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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

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

For the quarter ended March 31, 2004

Commission file number 000-50280

Registrant’s Telephone Number, Including Area Code:

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

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

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

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

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PART 1.

iPAYMENT, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.

CONSOLIDATED INCOME STATEMENTS

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.

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(1)     Organization and Business and Basis of Presentation

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

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

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

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

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

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

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

(2)     Acquisitions

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

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

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

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

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(3)     Intangible Assets

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

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

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

(4)     Long-Term Debt

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

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

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

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(5)     Mandatorily redeemable convertible preferred stock

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

(6)     Stockholders’ Equity

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

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