opportunity based on a combination of these factors and moves to acquire the acquisition candidate.

We have employed a strategy of entering  financing arrangements to facilitate our business development. During the year ended December 31, 2006, we entered a financing arrangement with several institutional investors to issue $37.0 million of convertible notes and warrants. The notes issued on June 29, 2006 and maturing four years from the date of issuance, can be converted into Pipeline common stock at the conversion price of $1.30 per share. 11,100,000 warrants were issued with an exercise price of $1.40 (the Centrecourt Financing). We used the proceeds of the Centrecourt Financing to repay the $15.0 million Sheridan note and the $2.0 million obligation to CAMOFI Master LDC, and to fund the purchase price for Valadata, Inc. and Paynet Systems, Inc.

On July 3, 2006, we acquired Paynet Systems, Inc., an e-commerce and retail merchant credit card processing provider. The anticipated purchase price for Paynet Systems is $9.5 million in cash and Pipeline restricted common stock valued at $940,000, based upon the value of the Companys stock at closing, and an additional $3.0 million in cash and 1.61 million shares of restricted common stock, subject to performance milestones.

On July 11, 2006, we acquired Valadata, Inc., a retail merchant credit card processing provider catering primarily to the restaurant industry. We also acquired a separate retail portfolio. The purchase price for Valadata was $5.4 million in cash and an additional $1.5 million over the next two years, subject to performance milestones. The purchase price for the separate retail portfolio was $500,000.



Our Strategy

Our strategy is to build our business through organic growth and efficiency. We intend to aggressively grow the number of merchant accounts serviced through the solicitation of new merchant accounts and the acquisition of merchant portfolios and compatible businesses that feature recurring revenue payments. We intend to achieve efficiency by creating a processing and servicing operation that is efficient and scalable, meaning that we can easily expand our operations without significantly increasing our fixed costs. Management has extensive experience in the payment processing business and a history of providing reliable, customer-focused service to our merchants. Our platform of services is very flexible, enabling merchant customization and scalability to meet the requirements of high transaction volumes.

Our strategic objectives are to:





        Make
            strategic acquisitions of merchant account portfolios and of compatible
            payment
            businesses.

We intend to continue to expand our merchant base by acquiring other providers of payment processing services, as well as portfolios of merchant accounts. The small to medium-sized merchant segment of the payment processing market is serviced by many independent providers of payment processing services that lack the resources to generate sufficient scale in this underserved market. We believe opportunities exist for us to purchase these businesses when their resources begin to limit their ability to continue to grow independently. Other sources of portfolio acquisitions include commercial banks, which, in an effort to focus on their core competencies, often sell or outsource their card-based payment processing operations, creating the opportunity for buyers to acquire their existing merchant portfolios.





        Expand our portfolio of merchant clients.

Our target market is small to medium-sized merchants who use payment processing services. We are seeking to expand our market presence through our internal sales efforts, banks and ISOs, as well as mobile merchants who use wireless payment processing services.

Our experience in the industry, coupled with our ability to evaluate and manage the risks related to providing payment processing services, allows us to accept and approve a high rate of merchant applications and, we believe,



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positions us well to continue to increase the size of our sales team and the number of new applications our existing team members refer to us.





        Grow our relationships with banks and ISOs.

We have found relationships with banks to be a cost -effective and valuable method of reaching small to medium-sized merchants that would otherwise be difficult to identify and locate using customary marketing practices. Pursuant to these relationships, banks endorse the processing systems we market and service and participate in referring new customers. We believe the utilization of ISOs to be another effective way of increasing the volume of merchant referrals.





        Maintain a stable and growing recurring revenue base.

Through merchant retention and increased credit card use, we have developed what we believe is a stable and recurring base of revenues. In addition to our high customer service level, endorsements from banks and direct salespersons provide an additional link to our merchants that should tend to reduce attrition. Furthermore, we believe that the size of the merchants we service make the merchants less likely to change providers because of the up-front costs associated with a transfer.





        Increase operating efficiencies.

Generally, we outsource our processing and network services to third-parties which have excess capacity and the expertise to handle our needs. We believe that because our merchant base generates significant transaction volume in the aggregate, we have been able to negotiate competitive pricing from our processing and network providers. We have achieved significant reductions in certain operating expenses through operational efficiencies, economies of scale and improved labor productivity. We will outsource processing and network services as long as it is economically more attractive than to develop and support these services within our company, allowing management to focus on its core business of sales, marketing and customer retention.



The Products and Services We Provide

Merchant Payment Processing Services

We provide comprehensive services and support to merchants accepting credit and debit-based payment cards, including the various services described below:





        Application Evaluation/ Underwriting. We recognize that there are varying degrees of risk associated with different merchants based on the nature of their businesses, processing volume and average transaction amounts. We apply varying levels of scrutiny in our application evaluation and underwriting of prospective merchants accounts, ranging from basic due diligence for merchants with a low risk profile to a more thorough and detailed review for higher risk merchants. The results of this review serve as the basis for our decision whether to accept or reject a merchant account and also provide the criteria for establishing rolling reserve requirements, processing limits and average transaction amounts and pricing, which assist us in monitoring merchant transactions for those accounts that
exceed pre-determined criteria.







4




        Merchant Set-up and Training. After we establish a contract with a merchant, we create the software configuration that is downloaded to the merchants credit card terminal or computer. This configuration includes the merchant identification number, which allows the merchant to accept Visa and MasterCard, as well as any other payment cards such as American Express, Discover and Diners Club provided for in the contract. The configuration might also accommodate check verification and gift and loyalty programs. If a merchant requires a pin-pad to accept debit cards, the configuration allows for the terminal or computer to communicate with the peripheral device. After the download has been completed, we may conduct a training session on the use of the products.
        Card Transaction Processing. A transaction begins with authorization of the customers credit or debit card. The transaction data is captured by the processor and electronically transmitted to the issuer of the card, which then determines the availability of credit or debit funds. The issuer then communicates an approval decision back to the merchant through the purchaser. This process typically takes less than five seconds. After the transaction is completed, the processor transmits the final transaction data to the card issuer for settlement of funds. Generally, we outsource these services to third-party processors.
        Risk Management/Detection of Fraudulent Transactions. Our risk management staff relies on the criteria set by the underwriting department to assist merchants in identifying and avoiding fraudulent transactions by monitoring exceptions and providing access to other resources for fraud detection. By employing these and other risk management procedures, we enable our merchants to balance the risk of fraud against the loss of a valid transaction.
        Merchant Service and Support. We provide merchants with ongoing service and support. Customer service and support includes answering billing questions, responding to requests for supplies, resolving failed payment transactions, troubleshooting and repair of equipment, educating merchants on Visa and MasterCard compliance and assisting merchants with pricing changes and purchases of additional products and services. We maintain a toll-free helpline, which is staffed by our customer service representatives.
        Chargeback Service. In the event of a billing dispute between a cardholder and a merchant, we assist the merchant in investigating and resolving the dispute as quickly and as accurately as possible. Before instructing the cardholders bank to debit the merchants account for the chargeback, we provide the merchant with the opportunity to demonstrate that the transaction was valid. If the merchant is unable to demonstrate that the transaction was valid and the dispute is resolved in favor of the cardholder, the transaction is charged back to the merchant, and that amount is credited to the cardholder. This service is provided by third parties on our behalf.
        Merchant Reporting. We organize our merchants transaction data into various files for merchant accounting purposes. We use this data to provide merchants with information, such as charge volume, discounts, fees and funds held for reserves to help them track their account activity. Merchants may access this archived information through our customer service representatives or online through our Internet-based customer service system.

The transactions for which we provide processing services involve the following third parties:

  *Merchants*.
    Merchants are the businesses that accept payment cards, including Visa and
    MasterCard, for their merchandise and services.

  *Sponsoring
    Banks*. Sponsoring banks are financial institutions that are card association
    members and provide the funds on behalf of the card user, enabling merchants
    to accept payment cards.





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Processors. Processors, which may include banks, gather sales information from merchants, obtain authorization for merchants transactions from card issuers, facilitate the collection of funds from sponsoring banks for payment to merchants and provide merchant accounting and settlement services on our behalf.

Virtual Terminal/Gateway

Our virtual terminal and gateway is the core SecurePay product which allows payment processing via any Internet connected device. The virtual terminal and gateway can process sales, voids, forces and returns. Our address verification system confirms shipping and cardholder address information to protect merchants from fraud. It will process recurring transactions and allows access to the entire suite of reporting functions. All transactions are encrypted using industry standard SSL technology.

Wireless Authorization Services

We provide electronic transaction authorization services for all major credit cards originating from certain wireless cell phone and PDA devices and transactions originating over the Internet. Authorization generally involves approving a cardholders purchase at the point-of-sale after verifying that the card is not lost or stolen and that the purchase amount is within the cardholders credit or account limit. The electronic authorization process for a credit card transaction begins when the merchant swipes the card through its wireless terminal or enters the card via the Internet and enters the dollar amount of the purchase. After capturing the data, the device transmits the authorization request via the SecurePay system to our switching center, where the data is routed to the appropriate credit card association network for authorization. The transaction is approved or
declined by the credit card association, and the response is transmitted back to our switching center where it is routed to the appropriate merchant.

Data Capture and Reporting Services

At the time of authorization, data relating to the transaction, such as the purchase price and card number, is encrypted and stored by the SecurePay system. The system maximizes accurate transaction reconciliation with each merchant and protects against potential loss of data. The data collected also allows us to provide merchants with information services such as specialized management reports, accounting export files and to assist in our other customer service operations. Merchants can access this archived information through the SecurePay system, which allows the merchant direct access to our database through a PC or wireless device.

Cell Phone and PDA Devices

The SecurePay gateway allows the acceptance of credit card payments over wireless Internet devices, such as certain cell phones that utilize Palm OS, Java and Windows CE platforms. The wireless solution enables the merchant to process transactions utilizing airwaves, as opposed to traditional phone lines, for wireless transaction authorization and processing. Wireless enabled transaction authorization and processing in environments where traditional phone lines are unavailable, inconvenient and/or prohibitively expensive, affords merchants increased flexibility, mobility and security in processing card transactions. Further, wireless technology allows merchants that have relied on paper-based processing, where the ability to check if a card is stolen or credit limits exceeded is generally unavailable or inconvenient, to convert to electronic processing. In so doing, such merchants can also
avoid the higher rates imposed by both Visa and MasterCard for paper-based transactions or key entered transactions. We intend to aggressively market our products and services to the wireless and mobile merchant sector. We believe the wireless and mobile transaction processing market is poised for exploitation, and, therefore, will market a suite of products and services through our Aircharge subsidiary to service mobile transaction processing merchants. In its May 2004 report, Mobile Merchants POS Terminals: Revisiting Untethered Card Acceptance, research firm the TowerGroup stated that  Targeting mobile merchants, plumbers, non-store retailers, restaurants and taxi and limousine services who accept a majority of payments through cash and checks will greatly affect the wireless market, especially through handheld devices.



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Shopping Cart Technology

The shopping cart (Easy Shop) is a powerful, yet user-friendly tool that is fully integrated into our proprietary gateway. The shopping cart gives merchants an easy way to create either a Buy Now button on their Web site or a simple HTML link to the Easy Shop cart. It can be used with most Web sites. Core features include sales tax and shipping cost calculations, real-time card processing, automatic customer configuration and e-mail order notification, advance cart support for product size and color selections, unlimited number of products supported, product import and export to accounting applications, support of downloadable items (soft goods) such as documents, program images and audio files, promotion of items and coupons and allowance of order viewing summaries by date or order detail via quick link technologies.

Gateway and Communication Interfaces

Our gateway solutions allow value added resellers (VAR) and programmers access to the card authorization systems by integrating their product to our system for card processing. We have eight different communication objects allowing flexibility to programmers who wish to create their own custom applications.

Software Application Products and Value-Added Services

In addition to card transaction processing, we offer related software application products and value-added services to our merchant customers. These products and services are designed to run on Internet connected Windows-based PCs and wireless devices. For example, our payment gateway enables merchants to securely pass customer credit card information to a processing center for verification. When combined with the SecurePay shopping cart, or previously existing shopping cart, multiple items or combinations of items may be purchased. The SecurePay Web terminal is an Internet-based product that allows merchants to accept orders over the telephone. Unlike many traditional credit card terminals, a Web terminal allows merchants to input certain data required by Visa and MasterCard in order to qualify for the lowest possible processing rates. Offering a broad range of products and services
historically unavailable to small to medium-sized merchants is an integral part of our strategy of focusing on these merchants and differentiating ourselves among the banks and ISOs serving this market segment. We believe that the quality and reliability of our products and services enhance our ability to attract and retain merchant customers.

Primary Sources of Revenue

Our primary source of revenue is the discount rate paid by the merchant for each credit card transaction processed for that merchant. In addition to revenues derived from the discount rate, we receive periodic fees from most of our merchants for providing various services. We negotiate the discount rate and fees with each of the merchants to whom we provide services. We contract with third parties to provide a portion of the services to the merchant, including communication networks, transaction processing and monthly preparation of detailed merchant statements. Additionally, we comply with the pricing structures established by Visa and MasterCard associations for the interchange fee paid to the retail consumers card-issuing banks and the associations fees. The primary costs we incur in delivering our services to merchants are: (i) an interchange fee paid to the card-issuing bank
which is set by the Visa and MasterCard associations and which is calculated as a percentage of the transaction amount and/or an associated transaction fee, (ii) a fee calculated as a percentage of the transaction amount that is paid to the Visa or MasterCard association which is established by the member banks of the Visa and MasterCard associations, (iii) a fixed, per-transaction fee paid to the network service provider which we negotiate with the network service provider and (iv) a fixed, per transaction fee paid to the processing bank which we negotiate with the processing bank. We believe, based on information received from our merchant customers, that the range of discount rates offered by other service providers is approximately 1.4% to 4.0%. The discount rates we offer are within this range.

In most cases, in accordance with our contracts with processing banks, the funds collection and disbursement function for each of the items listed above is performed on our behalf. At months end, the processing bank collects the total discount rate and various fees from the merchants via electronic



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withdrawal and disburses to each of the service providers its fees, except for the interchange fee paid to the card-issuing bank for which the disbursements are made daily. Shortly after month end, the processing bank disburses to us the remainder of the funds collected from the merchant. We then disburse funds to agents and other service providers. Several factors can alter our profitability for merchant transactions. Primarily, these include (i) improper use of the card reading terminal by the merchant resulting in higher interchange fees paid to the card-issuing bank, (ii) lower than anticipated average dollar sales of credit card transactions, thereby reducing our gross transaction margin because many of the transaction costs are fixed and (iii) the inability to collect the discount rate, chargeback or other fees because of insufficient funds in the merchants bank account.

Industry Overview and Our Market

Over the past ten years, the usage of non-cash forms of payment, such as credit and debit cards, has steadily increased. According to The Nilson Report, a leading industry publication that tracks the transaction processing industry, purchases by U.S. consumers using credit will grow from $1.89 trillion in 2003 to $2.81 trillion in 2008 (8% CAGR) and credit cards will comprise 47.7% of all transactions by 2009, up from 38.8% in 2004. In its most recent publication on transaction processing, leading equity research firm Raymond James Financial reported that overall credit card transactions will grow domestically from an estimated 26.6 billion transactions in 2006 to 36.2 billion by 2010. Raymond James reported that total credit card purchase volume will grow from $1.8 trillion in 2006 to $2.6 trillion by 2010, with average tickets increasing from $70.10 per transaction to $71.50 over the same period. The evident
shift in electronic payment reflects the expanding role of technology and its impact on consumer spending within retail, financial and banking sectors, which is likely to continue in the foreseeable future.

The significant industry drivers appear to include convenience, incentive-based programs, and a maturing demographic shift in younger U.S. adults migrating towards a cashless society. We believe there is a great opportunity in the transaction processing business to procure small to medium-sized merchants in retail environments, online transactions via e-commerce, mobile payment processing, municipal payment processing and other areas.

The Small to Medium-sized Merchant Market

The proliferation of credit and debit cards has made the acceptance of card-based payment a necessity for businesses, both large and small, in order to remain competitive. We believe that these businesses are experiencing increased pressure to accept card-based payment methods in order to remain competitive and to meet consumer expectations. As a result, many of these small to medium-sized businesses are seeking, and we expect many new small to medium-sized businesses to continue to seek to provide customers with the ability to pay for merchandise and services using credit or debit cards, including those in industries that have historically accepted cash and checks as the only forms of payment for their merchandise and services. Historically, the larger acquiring banks have marketed credit card processing services to national and regional merchants and have not focused on small to medium-sized merchants, as
small to medium-sized merchants are often perceived as too difficult to identify and expensive to service. This created an opportunity for non-banks, such as our company, which recognized the business potential of providing electronic processing to these small to medium-sized merchants. We have focused our marketing efforts on small to medium-sized merchants, which have traditionally been underserved by processing banks. We understand the unique characteristics of this market segment and have tailored our marketing and servicing efforts accordingly. We are able to provide electronic processing systems at rates that generally are lower than those available from small local processors as a result of our transaction volume. We serve a diverse portfolio of small to medium-sized merchants. No single merchant accounted for more than 3% of our aggregate transaction volume for 2006. This merchant diversification makes us less sensitive to shifting economic conditions in the industries or
regions in which our merchants operate. We believe that the loss of any single merchant would not have a material adverse effect on our financial condition or results of operations.

Merchant attrition is an expected aspect of the credit card processing business. Historically, our attrition has related to merchants going out of business, merchants returning to local processing banks or merchants transferring to competitors for rates we were unwilling to match. We expect merchant attrition  in the ordinary course of business, however, we believe the low average transaction volume of the merchants whose accounts we service make them less likely to change providers because of the inconveniences associated with a transfer. During 2006, we experienced an average monthly attrition of approximately 1% of our total charge volume, taking into consideration each of the acquisitions during this period. Much of our attrition is related to newly formed small businesses that ultimately fail. Because the transaction volumes of these



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unsuccessful businesses typically never reach meaningful levels, they do
not significantly contribute to the profitability of our business. Accordingly, our merchant attrition related to failed businesses does not significantly reduce our revenues.


Merchant fraud is another expected aspect of the credit card processing business. Currently, we are responsible for fraudulent credit card transactions of our merchants on approximately 33% of our merchant customers, but we expect this percentage to increase in calendar year 2007. Examples of merchant fraud include inputting false sales transactions or false credits. We, along with our processing banks, monitor merchant charge volume, average charge and number of transactions, as well as check for unusual patterns in the charges, returns and chargebacks processed. As part of our fraud avoidance policies, we generally will not process for certain types of businesses which provide future services wherein incidents of fraud have been common.

Generally, we are not responsible for cardholder fraud. We evaluate our risks and estimate the potential loss for chargebacks and merchant fraud based on historical experience. We also maintain a rolling reserve account, meaning we withhold a varying percentage of at risk merchants processing volume, for potential losses. Generally, our agreements with merchants are for three years and automatically renew for additional one-year periods unless otherwise terminated. Our sponsoring banks are also a party to these agreements. The merchants are obligated to pay for all chargebacks, fines, assessments and fees associated with their merchant account, and in some cases, statement fees, and monthly minimum fees and early termination fees. Generally, the sponsoring bank may terminate the agreement for any reason on 30 days notice, and the merchant may terminate the agreement on 30 days notice, subject to the
payment of any applicable early termination fees. Typically, the agreement may also be terminated by the sponsoring bank immediately upon a breach by the merchant of any of its terms. Generally, the merchant may not assign the agreement without the prior written consent of the sponsoring bank.

We believe that we have extensive experience and resources in assessing the risks associated with providing payment-processing services to small to medium-sized merchants. These risks include the limited operating history that many of the small to medium-sized merchants we serve have and the risk that these merchants could be subject to a higher rate of insolvency, which could adversely affect us financially.

Marketing and Sales of our Services and Products

In order to reach our target market in an effective and cost-efficient manner, we market our services through four principal channels: (i) Internet marketing, utilizing optimal search engine placement and affiliate referral programs (ii)  ;direct sales, to allow cost-effective access to small to medium-sized merchants dispersed throughout the United States and otherwise to supplement the bank alliance and ISO sales; (iii) partnering with ISOs that market and sell our services to merchants and (iv) bank alliances, through which we offer our services to merchants in cooperation with community and regional banks, allowing us to capitalize on the presence of those banks in particular geographic markets. . In addition, we utilize other marketing efforts that encompass cross-selling our Aircharge and SecurePay products. We also make use of various trade and other associations, as well as VARs to
further market our products and services.

Internet Market

We market over the Internet, targeting small to medium-sized e-commerce businesses. Internet marketing methods used include pay per click advertising, search engine positioning through our Charge.com subsidiary, our CardAccept and Paynet.com brands and our affiliate Internet marketing.

Direct Sales

We will continue to expand our direct sales activities. We currently employ and intend to expand a telemarketing sales force to generate further internal growth. We believe that our direct sales and telemarketing efforts constitute a significant opportunity to expand our business.

Independent Sales Organization Partnering

Generally, ISO partnering involves engaging an ISO to market and sell our products and services on a non-exclusive basis. An ISO that desires to refer a merchant customer to us will procure the merchant and submit it to us on the merchants behalf. Thereafter, the ISO will sell or lease hardware and software to the merchant.





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Our marketing efforts are diversified further through the integration of our transaction processing services with the specialized business management software of a growing number of ISOs. ISOs perform a marketing function for us since their software often is offered on a fully-integrated basis with our transaction processing services, creating additional opportunities for us to reach small to medium-sized merchants.

We compensate ISOs by paying them a residual payment for each transaction processed by it for merchants they refer to us, or they derive revenue by reselling our services to merchants at a price determined by the ISO. The ISOs determination of whether to refer a particular merchant to our company depends on a variety of factors, including the terms of the residual we offer and the industry in which the merchant conducts its business.

We periodically review our marketing efforts and distribution channels to minimize channel conflict. Although conflict among bank alliances, ISO partnering and direct sales marketing may occur, to date we have not experienced any significant conflict while pursuing our overall sales strategy.

Bank Alliances

We have an established marketing strategy of forming alliances with regional and community banks and offer our services to merchants through these banks. Under these arrangements, we obtain the exclusive endorsement of the bank and receive both its initial and ongoing marketing assistance. Our bank alliances consist of two types of relationships: (i) agent bank relationships, where the bank purchases our services and markets and resells those services directly to merchants (which we refer to herein as Agent Bank Alliances); and (ii) bank referral relationships, where the bank refers our company to merchants who desire or otherwise inquire about transaction processing services (which we refer to herein as Bank Referral Alliances).

We compensate our bank alliance partners through varying means. We compensate our Bank Referral Alliance partners typically by paying them a one-time referral fee. Agent Bank Alliance partners are not directly compensated, but rather, they derive revenue by reselling our services to merchants at a price determined by the Agent Bank.

Other Marketing Efforts

In addition to bank alliances, ISO/VAR partnering and direct sales, telemarketing and Internet marketing, we engage in other marketing efforts that we believe complement and diversify further our overall marketing strategy. Through our Aircharge subsidiary, we provide wireless, mobile payment solutions and, through our SecurePay subsidiary, we provide gateway solutions and Internet card acceptance tools.

Association Marketing

Through our association marketing program, we negotiate and enter into marketing agreements with various trade and other associations. Pursuant to these relationships, associations endorse and promote to their membership the transaction processing services we provide, creating additional opportunities for us to reach small to medium-sized merchants.

Customer Service and Support

We are dedicated to providing reliable and effective customer service and support to our merchant customers. The information access and retrieval capabilities of networked systems, where real-time information is available to any of our customer service representatives, allow us to provide a high level of customer service, reporting and support to small to medium-sized merchants that were historically available only to much larger merchants.

We maintain a call center for customers of our SecurePay and Aircharge subsidiaries, as well as for bank customers who are brought to us through direct bank referrals. We will measure the efficiency of our customer service through certain quantitative data, such as the number of rings prior to operator pick-up, the number of abandoned calls, the number of calls per day and the number of calls per customer service representative. We are developing comprehensive programs and procedures for training our customer service representatives to assist our merchant clients in a timely and efficient manner with any problems, issues or concerns they may have. We are dedicated to providing outstanding customer service and support and continually review our policies and procedures in an effort to improve these services.



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Relationships with Sponsors and Processors

In order to provide payment processing services for Visa and MasterCard transactions, we must be sponsored by a financial institution that is a principal member of the Visa and MasterCard card associations. Additionally, we must be registered with Visa as an ISO and with MasterCard as a Member Service Provider.

We have agreements with several banks that sponsor us for membership in the Visa and MasterCard card associations and settle card transactions for our merchants. Our sponsoring banks include US Bancorp and Wells Fargo Bank N.A. All may terminate their agreements with us if we materially breach the agreements and do not cure the breach within 30 days, if our membership with Visa or MasterCard terminates, if we enter bankruptcy or file for bankruptcy, or if applicable laws or regulations, including Visa and MasterCard regulations, change to prevent either the applicable bank or us from performing our services under the agreement. We have agreements with our processing banks to provide for us to continue to receive revenues so long as (i) the merchants subject to the agreements process credit card transactions with the banks, (ii) we provide appropriate service to the merchants and (iii) we
otherwise remain in compliance with the terms of the agreement. We provide transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools pursuant to non-exclusive contractual relationships with processing banks that are members of Visa and MasterCard. These processors include CTS Holdings, Inc. (a wholly owned subsidiary of First Data Corp) and Nova Information Systems, Inc. Our processing banks withhold from the merchants a discount rate and various fees for the processing of each credit card transaction. From our discount rate revenues, amounts are paid to the issuing bank, the network service provider, Visa or MasterCard and to the processing bank.

Generally, our agreements with processing banks contain aspects of both marketing and service. The marketing portions of the agreements permit us to originate new merchants. The service portions of the agreements permit us to provide services (including terminal programming and shipping, employee training, equipment supply and repair and operational support) to the merchants solicited. Although the marketing portions of the agreements have limited terms, the service portions of these agreements do not. Accordingly, we have a right to continue to receive revenues from these processors, so long as we remain in compliance with the service agreements.

To date, we have relied primarily on two banks/processors to process our clients credit card transactions: Wells Fargo Bank N.A./CTS Holdings, Inc., or Wells/CTS, and U.S.Bancorp/Nova Information Systems, Inc., or USB/NIS. Currently, our arrangement with our principal bank/processor, Wells/CTS, constitutes approximately 80% of our aggregate merchant base. Our arrangement with our second largest bank/processor, USB/NIS, constitutes approximately 10% of our aggregate merchant base. The remaining 10% of our aggregate merchant base consists of various rights to receive recurring revenue payment agreements, which, in the main, do not subject us to chargeback liability but have limited contractual rights to the merchants serviced. Our primary processing agreements may be terminated by either party in the event of default, insolvency or receivership, failure to make payments when due or to
abide by the rules and regulations of Visa and MasterCard.



11



Competition and our Competitive Position in the Market



The payment processing industry is highly competitive. We compete in this market on the basis of:





        quality of service;
        support and reliability of service;
        ability to evaluate, undertake and manage risk;
        speed in approving merchant applications;
        technological capability;
        price; and
        availability of additional features.

Both large and small companies compete with us in providing payment processing services and related services. Large competitors include First Data Merchant Services Corp., Global Payments, Inc., iPayment, Heartland Payment Systems, Inc. and Nova Information Systems, Inc., a subsidiary of U.S. Bancorp, that serve a broad market spectrum from large to small merchants and provide ATM and other payment-related services and systems, in addition to card-based payment processing. There are also a large number of smaller competing transaction processors that provide various services to small to medium-sized merchants. We also compete with local, regional and national banks that have internal sales forces and/or have developed relationships with independent service organizations that are our competitors. Many of our competitors have substantially greater capital resources than we have and operate as
subsidiaries of financial institutions or bank holding companies, which may allow them on a consolidated basis to own and conduct depository and other banking activities that we do not have the regulatory authority to own or conduct.

We believe we have core strengths which will allow us to compete in our industry. These include:





        Our focus on small to medium-sized merchants.We believe that our specific focus on small to medium-sized merchants, in addition to our understanding of the needs and risks associated with providing payment processing services to small to medium-sized merchants, gives us a competitive advantage over larger competitors which have a broader market perspective and over competitors of a similar or smaller size that may lack our extensive experience and resources.
        Our utilization of bank/direct sales relationships. We utilize bank/direct sales relationships to provide us a distinct competitive advantage in maintaining primary relationships with the underserved, small to medium-sized merchant segment of the market.





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
        Our scalable, efficient operating structure. We believe that as a result of our experience in payment processing, we have been able to develop operating efficiencies which we believe allow us to competitively bid for new business. Our scalable, efficient operating structure allows us to easily expand our operations without significantly increasing our fixed costs. We conduct our underwriting and risk management operations in-house, where we believe we can add the most value due to our managements experience and expertise in these areas. We consider underwriting and risk management highly important to our operations. We outsource our remaining processing services to third parties, including the evaluation and acceptance of card numbers and receipt and settlement of funds. By outsourcing
these non-core services, we are able to maintain a highly efficient operating structure. We believe there is sufficient capacity among third parties to meet our current and future outstanding needs. Many of our contracts include pricing terms that are more favorable to us as the transaction volume generated by our merchant base increases.
        Technical monitoring and value of the SecurePay system. We continually monitor and make technological improvements to our system and thus are able to respond to the specific needs of merchants in various industries. We also maintain that the quality, speed and reliability of the SecurePay system and the breadth, flexibility and user-friendliness of our software application products and services constitute a competitive advantage.
        Advantages of our cell phone payment application. Our cell phone application also provides distinct competitive advantages. It is considerably less expensive than traditional wireless terminals, which can have a price point up to 70% higher. Competing wireless terminals, by contrast, are single function only. In addition, our cell phone application offers superior coverage area.
        Proven acquisition and integration strategy. We have significant experience acquiring providers of payment processing services, as well as portfolios of merchant accounts, having acquired several portfolios of merchant accounts, including Charge.com in December 2005, Aircharge in September, 2005 and Valadata and Paynet in 2006. We have enhanced revenues and improved operating efficiencies of our acquired entities by improving the services, support and benefits we offer to the ISOs that serve the entities and merchant accounts we acquire. In addition, we have increased operating efficiencies of many of the businesses we have acquired by conducting profitability analyses of acquired merchant accounts and reducing processing fees and overhead.
        Strong position and substantial experience in our target market. We believe our understanding of the payment processing needs and risks of small to medium-sized merchants provides us with a competitive advantage over larger service providers that have a broader market perspective. We also believe that we have a competitive advantage over service providers of a similar or smaller size that may lack our extensive experience and resources.
        Experienced, efficient sales force. We market our services primarily through our contractual relationships with over 30 ISOs/VARs throughout the United States. Although it is not customary in our industry to obligate ISOs to refer their merchant applications to any one processing provider, many currently refer a majority of their new merchant applications to us as a result of our strong relationships with them. Our sales approach provides us with an  experienced sales force which markets our services with minimal direct investment in sales infrastructure and management. We continually strive to strengthen these relationships by delivering superior service and support.





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
        Comprehensive underwriting and risk management systems. Through our experience and cumulative knowledge in assessing risks associated with providing payment processing services to small to medium-sized merchants, we have developed business procedures and systems that provide effective risk management and fraud prevention solutions. Through our underwriting processes, we evaluate merchant applicants and balance the risks of accepting a merchant against the benefit of the charge volume we anticipate the merchant will generate. We believe our systems and procedures enable us to identify potentially fraudulent activity and other questionable business practices quickly, thereby minimizing our losses and those of our merchants.
        Superior Internet marketing.We have a comprehensive Internet-based sales organization through our subsidiary, Charge.com, which capitalizes on highly optimized search engine placement, extensive affiliate channels, unique referral programs and a dynamic Internet marketing sales team.

Patents, Trademarks, Licenses, Franchises, Concessions, Royalty Agreements

We have no patents, trademarks, franchises, concessions or royalty agreements. We are continuously developing software for use in four principal areas: (i) applications for Internet-based and wireless transactions; (ii) transaction switching; (iii) the SecurePay suite of products and (iv) customer service and fraud. We regard our proprietary software as protected by trade secret and copyright laws of general applicability and attempt to safeguard our software through the protection afforded by the above-referenced laws,  third-party non-disclosure agreements, licensing agreements and other methods of protection. Despite these precautions, it may be possible for unauthorized third- parties to copy, obtain or reverse engineer certain portions of our software or to otherwise obtain or use other information we regard as proprietary. While our competitive position may be affected by our ability
to protect our software and other proprietary information, we believe that the protection afforded by trade secret and copyright laws is less significant to us than other factors such as the knowledge, ability and experience of our personnel and the continued pursuit and implementation of our operating strategies.

We currently license certain software from third-parties to supplement our internal software and technology development and to shorten time-to-market software application product deliveries.

Employees and Labor Contracts

  As
    of December 31, 2006, we employed 92 full-time and 2 part-time personnel,
    including 14 information systems and technology, 14 operations and 64 sales
    and administration. Many of our employees are highly skilled, and we believe
    our future viability will depend in large part on our ability to attract and
    retain such employees. We have employment agreements with several individuals,
    including our chief operating officer, chief financial officer, our chief
    technology officer and chief marketing officer. None of our employees are
    represented by a labor union, and we have experienced no work stoppages. We
    consider our employee relations to be good.  

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RISK FACTORS AND CAUTIONARY STATEMENTS

An investment in our securities involves a high degree of risk. In addition to the other information in this annual report, including our financial statements and related footnotes, you should carefully consider the following risk factors before deciding to invest in our securities. If any of the following risks actually occur, it is likely that our business, financial condition and operating results would be harmed. As a result, the trading price of our common stock could decline, and you could lose part or all of your investment.

Risks Relating to our Business

We have a history of operating losses and will need to generate significant revenue to meet future obligations and achieve or maintain our profitability.

We are engaged in the payment processing and services business and have acquired payment processing related businesses and portfolios of merchant accounts to grow our business, both of which require substantial capital and other expenditures. As a result, we have not maintained profitability and may continue to incur losses in the future. We had a net loss of $2.3 million for the year ended December 31, 2006 and net income of $369,000 for the year ended December 31,  2005. We intend to continue to acquire businesses and merchant account portfolios. In addition, we expect our cash needs to increase significantly within the next two years to meet potential earn-out and share retirement obligations under existing merger and acquisition agreements.

  As
    a result of these continuing and new expenses, we need to generate significant
    revenues to achieve and maintain profitability. To date, our operations have
    been supported through, cash flow from operations, sales of our securities
    and by financings, including the Centrecourt Financing. If we do not continue
    to increase our revenues, our business, results of operations and financial
    condition could be materially and adversely affected. We have incurred substantial
    levels of debt, which could impair our financial and operating flexibility.

We have incurred substantial debt in connection with the financing of our operations and acquisitions. We incurred debt in the principal amount of $37.0 million in connection with the Centrecourt Financing. We used the proceeds of the Centrecourt Financing to repay a $15.0 million promissory note issued to Sheridan Capital Advisors, LLC and a $2.0 million convertible promissory note issued to CAMOFI Master LDC, as well as to fund the purchase price for Valadata and Paynet. We may incur additional debt in the future in order to pursue our acquisition strategy or for other purposes. Substantial indebtedness could impair our ability to obtain additional financing for working capital expenditures or further acquisitions. Covenants governing any indebtedness we incur would likely restrict our ability to take specific actions, including our ability to pay dividends or distributions, redeem or repurchase our capital
stock, issue, sell or allow distributions on capital stock of our subsidiaries, enter into transactions with affiliates, merge, consolidate or sell our assets, or make capital expenditure investments. In addition, the use of a substantial portion of the cash generated by our operations is used to cover debt service obligations. Security interests granted on our assets could limit our financial and business flexibility.

If an event of default occurs under the secured note we issued in connection with the Centrecourt Financing, it could result in a material adverse effect on our business operating results, or financial condition as the investors maintain a first priority security interest in all of our assets and the assets of our business.

On June 29, 2006, we issued $37.0 million in convertible notes in connection with the Centrecourt Financing. The investors in the Centrecourt Financing have a first priority security interest in all of our assets. Investors should be aware that the following events constitute events of default under these notes:



        failure to pay interest and principal payments when due;




        a breach of any material covenant or term or condition in the note in any agreement made in connection therewith; or




        a default or event default occurring under any of the agreements made in connection with the note or any other material agreement, lease, mortgage, indenture agreement, factoring agreement, or other instrument, to which the company or any of its subsidiaries is bound; or




        breach of any warranty or material representation made in the note or in any agreement made in connection therewith; or




15




        any form of bankruptcy or insolvency proceeding instituted by or against us which is not vacated in sixty (60) days; or




        a change in control.


In connection with the Centrecourt Financing, we agreed to certain restrictions on our activities that could negatively impact our ability to obtain financing from other sources.

So long as any portion of the principal amount of the convertible notes remains outstanding, we are restricted from incurring additional indebtedness other than certain permitted indebtedness, which includes certain purchase money indebtedness incurred in connection with the acquisition of capital assets subject to certain financial conditions and indebtedness approved by a majority of holders of our convertible notes. To the extent that additional debt financing is required for us to conduct our operations, these restrictions could materially and adversely impact our ability to achieve our operational objectives.

The conversions of the $37 million Centrcourt Financing  convertible note could adversely impact our common stock  resulting  in greater dilution to our stockholders.

The market price of our common stock significantly impacts the extent to which the notes issued in connection with the Centrecourt Financing are convertible into shares of our common stock and the dilution that will occur to our stockholders. The $37.0 million note is convertible into 28.5 million shares of common stock.



If requested, we have a requirement to repurchase up to 9,398,058 shares of our common stock issued to the former shareholders of Charge.com. If requested, we will be required raise money to satisfy this obligation. If left unsatisfied, it could result in a defaulted obligation and have a material adverse effect on our business operating results or financial condition of our company.



On December 5, 2006, the third amendment (the Amendment) to the Agreement and Plan of Merger (the Merger Agreement) among our company, Charge.com Acquisition, Inc., Charge.com, David Danzig and Gregory Danzig was entered into by Pipeline, Charge.com Acquisition, Inc., David Danzig and Gregory Danzig, on behalf of himself and Kauai. Pursuant to the Amendment, Gregory Danzig, Kauai and David Danzig have been provided with additional time to determine whether to exercise their rights under the Merger Agreement to sell their shares of Pipeline common stock back to Pipeline. Under the Amendment, if the Danzigs and Kauai want Pipeline to purchase all of such shares, they must notify Pipeline of such decision on or between June 15, 2007 and 5:00 p.m. (Eastern Daylight Time) on June 29, 2007 (the Put Right). If

Gregory Danzig, Kauai or David Danzig chooses to have Pipeline repurchase the shares of Pipeline common stock issued to him or it under the Merger Agreement at the per share purchase price of $1.33825 per share (Per Share Purchase Price), subject to interest assessment as set forth below, then Pipeline is obligated to do so by October 30, 2007. If Gregory Danzig, Kauai and/or David Danzig (the Selling Shareholders) exercises the Put Right in accordance with the terms of the Amendment, Pipeline must pay the Selling Shareholders in cash by October 30, 2007 the Per Share Purchase Price, plus interest, for each share of Pipeline common stock to be so repurchased. Any such payment of the Per Share Purchase Price made after June 30, 2007, will incur interest at the per annum rate of 12% as assessed on a pro rata daily basis on the date of payment. Any such payment of the Per Share Purchase
Price not made prior to October 31, 2007 will incur interest at the rate of 18% per annum based on the aggregate unpaid amount until paid for in full in cash, as assessed on a pro rata daily basis on

the date of payment. Interest will be assessed on the shares of Pipeline common stock actually sold by the Selling Shareholders to Pipeline. In the event the Danzigs and Kauai exercise their put right, we will be required raise money to satisfy this obligation. If left unsatisfied, it could result in a defaulted obligation and have a material adverse effect on our business operating results or financial condition of our company.



Additional authorized shares of our common stock and preferred stock available for issuance may adversely affect the market for our common stock.

We are authorized to issue 150,000,000 shares of our common stock. As of December 31, 2006, there were 47,986,000 shares of common stock issued and outstanding. We may also issue up to 28,861,000 shares in connection with the conversion of both a $525,000 convertible promissory note issued to  former Aircharge stockholders and the previously mentioned $37.0 million convertible notes. Additionally, we have 16.4 million warrants, with an average exercise price of $1.35 and 9.5



16



million options, with an average exercise price of $1.39, outstanding as of December 31, 2006. The combination of shares outstanding as of December 31, 2006, plus the potential shares that could be issued through the conversion of convertible notes payable, warrants and stock options outstanding is 102,753,000 shares of our common stock. As of December 31, 2006, there were 47,986,000 shares of our common stock outstanding, plus 6,330,000 potential shares that are vested and in the money, thus equating to 54,316,000 shares outstanding or in the money common stock equivalents as of December 31, 2006. We may be required to issue 1.6 million shares of  restricted common stock in connection with our acquisition of Paynet Systems in the event they meet certain performance milestones by June 30, 2007. To the extent such options or warrants are exercised or additional issuances are made in
connection with the acquisition of  Paynet Systems, the holders of our common stock may experience further dilution. To the extent we issue securities in future acquisitions or financings that are convertible into or exchangeable for equity securities, investors will experience further dilution.

In addition to the above referenced shares of common stock which may be issued without stockholder approval, we have five million (5,000,000) shares of authorized preferred stock, the terms of which may be fixed by our board of directors. We have issued preferred stock in the past, and our board of directors has the authority, without stockholder approval, to create and issue one or more additional series of such preferred stock and to determine the voting, dividend, conversion and other rights of holders of such preferred stock. The issuance of any of such series of preferred stock will have an adverse effect on the holders of common stock.

We face uncertainty about additional financing for our future capital needs, which may prevent us from growing our business.

If we are unable to increase our revenues, we will need to raise additional funds to finance our future capital needs. Additional financing may be required if we:





        Decide to expand faster than planned;
        Need to respond to competitive pressures; or
        need to acquire complementary products, businesses or technologies.

If we raise additional funds through the sale of equity or convertible debt securities, these transactions may dilute the value of our outstanding common stock or trigger contractual obligations to issue additional shares of our common stock to investors in the Centrecourt Financing. We may also decide to issue securities, including debt securities, which have rights, preferences and privileges senior to our common stock. We cannot assure you that we will be able to raise additional funds on terms favorable to us, or at all. If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs. This may prevent us from increasing our market share, capitalizing on new business opportunities, remaining competitive in our industry or continuing our business operations as a whole.

The full impact of our recent acquisitions on our operating results is not fully reflected in our historical financial results, which, as a result, are not necessarily indicative of our future results of operations.

We have expanded our card-based payment processing services through the acquisition of Valadata and Paynet Systems. Accordingly, our results for the fiscal year ended December 31, 2006, may not be indicative of results to be expected in future periods.

Increased consolidation in the market in which we operate will have an impact on price and availability of acquisition, joint venture and alliance opportunities.

Historically, our growth strategy has been materially dependent upon the purchase of additional merchant portfolios and the acquisition of operating businesses. This strategy will continue in the future. We face significant competition from other transaction processors for available acquisition, joint venture and alliance opportunities. These transaction processors potentially deprive us of acquisition opportunities and may cause the purchase price of such transactions to increase. We cannot give any assurances that the historical or current level or pricing of acquisition opportunities will continue to exist,



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that we will be able to acquire merchant portfolios, operating businesses or transaction processing assets that satisfy our criteria or that any such transaction will be on favorable terms.

We have faced, and may in the future face, significant chargeback liability if our merchants refuse or cannot reimburse chargebacks resolved in favor of their customers.

We have potential liability for chargebacks associated with the transactions we process. If a billing dispute between a merchant and a cardholder is not ultimately resolved in favor of the merchant, the disputed transaction is charged back to the merchants bank and credited to the account of the cardholder.

We also have potential liability for losses caused by fraudulent credit card transactions. Card fraud occurs when a merchants customer uses a stolen card (or a stolen card number in a card-not-present transaction) to purchase merchandise or services. In a traditional card-present transaction, if the merchant swipes the card, receives authorization for the transaction from the card issuing bank and verifies the signature on the back of the card against the paper receipt signed by the customer, the card issuing bank remains liable for any loss. In a fraudulent card-not-present transaction, even if the merchant receives authorization for the transaction, the merchant is liable for any loss arising from the transaction. Many of the merchants that we serve are businesses that transact a percentage of their sales over the Internet or in response to telephone or mail orders. Because
their sales are card-not-present transactions, these merchants are more vulnerable to customer fraud. Because we target merchants that process card-not-present transactions over the Internet, by telephone and by mail, we experience and expect to continue to experience chargebacks arising from cardholder fraud. Such chargebacks could negatively impact our financial results. Moreover, if we, or our processing banks, are unable to collect the chargeback from the merchants account, or if the merchant ceases operations, refuses or is financially unable due to bankruptcy or other reasons to reimburse the merchants bank for the chargeback, we bear the loss for the amount of the refund paid to the cardholders bank. We are not insured against this risk.

We face potential liability for merchant or customer fraud. We may not be able to accurately anticipate this liability, which could result in lost sales to us.

Merchant fraud occurs when a merchant, rather than a customer, knowingly uses a stolen or counterfeit card or card number to record a false sales transaction, or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Any time a merchant is unable to satisfy a chargeback, we are responsible for that chargeback. We have established systems and procedures to detect and reduce the impact of merchant fraud. In addition to credit review, we monitor merchant transactions against a series of standards developed to detect merchant fraud and excessive chargebacks. We apply varying levels of scrutiny in our evaluation of applications and underwriting of prospective merchants accounts, ranging from basic due diligence for merchants with a low-risk profile to a more thorough and detailed review for higher risk merchants. The results of this review serve as the basis for our
decision whether to accept or reject a merchant account, and also provide the criteria for establishing whether to maintain a reserve of a portion of a merchants processing volume, the particular reserve requirements, processing limits, average transaction amounts and pricing. It also assists us in monitoring merchant transactions for those accounts that exceed pre-determined criteria. We maintain rolling reserves, meaning we withhold a varying percentage of at risk merchants processing volume, to offset potential losses. On merchants whom we have instituted a rolling reserve, we maintain an average of 15% of  processing volume. Despite our efforts to detect merchant fraud, we cannot assure you that these measures are or will be effective. It is possible that we will experience significant amounts of merchant fraud in the future, which could increase our chargeback liability. Increased chargeback liability may have a material adverse effect on our business, financial
condition, results of operations and ability to continue business operations.

If our merchants experience adverse business conditions, they may generate fewer transactions for us to process or become insolvent, increasing our exposure to chargeback liabilities.

General economic conditions have caused some of the merchants we serve to experience difficulty in supporting their current operations and implementing their business plans. If these merchants make fewer sales of their products and services, we will have fewer transactions to process, resulting in lower revenues.

In addition, in a recessionary environment, the merchants we serve could be subject to a higher rate of insolvency which could adversely affect us financially. We bear credit risk for chargebacks related to billing disputes between credit card holders and bankrupt merchants. If a merchant seeks relief under bankruptcy laws or is otherwise unable or unwilling to pay, we may be liable for the full transaction amount of a chargeback.



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We rely on bank sponsors, which have substantial discretion with respect to certain elements of our business practices, in order to process bankcard transactions; if these sponsorships are terminated and we are not able to secure or migrate merchant portfolios to new bank sponsors, we will not be able to conduct our business.

Because we are not a bank, we are unable to belong to and directly access the Visa and MasterCard bankcard associations. Visa and MasterCard operating regulations require us to be sponsored by a bank in order to process bankcard transactions. We are currently registered with Visa and MasterCard through the sponsorship of banks that are members of the card associations. Our sponsoring banks include US Bancorp and Wells Fargo Bank N.A. If these sponsorships are terminated and we are unable to secure a bank sponsor, we will not be able to process bankcard transactions. Furthermore, our agreements with our sponsoring banks give the sponsoring banks substantial discretion in approving certain elements of our business practices, including our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants, the processing fees that we charge, our customer service
levels and our use of ISOs, which we define as any non-bank party that sells card-based payment processing services to merchants, that markets and services electronic credit card authorization and payment systems to merchants located throughout the United States. We are unable to guarantee that our sponsoring banks actions under these agreements will not be detrimental to us.

If we, or our bank sponsors, fail to adhere to the standards of the Visa and MasterCard credit card associations, our registrations with these associations could be terminated and  we could be required to stop providing payment processing services for Visa and MasterCard.

Substantially all of the transactions we process involve Visa or MasterCard. If we, or our bank sponsors, fail to comply with the applicable requirements of the Visa and MasterCard credit card associations, Visa or MasterCard could suspend or terminate our registration. The termination of our registration or any changes in the Visa or MasterCard rules that would impair their or our registration could require us to stop providing payment processing services.

We rely on other card payment processors and service providers; if they fail or no longer agree to provide their services, our merchant relationships could be adversely affected and we could lose business.

  We
    rely on agreements with several other large payment processing organizations
    to enable us to provide card authorization, data capture, settlement, and
    merchant accounting services and access to various reporting tools for the
    merchants we serve. We also rely on third parties to whom we outsource specific
    services, such as reorganizing and accumulating daily transaction data on
    a merchant-by-merchant and card issuer-by-card issuer basis and forwarding
    the accumulated data to the relevant bankcard associations. Our card payment
    processors include CTS Holdings, Inc. (a wholly owned subsidiary of First
    Data Corp.) and Nova Information Systems, Inc.

The termination by our service providers of their arrangements with us or their failure to perform their services efficiently and effectively may adversely affect our relationships with the merchants whose accounts we serve and may cause those merchants to terminate their processing agreements with us.

To acquire and retain merchant accounts, we depend on a group of banks and ISOs as referral sources and loss of any of these referral sources may cause us to lose an effective method of marketing our products and services to merchants.

We have contractual relationships with 50 banks, comprising over 400 bank branch locations, and 48 credit unions that serve as referral sources for our products and services to merchants seeking to establish an account with a payment processor. Our failure to maintain our relationships with these banks could adversely affect our revenues and internal growth and increase our merchant attrition.

We have contractual relationships with more than 30 ISOs/VARs to market our services to merchants seeking to establish an account with a payment processor. Our failure to maintain our relationships with our existing ISOs and those serving other service providers that we may acquire, and to recruit and establish new relationships with other ISOs, could adversely affect our revenues and internal growth and increase our merchant attrition. On occasion, we experience increases in interchange and sponsorship fees; if we cannot pass these increases along to our merchants, our margins will be reduced.

We pay interchange fees or assessments to card associations for each transaction we process using their credit and debit cards. From time to time, the card associations increase the interchange fees that they charge processors and the sponsoring banks. At their sole discretion, our sponsoring banks have the right to pass any increases in interchange fees on to us. In addition, our sponsoring banks may seek to increase their Visa and MasterCard sponsorship fees to us, all of which are based



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upon the dollar amount of the payment transactions we process. If we are not able to pass these fee increases along to merchants through corresponding increases in our processing fees, our margins will be reduced.

Unauthorized disclosure of merchant and cardholder data, whether through breach of our computer systems or otherwise, could expose us to protracted and costly litigation.

We collect and store sensitive data about merchants and cardholders, including names, addresses, social security numbers, drivers license numbers, checking and savings account numbers and payment history records, such as account closures and returned checks. In addition, we maintain a database of cardholder data relating to specific transactions, including payment card numbers and cardholder addresses, in order to process the transactions and for fraud prevention and other internal processes. If a person penetrates our network security or otherwise misappropriates sensitive merchant or cardholder data, we could be subject to liability or business interruption. These claims also could result in protracted and costly litigation.

Although we generally require that our agreements with our ISOs and service providers who have access to merchant and customer data include confidentiality obligations that restrict these parties from using or disclosing any customer or merchant data except as necessary to perform their services under the applicable agreements, we cannot assure you that these contractual measures will prevent the unauthorized disclosure of merchant or customer data. In addition, our agreements with financial institutions require us to take certain protective measures to ensure the confidentiality of merchant and consumer data. Any failure to adequately take these protective measures could result in protracted or costly litigation. Although we have fulfilled our requirements to an authorized Visa/MasterCard compliance auditor regarding cardholder information and security procedures and as of July 2006 have been certified
compliant as a Visa/MasterCard merchant payment processor, we could fail to maintain compliance. Noncompliance could result in material interruptions in our ability to store and transmit card data.

Increased attrition in merchant charge volume due to an increase in closed merchant accounts that we cannot anticipate or offset with new accounts may reduce our revenues.

We experience attrition in merchant charge volume in the ordinary course of business resulting from several factors, including business closures, transfers of merchants accounts to our competitors and account closures that we initiate due to heightened credit risks relating to, and contract breaches by, a merchant. During 2006, we experienced average attrition of 1% of merchant transaction charge volume per month. In addition, substantially all of our processing contracts with merchants may be terminated by either party on relatively short notice, allowing merchants to move their processing accounts to other providers with minimal financial liability and cost. Increased attrition in merchant charge volume may have a material adverse effect on our financial condition and results of operations. We may not be able to accurately predict the level of attrition in the future, particularly in
connection with our recent acquisitions of merchant account portfolios. If we are unable to increase our transaction volume or establish accounts with new merchants in order to counter the effect of this attrition, or, if we experience a higher level of attrition in merchant charge volume than we anticipate, our revenues will decrease.

The loss of key personnel or damage to their reputations could adversely affect our relationships with ISOs, card associations, bank sponsors and our other service providers, which would adversely affect our business.

Our ability to run our business depends upon the continued services of our senior management and other key employees, in particular MacAllister Smith, our Chief Executive Officer, all of whom have substantial experience in the payment processing industry and the small to medium-sized merchant markets in which we offer our services. In addition, our ability to execute our business strategy will depend in large part upon the reputation and influence within the industry of Mr. Smith, who has, along with our other senior managers, over their years in the industry, developed long-standing and highly favorable relationships with ISOs, card associations, bank sponsors and other payment processing and service providers. We would expect that the loss of the services of one or more of our key employees, particularly Mr. Smith, would have an adverse effect on our operations. We would also expect that any damage
to the reputation of our senior managers, including Mr. Smith, would adversely affect our business. Currently, we do not maintain key person life insurance on any employees.

We may become subject to certain state taxes that currently are not passed through to our merchants.

We, like other transaction processing companies, may be subject to state taxation of certain portions of our fees charged to merchants for our services. Application of this tax is an emerging issue in the transaction processing industry and the states





20



have not yet adopted uniform guidelines. If we are required to pay such taxes and are not able to pass this tax expense through to our merchant customers, our financial condition and results of operations could be adversely affected.

The payment processing industry is highly competitive and such competition is likely to increase, which may further adversely influence our prices to merchants, and as a result, our profit margins.

The market for card processing services is highly competitive. The level of competition has increased in recent years, and other providers of processing services have established a sizable market share in the small to medium-sized merchant processing sector. Some of our competitors are financial institutions, subsidiaries of financial institutions or well-established payment processing companies that have substantially greater capital and technological, management and marketing resources than we have. Some of our competitors are large associations, such as Costco, BJs Wholesale Club, chambers of commerce, community associations and trade associations that may offer lower rates based on a better buy rate or as a loss leader and, thus, attract customers who shop price or, alternatively, attract business out of association loyalty. There are also a large number of small providers of
processing services that provide various ranges of services to small to medium-sized merchants. Our competition may influence the prices we can charge, attract employees and our sales force away from us and requires us to control costs aggressively in order to maintain acceptable profit margins. In addition, our competitors continue to consolidate as large banks merge and combine their networks. This consolidation may also require that we increase the consideration we pay for future acquisitions and could adversely affect the number of attractive acquisition opportunities presented to us.

Increased attrition in merchant charge volume due to an increase in closed merchant accounts that we cannot anticipate or offset with new accounts may reduce our revenues.

We experience attrition in merchant charge volume in the ordinary course of business resulting from several factors, including business closures, transfers of merchants accounts to our competitors and account closures that we initiate due to heightened credit risks relating to, and contract breaches by, a merchant. During 2006, we experienced average attrition of 1% of merchant transaction charge volume per month. In addition, substantially all of our processing contracts with merchants may be terminated by either party on relatively short notice, allowing merchants to move their processing accounts to other providers with minimal financial liability and cost. Increased attrition in merchant charge volume may have a material adverse effect on our financial condition and results of operations. We may not be able to accurately predict the level of attrition in the future, particularly in
connection with our recent acquisitions of merchant account portfolios. If we are unable to increase our transaction volume or establish accounts with new merchants in order to counter the effect of this attrition, or, if we experience a higher level of attrition in merchant charge volume than we anticipate, our revenues will decrease.

Our operating results are subject to seasonality, and if our revenues are below our seasonal norms during our historically stronger third and fourth quarters, our net income could be lower than expected.

We have experienced in the past, and expect to continue to experience, seasonal fluctuations in our revenues as a result of consumer spending patterns. Historically, revenues have been weaker during the first two quarters of the calendar year and stronger during the third and fourth quarters. If, for any reason, our revenues are below seasonal norms during the third or fourth quarter, our operating results could be negatively affected.

Our systems may fail due to factors beyond our control, which could interrupt our business or cause us to lose business and would likely increase our costs.

We depend on the efficient and uninterrupted operations of our computer network systems, software and data centers. We do not presently have fully redundant systems. Our systems and operations could be exposed to damage or interruption from fire, natural disaster, power loss, telecommunications failure, unauthorized entry and computer viruses. Our property and business interruption insurance may not be adequate to compensate us for all losses or failures that may occur. Defects in our systems, errors or delays in the processing of payment transactions or other difficulties could result in:





        additional development costs;





21




        diversion of technical and other resources;
        loss of merchants;
        loss of merchant and cardholder data;
        negative publicity;
        harm to our business or reputation; or
        exposure to fraud losses or other liabilities.

We face uncertainty about additional financing for our future capital needs, which may prevent us from growing our business.

If we are unable to increase our revenues, we will need to raise additional funds to finance our future capital needs. Additional financing may be required if we:





        Decide to expand faster than planned;
        need to respond to competitive pressures; or
        need to acquire complementary products, businesses or technologies.

If we raise additional funds through the sale of equity or convertible debt securities, these transactions may dilute the value of our outstanding common stock or trigger contractual obligations to issue additional shares of our common stock to CAMOFI Master LDC. We may also decide to issue securities, including debt securities, which have rights, preferences and privileges senior to our common stock. We cannot assure you that we will be able to raise additional funds on terms favorable to us, or at all. If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs. This may prevent us from increasing our market share, capitalizing on new business opportunities, remaining competitive in our industry or continuing our business operations, as a whole.



We currently rely solely on common law to protect our intellectual property; should we seek additional protection in the future, we may fail to register our trademarks or otherwise obtain intellectual property protection, causing us to potentially lose our rights to use these marks.

Currently, we have no patents or trademarks or copyrights and we rely on common law rights to protect our marks and logos. We do not rely heavily on the recognition of our marks to obtain and maintain business. We have recently applied for trademark registration for certain of our marks. However, we cannot assure you that any such applications will be approved. Even if they are approved, these trademarks may be challenged by others and/or invalidated. Our trademark registrations may not be approved because third parties own these trademarks, or our use of these trademarks may be restricted or completely prohibited unless we enter into agreements with these parties, which may not be available on commercially reasonable terms or at all.

New and potential governmental regulations designed to protect or limit access to consumer information could adversely affect our ability to provide the services we provide our merchants.

  Due
    to the increasing public concern over consumer privacy rights, governmental
    bodies in the United States and abroad have adopted, and are considering adopting
    additional laws and regulations restricting the purchase, sale and sharing
    of personal information about customers. For example, the Gramm-Leach-Bliley
    Act requires non-affiliated third-party service



22



providers to financial institutions to take certain steps to ensure the privacy and security of consumer financial information. We believe our present activities fall under exceptions to the consumer notice and opt-out requirements contained in this law for third -party service providers to financial institutions because we provide business-to-business services and not business-to-consumer services. The law, however, is new and there have been very few rulings on its interpretation. We believe that current legislation permits us to access and use this information as we do now. The laws governing privacy generally remain unsettled, however, and even in areas where there has been some legislative action, such as the Gramm-Leach-Bliley Act and other consumer statutes, it is difficult to determine whether and how existing and proposed privacy laws will apply to our business. Limitations on our ability to access
and use customer information could adversely affect our ability to provide the services we offer to our merchants or could impair the value of these services.

Several states have proposed legislation that would limit the use of personal information gathered using the Internet. Some proposals would require proprietary online service providers and Web site owners to establish privacy policies. Congress has also considered privacy legislation that could further regulate use of consumer information obtained over the Internet or in other ways. The Federal Trade Commission has also recently settled a proceeding with one on-line service regarding the manner in which personal information is collected from users and provided to third parties. Our compliance with these privacy laws and related regulations could materially affect our operations.



Changes to existing laws or the passage of new laws could, among other things:





        create uncertainty in the marketplace that could reduce demand for our services;
        Limit our ability to collect and to use merchant and cardholder data;
        increase the cost of doing business as a result of litigation costs or increased operating costs; or
        in some other manner have a material adverse effect on our business, results of operations and financial condition.

We are subject to federal and state laws regarding anti-money laundering, including the Patriot Act, and if we break any of these laws we could be subject to significant fines and/or penalties, and our ability to conduct business could be limited.

We are subject to U.S. federal anti-money laundering laws and the requirements of the Office of Foreign Assets Control, which prohibit us from transmitting money to specified countries or on behalf of prohibited individuals. The money transfer business has been subject to increased scrutiny following the events of September 11, 2001. The Patriot Act, enacted following those events, mandates several new anti-money laundering requirements. The federal government or the states may elect to impose additional anti-money laundering requirements. Changes in laws or regulations that impose additional regulatory requirements, including the Patriot Act, could increase our compliance and other costs of doing business, and therefore have an adverse effect on our results of operation.

Failure to comply with the laws and regulatory requirements of federal and state regulatory authorities could result in, among other things, revocation of required registrations, loss of approved status, termination of contracts with banks, administrative enforcement actions and fines, class action lawsuits, cease and desist orders and civil and criminal liability. The occurrence of one or more of these events could materially adversely affect our business, financial condition and results of operations.

If we were to inadvertently transmit money on behalf of, or unknowingly conduct business with, a prohibited individual, we could be required to pay significant damages, including fines and penalties. Likewise, any intentional or negligent violation of anti-money laundering laws by our employees could lead to significant fines and/or penalties, and could limit our ability to conduct business in some jurisdictions.



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Risks Relating to Acquisitions

We may not be able to integrate recently acquired companies or potential future acquisitions into our company, and resources available to assist our acquired companies may be insufficient.

We have made strategic acquisitions and we intend to continue to make such acquisitions in accordance with our business plan. On July 11, 2006, we acquired Valadata and on July 3, 2006, we acquired Paynet Systems. On December 20, 2005, we completed our acquisition of Charge.com. In addition, we also acquired Aircharge. Each acquisition involves a number of risks, including:



        the diversion of our managements attention to the assimilation and ongoing assistance with the operations and personnel of the acquired business, which could strain  managements resources;




        the potential for our affiliated companies to grow rapidly and adversely affect our ability to assist our affiliated companies as intended;




        possible adverse effects on our results of operations and cash flows,




        possible inability by us to achieve the intended objective of the acquisition;




        possible inability by acquisition target to achieve promised goals; and




        possible inability by acquisition target to retain and maintain strategic contracts.

Our inability to assist our affiliated companies as intended or to acquire and integrate businesses under our business plan could negatively impact our operations, financial results and cash flows.

We have previously acquired, and expect to continue to acquire, other providers of payment processing services and portfolios of merchant processing accounts. These acquisitions entail risks in addition to those incidental to the normal conduct of our business, and failure to make acquisitions in general could significantly impair our growth.

To date, our revenue growth has been generated in large part through acquisitions of complementary businesses and portfolios of accounts. We expect such acquisitions to be key to our growth strategy going forward. We may not be able to find suitable acquisition candidates or to consummate acquisitions on favorable terms, if at all. Our failure to make such acquisitions could have a material adverse effect on our ability to grow our company.

Moreover, even if we make such acquisitions, revenues generated, or expenses incurred, by acquired businesses or account portfolios may not comport to our projections, resulting in losses or a decline in revenue and profits, if any, as well as potential impairment charges.

In evaluating and determining the purchase price for a prospective acquisition, we estimate the future revenues from that acquisition based on the historical transaction volume of the acquired provider of payment processing services or portfolio of merchant accounts. Following an acquisition, it is customary to experience some attrition in the number of merchants serviced by an acquired provider of payment processing services or included in an acquired portfolio of merchant accounts. Should the rate of post-acquisition merchant attrition exceed the rate we have forecasted, the revenues generated by the acquired providers of payment processing services or portfolio of accounts may be less than we estimated, which could result in losses or a decline in profits, as well as potential impairment of asset charges.

We may fail to uncover all liabilities of acquisition targets through the due diligence process prior to an acquisition, exposing us to potentially large, unanticipated costs.

Prior to the consummation of any acquisition, we perform a due diligence review of the provider of payment processing services or portfolio of merchant accounts that we propose to acquire. Our due diligence review, however, may not adequately uncover all of the contingent or undisclosed liabilities we may incur as a consequence of the proposed acquisition. If any undiscovered, contingent or undisclosed liabilities materialize, our results of operations could be negatively affected.



24



Acquisitions that we may undertake would involve a number of inherent risks, any of which could cause us not to realize the anticipated benefits to result.

Our strategy has been and will likely continue to include expanding our operations and capabilities through acquisitions of businesses and assets. Acquisition transactions involve various inherent risks, such as:





        uncertainties in assessing the value, strengths and potential profitability of, and identifying the extent of all weaknesses, risks, contingent and other liabilities (including environmental liabilities) of, acquisition or other transaction candidates;
        the potential loss of key customers, management and employees of an acquired business;
        the ability to achieve identified operating and financial synergies anticipated to result from an acquisition or other transaction;
        problems that could arise from the integration of the acquired business; and
        unanticipated changes in business, industry or general economic conditions that affect the assumptions underlying the acquisition or other transaction rationale.

Any one or more of these factors could cause us not to realize the benefits anticipated to result from the acquisition of businesses or assets or could result in unexpected liabilities associated with acquisition candidates.

We may not fully maximize our business relationship with Sprint Nextel Corp.

We acquired Aircharge in part due to its classification as a national Industry Solutions Partner of Sprint Nextel Corp. (NYSE:S). We believe that this classification should allow us to provide credit card acceptance solutions to Sprint Nextel Corp.s business customers. There can be no assurance, however, that Sprint Nextel Corp. will continue such classification or that such classification will be successfully integrated into our business model. If Sprint Nextel Corp. does not continue such classification or we are unable to successfully integrate such classification into our business model, there can be no assurance that Sprint Nextel Corp. will continue to provide us with such access to their customers.

The inability of the sellers of companies we may acquire to fulfill their indemnification obligations to us under our acquisition agreements could increase our liabilities, our costs for acquisition and adversely affect our results of operations and financial position.

We have required in the past, and expect that in the future, under our acquisition agreements, the respective sellers will agree to retain responsibility for and indemnify us against damages resulting from certain third-party claims or other liabilities. Our inability to obtain such agreements or the failure of any seller to satisfy its obligations with respect to claims and retained liabilities covered by the acquisition agreements could have an adverse effect on our results of operations and financial position, as claimants may successfully assert that we are liable for those claims and/or retained liabilities. In addition, we expect that certain obligations of the sellers to indemnify us will terminate upon expiration of the applicable indemnification periods and will not cover damages in excess of the applicable coverage limits. The incurrence of unexpected losses and assertion of third-party claims after
the expiration of the applicable indemnification period or in excess of the applicable coverage limit, or the failure of any seller to satisfy its indemnification obligations with respect to breaches of its representations and warranties, could have an adverse effect on our results of operations and financial position.

We may encounter delays and operational difficulties in completing the necessary transfer of data processing functions and connecting systems links required by acquisitions, resulting in increased costs for, and a delay in the realization of revenues from, acquisitions.

The acquisition of a provider of payment processing services, as well as a portfolio of merchant processing accounts, requires the transfer of various data processing functions and connecting links to our systems and those of our own third -party service providers. If the transfer of these functions and links does not occur rapidly and smoothly, payment processing delays and



25



errors may occur, resulting in a loss of revenues, increased merchant attrition and increased expenditures to correct the transitional problems, which could preclude our attainment of or reduce our operating results.

Special non-recurring and integration costs associated with acquisitions could adversely affect our operating results in the periods following these acquisitions.

In connection with some acquisitions, we may incur non-recurring severance expenses, restructuring charges and change of control payments. These expenses, charges and payments, as well as the initial costs of integrating the personnel and facilities of an acquired business with those of our existing operations, may adversely affect our operating results during the initial financial periods following an acquisition. In addition, the integration of newly-acquired companies may lead to diversion of management attention from other ongoing business concerns.

Our facilities, personnel and financial and management systems may not be adequate to effectively manage the future expansion we believe necessary to increase our revenues and remain competitive.

We anticipate that future expansion will be necessary in order to increase our revenues. In order to effectively manage our expansion, we may need to attract and hire additional sales, administrative, operations and management personnel. We cannot assure you that our facilities, personnel, financial and management systems and controls will be adequate to support the expansion of our operations and provide adequate levels of service to our merchants and ISOs. If we fail to effectively manage our growth, our business could be harmed.

We have significant intangible assets and goodwill, the carrying value of which we may have to reduce if our revenues relating to these assets decline.

We have acquired numerous intangible assets related to purchased portfolios of merchant accounts and business operations. These intangible assets represent a substantial portion of our total assets. Statement of Financial Accounting Standards Nos. 141 and 142 require us to periodically re-examine the value of our purchased assets. A material decline in the revenues and more importantly profits generated from any of our purchased portfolios of merchant accounts or business operations could reduce the fair value of the portfolio or operations. In that case, we may be required to reduce the carrying value of the related intangible asset and/or goodwill. Please see Managements Discussion and Analysis of Financial Condition and Results of OperationsCritical Accounting Policies and Estimates or our attached audit financials for a discussion of how we test impairment of  assets. Additionally,
changes in accounting policies or rules that affect the way in which we reflect these intangible assets in our financial statements, or the way in which we treat the assets for tax purposes, could have a material adverse effect on our financial condition.

Risks Relating to Our Company Generally

Our executive officers, directors and principal stockholders have substantial control over our business, and their interests may not be aligned with the interests of our other stockholders.

As of December 31, 2006, our officers and directors beneficially own approximately 45% of our outstanding common stock. Accordingly, these stockholders, acting together, will be able to exert significant influence over all matters requiring stockholder approval, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders may dictate the day-to-day management of our business. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination or a sale of all or substantially all of our assets.

Future sales of our common stock, or the perception in the public markets that these sales may occur, could depress our stock price.

Sales of substantial amounts of our common stock in the public market, or the perception in the public markets that these sales may occur, could cause the market price of our common stock to decline. This could also impair our ability to raise additional capital through the sale of our equity securities or to make acquisitions through the issuance of additional shares of our common stock or other equity securities.

We currently have a significant number of shares of common stock which may be issued in the future. As of December 31, 2006, there are 47.9 million shares of our common stock outstanding. In addition, there are 9.5 million options to purchase an



26



equal number of shares outstanding under our Non-Statutory Incentive Stock Option Plan, including, without limitation, options issued to former executives of Aircharge and options issued to the principals of Charge.com. We also anticipate that: (i) pursuant to our acquisition of Aircharge, we may issue additional shares in connection with the conversion of a $525,000 promissory note; (ii) pursuant to our recently completed Centrecourt Financing, we may issue up to an additional 49,418,134 shares, which includes a 25% over allotment, in connection with the conversion of convertible promissory notes, including interest thereon, and the exercise of warrants or pursuant to certain anti-dilution provisions; and (iii) pursuant to our acquisition of Paynet Systems we may be required to issue an additional 1.61 million shares of our common stock. Our current stock option and warrant holders and holders of convertible
promissory notes, on a fully-diluted basis assuming exercise of all outstanding options and warrants and conversion of the convertible promissory notes, are expected to own 38.6% of the outstanding shares of our common stock.

In addition, from time to time, certain of our stockholders may be eligible to sell all or some of their shares of common stock by means of ordinary brokerage transactions in the open market pursuant to Rule 144, promulgated under the Securities Act of 1933, as amended, subject to certain limitations. In general, pursuant to Rule 144, a stockholder (or stockholders whose shares are aggregated) who has satisfied a one year holding period may, under certain circumstances, sell within any three month period a number of securities which does not exceed the greater of 1% of the then outstanding shares of common stock or the average weekly trading volume of the class during the four calendar weeks prior to such sale. Rule 144 also permits, under certain circumstances, the sale of securities, without any limitation, by our stockholders that are non-affiliates that have satisfied a two year holding period. Any
substantial sale of our common stock pursuant to Rule 144 or pursuant to any resale prospectus may have a material adverse effect on the market price of our securities.

Failure to achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our business and operating results. In addition, current and potential stockholders could lose confidence in our financial reporting, which could have an adverse effect on our stock price.

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed. Commencing December 15, 2007, we will be required to document and test our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing these assessments. Although we intend to augment our internal controls procedures and expand our accounting staff, there is no guarantee that this effort will be adequate.



During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for compliance with the requirements of Section 404. In addition, if we fail to maintain the adequacy of our internal accounting controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. Moreover, in the course of our testing, financial reporting deficiencies may be uncovered which could cause us to restate our financial results. Failure to achieve and maintain an effective internal control environment could cause us to face regulatory action and also cause investors to lose confidence in our reported financial information, either of which could have an
adverse effect on our stock price.

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses, which as a smaller public company may be disproportionately high.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act, new SEC regulations and stock market rules, are creating uncertainty for development companies such as ours. These new and changing laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. As a result, our efforts to comply with evolving laws, regulations and standards will likely result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to
compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act and the related regulations regarding our required assessment of our internal controls over financial reporting and our independent registered public accounting firms audit of that assessment will require the commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant resources. Further, our board members, chief executive officer and chief financial



27



officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could slow  our business. If we are unable to fully comply with new or changed laws, regulations and standards, or if our efforts differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed and our stock price may suffer.

The price of our common stock may be volatile, which could cause our investors to incur trading losses and fail to resell their shares at or above the price they paid for them. Our securities are currently quoted on the OTCBB and, thus, your ability to sell your shares in the secondary market may be limited.

We do not currently maintain an active market for our common stock, and we cannot predict the extent to which investor interest will lead to the development of an active and liquid trading market in our common stock. The failure to achieve and maintain an active and liquid market for our common stock means that you may not be able to dispose of your common stock in a desirable manner and the price for our shares may fluctuate greatly.

Moreover, some companies that have had volatile market prices for their securities have been subject to securities class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion of our managements attention and resources. This could have a material adverse effect on our business, results of operations and financial condition.

Our certificate of incorporation, our bylaws and Delaware law contain provisions that preserve our current management.

Our certificate of incorporation and by-laws may discourage, delay or prevent a change in our management team that stockholders may consider favorable. These provisions include:




        authorizing the issuance of blank check preferred stock without any need for action by stockholders;
        eliminating the ability of stockholders to call special meetings of stockholders;
        permitting stockholder action by written consent; and
        establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.


These provisions could allow our board of directors to affect your rights as a stockholder since our board of directors can make it more difficult for common stockholders to replace members of the board. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt to replace our current management team.

Provisions of Delaware law could discourage a takeover you may consider favorable or could cause current management to become entrenched and difficult to replace.

We are subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for three years unless the holders acquisition of our stock was approved in advance by our board of directors. These provisions could affect our stock price adversely.

Penny stock regulations may impose certain restrictions on the marketability of our securities.

The Securities and Exchange Commission has adopted regulations which generally define a penny stock to be any equity security that has a market price (as defined) of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Our common stock and warrants may become subject to rules that impose additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors (generally those with assets in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 together





28



with their spouse). For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of such securities and have received the purchasers written consent to the transaction prior to the purchase. Additionally, for any transaction involving a penny stock, unless exempt, the rules require the delivery, prior to the transaction, of a risk disclosure document mandated by the Commission relating to the penny stock market. The broker-dealer must also disclose the commission payable to both the broker-dealer and the registered representative, current quotations for the securities and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealers presumed control over the market. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks. Consequently, the penny stock rules may restrict the ability of broker-dealers to sell our securities and may affect the ability of investors to sell our securities in the secondary market and the price at which such purchasers can sell any such securities.

Investors should be aware that, according to the Commission, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include:





        Control of the market for the security by one or a few broker-dealers that are oftenrelated to the promoter or issuer;
        Manipulation of prices through prearranged matching of purchases and sales andfalse and misleading press releases;
        Boiler room practices involving high pressure sales tactics and unrealistic priceprojections by inexperienced salespersons;
        Excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and
        The wholesale dumping of the same securities by promoters and broker-dealersafter prices have been manipulated to a desired level, along with the inevitablecollapse of those prices with consequent investor losses.



We do not intend to pay cash dividends on our common stock in the foreseeable future.

We currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business and do not anticipate paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors. Further, under the terms of a loan agreement, we are restricted from paying cash dividends and making other distributions to our stockholders.



Item 2. Properties.

Our principal executive offices are located in approximately 10,425 square feet of leased office space in Quincy, Massachusetts. We also lease approximately 9,158 square feet of office space in Alpharetta, Georgia, 5,578 square feet in Brasher Falls, NY and 1,525 square feet in Gurnee, Illinois. All of our facilities are insured. We believe that these facilities are adequate for our current operations and, if necessary, can be replaced with little disruption to our company.



29



Item 3. Legal Proceedings.

Pipeline:

The action filed by Publicity Guaranteed, Inc. in the Circuit Court for Fairfax County, Virginia (Law Number: 06-3403) for withholding funds held by our processing bank to cover chargeback losses was dismissed with prejudice.

Our Subsidiary SecurePay:

Except for that certain suit in the United States District Court of Arizona by Net MoneyIN,  Inc. (plaintiff) vs. Mellon Financial Corp., et al (defendants) (Cause No. CV-01-441-TUC-RCC), there are no material legal proceedings pending or, to our knowledge, threatened against SecurePay. The outstanding lawsuit is an industry-wide suit against numerous defendants based on intellectual property infringement. A default  judgment  has been  rendered  against  several  of the parties,  including  SecurePay. Removal of this judgment  is  currently  being sought. SecurePay views this suit to be without merit.



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



No items were submitted for shareholder approval in the fourth quarter 2006.

On August 30, 2006, we voted to increase the authorized number of shares of our common stock of the Corporation from 95,000,0000 shares to 150,000,000 and to amend our certificate of incorporation to reflect this increase.



PART II



Item 5. Market for Common Equity and Related Stockholder Matters.



(a) Market information.



The companys $0.001 par value common stock is listed on the NASD OTCBB under the ticker symbol PPDA. The following table sets forth the highest and lowest prices quoted for our common stock, during the most recent eight quarters between  January 1, 2005 and December  31, 2006. The closing quote for our common stock on March 23, 2007 was $1.07. The quotations reflect  inter-dealer  prices, with no retail mark-up, mark-down  or  commissions,  and  may not  represent  actual  transactions. .




Year Ended December 31, 2006
        Year Ended December 31, 2005Three months ended:
        High Bid
        Low Ask
        High Bid
        Low AskMarch 31
        1.70
        1.03
        $1.23
        $0.76June 30
        1.65
        1.25
        $1.08
        $0.81September 30
        1.50
        1.20
        $1.09
        $0.87December 31
        1.35
        1.08
        $1.17
        $0.89





(b) Holders.



As of December 31, 2006, there were approximately 859 shareholders of record of our common stock.




(c) Dividends.



  Our
    company has never declared or paid any cash dividends on its capital stock.
    We currently intend to retain all available funds and any future earnings
    of our business for use in the operation of our business and do not anticipate
    paying any cash dividends in the foreseeable future. The declaration, payment
    and amount of future dividends, if any, will depend upon the future earnings,
    results of operations, financial position and capital requirements of our
    company, among other factors, and will be at the sole discretion of our board
    of directors.



Under the Delaware General Corporation Law, our company may only pay dividends out of capital and surplus, or out of certain enumerated retained earnings, as those terms are defined in the Delaware General Corporation Law. The payment of





30



dividends on our common stock is, therefore, subject to the availability of capital and surplus or retained earnings as provided in the Delaware General Corporation Law.



(d) Recent sales of securities.



The following material transactions have occurred in the past fiscal year. They are identified below:



On December 7, 2006, we completed the registration for certain selling stockholders (the Selling Stockholders) of up to an aggregate of 21,100,000 shares of common stock, par value $0.001 per share (Common Stock), which includes 11,100,000 shares issuable upon the exercise of warrants, 10,000,000 shares issuable upon the conversion of convertible promissory notes as required by the registration rights agreement between our company and the Selling Stockholders. The lead investor in this financing was Centrecourt Asset Management LLC and the financing is referred to herein as the Centrecourt Financing. All of such shares of Common Stock are being offered for resale by the Selling Stockholders. We are required to register the remaining 18,461,538 shares of our common stock underlying the convertible note, as well as an additional 25% of the aggregate shares registered pursuant
to our registration rights agreement. Effectiveness of these additional registrations is subject to review by the Securities and Exchange Commission.

Under the terms of the convertible notes, we are obligated to pay interest of 8% per annum on the outstanding principal amount of the convertible notes, payable quarterly in arrears beginning on October 2, 2006. The outstanding principal and accrued but unpaid interest is due on June 29, 2010. The convertible notes are convertible into shares of common stock of the Company at $1.30 per share. In addition, the terms of the notes provide that upon conversion a holder may not beneficially own in excess of 4.9% of the number of shares of common stock outstanding immediately after giving effect to such conversion subject to certain exceptions.

We granted warrants to purchase 11,100,000 shares of our common stock at an exercise price of $1.40 per share to investors in the Centrecourt Financing and agreed to provide for a cashless exercise. In addition, the warrant provides for adjustments to the number of shares underlying each warrant upon the occurrence of certain events, including a stock dividend, stock split or subsequent equity sales at a price lower than the exercise price of the warrant. The warrants expire on June 28, 2011.

We used the proceeds of the Centrecourt Financing to repay a $15.0 million promissory note issued to Sheridan Capital Advisors, LLC, a $2.0 million convertible promissory note issued to CAMOFI Master LDC and to fund the purchases of Valadata, Inc. and Paynet Systems, Inc. The balance of the proceeds were used for working capital. We paid a $1,450,000 placement agent fee to The Maxim Group, LLC and 1,750,000 warrants to purchase our common stock at $1.75 per share in connection with this transaction.



[remainder of page intentionally left blank]



31



Item 6. Managements Discussion and Analysis or Plan of Operation.



Managements Discussion And Analysis Of

Financial Condition And Results Of Operations

This discussion contains forward looking statements relating to our future economic performance, plans and objectives of management for future operations, projections of revenue mix and other financial items that are based on the beliefs of, as well as assumptions made by, and information currently known to, our management. The words expects, intends, believes, anticipates, may, could, should, would and similar expressions and variations thereof are intended to identify forward-looking statements. The cautionary statements set forth in this section are intended to emphasize that actual results may differ materially from those contained in any forward looking statement.

Overview

We are an integrated provider of merchant payment processing services and other related software products. We currently deliver credit and debit card-based payment processing solutions to small to medium-sized merchants who operate either in a physical brick and mortar business environment, over the Internet, or in mobile or wireless settings via cellular-based wireless devices. Our payment processing services enable merchants to process both traditional card-present, or swipe transactions, as well as card-not-present transactions. Significant market research supports the following on the companys industry:



        The Nilson Report, a leading industry publication that tracks the transaction processing industry, reported purchases by U.S. consumers using credit cards will grow from $1.47 trillion in 2003 to $2.28 trillion in 2008. Additionally, forecasts estimate that purchase volume by U.S. consumers using Visa credit cards will increase 63% from 2003 through 2008, while MasterCard usage is projected to increase by 46% during the same period.




        In its most recent publication on transaction processing, leading equity research firm, Raymond James Financial, reported that overall credit card transactions will grow domestically from an estimated 26.6 billon transactions in 2006 to 36.2 billion by 2010. Total credit card purchase volume will grow from $1.8 trillion in 2006 to $2.6 trillion by 2010, with average tickets increasing from $70.10 per transaction to $71.50 over the same period.




A traditional card-present transaction occurs whenever a cardholder physically presents a credit or debit card to a merchant at the point-of-sale. Card-not-present transactions occur whenever the customer does not physically present a payment card at the point-of-sale and may occur over the Internet or by mail, fax or telephone. An overview of our customer base and operational focus is as follows:





        We derive the majority of our revenue from fee income related to payment 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 our services provided in the transaction, we remit a portion of the fee income to the third-parties that have provided these services.






        Our primary customer base consists of small to medium-sized merchants. These merchants generally have a lower volume of credit card transactions, yet are not as price sensitive as larger merchants. The company believes these are difficult to identify and traditionally have been underserved by credit card processors.






        We market and sell our products and services through an in-house sales force utilizing multiple lines of origination, including the Internet, call generation and other marketing media.






        We also market and sell our products and services by utilizing contractual relationships with 50 commercial banks and financial institutions comprising 460 bank branch locations, 48 credit unions, 30 ISOs/VARs and a national cell phone carrier.






        Pipeline is one of only a handful of companies to be deemed by Visa as both a CISP compliant and an authorized merchant payment processor.




32




        Pipeline distinguishes itself from competitors by its VISA certification, its technology, its operating efficiencies and its marketing ability.






        Pipelines technology includes:




o
        Online proprietary digital applications,



o
        Proprietary shopping cart and gateway services,



o
        Wireless cellular phone software to enable mobile card payment acceptance.



Overview  2006 Financial and Operational Highlights





        During the twelve months ended December 31, 2006, we continued our growth by acquiring new merchant accounts through our sales channels, as well as making selective merchant portfolio and company acquisitions.






        Our processing volume for the year ended December 31, 2006 was $1,288 million, an 83% increase from the $701 million processed during the same period in 2005.






        During fiscal 2006 we completed and integrated the acquisitions of Paynet Systems, Inc. and Valadata, Inc. Paynet gave us additional sales and marketing capabilities via the internet and Valadata enhanced our retail card present transaction volume.




        During the third quarter, we commenced the expansion of our sales and marketing team, including that of our national sales center in Quincy, Massachusetts. We believe that our expanded marketing and sales center will enable us to increase sales through a combination of additional team members and a more efficient centralized sales and applications processing environment. We have the ability to increase capacity as our marketing results dictate.




        Revenues increased $17.7 million or 73.5% to $41.8 million for the year ended December 31, 2006 from $24.1 million for the year ended December 31, 2005. Revenue growth was impacted by both acquisitions and recognizing organic revenue growth of $5.0 million for the year ended December 31, 2006.




        Gross Profit, which is defined as total revenue less interchange fees, cost of services sold and cost of goods sold, increased 128% to $14.9 million for the year ended December 31, 2006 from $6.5 million during the year ended December 31, 2005. Gross Margin, as a percentage of sales, increased to 35.7% for the year ended December 31, 2006 as compared to 27.1% for the year ended December 31, 2005.




        Operating Income grew to $2.6 million for the year ended December 31, 2006 from $0.3 million during the year ended December 31, 2005. Operating Income, as a percentage of sales, increased to 6.3% for the year ended December 31, 2006 as compared to 1.3% for the year ended December 31, 2005.


Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements require us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, as well as our related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, intangible assets and income taxes.

We believe the following critical accounting policies and the related judgments and estimates affect the preparation of our consolidated financial statements.

Revenue and Cost Recognition

We derive revenues primarily from the electronic processing of credit, charge and debit card transactions that are authorized and captured through third-party networks. Typically, merchants are charged for these processing services based on a percentage of the dollar amount of each transaction and in some instances, additional fees are charged for each transaction. Certain merchant customers are charged a flat fee per transaction and may also be charged miscellaneous fees, including fees for handling chargebacks, monthly minimums, equipment rentals, sales or leasing and other miscellaneous services.



33



Revenues are reported gross of amounts paid to sponsor banks, as well as interchange and assessments paid to credit card associations (MasterCard and Visa) under revenue sharing agreements pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants. Included in cost of goods and services sold are the expenses covering interchange and bank processing directly attributable to the furnishing of transaction processing and other services to our merchant customers and are recognized simultaneously with the recognition of revenue.

We follow the requirements of EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining our revenue reporting. Generally, we report revenues at the time of sale on a gross basis where we are the primary obligor in the arrangement, have latitude in establishing the price of the services, change the product and perform part of the service, have discretion in supplier selection, have latitude in determining the product and service specifications to meet our clients needs and assume credit risk. Revenues generated from certain portfolios are reported net of interchange, as required by EITF 99-19, where we may not have credit risk, or the ultimate responsibility for the merchant accounts.

This amount includes interchange paid to card issuing banks and assessments paid to credit card associations pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants.



Merchant Deposits and Loss Reserves



We follow the Financial Accounting Standards Board Interpretation No. 45: Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45), which requires all guarantees to be recorded at their fair value at inception. We believe our potential liability for the full amount of the operating losses discussed above is a guarantee under FIN 45. We estimate the fair value of these guarantees by adding a fair value margin to our estimate of losses. This estimate of losses is comprised of known losses and a projection of future losses based on a percentage of direct merchant credit card and debit card sales volumes processed.  Disputes between a cardholder and a merchant periodically arise due to the cardholders dissatisfaction with merchandise quality or the merchants service, and the disputes may not always be
resolved in the merchants favor. In some of these cases, the transaction is charged back to the merchant and the purchase price is refunded to the cardholder by the credit card-issuing institution. If the merchant is unable to fund the refund, we are liable for the full amount of the transaction. We maintain deposits from certain merchants as an offset to potential contingent liabilities that are the responsibility of such merchants. At December 31, 2006 and 2005, we held merchant deposits totaling $266,000 and $86,000, respectively. Additionally, we have a recovery team that is responsible for collecting charge backs. Our company evaluates its ultimate risk and records an estimate of potential loss for chargebacks related to merchant fraud based upon an assessment of actual historical fraud loss rates compared to recent processing volume levels. We believe that the liability recorded as loss reserves approximates fair value. At December 31,
2006 and 2005, our loss reserve totaled $82,000 and $0 respectively.

Deferred Customer Acquisition Costs

  Deferred
    customer acquisition costs consist of up-front signing bonus payments made
    to sales personnel (our sales force), and cash payments made to external vendors
    resulting in the establishment of new merchant relationships. Deferred acquisition
    costs represent incremental, direct customer acquisition costs that are recoverable
    through future operations, contractual minimums, and/or penalties in the case
    of early termination. The deferred customer acquisition costs are amortized
    over the three-year term of the contract the merchant enters into with us.
    In the event the customer cancels the contract or ceases operations, we expense
    the un-amortized balance of deferred acquisition costs. Generally, the acceleration
    or expensing of any unamortized deferred acquisition cost is offset by a termination
    fee the company charges the customer for opting out of their contractual obligation.

Management evaluates the deferred customer acquisition costs for impairment at each balance sheet date by comparing, on a pooled basis by vintage quarter of origination, the active accounts against the original boarded accounts in relationship to the carrying amount of the deferred customer acquisition costs. Our deferred customer acquisition cost was approximately $450,000 and $435,000 as of December 31, 2006 and December 31, 2005, respectively.



Accounting for Goodwill and Intangible Assets

In July 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible Assets (SFAS 142), which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment. Intangible assets determined to have definitive lives will continue to be amortized



34



over their useful lives. Goodwill and intangible assets acquired after June 30, 2001 were subject immediately to the non-amortization and amortization provisions of this Statement.

For the years 2005 and 2006, we applied Statement No. 142 to our merchant portfolios and residual rights purchases and revised our estimated life of our merchant portfolios. We estimate for accounting purposes the useful life to be seven years. The amortization expense represents a recognition and estimated allocation of the initial cost of the acquired merchant portfolios and residual rights as a non-cash expense against the income generated by these assets.

We have intangible assets, which consist primarily of customer relationships and are recorded in connection with acquisitions at their fair value based on the net present value of the customer relationship. Customer relationships are amortized over their estimated useful lives using a straight line basis which takes into consideration expected customer attrition rates over a seven year period. Intangible assets with estimated useful lives are reviewed for impairment in accordance with SFAS No. 144, while intangible assets that are determined to have indefinite lives are reviewed for impairment at least annually in accordance with SFAS No. 142.



Share-Based Payments

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R). This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123, which had allowed companies to choose between expensing stock options and showing pro forma disclosure only. This standard is effective as of January 2006 and will apply to all awards granted, modified, cancelled or repurchased after that date, as well as the unvested portion of prior awards. SFAS No. 123R permits public companies to adopt its requirements using one of three methods: the modified prospective method, the modified retrospective method to January 1, 2005, or the modified retrospective method to all prior years for which SFAS No. 123 was effective. We elected to adopt the modified prospective method described in FAS 123R which specifies that
compensation expense for options granted prior to the effective date be recognized in the consolidated statement of income over the remaining vesting period of those options, and that compensation expense for options granted subsequent to the effective date be recognized in the consolidated statement of income over the vesting period of those options. In addition, in accordance with the implementation of the modified prospective method, prior period amounts have not been restated.

As permitted by SFAS No. 123, prior to January 1, 2006, we followed APB Opinion No. 25, which accounts for share-based payments to employees using the intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123R fair value method had  an impact on our consolidated results of operations, although it had no impact on our cash flows. The impact of the adoption of SFAS No. 123R for the twelve months ended December 31, 2006 was to increase compensation expense of approximately $253,000 with corresponding tax benefits of $86,000, resulting in a net reduction of earnings of $167,000. We made the decision to accelerate the vesting of outstanding stock options during the quarter ended March 31, 2006 and in so doing opted to recognize the cost of stock options.

Income Taxes

We recognize deferred income tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and expected benefits of utilizing net operating loss and credit carry forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The impact on deferred income taxes of changes in tax rates and laws, if any, are reflected in the consolidated and combined financial statements in the period enacted.

Earnings per share

Basic earnings per share is computed by dividing reported earnings available to common shareholders by the weighted average shares outstanding during the period. Earnings available to common shareholders are the same as reported net income for all periods presented.

Diluted earnings per share is computed by dividing reported earnings available to common shareholders by the weighted average shares outstanding during the period and the impact of securities that, if exercised, would have a dilutive effect on earnings per share. All options with an exercise price less than theaverage market shareprice for the period generally are



35



assumed to have a dilutive effect on earnings per share. The dilutive effect of stock options and restricted share grants was 0 and $3,638,592 for the twelve months ended December 31, 2006 and 2005, respectively.




Year Ended December 31,2006
        
        
        2005Basic and diluted net earnings(loss)
        
        $
        (2,285,815
        )
        $
        368,757Weighted average shares outstanding  basic
        
        
        44,324,014
        
        
        27,909,673Plus: Common stock equivalent shares assumed from conversion of options
        
        
        N/A
        
        
        1,402,410Weighted average shares outstanding  diluted
        
        
        N/A
        
        
        29,312,083Basic net earnings(loss) per share
        
        $
        (0.05
        )
        $
        0.01Diluted net earnings per share
        
        
        N/A
        
        $
        0.01





36



Results of Operations

Year Ended December31, 2006 Compared to Year Ended December31, 2005

The following table shows certain income statement data as a percentage of revenue for the year ended December 31, 2006 compared to the year ended December 31, 2005 (in thousands of dollars):






2006
        
        %
            ofRevenue
        
        2005
        
        %
            ofRevenue
        
        Change
        
        %
            ChangeRevenue
        
        41,814
        
        100
        %
        24,098
        
        100
        %
        17,716
        
        74
        %Interchange
        
        18,543
        
        44.3
        %
        12,049
        
        50.0
        %
        6,493
        
        54
        %Other
            cost of services/goods sold
        
        8,345
        
        20.0
        %
        5,525
        
        22.9
        %
        2,820
        
        51
        %Total
            costs of services and goods sold
        
        26,888
        
        64.3
        %
        17,575
        
        72.9
        %
        9,313
        
        53
        %Gross
            profit
        
        14,926
        
        35.7
        %
        6,523
        
        27.1
        %
        8,403
        
        129
        %Salaries
            and payroll costs
        
        6,403
        
        15.3
        %
        3,677
        
        15.3
        %
        2,726
        
        74
        %Other
            selling, general and administrative
        
        3,536
        
        8.5
        %
        1,706
        
        7.1
        %
        1,830
        
        107
        %Depreciation
            and amortization
        
        2,373
        
        5.7
        %
        834
        
        3.5
        %
        1,539
        
        185
        %Total
            operating expenses
        
        12,312
        
        29.4
        %
        6,217
        
        25.8
        %
        6,095
        
        50
        %Operating
            income
        
        2,614
        
        6.3
        %
        306
        
        1.3
        %
        2,308
        
        753
        %Other
            income (expense)
        
        (6,739
        )
        -16.1
        %
        (717
        )
        -3.0
        %
        (6,022
        )
        839
        %Earnings
            before income taxes
        
        (4,125
        )
        -9.9
        %
        (411
        )
        -1.7
        %
        (3,714
        )
        904
        %Provision
            for income taxes
        
        (1,839
        )
        -4.4
        %
        (780
        )
        -3.2
        %
        (1,059
        )
        -36
        %Net earnings (loss)
        
        (2,286
        )
        -5.5
        %
        369
        
        1.5
        %
        (2,655
        )
        -720
        %








37



Comparisons of year ended December 31, 2006 and December 31, 2005



Revenues

  Revenues
    increased $17.7 million or 73.5% to $41.8 million for the year ended December
    31, 2006 from $24.1 million for the year ended December 31, 2005. This increase
    was primarily attributable to a combination of internal sales and marketing
    efforts, the purchase of selective merchant account portfolios and the successful
    integration of Charge.com, Aircharge, Valadata and Paynet.
  Interchange
    Expenses
  Interchange
    expenses increased $6.5 million or 54% to $18.5 million for the year ended
    December 31, 2006 from $12.0 million for the year ended December 31, 2005.
    The increase was primarily attributable to an 83% increase in processing volume
    to $1.3 billion for the year ended December 31, 2006 and charge volume from
    our merchant account portfolio acquisitions.

Other costs of goods and services sold

Other costs of goods and services sold increased $2.8 million or 51% to $8.3 million for the year ended December 31, 2006 as compared to $5.5 million for the year ended December 31, 2005.

Gross Profit

Gross profitincreased $8.4 million or 128% to $14.9 million for the year ended December 31, 2006 from $6.5 million for the year ended December 31, 2005.  Gross margin expanded from 27.1% to 35.7% in the same period.

Operating Expenses

Total operating expenses increased $6.1 million or 98% to $12.3 million for the year ended December 31, 2006 from $6.2 million for the year ended December 31, 2005. The increase in operating expense is attributable to the increase in personnel, sales and marketing and depreciation and amortization of assets. The major components of operating expense include;



        Salaries and payroll related costs increased $2.7 million or 74% to $6.4 million for the year ended December 31, 2006 as compared to $3.7 million for the year ended December 31, 2005. The increase was due primarily to the expansion of our sales and marketing efforts, which included additional personnel and the resulting expenses related to managing higher processing volume.




        Sales,
            general and administrative expenses increased $1.8 million or 107%
            to $3.5 million for the year ended December 31, 2006 as compared to
            $1.7 million for the year ended December 31, 2005. The increase was
            due primarily to the acceleration of our advertising and marketing
            efforts, as we began a robust national advertising campaign in the
            third quarter of 2006. There had been minimal advertising expense
            in 2005. Another variable influencing the increase in general and
            administrative costs is the expansion of our facilities in the fourth
            quarter of 2006.




        Depreciation and amortization increased $1.5 million or 185% to $2.4 million for the year ended December 31, 2006 as compared to $0.8 million for the year ended December 31, 2005. The increase was mainly attributable to the amortization and depreciation of assets acquired in the Charge.com, Aircharge, Paynet and Valadata acquisitions plus the amortization of acquired portfolios.


Operating Income

Operating income increased $2.3 million or 753% to $2.6 million for the year December 31, 2006 from $0.3 million for the year ended December 31, 2005. Operating income as a percentage of gross revenue was 6.3% for the year December 31, 2006 as compared to 1.3% for the year ended December 31, 2005.

Other Expenses

Other expenses increased $6.0 million to $6.7 million for the year December 31, 2006 from $0.7 million for the year ended December 31, 2005. Other expenses primarily consisted of $6.9 million related to interest expense and the cost associated with the early retirement of debt for the year ended December 31, 2006. The cost associated with early retirement of debt was



38



$2.1 million, of which $1.9 million was a cash payment for the pre-payment of an 18% interest bearing note. The remaining $4.7 million was interest expense related to the companys various notes payable, which included cash interest of $3.1 million and $1.6 million of amortization of debt issuance costs and the beneficial conversion feature.

Income Tax

Income tax benefit increased to $1.8 million for the year ended December 31, 2006 from a tax benefit of $0.8 for the year-ended December 31, 2005. The increase was primarily due to changes in net deferred tax assets and deferred tax liability balances as of the end of the year. The decrease in income before income taxes  is due in part to the increase in other expenses as outlined above.

Net income

As a result of the above factors, net income decreased from $370,000 in 2005 to $(2.3) million in 2006.



Balance Sheet Information




December 31,2006
        
        2005Selected Balance Sheet Data
        
        (in thousands)Cash and cash equivalents
        
        $
        2,770
        
        $
        2,255Other current assets
        
        
        3,675
        
        
        1,962Fixed assets
        
        
        1,117
        
        
        667Goodwill
        
        
        38,822
        
        
        24,557Intangible assets
        
        
        15,586
        
        
        9,856Other assets
        
        
        3,054
        
        
        2,591Total assets
        
        $
        65,024
        
        $
        41,888Accounts payable and other current liabilities
        
        $
        2,513
        
        $
        16,956Long term debt and notes payable
        
        
        31,914
        
        
        2,382Total liabilities
        
        
        34,427
        
        
        19,138Total stockholders equity
        
        
        30,597
        
        
        22,550Total liabilities and stockholders equity
        
        $
        65,024
        
        $
        41,888





December31, 2006 Compared to December31, 2005

  Total
    assets increased $23.1 million or 55.2% to $65.0 million at December 31,
    2006 from $41.9 million at December 31, 2005. The increase was primarily
    attributable to increases in goodwill and the merchant portfolio acquisitions
    of Paynet and Valadata. Additionally, receivables, deferred acquisition and
    financing costs, restricted cash, and property and equipment expanded commensurate
    with business growth. Cash and cash equivalents increased by $0.5 million
    or 22.8%, as the result of cash flow from operations and financing was greater
    than investing activities

Receivables, which primarily result from our practice of advancing interchange and processing fees to most of our merchants during the processing month and collecting those fees from our merchants at the beginning of the following month, as well as recognizing other revenue on an accrual basis and collecting the funds in the ensuing periods, increased $1.5 million, or 99.4%, to $3.0 million at December 31, 2006 from $1.5 million at December 31, 2005. The increase in receivables from merchants was primarily due to the impact of an increase in December 2006 monthly bank card processing volume and other customer revenue recognition accruals compared with December 2005 monthly bank card processing volume and other customer revenue recognition accruals. The increase is a function  of processing and billing more merchants, as well as increasing our bankcard processing volume. We expect to collect a net
amount of approximately $1.3 million of the $3.0 million receivables balance during January 2007.



39



Property and equipment increased $450,000, or 67.5%, due to the continued build-out of our technology infrastructure, primarily for the hardware and software required for the expansion of the companys core operating platform and secure payment gateway.  Additional expenditures in plant, property and equipment were made towards the build-out of our Quincy sales office and Georgia operations.

Goodwill and merchant portfolios increased $14.3 million and $5.7 million, respectively or 58.1% and 57.8%, which reflects the result of our acquisition of Paynet and Valadata, as well as other small merchant portfolios.

Total liabilities increased $15.3 million or 79.9% to $34.4 million at December 31, 2006 from $19.1 million at December 31, 2005. The rise was primarily due to increases in notes payable, as we adopted a $37.0 million convertible note to refinance a $15.6 million short- term note and provide the financing for the Valadata and Paynet acquisitions. Additionally, our companys net deferred tax liability increased from a net asset position of $0.8 million to a net liability position of $3.6 million, an overall increase of $4.4 million. These tax liabilities reflect estimated tax payments that we expect to incur in the future resulting from the consequences of events that have been included in the financial statements or tax returns. These include a $3.7 million liability associated with the amortization of the warrants and beneficial conversion feature attached to the $37.0 million convertible
note and another $2.2 million associated with the amount of depreciation and amortization that we deduct in our financial statements compared to the amount that we can deduct on tax returns.

Total stockholders equity increased $8.0 million from December 31, 2005, primarily due to the issuance of stock for mergers and acquisitions, and additional paid-in capital totaling $10.7 million, related to the issuance of warrants and the beneficial conversion feature associated with the $37.0 million note convertible, less an allowance of $4.2 million for a future tax liability.

Effects of Inflation

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

Liquidity and Capital Resources




Year endedDecember31,2006
        2005Selected Statement of Cash Flows Data
        
        (in thousands)Cash flow from operations
        
        $2,035
        $817Cash flow from investing activities
        
        (18,833)
        (11,055)Cash flow financing activities
        
        17,313
        11,798Total change in cash
        
        516
        1,561Cash balance, year end
        
        $2,771
        $2,254



At December 31, 2006, we had a cash balance of $2.8 million compared to $2.3 million at December 31, 2005. We expect cash flow from operations over the next twelve months will be sufficient to fund operating and debt obligations.

In accordance with our external growth strategy, we have identified the small to medium-sized merchant segment of the payment processing market as one containing possible acquisition targets for us. This business segment is serviced by many independent service organizations that lack the resources to generate sufficient scale in this underserved market. We believe opportunities exist for us to purchase these businesses or their portfolios when, among other things, their resources begin to limit their ability to continue to grow independently.



Our cash requirements include cost of revenues, selling, general and administrative expenses, income taxes, debt service payments, capital expenditures, systems development and business and portfolio acquisitions. Our principal sources of funds are cash generated by operations and borrowings.



40



Cash Flow Provided by (Used by) Operating Activities

Net cash provided by operating activities was $2.0 million for the year ended December 31, 2006, an increase of $1.2 million from $817,000 for the year ended December 31, 2005. Cash interest expense consumed $2.7 million for the year ended December 31, 2006, an increase of $1.9 million from $793,000 for the year ended December 31, 2005. Additionally, a use of cash of $631,000 resulted from changes in net operating assets and liabilities . The figure reflects the growth of the business and the working capital necessary to support the changes in receivables, inventory, advances and pre-paid expenses, accounts payable and accrued expenses.

Cash Flow Provided by (Used by) Investing Activities

Net cash used in investing activities was $18.8 million for the year ended December 31, 2006 as compared to $11.1 million for the year ended December 31, 2005.  The majority of the funds used in investing activities, totaling $15.7 million, were used for the acquisition of Paynet Systems and Valadata, as well as an additional $2.0 million for selective portfolio purchases.

Total capital expenditures for 2006 were $592,000 compared to $390,000 invested in 2005. These expenditures were primarily related to the continued build-out of our technology infrastructure. We anticipate that these expenditures may increase as we further develop our technology.

Cash Flow Provided by (Used by)Financing Activities

Net cash provided by financing activities was $17.3 million for the year ended December 31, 2006 as compared to $11.8 million for the year ended December 31, 2005.  The increase is largely attributable  to the $37.0 million convertible financing we entered into on June 29, 2006. The financing was used to retire $17.0 million of short-term debt and fund the Paynet Systems and Valadata acquisitions. An additional $1.9 million was used to fund the early retirement of these short-term notes.

Off-Balance Sheet Arrangements

We have not entered into any transactions with third- parties or unconsolidated entities whereby we have financial guarantees, subordinated retained interest, derivative instruments, or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or other obligations.



[remainder of page intentionally left blank]



41



New accounting pronouncements



In February 2006, the FASB issued SFAS No. 155. Accounting for certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140, or SFAS No. 155. SFAS No. 155 permits fair value remeasurement for any hybrid financial  instrument that contains an embedded derivative that otherwise would require  bifurcation,  clarifies which  interest-only  strips and principal-only strips are not subject to the  requirements of Statement No. 133,  establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on a
qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS 155 to have a material impact on our consolidated financial position, results of operations or cash flows.



In March 2006, the FASB issued FASB Statement No. 156, Accounting for Servicing of Financial Assets - an amendment to FASB Statement No. 140. Statement 156 requires that an entity recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a service contract under certain situations. The new standard is effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No.156 did not have a material impact on our financial position and results of operations.



In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in a companys financial statements and establishes guidelines for recognition and measurement of a tax position taken or expected to be taken in a tax return. We are currently evaluating the impact of this standard on our consolidated financial statements , which will become effective on June 1, 2007.



In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. We are currently evaluating the impact on our consolidated financial statements of FAS 157, which will become effective for us on June 1, 2008.



In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R), which will require employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. Under past accounting standards, the funded status of an employers postretirement benefit plan (i.e., the difference between the plan assets and obligations) was not always completely reported in the balance sheet. Past standards only required an employer to disclose the complete funded status of its plans in the notes to the financial statements. SFAS No. 158 applies to plan sponsors that are public and private companies and nongovernmental not-for-profit organizations. The requirement to recognize
the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, for entities with publicly traded equity securities, and at the end of the fiscal year ending after June 15, 2007, for all other entities. The requirement to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We do not expect that the adoption of SFAS No. 158 will have a significant impact on our consolidated results of operations or financial position.



42



**Item
    7****. Financial Statements. Following pages 43 - 69**
  ****

PART I





ITEM 1. FINANCIAL STATEMENTS





The consolidated financial statements included herein have been prepared By the Company, pursuant to the rules and regulations of the Securities and Exchange Commission.





In the opinion of the Company, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the financial position of the Company as of December 31, 2006, and the results of its operations and changes in its financial position from January 1, 2006, through December 31, 2006 have been made.









43



INDEX TO FINANCIAL STATEMENTS






Part 1 - Financial InformationPageItem 1 - Financial StatementsBalance Sheets as of December 31, 2006 and 2005
        46Statements of Operations for the years ended December 31, 2006 and 2005
        47Statements of Stockholders Equity for the years ended December 31, 2006 and 2005
        48Statements of Cash Flows for the years ended December 31, 2006 and 2005
        49Notes to Financial Statements
        50 - 69







44



DRAKEFORD & DRAKEFORD, LLC

NEW YORK,  NEW YORK







REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To  the  Shareholders  and  Directors  of

Pipeline Data Inc.



We have audited the consolidated balance sheet of Pipeline Data Inc. as of December 31,2006 and the related consolidated statements of operations, changes in stockholders equity, and  cash flows for the years ended December 31, 2006 and 2005. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. Also, an audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pipeline Data Inc., as of December 31, 2006 and the consolidated results of its operations and its cash flows for the two years then ended, in conformity with accounting principles generally accepted in the United States of America.







/S/Drakeford & Drakeford, LLC

New York, New York



March 27, 2007



45



PIPELINE DATA INC.

CONSOLIDATED BALANCE SHEETS




December  31,ASSETS
        
        2006
        
        2005CURRENT ASSETSCash and cash equivalents
        
        $
        2,770,494
        
        $
        2,254,664Accounts receivable, net
        
        
        3,028,719
        
        
        1,518,830Interest receivable
        
        
        7,778
        
        
        57,214Inventory
        
        
        95,184
        
        
        71,689Advances and prepaid expenses
        
        
        243,125
        
        
        139,322Note receivable
        
        
        300,000
        
        
        175,000Total current assets
        
        
        6,445,300
        
        
        4,216,719PROPERTY AND EQUIPMENT, net
        
        
        1,117,380
        
        
        666,514OTHER ASSETSRestricted cash
        
        
        564,575
        
        
        75,489Merchant portfolio, residual rights and other intangibles
        
        
        15,585,602
        
        
        9,855,679Deferred acquisition and debt issuance costs
        
        
        1,748,814
        
        
        932,938Notes receivable, net
        
        
        693,792
        
        
        750,000Deposits
        
        
        46,991
        
        
        53,521Deferred tax assets, net
        
        
        0
        
        
        780,138Goodwill
        
        
        38,821,893
        
        
        24,556,638Total other assets
        
        
        57,461,667
        
        
        37,004,403TOTAL ASSETS
        
        $
        65,024,347
        
        $
        41,887,636LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable and accrued expenses
        
        $
        2,104,939
        
        $
        1,320,334Lease obligations-equipment
        
        
        60,765
        
        
        35,376Notes payable
        
        
        0
        
        
        15,600,000Merchant deposits and loss reserve
        
        
        347,670
        
        
        0Total current liabilities
        
        
        2,513,374
        
        
        16,955,710LONG-TERM LIABILITIESNotes payable-senior secured convertible
        
        
        27,695,571
        
        
        1,400,000Notes payable-World Products shareholders
        
        
        525,000
        
        
        525,000Lease obligations-equipment
        
        
        53,443
        
        
        134,330Notes payable  current 8%
        
        
        0
        
        
        322,734Deferred tax liability, net
        
        
        3,640,109
        
        
        0Total long-term liabilities
        
        
        31,914,123
        
        
        2,382,064STOCKHOLDERS EQUITYPreferred stock, $.001 par value: 5,000,000 shares authorized,no shares issued or outstanding at December 31, 2006Common stock,  $.001 par value: 150,000,000 shares authorized,47,986,137 and 38,594,070 shares issued and outstanding at December 31, 2006and December 31, 2005, respectively
        
        
        48,016
        
        
        38,594Common stock subscribed
        
        
        0
        
        
        5,780,207Additional paid-in capital
        
        
        35,041,816
        
        
        18,900,948Retained earnings (deficit)
        
        
        (4,455,722
        )
        
        (2,169,887
        )Less: 30,000 shares of treasury stock, at cost
        
        
        (37,260
        )
        
        0Total stockholders equity
        
        
        30,596,850
        
        
        22,549,862TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
        
        $
        65,024,347
        
        $
        41,887,636

The accompanying notes are an integral part of these statements.



46



PIPELINE DATA INC.



CONSOLIDATED STATEMENTS OF OPERATIONS




Year Ended December 31,2006
        
        
        2005Revenue
        
        $
        41,813,817
        
        $
        24,097,575Interchange
        
        
        18,542,700
        
        
        12,049,353Cost of services sold
        
        
        7,971,977
        
        
        5,377,176Cost of goods sold
        
        
        373,408
        
        
        148,076Total cost of goods and services sold
        
        
        26,888,085
        
        
        17,574,605Gross profit
        
        
        14,925,732
        
        
        6,522,970Operating expensesSalaries and payroll cost
        
        
        6,403,301
        
        
        3,676,989Selling, general and administrative
        
        
        3,536,088
        
        
        1,705,680Depreciation and amortization
        
        
        2,372,503
        
        
        833,964Total operating expenses
        
        
        12,311,892
        
        
        6,216,633Income from operations
        
        
        2,613,840
        
        
        306,337Other income and expensesInterest and other income
        
        
        121,540
        
        
        75,375Interest expense
        
        
        (4,720,526
        )
        
        (792,788
        )Loss on early retirement of debt
        
        
        (2,140,107
        )
        
        0Total other income (expenses)
        
        
        (6,739,093
        )
        
        (717,413
        )(Loss) before income taxes
        
        
        (4,125,253
        )
        
        (411,076
        )Provision for income taxes
        
        
        (1,839,438
        )
        
        (779,833
        )Net income (loss)
        
        $
        (2,285,815
        )
        $
        368,757Basic and diluted earnings (loss) per common share:Earnings (loss) per shareBasic
        
        $
        (0.05
        )
        $
        0.01Diluted
        
        
        N/A
        
        $
        0.01Weighted average number of shares outstanding:Basic
        
        
        44,324,014
        
        
        27,909,673Diluted
        
        
        N/A
        
        
        29,312,083



  The
    accompanying notes are an integral part of these statements.


47



PIPELINE DATA INC.



CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY




Additional

    

    

    

    

    

    

    

    

    StockholdersCommon Stock

    

    

    Paidin

    

    

    Accumulated

    

    

    Treasury

    

    

    EquityShares

    

    

    Amount

    

    

    Capital

    

    

    Deficit

    

    

    StockBalance at December 31, 2004

    

    26,102,022

    

    

    26,101

    

    

    8,033,837

    

    

    (2,538,664

    )

    

    

    

    

    5,521,274Common stock subscribed

    

    5,780,207Issuance of common stock for interest andconversion of principal on Laurus debt

    

    199,880

    

    

    200

    

    

    199,680

    

    

    

    

    

    

    

    

    199,880Conversion of 8% convertible notes and interest tocommon stock

    

    828,571

    

    

    828

    

    

    289,171

    

    

    

    

    

    

    

    

    289,999Exercise of warrants

    

    342,857

    

    

    343

    

    

    121,342

    

    

    

    

    

    

    

    

    121,685Issuance of common stock for services

    

    297,332

    

    

    297

    

    

    78,420

    

    

    

    

    

    

    

    

    78,717Issuance of common stock for employmentagreements/unvested stock bonus

    

    153,340

    

    

    153

    

    

    186,600

    

    

    

    

    

    

    

    

    186,753Conversion of stock options

    

    308,000

    

    

    308

    

    

    (308

    )

    

    

    

    

    

    

    

    0Acquisitions/Mergers

    

    10,362,068

    

    

    10,364

    

    

    9,992,226

    

    

    

    

    

    

    

    

    10,002,590Net income for the year ended December 31, 2005

    

    

    

    

    

    

    

    

    

    

    368,757

    

    

    

    

    

    368,757Balance at December 31, 2005

    

    38,594,070

    

    $

    38,594

    

    $

    18,900,968

    

    $

    (2,169,907

    )

    $

    0

    

    $

    22,549,862Common stock previously subscribed

    

    5,999,628

    

    

    6,000

    

    

    5,774,207Common stock for services

    

    128,574

    

    

    129

    

    

    374,497

    

    

    

    

    

    

    

    

    374,626Vesting of options granted to employees

    

    

    

    

    

    

    

    282,979

    

    

    

    

    

    

    

    

    282,979Vesting of options granted to outside consultant

    

    

    

    

    

    

    

    7,574

    

    

    

    

    

    

    

    

    7,574Exercise of stock options

    

    356,098

    

    

    356

    

    

    37,541

    

    

    

    

    

    

    

    

    37,897Exercise of warrants

    

    674,281

    

    

    674

    

    

    708,369

    

    

    

    

    

    

    

    

    709,043Conversion of 8% convertible notes

    

    485,742

    

    

    485

    

    

    322,248

    

    

    

    

    

    

    

    

    322,733Interest on 8% convertible notes

    

    111,077

    

    

    111

    

    

    84,860

    

    

    

    

    

    

    

    

    84,971Fair value of warrants issued with convertible debt

    

    

    

    

    

    

    

    4,329,000

    

    

    

    

    

    

    

    

    4,329,000Fair value of warrants issued foradvisory/underwriting fee

    

    

    

    

    

    

    

    437,500

    

    

    

    

    

    

    

    

    437,500Beneficial conversion feature on convertible debt

    

    

    

    

    

    

    

    5,803,863

    

    

    

    

    

    

    

    

    5,803,863Deferred tax liability on beneficial conversionfeature and warrants

    

    

    

    

    

    

    

    (4,260,123

    )

    

    

    

    

    

    

    

    (4,260,123

    )Acquisitions/Mergers

    

    1,666,667

    

    

    1,667

    

    

    2,238,333

    

    

    

    

    

    

    

    

    2,240,000Purchase of treasury stock

    

    (30,000

    )

    

    

    

    

    

    

    

    

    

    

    (37,260

    )

    

    (37,260

    )Net loss for the year December 31, 2006

    

    

    

    

    

    

    

    

    

    

    (2,285,815

    )

    

    

    

    

    (2,285,815

    )Balance at December 31, 2006

    

    47,986,137

    

    $

    48,016

    

    $

    35,041,816

    

    $

    (4,455,722

    )

    $

    (37,260

    )

    $

    30,596,850



The accompanying notes are an integral part of these statements.



48



PIPELINE DATA INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS




Year
        Ended December 31,2006
    
    2005OPERATING
        ACTIVITIES:Net
        Income (loss)
    
    $
    (2,285,815
    )
    $
    368,757Adjustments
        for noncash and nonoperating items:Depreciation
        and amortization
    
    
    2,372,504
    
    
    833,964Loss
        on early retirement of debt
    
    
    2,140,107
    
    
    0Stock
        based compensation
    
    
    423,250
    
    
    728,967Common
        stock for services and other
    
    
    272,876
    
    
    179,097Amortization
        of debt issuance cost and discount onlong
        term debt
    
    
    1,582,451
    
    
    414,176Deferred
        taxes, net
    
    
    (1,839,438
    )
    
    (780,138
    )Changes
        in operating assets and liabilities:Receivables
    
    
    (1,436,105
    )
    
    (508,718
    )Note
        receivable
    
    
    57,214
    
    
    (35,630
    )Inventory
    
    
    (23,495
    )
    
    (31,602
    )Advances
        and prepaid expenses
    
    
    (99,686
    )
    
    13,775Deposits
        and restricted cash
    
    
    (127,799
    )
    
    (97,141
    )Accounts
        payable and accrued expenses
    
    
    999,139
    
    
    (253,129
    )Income
        taxes payable
    
    
    0
    
    
    (15,547
    )Cash
        provided by operating activities
    
    
    2,035,203
    
    
    816,831INVESTING
        ACTIVITIES:Capital
        expenditures
    
    
    (592,055
    )
    
    (389,952
    )Merchant
        portfolio and residual rights purchase
    
    
    (2,027,223
    )
    
    (4,139,436
    )Note
        receivable
    
    
    (140,900
    )
    
    (273,453
    )Acquisitions
        of businesses
    
    
    (15,717,318
    )
    
    (8,262,900
    )Change
        in restricted cash
    
    
    (355,795
    )
    
    2,011,022Cash
        used by investing activities
    
    
    (18,833,291
    )
    
    (11,054,719
    )FINANCING
        ACTIVITIES:Proceeds
        from lease financing
    
    
    0
    
    
    129,059Proceeds
        from notes payable
    
    
    0
    
    
    17,525,000Proceeds
        from senior secured convertible notes, net
    
    
    26,349,693
    
    
    0Warrants
        and beneficial conversion feature
    
    
    10,650,307
    
    
    0Debt
        issuance cost
    
    
    (1,477,060
    )
    
    (231,692
    )Debt
        service payments
    
    
    (17,000,000
    )
    
    (5,711,187
    )Loss
        on early retirement of debt
    
    
    (1,863,000
    )
    
    0Warrant
        and stock option exercise
    
    
    746,735
    
    
    124,356Purchase
        of treasury stock
    
    
    (37,260
    )
    
    0Lease
        obligation payments and loan payments
    
    
    (55,497
    )
    
    (36,836
    )Cash
        provided by financing activities
    
    
    17,313,918
    
    
    11,798,700NET
        INCREASE IN CASH
    
    
    515,830
    
    
    1,560,812CASH
        BALANCE BEGINNING OF PERIOD
    
    
    2,254,664
    
    
    693,852CASH
        BALANCE END OF PERIOD
    
    $
    2,770,494
    
    $
    2,254,664Supplemental
        Disclosures:Cash
        paid during the year for:Interest
    
    $
    2,678,740
    
    $
    792,788Income
        taxes
    
    $
    0
    
    $
    0



  The
    accompanying notes are an integral part of these statements.



49



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE A  ORGANIZATION AND OPERATIONS



Nature of Operations



Pipeline Data Inc. (the Company), was incorporated in June 1997 in the state of Delaware. We are an integrated provider of merchant payment processing services and related software products throughout the United States. We deliver credit and debit card-based payment processing solutions primarily to small to medium-sized merchants who operate either in a physical business environment, over the Internet, or in mobile or wireless settings via cellular-based wireless devices that the Company sells.

Basis of Financial Statement Presentation

The accompanying consolidated financial statements include those of Pipeline Data, Inc. (the Company) and its subsidiaries. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. All intercompany balances and transactions with the Companys subsidiaries have been eliminated upon consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates include, among other things, capitalized customer acquisition costs, loss reserves, certain accounts payable and accrued expenses, certain tax assets and liabilities, and convertible debt. On an ongoing basis, we evaluate our estimates. Actual results could differ from those estimates.

Concentrations

The majority of the Companys merchant processing activity has been processed by two key vendors. The Company believes that these vendors maintain appropriate backup systems and alternative arrangements to avoid a significant disruption of processing in the event of an unforeseen event.

Substantially all of the Companys revenue is derived from processing Visa and MasterCard bank card transactions. Because the Company is not a member bank as defined by Visa and MasterCard, in order to process these bank card transactions the Company has entered into  sponsorship agreements with banks that are member banks and paid applicable fees.. The agreements with the bank sponsors require, among other things, that the Company abide by the by-laws and regulations of the Visa and MasterCard associations.



50



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



We believe the following critical accounting policies and the related judgments and estimates affect the preparation of our consolidated financial statements.

Cash and Cash Equivalents

For purposes of reporting cash flows, highly liquid instruments purchased with original maturities of three months or less are considered cash equivalents. The carrying amounts reported in the Consolidated Balance Sheets for these instruments approximate their fair value.

Restricted Cash



Cash held on deposit to cover potential merchant losses or cash set aside for contractual obligations is classified as Restricted Cash on the Consolidated Balance Sheets. Additional restricted cash is also set aside by the Company per the contractual obligation with the former owners of Valadata requiring the Company to escrow funds in the event the acquired entity meets earn-out thresholds through July 11, 2008.



Inventories



Inventories consist of point-of-sale terminal equipment held for sale to merchants, resellers and distributors. Inventories are valued at the lower of cost or market price. Cost is arrived at using the first-in, first-out method. Market price is estimated based on current sales of equipment.



Accounts Receivable, net



The Company uses the allowance method to account for uncollectible accounts receivable. We maintain allowances for the estimated losses from doubtful accounts which result when our customers are unable to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would result in an additional general and administrative expense in the period such determination was made. Accounts receivable are presented net of an allowance for doubtful accounts of $65,791 as of December 31, 2006 and $123,251 as of December 31, 2005.



Notes Receivable



The Company has two demand notes aggregating $300,000 at the simple rate of 10-18% per annum and a long term secured promissory note, due February 1, 2008, with a balance, net of discount of $693,792. The face amount of the note is $739,900. Interest is imputed at the rate of 6%. The note is  secured by 1,000,000 shares of the Companys common stock



Property and Equipment, net



Property and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method for financial reporting purposes and primarily accelerated methods for tax purposes. For financial reporting purposes, equipment is depreciated over five to seven years. Leasehold improvements and property acquired under capital leases are amortized over the useful life of the asset or the lease term, whichever is shorter. Depreciation expenses for property and equipment for the years ended December 31, 2006 and 2005 was $ 141,189 and $ 88,266, respectively.Repairs and maintenance are expensed as incurred. Expenditures that increase the value or productive capacity of assets are capitalized.



51
PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Revenue and Cost Recognition

We derive revenues primarily from the electronic processing of credit, charge and debit card transactions that are authorized and captured through third-party networks. Typically, merchants are charged for these processing services based on a percentage of the dollar amount of each transaction and in some instances, additional fees are charged for each transaction. Certain merchant customers are charged a flat fee transaction and may also be charged miscellaneous fees, including fees for handling chargebacks, monthly minimums, equipment rentals, sales or leasing and other miscellaneous services. Revenues are reported gross of amounts paid to sponsor banks as well as interchange and assessments paid to credit card associations (MasterCard and Visa) under revenue sharing agreements pursuant to which such parties receive payments based primarily on processing volume for particular groups of
merchants. Included in cost of goods and services sold are the expenses covering interchange and bank processing directly attributable to the furnishing of transaction processing and other services to our merchant customers and are recognized simultaneously with the recognition of revenue.

We follow the requirements of EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining our revenue reporting. Generally, we report revenues at the time of sale on a gross basis where we are the primary obligor in the arrangement, have latitude in establishing the price of the services, change the product and perform part of the service, have discretion in supplier selection, have latitude in determining the product and service specifications to meet our clients needs and assume credit risk. Revenues generated from certain portfolios are reported net of interchange, as required by EITF 99-19, where we may not have credit risk, or the ultimate responsibility for the merchant accounts.

This amount includes interchange paid to card issuing banks and assessments paid to credit card associations pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants.



Merchant Deposits and Loss Reserves



The Company follows the Financial Accounting Standards Board Interpretation No. 45: Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45) requires all guarantees be recorded at their fair value at inception. We believe our potential liability for the full amount of the operating losses discussed above is a guarantee under FIN 45. We estimate the fair value of these guarantees by adding a fair value margin to our estimate of losses. This estimate of losses is comprised of known losses and a projection of future losses based on a percentage of direct merchant credit card and debit card sales volumes processed. Disputes between a cardholder and a merchant periodically arise due to the cardholders dissatisfaction with merchandise quality or the merchants service, and the disputes may
not always be resolved in the merchants favor. In some of these cases, the transaction is charged back to the merchant and the purchase price is refunded to the cardholder by the credit card-issuing institution. If the merchant is unable to fund the refund, the Company is liable for the full amount of the transaction. The Company maintains deposits from certain merchants as an offset to potential contingent liabilities that are the responsibility of such merchants. Additionally, the Company has a recovery team that is responsible for collecting charge backs. The Company evaluates its ultimate risk and records an estimate of potential loss for chargebacks related to merchant fraud based upon an assessment of actual historical fraud loss rates compared to recent processing volume levels. The Company believes that the liability recorded as loss reserves approximates fair value.



52



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)



Deferred Customer Acquisition Costs

Deferred customer acquisition costs consist of up-front signing bonus payments made to sales personnel (the Companys sales force), and cash payments made to external vendors resulting in the establishment of new merchant relationships. Deferred acquisition costs represent incremental, direct customer acquisition costs that are recoverable through future operations, contractual minimums, and/or penalties in the case of early termination. The deferred customer acquisition costs are amortized over the three-year term of the contract the merchant enters into with the Company. In the event the customer cancels the contract or ceases operations, the Company expenses the un-amortized balance of deferred acquisition costs. Generally, the acceleration or expensing of any unamortized deferred acquisition cost is off-set by a termination fee the company charges the customer for opting out of
their contractual obligation.

Management evaluates the deferred customer acquisition costs for impairment at each balance sheet date by comparing, on a pooled basis by vintage quarter of origination the active accounts against the original boarded accounts in relationship to the carrying amount of the deferred customer acquisition costs.



Accounting for Goodwill and Intangible Assets

In July 2001, the FASB issued Statement No. 142, Goodwill and Other Intangible Assets (SFAS 142), which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings, but instead be subject to periodic testing for impairment. Intangible assets determined to have definitive lives will continue to be amortized over their useful lives. Goodwill and intangible assets acquired after June 30, 2001 were subject immediately to the non-amortization and amortization provisions of this Statement.

For the years 2005 and 2006, we applied Statement No. 142 to our merchant portfolios and residual rights purchases and revised our estimated life of our merchant portfolios. We estimate for accounting purposes the useful life to be seven years. The amortization expense represents a recognition and estimated allocation of the initial cost of the acquired merchant portfolios and residual rights as a non-cash expense against the income generated by these assets.



The Company has intangible assets which consist primarily of customer relationships and are recorded in connection with acquisitions at their fair value based the net present value of the customer relationship. Customer relationships are amortized over their estimated useful lives using a straight line basis which takes into consideration expected customer attrition rates over a seven -year period. Intangible assets with estimated useful lives are reviewed for impairment in accordance with SFAS No. 144 while intangible assets that are determined to have indefinite lives are reviewed for impairment at least annually in accordance with SFAS No. 142.



Reclassifications



The prior period presentation of certain accounts has been changed to conform to the current year presentation.





53



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)



Share-Based Payments

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R). This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123, which had allowed companies to choose between expensing stock options and showing pro forma disclosure only. This standard is effective as of January 2006 and will apply to all awards granted, modified, cancelled or repurchased after that date as well as the unvested portion of prior awards. SFAS No. 123R permits public companies to adopt its requirements using one of three methods: the modified prospective method, the modified retrospective method to January 1, 2005, or the modified retrospective method to all prior years for which SFAS No. 123 was effective. We elected to adopt the modified prospective method described in FAS 123R which
specifies that compensation expense for options granted prior to the effective date be recognized in the consolidated statement of income over the remaining vesting period of those options, and that compensation expense for options granted subsequent to the effective date be recognized in the consolidated statement of income over the vesting period of those options. In addition, in accordance with the implementation of the modified prospective method, prior period amounts have not been restated.

As permitted by SFAS No. 123, prior to January 1, 2006, we followed APB Opinion No. 25, which accounts for share-based payments to employees using the intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123R fair value method will have a significant impact on our consolidated results of operations, although it will have no impact on our cash flows. The impact of the adoption of SFAS No. 123R for the twelve months ended December 31, 2006 was to increase compensation expense of $282,979 with corresponding tax benefit of $85,870, resulting in a net reduction of earnings of $166,689. We made the decision to accelerate the vesting of outstanding stock options during the quarter ended, March 31, 2006 and in doing so recognize the remaining cost of stock options outstanding from prior years.

Computer Software

Computer software includes the fair value of software acquired in business combinations, purchased software and capitalized software development costs. Purchased software is recorded at cost and amortized using the straight-line method over a 3-5 year period and software acquired in business combinations is recorded at its fair value and amortized using straight-line method over their estimated useful lives, ranging from three to five years.

Income Taxes

The Company recognizes deferred income tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Companys assets and liabilities and expected benefits of utilizing net operating loss and credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The impact on deferred income taxes of changes in tax rates and laws, if any, are reflected in the consolidated and combined financial statements in the period enacted.



54



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(continued)



Earnings per share

Basic earnings per share is computed by dividing reported earnings available to common shareholders by the weighted average shares outstanding during the period. Earnings available to common shareholders are the same as reported net income for all periods presented.

Diluted earnings per share is computed by dividing reported earnings available to common shareholders by the weighted average shares outstanding during the period and the impact of securities that, if exercised, would have a dilutive effect on earnings per share. All options with an exercise price less than theaverage market shareprice for the period generally are assumed to have a dilutive effect on earnings per share. The dilutive effect of stock options and restricted share grants was  0 and 3,638,592 for the twelve months ended December 31, 2006 and 2005 respectively.






Year ended December 31,2006
        
        
        2005Basic and diluted net earnings
        
        $
        (2,285,815
        )
        $
        368,757Weighted average shares outstanding  basic
        
        
        44,324,014
        
        
        27,909,673Plus: Common stock equivalent shares assumedfrom conversion of options
        
        
        N/A
        
        
        1,402,410Weighted average shares outstanding  diluted
        
        
        N/A
        
        
        29,312,083Basic net earnings(loss) per share
        
        $
        (0.05
        )
        $
        0.01Diluted net earnings per share
        
        
        N/A
        
        $
        0.01

Derivative Financial Instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

The Company reviews the terms of convertible debt, equity instruments and other financing arrangements to determine whether there are embedded derivative instruments, including embedded conversion options that are required to be bifurcated and accounted for separately as a derivative financial instrument. Also, in connection with the issuance of financing instruments, the Company may issue freestanding options or warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity. The Company may also issue options or warrants to non-employees in connection with consulting or other services they provide.

Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. For option-based derivative financial instruments, the Company uses the Black-Scholes option pricing model to value the derivative instruments. To the extent that the initial fair values of the freestanding and/or bifurcated derivative instrument liabilities exceed the total proceeds received, an immediate charge to income is recognized, in order to initially record the derivative instrument liabilities at their fair value.

The discount from the face value of the convertible debt or equity instruments resulting from allocating some or all of the proceeds to the derivative instruments, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges to income, usually using the effective interest method.



55



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)



Derivative Financial Instruments (continued)

The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is reassessed at the end of each reporting period. If reclassification is required, the fair value of the derivative instrument, as of the determination date, is reclassified. Any previous charges or credits to income for changes in the fair value of the derivative instrument are not reversed. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

New accounting pronouncements



In February 2006, the FASB issued SFAS No. 155. Accounting for certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140, or SFAS No. 155. SFAS No. 155 permits fair value  remeasurement  for any hybrid financial  instrument that contains an embedded  derivative that otherwise would require  bifurcation,  clarifies which  interest-only  strips and principal-only strips are not subject to the  requirements of Statement No. 133,  establishes a requirement to evaluate  interests in securitized  financial  assets to identify interests  that  are  freestanding  derivatives  or that  are  hybrid  financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives,  and  amends  SFAS  No. 140  to  eliminate  the  prohibition  on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial  interest other than another derivative  financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. We do not expect the adoption of SFAS 155 to have a material impact on our consolidated financial position, results of operations or cash flows.



In March 2006,  the FASB  issued FASB  Statement  No. 156,  Accounting  for Servicing  of  Financial  Assets  - an  amendment  to FASB  Statement  No. 140. Statement 156 requires that an entity recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a service contract under certain situations. The new standard is effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No.156 did not have a material impact on the Companys financial position and results of operations.



In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in a companys financial statements and establishes guidelines for recognition and measurement of a tax position taken or expected to be taken in a tax return. We are currently evaluating the impact on our consolidated financial statements of this standard, which will become effective on June 1, 2007.



In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. We are currently evaluating the impact on our consolidated financial statements of FAS 157, which will become effective for us on June 1, 2008.



56



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE B   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)



New accounting pronouncements(continued)



In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R), which will require employers to fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare and other postretirement plans in their financial statements. Under past accounting standards, the funded status of an employers postretirement benefit plan (i.e., the difference between the plan assets and obligations) was not always completely reported in the balance sheet. Past standards only required an employer to disclose the complete funded status of its plans in the notes to the financial statements. SFAS No. 158 applies to plan sponsors that are public and private companies and nongovernmental not-for-profit organizations. The
requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, for entities with publicly traded equity securities, and at the end of the fiscal year ending after June 15, 2007, for all other entities. The requirement to measure plan assets and benefit obligations as of the date of the employers fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. The Company does not expect that the adoption of SFAS No. 158 will have a significant impact on the consolidated results of operations or financial position of the Company.



NOTE C  ACQUISITIONS



The results of operations and financial position of the entities acquired during the twelve month period ended December 31, 2006 are included in the Consolidated and Combined Financial Statements from and after the date of acquisition. The purchase price of each acquisition was allocated to the assets acquired and liabilities assumed based on independent and third party assisted valuations with any excess cost over fair value being allocated to goodwill.



The Paynet Systems Acquisition:



On July 3, 2006, we acquired Paynet Systems, Inc. by acquiring all of the outstanding capital stock of Paynet Systems, Inc, an e-commerce and retail merchant credit card processing provider. The total cost of Paynet Systems was $10,890,996. In the event certain milestones are reached, we may pay the former Paynet Systems shareholders up to an additional $3 million in cash and 1.61 million shares of restricted common stock. The assets acquired and liabilities assumed in the Paynet Systems acquisition were as follows:






Cash
        
        
        $
        0Trade receivables
        
        
        
        0Plant, property and equipment
        
        
        
        0Computer software
        
        
        
        0Intangible assets
        
        
        
        3,304,249Goodwill
        
        
        
        7,586,747Liabilities assumed
        
        
        
        0Total Purchase Price
        
        
        $
        10,890,996







57




PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE C  ACQUISITIONS (continued)



The Valadata Acquisition:



On July 11, 2006, we acquired Valadata, Inc., by acquiring all of the outstanding capital stock of Valadata, Inc, a retail merchant credit card processing provider catering primarily to the restaurant industry. The total cost of the Valadata acquisition was $5,766,456. In the event certain milestones are reached, we may pay the former Valadata shareholders up to an additional $1.5 million over the next two years. Our wholly owned subsidiary, Valadata Acquisition, Inc. was formed to merge into Valadata, Inc. The assets acquired and liabilities assumed in the Valadata acquisition were as follows:




Cash
        
        
        
        
        $
        134Trade receivables
        
        
        
        
        
        0Plant, property and equipment
        
        
        
        
        
        0Computer software
        
        
        
        
        
        0Intangible assets
        
        
        
        
        
        2,609,901Goodwill
        
        
        
        
        
        3,156,421Liabilities assumed
        
        
        
        
        
        0Total Purchase Price
        
        
        
        
        $
        5,766,456



World Products, Inc. D/B/A Aircharge



On October 7, 2005, the Company completed the purchase of World Products, Inc. d.b.a. AIRCHARGE, by acquiring all of the outstanding capital stock of World Products, Inc, for a total cost of $1,655,125.The assets acquired and liabilities assumed in the Aircharge acquisition were as follows:




Cash
        
        
        
        
        
        $
        1,941Trade receivables
        
        
        
        
        
        
        15,047Plant, property and equipment
        
        
        
        
        
        
        3,487Computer software
        
        
        
        
        
        
        0Intangible assets
        
        
        
        
        
        
        0Goodwill
        
        
        
        
        
        
        1,793,245Liabilities assumed
        
        
        
        
        
        
        (158,595
        )Total Purchase Price
        
        
        
        
        
        $
        1,655,125





58



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE C  ACQUISITIONS (continued)



Charge.com, Inc.

On December 19, 2005, the Company completed the purchase of Charge.com, Inc., by acquiring all of the outstanding capital stock of Charge.com, Inc. for a total purchase price of $25,288,839.




Cash
        
        
        
        
        $
        878,627Trade receivables
        
        
        
        
        
        476,132Inventory
        
        
        
        
        
        1,250Plant, property and equipment
        
        
        
        
        
        1,000Computer Software
        
        
        
        
        
        12,000Intangible assets
        
        
        
        
        
        5,115,840Goodwill
        
        
        
        
        
        21,654,828Liabilities assumed
        
        
        
        
        
        (799,702
        )Deferred tax liability
        
        
        
        
        
        (2,051,136
        )Total Purchase Price
        
        
        
        
        $
        25,288,839



Subsequent to our initial purchase price, allocation we adjusted the price allocation to recognize the related deferred tax liability and corresponding adjustment to goodwill by 2,051,136.



Northern Merchant Services, Inc.

As a part of our agreement to acquire Northern Merchant Services, Inc in 2002, we agreed to issue additional shares of our common stock to the sellers upon the achievement of certain milestones. The final one million shares earn-in was earned when Kevin and Nancy Weller successfully (i) oversaw and opened a new facility in Brasher Falls and (ii) developed and launched a government payment processing solution. The shares related to this milestone have been issued. This issuance of stock increased the amount of goodwill related to the acquisition by, $1,300,000.



NOTE D  GOODWILL



The changes to the goodwill balance during the twelve months ended December 31, 2005 and December 31, 2006 are as follows:




Goodwill balance as of December 31, 2004
        
        
        $
        2,324,762Goodwill acquired
        
        
        
        22,231,876Goodwill amortized or impaired
        
        
        
        0Goodwill balance as of December 31, 2005
        
        
        $
        24,556,638Goodwill acquired
        
        
        
        14,265,255Goodwill amortized or impaired
        
        
        
        0Goodwill balance as of December 31, 2006
        
        
        $
        38,821,893




59



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE E- INTANGIBLE ASSETS

The changes to the intangible assets, which include merchant portfolios and customer relationships during the twelve months ended December 31, 2005 and December 31, 2006 are as follows:




Intangible assets balance as of December 31, 2004
        
        
        $
        5,222,654Intangible assets acquired
        
        
        
        5,036,123Intangible assets amortized
        
        
        
        (403,098
        )Intangible assets impaired
        
        
        
        0Intangible assets balance as of December 31, 2005
        
        
        $
        9,855,679Intangible assets acquired
        
        
        
        7,897,192Intangible assets amortized
        
        
        
        (2,167,269
        )Intangible assets impaired
        
        
        
        0Intangible assets balance as of December 31, 2006
        
        
        $
        15,585,602





NOTE F- INCOME TAXES

The Company provides for the tax effects of transactions reported in the financial statements. The provision if any, consists of taxes currently due plus deferred taxes related primarily to differences  between the basis of assets and liabilities for financial and income tax reporting. The deferred tax assets and liabilities,  if any,  represent  the future tax  return  consequences  of those differences,  which will  either be taxable  or  deductible  when the assets and liabilities  are recovered or settled. As of December 31, 2006, the Company had deferred tax assets of $2,284,498, deferred tax liabilities of $5,924,607, and no material current tax liability.

At December 31, 2006, the Company has net operating loss carry forwards for income tax purposes of approximately $5,100,000. These carry forward losses are available to offset future taxable income, if any, and expire in the year 2026.

The components of income tax expense for the years ended December 31, were as follows:




2006
        
        2005Current:Federal
        
        $
        0
        
        $
        0State
        
        
        0
        
        
        0Deferred:Federal

    

    

    (1,438,613

    )

    

    (779,833

    )State

    

    

    (400,825

    )

    

    0Total provision for income taxes
        
        $
        (1,839,438
        )
        $
        (779,833
        )




60



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE F- INCOME TAXES (continued)

The components of the net deferred tax assets and liabilities are as follows:




December 31,2006
        
        2005Deferred tax assets:Net operating loss carry forward
        
        
        
        $
        846,078
        
        $
        706,312Current period (income) loss
        
        
        
        
        1,075,368
        
        
        139,766Prior period change in NOL carry forward
        
        
        
        
        121,465
        
        
        0Difference between book and tax depreciation and amortization
        
        
        
        
        104,539
        
        
        0Deferred revenue
        
        
        
        
        0
        
        
        306Stock-based compensation
        
        
        
        
        137,048
        
        
        10,131Total deferred tax assets before valuation allowance
        
        
        
        
        2,284,498
        
        
        856,515Valuation allowance
        
        
        
        
        0
        
        
        0Total deferred tax assets
        
        
        
        
        2,284,498
        
        
        856,515Deferred tax liabilitiesDifference between book and tax depreciation and amortization
        
        
        
        $
        2,202,885
        
        $
        76,377Discount on debt
        
        
        
        
        3,721,722
        
        
        0Total deferred tax liabilities
        
        
        
        
        5,924,607
        
        
        76,377Net deferred tax asset (liability )
        
        
        
        
        ($3,640,109
        )
        $
        780,138



SFAS No. 109 requires that a valuation allowance be provided if it is more likely than not that some portion or all of a deferred tax asset will not be realized. Based on the Companys forecast of future taxable income, management determined that a valuation allowance related to deferred tax assets was not required as of December 31, 2006.



The differences in Federal taxes provided and the amounts determined by applying the federal statutory tax rate to income (loss) from continuing operations for the years ended December 31, 2006 and 2005 are as follows:




Year
        ended December 31,2006
    2005$ Amount
    
    Percentage
    
    $ Amount
    
    PercentageU.S
        Federal income tax at the statutory rate
    
    $
    (1,402,587
    )
    (34%)
    
    $
    (139,766
    )
    (34%)U.S
        State taxes
    
    
    (247,515
    )
    (6%)
    
    
    0
    
    (0%)Changes
        in valuation allowance
    
    
    (0
    )
    (0%)
    
    
    (619,907
    )
    (151%)Non-deductible
        expenses and other
    
    
    (189,337
    )
    (5%)
    
    
    (20,160
    )
    (5%)Provision
        for (benefit from) income taxes
    
    $
    (1,839,438
    )
    (45%)
    
    $
    (779,833
    )
    (n/a




61



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE G- COMMITMENTS AND CONTINGENCIES



Operating Leases



We lease various office spaces and certain equipment under operating leases with remaining terms ranging up to seven years. Our facilities are located in Quincy, Massachusetts, Brasher Falls, New York, Gurnee, Illinois, and Alpharetta, Georgia. The majority of the office space lease agreements contain renewal options.



Our future minimum lease commitments under noncancelable leases are as follows at December 31, 2006.




Twelve Months EndingDecember 31
        
        
        Amount2007
        
        $
        356,5602008
        
        
        372,8562009
        
        
        377,2422010
        
        
        321,9682011
        
        
        270,691Later years
        
        
        334,052Total minimum payments required
        
        $
        2,033,369



Total rent expense for the twelve months ended December 31, 2006 and 2005 was $ 275,954 and $ 193,248, respectively.



Lease-Related Party



The office of Northern Merchant Services, Inc. is located in Brasher Falls, New York, and has an annual lease with Kevin and Nancy Weller, officers of the Company. A five year lease commenced on January 1, 2006 with monthly rental of $3,000.



Capital Leases



The following is a schedule by year of future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2006.




Twelve Months EndingDecember 31
        
        
        Amount2007
        
        $
        75,0102008
        
        
        42,9872009
        
        
        13,9812010
        
        
        4,7462011
        
        
        0Later years
        
        
        0Total minimum payments required
        
        $
        136,724Less: amount representing interest
        
        
        22,516Present value of net minimum lease payments
        
        $
        114,208




62



.PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE G- COMMITMENTS AND CONTINGENCIES (continued)

Charge.com, Inc acquisition agreement amendment



The company amended its agreement with the selling shareholders of Charge.com, Inc giving the selling shareholders of Charge.com, Inc a put right whereby they have the right, between June 15, 2007 and June 29, 2007, to require the company to repurchase the shares of stock issued to them  at a price per share of $1.33825 per share. We have reviewed this arrangement under the terms of SFAS-150 - Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and consider this to be a conditional obligation. The provisions of this agreement will be assessed at each balance sheet date to determine if the agreement is no longer conditional.



Paynet Systems, Inc contingent payment



On July 3, 2006 when we acquired Paynet Systems, Inc., we agreed to pay up to an additional $3 million in cash and up to an additional 1.61 million shares of restricted stock upon reaching certain milestones on the later of reaching the milestone or July 1, 2007.



Valadata, Inc contingent payment

On July 11, 2006, when we acquainted Valadata, Inc, we agreed to pay approximately an additional $1.5 million over the next two years to subject to performance milestones. These payments are secured by a security agreement granting a continuing security interest in the assets of Valadata, Inc.



NOTE H- STOCK OPTIONS AND WARRANTS



Stock-Based Compensation



The Company has adopted the provisions of FAS 123R, as of January 1, 2006. The provisions of FAS 133R require a company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date value of the award. That cost is recognized in the statement of operations over the period during which an employee is required to provide service for the award. FAS 123R also amends FASB Statement No. 95, Statement of Cash Flows, to require that excess tax benefits, as defined, realized from the exercise of stock options be reported as a financing cash inflow rather as a reduction of taxes paid in cash flow from operations.



Prior to the adoption of FAS 123 R, the Company had followed the provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (FAS 123), which allowed the Company to follow the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and disclose the pro forma effects on net income (loss) had the fair value of the equity awards been expensed. In connection with adopting FAS 123R, the Company elected to adopt the modified prospective application method provided by FAS 123R. The following table illustrates the effect on net earnings for the year ended December 31, 2005 as if the Company had applied the fair value recognition provisions of SFAS No. 123 to all awards held by Pipeline Data employees, including those that were issued prior to the adoption of SFAS 123.


63



.PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE H - STOCK OPTIONS AND WARRANTS (continued)

Stock-Based Compensation (continued)



Impact of Change for adoption of FAS 123R




Year ended December 31,2006
        
        2005Net loss, as reported
        
        $
        (2,285,815
        )
        $
        368,757Add: Stock-based compensation expense included inreported net earnings, net of related income tax effects
        
        
        n/a
        
        
        0Deduct: Total stock-based employee compensationexpense determined under fair value based methods forall awards, net of related income tax effects
        
        
        n/a
        
        
        (144,787
        )Net earnings  Pro Forma
        
        $
        (2,285,815
        )
        $
        223,990Earnings per sharebasic, as reported
        
        $
        (0.05
        )
        $
        0.01Earnings per sharebasic, pro forma
        
        
        n/a
        
        $
        0.01Earnings per sharefully diluted, as reported
        
        
        n/a
        
        $
        0.01Earnings per sharefully diluted, as reported
        
        
        n/a
        
        $
        0.01





In September 2005, the Companys Board of Directors approved the adoption of the 2005 Pipeline Data Inc Stock Incentive Plan in order to award restricted stock, nonqualified stock options and incentive stock options. This plan was approved by the Companys stockholders in January 2006.



Options



As of December 31, 2006, the Company has reserved an aggregate of 9,517,200 shares of common stock pending the exercise of the options.




Stock option activity is summarized as follows:
        
        OptionsOptions outstanding, December 31, 2004
        
        2,968,115Forfeited
        
        (130,250
        )Exercised
        
        (430,000
        )Issued
        
        6,979,964Options outstanding, December 31, 2005
        
        9,387,829Forfeited
        
        (544,837
        )Exercised
        
        (450,792
        )Issued
        
        1,125,000Options outstanding, December 31, 2006
        
        9,517,200





64



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE H - STOCK OPTIONS AND WARRANTS (continued)



Options (continued)



The following table summarizes information related to stock options outstanding and exercisable as of December 31, 2006:




OptionsOutstanding
        
        
        
        
        
        
        OptionsExercisableRange ofExercisePrices
        
        Number of Options
        
        Weighted Average Remaining Contractual Life
        
        Weighted Average Exercise Price
        
        Number of Options
        
        Weighted Average Remaining Contractual Life
        
        Weighted Average Exercise Price0.00 - 0.99
        
        2,180,086
        
        2.02
        
        $
        0.58
        
        2,180,086
        
        2.02
        
        $
        0.581.00-1.24
        
        2,232,114
        
        3.29
        
        $
        1.09
        
        2,232,114
        
        3.29
        
        $
        1.091.25-1.39
        
        800,000
        
        4.04
        
        $
        1.25
        
        800,000
        
        4.04
        
        $
        1.251.40-1.74
        
        1,265,000
        
        4.36
        
        $
        1.50
        
        1,040,000
        
        3.89
        
        $
        1.501.75+
        
        3,040,000
        
        4.29
        
        $
        2.19
        
        2,590,000
        
        3.90
        
        $
        2.249,517,200
        
        3.52
        
        $
        1.39
        
        8,842,200
        
        3.29
        
        $
        1.36



Warrants

As of December 31, 2006, the Company has reserved an aggregate of 16,389,923 shares of common stock pending the exercise of the warrants.




Warrant activity is summarized as follows:WarrantsWarrants outstanding, December 31, 2005
        
        4,655,450Exercised
        
        (700,127
        )Expired
        
        (415,400
        )Issued
        
        12,850,000Warrants outstanding, December 31, 2006
        
        16,389,923



The following table summarizes information related to warrants outstanding and exercisable as of December 31, 2006:




Strike Price
        
        Number of Warrants
        
        Weighted Average RemainingContractual Life
        
        Weighted Average ExercisePrice0.00 - 0.99
        
        418,690
        
        1.13
        
        $
        0.351.00-1.24
        
        700,000
        
        3.75
        
        $
        1.101.25-1.39
        
        266,667
        
        4.55
        
        $
        1.251.40-1.74
        
        11,950,001
        
        4.50
        
        $
        1.401.75+
        
        3,054,565
        
        3.36
        
        $
        2.0016,389,923
        
        4.17
        
        $
        1.35





65



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE H - STOCK OPTIONS AND WARRANTS (continued)



Deferred Shares

Deferred shares vest ratably over the applicable vesting period from the date of the grant. On each vesting date the employee receives common stock of the Company equal in number to the deferred shares that have vested. Upon delivery of the Company common stock an equal number of deferred shares are terminated. The participants have no voting or dividend rights with the deferred shares. The deferred shares are valued at the price of the common stock on the date of grant and the expense is recorded ratably over the vesting period.

Generally, grants of deferred shares are subject to forfeiture if a grantee, among other conditions, leaves our employment prior to the end of the vesting period.

A summary of the non-vested deferred share activity for the year ended December 31, 2006 is presented below.




Year endedDecember 31, 2006Awards/UnitsNon-vested at December 31. 2005
        146,667Granted
        60,000Vested
        (109,999
        )Forfeited
        (3,334
        )Non-vested at December 31, 2006
        93,334



NOTE I  RELATED PARTY TRANSACTIONS

The Companys subsidiary, Northern Merchant Services, Inc., leases office space from Kevin and Nancy Weller.

When Northern Merchant Services, Inc. was purchased, certain earn-in capabilities based upon milestones achieved were recorded as a contingency based on SFAS No.141-Business Combinations. To date, an additional 2,000,000 shares of our common stock have been issued pursuant to these milestones. The board of directors determined that it was in the best interest of the company to change the nature of the earn-in requirement for the final one million shares and requested that a new milestone be created. Thus, the final one million shares earn-in was earned when Kevin and Nancy Weller successfully (i) oversaw and opened a new facility in Brasher Falls and (ii) developed and launched a government payment processing solution. The shares related to this milestone have been issued.

The Company entered into a consulting services agreement with Capital Advisory Services. Our Chairman, Jack Rubinstein, is a partner of Capital Advisory Services. The total charged to operating expenses for the year ending December 31, 2006 was $20,000. The amount payable to Capital Advisory Services was $20,000 as of December 31, 2006.



66



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE J  SHORT-TERM AND LONG-TERM DEBT OBLIGATIONS



Debt/Financing:



(a) Senior Secured Convertible Notes



The Company, on June 29, 2006 entered into a series of Senior Secured Convertible Notes having an aggregate principal amount of $37,000,000 due on June 29, 2010 and warrants to purchase 11,100,000 shares of the Companys common stock at $1.40.



Interest will accrue at 8% per annum on the outstanding principal amount and is payable on the first day of each calendar quarter, starting October 1, 2006. The notes are convertible into common stock of the Company at a fixed conversion rate of $1.30 per share up to a maximum of 4.9% of the number of shares outstanding immediately after giving effect to the conversion and contains standard anti-dilution provisions.



The Company has the option, at any time, to redeem up to 25% of the original Debenture principal amount, in cash, in an amount equal to the sum of (i) 115% of the principal amount of the Debenture outstanding, plus accrued and unpaid interest through June 29 2008 and the sum of (ii) 110% of the principal amount of the Debenture outstanding, plus accrued and unpaid interest through maturity. The note is convertible at the sole discretion of the Holders unless value of the common stock exceeds 250% of the conversion price for 20 consecutive days. Then the Company may cause the holder to convert all or part of the then outstanding principal, up to 25% of the average trading volume. Any converted shares are not puttable back to the Company by the Holder.



In connection with the convertible note, the Company issued to the holder of the note a five-year warrant to purchase up to 11,100,000 shares of the Companys common stock at an exercise price of $1.40 per share. The warrants are exercisable at the sole discretion of the Holders. Any warrants converted to shares are not puttable back to the Company, nor can Holders demand a cash settlement of warrants. Cashless exercises are permissible.

The Company has entered into a Registration Rights Agreement with each of the Holders of our convertible notes and warrants issued in connection with Centrecourt Financing to register the underlying common stock thereunder. The Registration Rights Agreement provides that we will file a registration statement with the SEC within 45 days of June 29, 2006. The Registration Rights Agreement requires us to register an amount of Common Stock equal to 125% of the Registrable Securities which as defined under the Registration Rights Agreement includes the shares of our common stock issuable upon the conversion of the convertible note and the exercise of the warrants to purchase 11,100,000 shares of common stock at $1.40 per share. The Company is required to keep the Registration Statement continuously effective until all Registrable Securities have been sold.

If the Company does not comply with certain requirements relating to filing the registration statement or maintaining its effectiveness, we are required to pay each holder monthly in cash as partial liquidated damages 1.25% of the aggregate purchase price paid by such holder for the convertible notes and warrants. A Registration Statement for 11,100,000 common stock underlying warrants at $1.40 and 10,000,000 Common Stock underlying convertible promissory note at $1.30 per share was deemed effective December 6, 2006. We are required to register the remaining 18,461,538 shares of our common stock underlying the convertible note as well as an additional 25% of the aggregate shares registered pursuant to our registration rights agreement. Effectiveness of these additional registrations is subject to the review by the Securities and Exchange Commission. The Company is in negotiations with
the Holders pertaining to the registration payment arrangement and filing a new Registration Statement. We have accrued an additional and  probable settlement to interest expense, estimated at $116,000 related to the registration payment arrangement. This most likely will be settled in additional warrants issued to the holders of the notes.


67



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE J  SHORT-TERM AND LONG-TERM DEBT OBLIGATIONS (continued)



Debt/Financing (continued):



In accordance with APB No. 14, EITF 00-19-2 and related amendments, the warrants issued represents a premium paid by the Company at the date of issuance of the Convertible Note in the form of additional interest, which should be bifurcated from the Convertible Note and recognized as interest expense over the initial term of the notes. The fair value for these warrants was estimated at the grant date using the Black-Scholes option pricing model based upon the closing price per share of the Companys common stock on the date of issuance, the Company estimated the fair value of the warrant and allocated $4,329,000 of the proceeds from the note to the warrant, which is presented as a discount on the convertible note, net of amortization to be taken over the four -year term of the note using the effective interest method. Due to the convertible nature of the Senior Secured Convertible Notes,
the Company recorded a charge due to the beneficial conversion feature of $7,003,807 in accordance with EITF Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF Issue No. 00-27, Application of EITF Issue No. 98-5 to Certain Convertible Instruments. The value of the beneficial conversion feature was measured using the intrinsic value and was being amortized over the four -year term of the note using the effective interest method.



Proceeds from the Senior Secured Convertible Notes replaced the $15,000,000 Sheridan Asset Management LLC note, dated December 20, 2005. On June 29, 2006 the company repaid the full outstanding amount and incurred remaining amounts of unamortized debt issuance costs and prepayment fees totaling approximately $1,535,607 were charged as a loss on early extinguishment of debt.



Proceeds from the Senior Secured Convertible Notes were used to retire the remaining portion of the $2,000,000 Centrecourt Asset Management note, dated September 30, 2005. The holders of the Convertible Note had the option to convert all or part of their notes into shares of the Companys Common Stock on June 29, 2006, the Company prepaid the Convertible Note plus accrued interest in full using the proceeds from the issuance of Senior Secured Convertible Notes on that date. Consequently, on that date, the remaining amounts of unamortized original issue discount, unamortized debt issuance costs and prepayment fees totaling approximately $604,500 were charged as a loss on early extinguishment of debt. The warrants issued in connection with the Subordinated Note remain outstanding.





68



PIPELINE DATA INC.



NOTES TO FINANCIAL STATEMENTS



December 31, 2006



NOTE J  SHORT-TERM AND LONG-TERM DEBT OBLIGATIONS (continued)



Long-term debt as of December 31, 2006 and December 31, 2005 consists of the following:




December 31,2006
        
        
        2005World Products interest payable at LIBOR, convertible at$1.50 per share, due March 2013
        $
        525,000
        
        $
        525,000Sheridan Asset Management LLC, secured, interest payable at17% due December 20, 2005
        
        0
        
        
        15,000,000Centrecourt Asset Management, interest payable at prime rate plus 2.5%
        
        0
        
        
        2,000,0008 % convertible note
        
        0
        
        
        322,734Other promissory notes and capital leases
        
        114,208
        
        
        169,706Senior secured, interest payable at 8.00% due June 29, 2010,convertible at $1.30 per share
        
        37,000,000
        
        
        037,639,208
        
        
        18,017,440Less current portion
        
        (60,765
        )
        
        (15,635,376
        )Unamortized discount on long term debt of beneficialconversion feature and warrants
        
        (9,304,429
        )
        
        0Long-term debt, excluding current portion
        $
        28,274,014
        
        $
        2,382,064



Capital Lease Obligations



See Note G-Lease Agreements for lease obligations with American Express Business Finance, Highline Funding, LLC, Ikon Financial Services and US Express Leasing. As of December 31, 2006, the current portion amounted to $60,765, and the long-term portion amounted to $53,443.

NOTE K PENSION PLAN-DEFINED CONTRIBUTION



During the third quarter of 2006, the Company adopted a Simple IRA Plan. Under this plan the Company will match employee contribution up to one percent of eligible compensation. The amount recognized as an expense during the year ended December 31, 2006 was $18,378 and for the year ended December 31, 2005 was $0.



  69



**Item
    8****. Changes In and Disagreements with Accountants on Accounting
    and Financial Disclosure.**
  ****

There have been no changes in, and no disagreements with, our companys public accountants.



  **Item****8A. Controls and Procedures.**



As of December 31, 2006, an evaluation was performed under the supervision and with the participation of our management, including our corporate executive committee (CEC) and our chief financial officer (CFO), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including the CEC and CFO, concluded that our disclosure controls and procedures were effective as of December 31, 2006. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to December 31, 2006.



Disclosure  controls and procedures  are our controls and other  procedures that are designed to ensure that  information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officers and principal financial officer, as appropriate to allow timely decisions regarding required disclosure



  **Item
    8B.****Other Information.**
  ****

N/A



70



PART III



  **Item
    10.****Directors, Executive Officers, Promoters and Control
    Persons. Directors, Executive Officers, Promoters and Control Persons**



The information required by this Item 10 is incorporated herein by reference from the section captioned Corporate Governance, Our Management Team, and Section 16(a) Beneficial Ownership Reporting Compliance of the Companys definitive proxy statement for the 2007 annual meeting of stockholders to be filed not later than April 30, 2007 with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the 2007 Proxy Statement).



  **Item
    11.****Executive Compensation**
  ****

The information required by this Item 11 is incorporated by reference from the section captioned Executive Compensation of the 2007 Proxy Statement.



  **Item
    12.****Security Ownership of Certain Beneficial Owners and
    Management.**
  ****

The information required by this Item 12 is incorporated by reference from the section captioned Stock Ownership Information of the 2007 Proxy Statement



  **Item
    13.****Certain Relationships and Related Transactions, and
    Director Independence**.



The information required by this Item 13 is incorporated by reference from the section captioned Certain Relationships and Related Party Transactions of the 2007 Proxy Statement.



  **Item
    14.****Principal Accountant Fees and Services.**



The following table sets forth the aggregate fees billed to Pipeline Data Inc for the years ended December 31, 2006 and 2005, by Drakeford & Drakeford, LLC .




2006
        
        2005Audit Fees
        $134,440
        (a)
        $ 66,200
        (b)Audit Related Fees
        0
        
        0Tax Fees
        5,800
        
        5,800All Other Fees
        62,000
        (c)
        49,500
        (d)$202,240
        
        $121,800






(a)
        
        Comprised of fees for financial statement audit and review of financial statements included in our Form 10-QSB quarterly reports, and services that are normally provided by the independent registered public accounting firm in connection with statutory and regulatory filings or engagements.(b)
        
        Comprised of fees for financial statement audit and review of financial statements included in our Form 10-QSB quarterly reports, and services that are normally provided by the independent registered public accounting firm in connection with statutory and regulatory filings or engagements.(c)
        
        For the year ended December 31, 2006, fees in the amount of $62,000 were billed for audits and due diligence work related to the acquisitions of Paynet Systems, Inc and Valadata, Inc(d)
        
        For the year ended December 31, 2005, fees in the amount of $49,500 were billed for audits and due diligence work related to the acquisitions of World Products, Inc and Charge.com, Inc





71



SIGNATURES

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

PIPELINE DATA INC.

(Registrant)




By:
        /s/ MacAllister Smith
        
        By:
        /s/ Curt JamesName:
        MacAllister Smith
        
        Name:
        Curt JamesTitle:
        Chief Executive Officer and President
        
        Title:
        Chief Financial Officer(Principal Financial and Accounting Officer)



Date: March 28, 2007

Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in their capacities as directors and on the dates indicated.




/s/
              JACK RUBINSTEIN
        
        
        
        DirectorJACK
            RUBINSTEIN
        
        March
            28, 2007/s/
              KEVIN WELLER
        
        
        
        DirectorKEVIN
            WELLER
        
        March
            28, 2007/s/
              MACALLISTER SMITH
        
        
        
        DirectorMACALLISTER
            SMITH
        
        March
            28, 2007/s/
              JOHN M REEDER
        
        
        
        DirectorJOHN
            M REEDER
        
        March
            28, 2007/s/
              HAROLD DENTON
        
        
        
        DirectorHAROLD
            DENTON
        
        March
            28, 2007/s/
              MICHAEL GREENBURG
        
        
        
        DirectorMICHAEL
            GREENBURG
        
        March
            28, 2007





72