UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2004

Commission file number 000-50280

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]

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

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TABLE OF CONTENTS

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Part 1.

iPAYMENT, INC.

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.

See accompanying notes to consolidated financial statements.

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iPAYMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) Organization and Business and Basis of Presentation

Organization and Business

     iPayment, Inc. (subsequently referred to as “iPayment”, “we”, “our” or the “Company”) was originally incorporated as iPayment Holdings, Inc. in Tennessee and was reincorporated in Delaware under the name iPayment, Inc. We are 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 between merchants and cardholders. We market and sell our services primarily through independent sales organizations (“ISOs”).

Stock split

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

Basis of Presentation

     The accompanying unaudited consolidated financial statements of iPayment have been prepared in accordance with accounting principles generally accepted in the United States and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments and reclassifications considered necessary for a fair presentation of the results of operations and financial condition for the interim periods. All significant intercompany transactions have been eliminated in consolidation. These statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2003 Annual Report on Form 10-K. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2004.

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

Use of Estimates

     The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates and assumptions also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Stock-Based Compensation

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

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

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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

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

(2) Acquisitions

     The effective date of each of the acquisitions discussed in this Note are the dates the acquisitions were recognized in our financial statements, unless otherwise noted. There were no acquisitions of businesses during 2003 and 2004 that would require pro forma disclosure.

First Data Merchant Services

     During December 2003, we entered into an asset purchase agreement with First Data Merchant Services to acquire certain assets related to their agent bank portfolio (the “FDMS Portfolio”) for $55.0 million in cash, of which $1.8 million related to certain rental equipment. The operating results of the FDMS Portfolio were not included in our consolidated income statements until January 1, 2004. The $53.2 million of acquired customer relationships have an amortization life of seven years, and are deductible over fifteen years for income tax purposes. Revenues generated from certain agent bank portfolios acquired as part of the FDMS acquisition are reported net of interchange, as required by EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, where we may not have credit risk, portability or the ultimate responsibility for the merchant accounts.

CardPayment Solutions, Inc.

     During August 2003, we entered into an asset purchase agreement (the “CardPayment Agreement”) with CardPayment Solutions, Inc. (“CardPayment”), whereby we acquired substantially all of the assets and assumed debt of approximately $1.0 million, which was repaid in the third quarter of 2003, for $12.0 million cash and 118,409 shares of our common stock valued at $25.34 per share, plus a contingent payment based upon performance, which CardPayment has achieved and has been paid as of September 30, 2004. CardPayment is an integrated provider of credit card transaction processing services. The acquisition was recorded under the purchase method. The operating results of CardPayment from August 1, 2003, are included in our consolidated income statements.

Other Acquisitions

     We made various other purchases of residual cash flow streams and merchant processing portfolios, as well as one business (“Transaction Solutions”), collectively totaling $16.8 million during the nine months ended September 30, 2004. Transaction Solutions was acquired during September 2004. Consideration included cash at closing and a contingent payment based upon future performance over two years which we anticipate to be partially supported by a letter of credit. The acquisition of Transaction

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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Solutions was recorded under the purchase method. The purchase prices for the residual cash flow streams and merchant processing portfolios has been assigned to intangible assets in the accompanying consolidated balance sheets and are amortized over their expected useful lives of four to seven years.

(3) Intangible Assets

     As of September 30, 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 September 30, 2004 and 2003, respectively, amortization expense related to the merchant processing portfolios was $3,994,000 and $1,415,000 and amortization expense related to other intangible assets was $211,000 and $197,000. For the nine months ended September 30, 2004 and 2003, respectively, amortization expense related to the merchant processing portfolios was $11,626,000 and $4,042,000 and amortization expense related to other intangible assets was $612,000 and $803,000.

(4) Long-Term Debt

     As of September 30, 2004, we had notes, capital lease obligations and a revolving credit facility arrangement outstanding in an aggregate principal amount of $45.4 million, consisting of $29.5 million outstanding under our revolving credit facility and $15.9 million of convertible subordinated promissory notes (including $0.9 million of accrued interest, of which $0.4 million is convertible). The convertible notes may be converted into 662,079 shares of our common stock at the discretion of the holders at a price of $23.16 per share.

     We have an $80.0 million revolving credit facility with Bank of America as the lead bank. The credit facility includes a $5.0 million letter of credit sublimit. Interest on outstanding borrowings is payable at a rate of LIBOR plus a margin of 2.25% to 2.75% (currently 2.25%) depending on our ratio of consolidated debt to EBITDA, as defined in the agreement. We have the option to choose 1-month, 2-month, 3-month or 6-month LIBOR rates each time we make a draw on the credit facility. In addition, the credit facility requires us to pay unused commitment fees of up to 0.50% (currently 0.375%) on any undrawn amounts. The credit facility contains customary affirmative and negative covenants including financial covenants requiring the maintenance of specified limitations on debt-to-capitalization and debt-to-EBITDA (as defined therein) and restrictions on incurring liens and transactions with affiliates. We were in compliance with all debt covenants as of September 30, 2004. At September 30, 2004, $29.5 million was outstanding under the credit facility, at a weighted average interest rate of 4.05%.

     All borrowings under the credit facility are due when the facility expires on December 31, 2006. The credit facility initially contained provisions that would have required all principal amounts outstanding in excess of $20 million on June 30, 2004 (up to a maximum of $35 million) to convert to a term loan if we did not consummate a financing transaction (as defined) prior to that date. This provision was amended during the second quarter of 2004 to increase the limit from $20 million to $25 million. The balance outstanding under the credit facility was $23.5 million on June 30, 2004. Accordingly, none of the outstanding principal was converted to a term loan on June 30, 2004.

     In May 2003, we completed an initial public offering (see Note 9) and used $55.7 million of the proceeds to repay outstanding

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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

debt with a carrying value of $52.1 million and a weighted average interest rate of 10.5%. Additionally, in conjunction with the offering we converted $9.0 million of debt with a carrying value of $8.2 million and an interest rate of 12.0% into 562,500 shares of common stock. These repayments and conversions resulted in a non-cash pre-tax charge of approximately $4.4 million, which was recognized as interest expense in the second quarter of 2003.

(5) Mandatorily redeemable convertible preferred stock

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

(6) Stockholders’ Equity

Earnings Per Share

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

     Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS includes in-the-money stock options and warrants and restricted stock 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):

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

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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(7) Segment Information and Geographical Information

     We consider our business activities to be in a single reporting segment as we derive greater than 90% of our revenue and results of operations from processing revenues and other fees from card-based payments. During 2004 and 2003, we had no single customer that represented 2% or more of revenues. All revenues are generated in the United States.

(8) Recent Accounting Pronouncements

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

(9) Initial Public Offering

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

(10) Income Taxes

     We account for income taxes pursuant to the provisions of SFAS No. 109, Accounting for Income Taxes. Our effective income tax rate differs from the federal and state statutory income tax rates primarily due to the utilization of net operating loss carryforwards in 2004. Our income taxes currently payable for federal and state purposes have been reduced by the tax benefits from employee stock option transactions. These benefits totaled $1.2 million for the nine months ended September 30, 2004, and were reflected as an increase to common stock.

(11) Commitments and Contingencies

HOWARD EHRENBERG, Chapter 7 Trustee for the Estate of ITSV, Inc., vs. CREDITCARDS.COM, INC., a California corporation, IPAYMENT, INC., et al.

U.S B.C. CASE NO. LA 02-31259-EC, Adversary Case No. 04-2214VZ.

     The Company’s Quarterly Report for the quarter ended June 30, 2004, filed on Form 10-Q, previously reported, stated that a complaint had been filed in the United States Bankruptcy Court on behalf of a U.S. Bankruptcy Court Trustee against the Company, certain of its officers and directors and other non-affiliated entities, whereby the Debtor was alleging

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iPAYMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

causes of action for fraud; fraudulent transfer; conspiracy to defraud; and violation of California Business & Professions Code Sections 17200 et. seq. Subsequent to the filing of the First Amended Complaint, Plaintiff voluntarily dismissed, with prejudice, defendants Ernst & Young LLP, Arthur Andersen LLP, Morgan, Lewis & Bockius, LLP and attorneys David J. Brown and Steven N. Holland from the Action, which became effective as of October 18, 2004. The Company continues to vigorously defend itself in this matter, and currently expects that in early December, the Bankruptcy Court will hear the several pending motions filed by the Company and various othe