UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2011
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-50280
iPayment, Inc.
(Exact name of registrant as specified in its charter)
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Delaware
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62-1847043 |
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(State or other jurisdiction
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(I.R.S. Employer |
of incorporation or organization)
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Identification No.) |
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40 Burton Hills Boulevard, Suite 415 |
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Nashville, Tennessee
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37215 |
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(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code: (615) 665-1858
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
o No
þ (Note: The
registrant, as a voluntary filer, is not subject to the filing requirements under Section 13 or
15(d) of the Securities Exchange Act of 1934, but has been filing all reports required to be filed
by those sections for the preceding 12 months.)
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange
Act.
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer þ
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Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act). Yes o No þ
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Title of each class
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Shares Outstanding at August 15, 2011 |
(Common stock, $0.01 par value)
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100 |
PART I FINANCIAL INFORMATION
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Item 1. |
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Financial Statements. |
iPAYMENT, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
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June 30, |
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December 31, |
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2011 |
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2010 |
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Successor |
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Predecessor |
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(Unaudited) |
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(Note 1) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
1,084 |
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$ |
1 |
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Accounts receivable, net of allowance for doubtful accounts of $998 and $735 at
June 30, 2011 and December 31, 2010, respectively |
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27,016 |
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27,542 |
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Prepaid expenses and other current assets |
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1,650 |
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1,191 |
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Deferred tax assets |
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2,073 |
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Total current assets |
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29,750 |
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30,807 |
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Restricted cash |
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555 |
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556 |
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Property and equipment, net |
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5,492 |
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4,766 |
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Merchant portfolio and other intangible assets, net of accumulated amortization
of $5,674 and $177,600 at June 30, 2011 and December 31, 2010, respectively |
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248,252 |
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156,734 |
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Goodwill |
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694,736 |
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527,978 |
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Deferred tax assets, net |
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4,324 |
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Other assets, net |
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24,287 |
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10,464 |
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Total assets |
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$ |
1,003,072 |
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$ |
735,629 |
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LIABILITIES and STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
3,728 |
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$ |
3,265 |
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Income taxes payable |
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291 |
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11,818 |
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Accrued interest |
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7,635 |
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2,573 |
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Accrued liabilities and other |
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15,779 |
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17,060 |
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Current portion of long-term debt |
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250 |
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5,823 |
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Total current liabilities |
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27,683 |
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40,539 |
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Deferred tax liabilities, net |
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35,437 |
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Long-term debt |
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769,414 |
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619,144 |
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Other liabilities |
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2,663 |
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3,505 |
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Total liabilities |
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835,197 |
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663,188 |
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Commitments and contingencies (Note 8) |
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Equity |
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Common stock, $0.01 par value; 1,000 shares authorized, 100 shares issued and
outstanding at June 30, 2011 and December 31, 2010 |
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167,756 |
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20,055 |
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Retained earnings |
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119 |
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52,386 |
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Total stockholders equity |
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167,875 |
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72,441 |
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Total liabilities and stockholders equity |
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$ |
1,003,072 |
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$ |
735,629 |
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See accompanying notes to consolidated financial statements.
3
iPAYMENT, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
(Unaudited)
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Period From |
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Three |
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Period From |
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Six |
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May 24 |
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April 1 |
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Months |
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May 24 |
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January 1 |
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Months |
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through |
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through |
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Ended |
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through |
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through |
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Ended |
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June 30, |
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May 23, |
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June 30, |
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June 30, |
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May 23, |
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June 30, |
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2011 |
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2011 |
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2010 |
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2011 |
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2011 |
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2010 |
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Successor |
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Predecessor |
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Predecessor |
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Successor |
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Predecessor |
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Predecessor |
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Revenues |
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$ |
77,519 |
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$ |
107,077 |
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$ |
183,933 |
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$ |
77,519 |
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$ |
276,690 |
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$ |
343,473 |
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Operating expenses: |
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Interchange |
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42,262 |
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57,051 |
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98,544 |
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42,262 |
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147,779 |
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189,541 |
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Other costs of services |
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26,104 |
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33,733 |
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55,605 |
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26,104 |
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88,474 |
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106,206 |
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Selling, general and administrative |
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1,728 |
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2,446 |
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3,303 |
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1,728 |
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6,736 |
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6,385 |
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|
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Total operating expenses |
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70,094 |
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|
93,230 |
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|
157,452 |
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70,094 |
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242,989 |
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302,132 |
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Income from operations |
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7,425 |
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13,847 |
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|
|
26,481 |
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7,425 |
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33,701 |
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|
41,341 |
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|
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|
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Other expense: |
|
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|
|
|
|
|
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|
|
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|
|
|
|
|
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Interest expense, net |
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7,237 |
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|
|
7,677 |
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|
|
11,449 |
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7,237 |
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|
15,578 |
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|
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22,820 |
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Other (income) expense, net |
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|
(4 |
) |
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|
18,834 |
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|
602 |
|
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|
(4 |
) |
|
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18,804 |
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|
|
372 |
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
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|
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|
|
|
|
|
|
|
|
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|
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|
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|
Income (loss) before income taxes |
|
|
192 |
|
|
|
(12,664 |
) |
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|
14,430 |
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|
|
192 |
|
|
|
(681 |
) |
|
|
18,149 |
|
|
|
|
|
|
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|
|
|
|
|
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|
|
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|
|
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Income tax provision (benefit) |
|
|
73 |
|
|
|
(3,849 |
) |
|
|
6,121 |
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|
|
73 |
|
|
|
572 |
|
|
|
7,619 |
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
|
|
|
|
|
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|
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|
|
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|
|
|
|
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|
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Net income (loss) |
|
$ |
119 |
|
|
$ |
(8,815 |
) |
|
$ |
8,309 |
|
|
$ |
119 |
|
|
$ |
(1,253 |
) |
|
$ |
10,530 |
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|
|
|
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|
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See accompanying notes to consolidated financial statements.
4
iPAYMENT, INC.
CONSOLIDATED STATEMENTS of CASH FLOWS
(In thousands)
(Unaudited)
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Period From |
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|
|
|
|
|
May 24 |
|
|
January 1 |
|
|
Six Months |
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through |
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through |
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Ended |
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June 30 |
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May 23 |
|
|
June 30, |
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|
2011 |
|
|
2011 |
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2010 |
|
|
|
Successor |
|
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Predecessor |
|
|
Predecessor |
|
Cash flows from operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
119 |
|
|
$ |
(1,253 |
) |
|
$ |
10,530 |
|
Adjustments to reconcile net (loss) income to net cash (used in)
provided by operating activities |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
5,921 |
|
|
|
16,441 |
|
|
|
20,775 |
|
Noncash interest expense and other |
|
|
301 |
|
|
|
7,791 |
|
|
|
1,292 |
|
Changes in assets and liabilities, excluding effects of redemption: |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
478 |
|
|
|
48 |
|
|
|
460 |
|
Prepaid expenses and other current assets |
|
|
(2 |
) |
|
|
(457 |
) |
|
|
356 |
|
Other assets |
|
|
(491 |
) |
|
|
(3,972 |
) |
|
|
(1,433 |
) |
Accounts payable and income taxes payable |
|
|
(431 |
) |
|
|
(10,632 |
) |
|
|
(3,547 |
) |
Accrued interest |
|
|
2,102 |
|
|
|
2,959 |
|
|
|
(151 |
) |
Accrued liabilities and other |
|
|
(8,342 |
) |
|
|
6,219 |
|
|
|
(4,552 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by operating activities |
|
|
(345 |
) |
|
|
17,144 |
|
|
|
23,730 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Change in restricted cash |
|
|
1 |
|
|
|
|
|
|
|
12 |
|
Expenditures for property and equipment |
|
|
(584 |
) |
|
|
(1,571 |
) |
|
|
(1,309 |
) |
Acquisitions of merchant portfolios |
|
|
(3,600 |
) |
|
|
|
|
|
|
|
|
Payments for prepaid residual expenses |
|
|
(371 |
) |
|
|
(539 |
) |
|
|
(4,484 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(4,554 |
) |
|
|
(2,110 |
) |
|
|
(5,781 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities |
|
|
|
|
|
|
|
|
|
|
|
|
Net repayments on line of credit |
|
|
(7,500 |
) |
|
|
(15,500 |
) |
|
|
(10,450 |
) |
Repayments of debt |
|
|
(3,500 |
) |
|
|
(615,138 |
) |
|
|
(7,500 |
) |
Net dividends paid to parent company |
|
|
|
|
|
|
(135,539 |
) |
|
|
|
|
Proceeds from issuance of long-term debt, net of discount |
|
|
|
|
|
|
768,125 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities |
|
|
(11,000 |
) |
|
|
1,948 |
|
|
|
(17,950 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (decrease) increase in cash and cash equivalents |
|
|
(15,899 |
) |
|
|
16,982 |
|
|
|
(1 |
) |
Cash and cash equivalents, beginning of period |
|
|
16,983 |
|
|
|
1 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
1,084 |
|
|
$ |
16,983 |
|
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the period for income taxes |
|
$ |
70 |
|
|
$ |
11,518 |
|
|
$ |
10,520 |
|
Cash paid during the period for interest |
|
$ |
4,847 |
|
|
$ |
11,596 |
|
|
$ |
21,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash increases in assets from redemption: |
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets |
|
$ |
103,125 |
|
|
$ |
|
|
|
$ |
|
|
Goodwill |
|
$ |
166,759 |
|
|
$ |
|
|
|
$ |
|
|
See accompanying notes to consolidated financial statements.
5
Notes to Consolidated Financial Statements
(1) Organization, Business and Basis of Presentation
Organization
iPayment, Inc. (iPayment or the Company) was originally incorporated as iPayment Holdings, Inc.
(Holdings) in Tennessee and was reincorporated in Delaware under the name iPayment, Inc.
iPayment is a provider of credit and debit card payment processing services to small merchants across the United States. We enable merchants to accept credit cards as well as other forms of card-based 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 groups (ISGs).
As more fully described in Note 2 below, on May 23, 2011, iPayment Investors, LP (Investors), our
ultimate parent, and iPayment GP, LLC (the General Partner), the general partner of Investors,
completed the redemption (the Equity Redemption) of all of the direct and indirect equity
interests in Investors and the General Partner of (i) Gregory Daily, our former Chairman and Chief
Executive Officer and (ii) the trusts for the benefit of, and other entities controlled by, members
of Mr. Dailys family that held equity interests in Investors. The Equity Redemption resulted in a change in control and accordingly
it has been accounted for as a business combination in accordance with ASC 805 Business Combinations. As a result of the Equity
Redemption, the Companys results of operations, financial position and cash flows prior to the
date of the Equity Redemption are presented as the Predecessor. The financial effects of the
Equity Redemption and the Companys results of operations, financial position and cash flows
following the Equity Redemption are presented as the Successor. In addition, the terms second quarter of 2011 and
three months ended June 30, 2011 refer to the combined results of the Predecessor and Successor entities for such period and the terms
first six months of 2011 and six months ended June 30, 2011 refer to the combined results of the Predecessor and Successor entities for such period.
Business
We are a provider of credit and debit card payment processing services to small merchants
across the United States. Our payment processing services enable our merchants to accept credit
cards as well as other forms of card-based payment, including debit cards, checks, gift cards and
loyalty programs in both traditional card-present, or swipe transactions, as well as
card-not-present transactions. We market and sell our services primarily through independent sales
groups or ISGs, which are non-employee, external sales organizations and other third party
resellers. We also partner with banks such as Wells Fargo to sponsor
us for membership in the Visa and MasterCard associations and to settle transactions with
merchants. We perform core functions for small merchants such as application processing,
underwriting, account set-up, risk management, fraud detection, merchant assistance and support,
equipment deployment, and chargeback services in our main operating center in Westlake Village,
California.
We have significant outstanding long-term debt as of June 30, 2011. On May 6, 2011, we entered into
new senior secured credit facilities (the New Senior Secured Credit Facilities) consisting of (i)
a $375 million term facility and (ii) a $75 million revolving facility. The new revolving facility
will mature on May 6, 2016, and the new term facility will mature on May 8, 2017. We also issued
$400 million in aggregate principal amount of 10.25% senior notes due 2018 (the New Senior
Notes). The New Senior Secured Credit Facilities and the New Senior Notes are more fully
described in Note 5 below. We used a portion of the proceeds from the offering of the New Senior Notes together
with borrowings under the New Senior Secured Credit Facilities to (i) permanently repay all of the
outstanding indebtedness under the Companys then existing
senior secured credit facilities; (ii)
redeem and satisfy and discharge all of the Companys then
existing senior subordinated notes; and (iii) pay a dividend to Holdings which was ultimately used to fund the Equity Redemption.
The terms of our long-term debt contain various nonfinancial and financial covenants as further
described in Note 5 below. If we fail to comply with these covenants and are unable to obtain a
waiver or amendment or otherwise cure the breach, an event of default would result. If an event of
default were to occur, the trustee under the indenture governing the New Senior Notes or the
lenders under our New Senior Secured Credit Facilities could, among other things, declare
outstanding amounts immediately due and payable. We currently do not have available cash and
similar liquid resources available to repay all of our debt obligations if they were to become due
and payable. Our Senior Secured Leverage Ratio, as defined in our New Senior Secured Credit
Facilities, was 2.77 to 1.00 as of June
30, 2011, compared to the allowed maximum of 3.75 to 1.00. Our Consolidated Interest Coverage
Ratio, as defined in our New Senior Secured Credit Facilities, was 2.15 to 1.00 as of June 30,
2011, compared to the allowed minimum of 1.40 to 1.00.
6
As used in this Quarterly Report on Form 10-Q, the terms iPayment, the Company, we, us,
our and similar terms refer to iPayment, Inc. and, unless otherwise indicated or required by the
context, its consolidated subsidiaries.
Basis of Presentation
The accompanying consolidated financial statements of iPayment have been prepared in accordance
with U.S. generally accepted accounting principles (GAAP) and reflect all adjustments, which are
of a normal and recurring nature, that are, in the opinion of management, necessary for a fair
presentation of results. All significant intercompany transactions and balances have been
eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the
current year presentation. As a result of the Equity Redemption as further described in Note 2, the
Companys results of operations, financial position and cash flows prior to the date of the Equity
Redemption are presented as the Predecessor. The financial effects of the Equity Redemption and
the Companys results of operations, financial position and cash flows following the Equity
Redemption are presented as the Successor. In the opinion of management, the unaudited
consolidated financial statements contain all normal recurring adjustments which are necessary to
state fairly the consolidated financial position and results of operations for the related periods.
The consolidated results of operations for any of these interim periods are not necessarily
indicative of results to be expected for the full year.
Use of Estimates
The preparation of our financial statements in conformity with GAAP 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 our 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. As a result of the change in control described
in Note 2 below, the Company estimated the allocable fair value of certain assets and the allocation of such fair value
to its assets and liabilities as of June 30, 2011. The Company has engaged an independent,
third party valuation firm to assist in valuing certain assets and expects their valuation to be
completed during the third quarter of this year.
Revenue and Cost Recognition
Substantially all of our revenues are generated from fees charged to merchants for card-based
payment processing services. We typically charge these merchants a bundled rate, primarily based
upon each merchants monthly charge volume and risk profile. Our fees principally consist of
discount fees, which are a percentage of the dollar amount of each credit or debit transaction. We
recognize discounts and other fees related to payment transactions at the time the merchants
transactions are processed. Related interchange and assessment costs are also recognized at that
time. We derive the balance of our revenues from a variety of fixed transaction or service fees,
including fees for monthly minimum charge volume requirements, statement fees, annual fees, payment
card industry compliance fees, and fees for other miscellaneous services, such as handling
chargebacks. We recognize revenues derived from service fees at the time the service is performed.
Other Costs of Services
Other costs of services include costs directly attributable to processing and bank sponsorship
costs such as residual payments to ISGs, which are commissions we pay to our ISGs based upon a
percentage of the net revenues we generate from their merchant referrals, and assessment fees
payable to card associations, which is a percentage of the charge volume we generate from Visa and
MasterCard. In addition, other costs of services includes telecommunications costs, personnel
costs, occupancy costs, losses due to merchant defaults, other miscellaneous merchant supplies and
services expenses, bank sponsorship costs and other third-party processing costs directly
attributable to our provision of payment processing and related services to our merchants.
7
Financial Instruments
ASC 820 Fair Value Measurement and Disclosures establishes a framework for measuring fair value,
establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances
disclosure requirements for fair value measurements. The valuation hierarchy is based upon the
transparency of inputs to the valuation of an asset or liability as of the measurement date. The
three levels are defined as follows:
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Level 1: Observable quoted prices in active markets for identical assets and
liabilities. |
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Level 2: Observable quoted prices for similar assets and liabilities in active
markets, quoted prices for identical or similar instruments in markets that are not
active, and model-based valuation techniques for which all significant assumptions are
observable in the market. |
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Level 3: Model-based techniques that use at least one significant assumption not
observable in the market. These unobservable assumptions reflect estimates of
assumptions that market participants would use in pricing the asset or liability.
Valuation techniques include use of option pricing models, discounted cash-flow models
and similar techniques. |
We believe the carrying amounts of financial instruments at June 30, 2011 approximate fair value.
Due to the short maturities of the cash and cash equivalents and accounts receivable, carrying
amounts approximate the respective fair values. The carrying value of our New Senior Notes was
$400.0 million as of June 30, 2011. We estimate the fair value to be approximately $399.0 million,
considering executed trades occurring around June 30, 2011. The carrying value of the term loans
under our New Senior Secured Credit Facilities, net of discount, was $369.7 million as of June 30,
2011. We estimate the fair value to be approximately $370.2 million, considering executed trades
occurring around June 30, 2011. The fair value of the Companys New Senior Notes and New Senior
Secured Credit Facilities are estimated using direct and indirect observable market information and
are classified within Level 2 of the fair value hierarchy, as defined by ASC 820. The Company is
contractually obligated to repay its borrowings in full and the Company does not believe the
creditors under its borrowing arrangements are willing to settle these instruments with the Company
at their estimated fair values indicated herein.
Derivative Financial Instruments
The Company uses certain variable rate debt instruments to finance its operations. These debt
obligations expose the Company to variability in interest payments due to changes in interest
rates. If interest rates increase, interest expense increases. Conversely, if interest rates
decrease, interest expense also decreases.
The Company may enter into certain derivative instruments to manage fluctuations in cash flows
resulting from interest rate risk. Historically, these instruments have consisted solely of
interest rate swaps. Under the interest rate swaps, the Company historically received variable
interest rate payments and made fixed interest rate payments, thereby effectively creating
fixed-rate debt. The Company enters into derivative instruments solely for cash flow hedging
purposes and does not speculate using derivative instruments.
The Company accounts for its derivative financial instruments in accordance with ASC 815
Derivatives and Hedging. Under ASC 815, we recognized all derivatives as either other assets or
other liabilities, measured at fair value. Under our then existing senior secured credit
facilities, we were required to hedge at least 50% of the outstanding balance through May 10, 2008,
and accordingly, we entered into interest rate swap agreements with a total notional amount of
$260.0 million. These swap agreements expired on December 31, 2010, and our interest rate swap
balance at that date was $0. ASC 815 also requires that any ineffectiveness in the hedging
relationship, resulting from differences in the terms of the hedged item and the related
derivative, be recognized in earnings each period. The underlying terms of our interest rate swaps,
including the notional amount, interest rate index, duration, and reset dates, were identical to
those of the associated debt instruments and therefore the hedging relationship resulted in no
material ineffectiveness. Accordingly, such derivative instruments were classified as cash flow
hedges, and any changes in the fair value of the derivative instruments were previously included in
accumulated other comprehensive income (loss) in our consolidated balance sheets. As of June 30,
2011, the Company was not a party to any derivative financial instruments.
8
Amortization of Intangible Assets
Purchased merchant processing portfolios are recorded at cost and are evaluated by management for
impairment at the end of each fiscal quarter through review of actual attrition and cash flows
generated by the portfolios in relation to the expected attrition and cash flows and the recorded
amortization expense. The estimated useful lives of our merchant processing portfolios are
assessed by evaluating each portfolio to ensure that the recognition of the costs of revenues,
represented by amortization of the intangible assets, approximate the distribution of the expected
revenues from each processing portfolio. If, upon review, the actual costs of revenues differ from
the expected costs of revenues, we will adjust amortization expense accordingly. Historically, we
have experienced an average monthly volume attrition of approximately 1.0% to 3.0% of our total
charge volume.
We use an accelerated method of amortization over a 15-year period for purchased merchant
processing portfolios. We believe that this method of amortization approximates the distribution
of actual cash flows generated by our merchant processing portfolios. All other intangible assets
are amortized using the straight-line method over estimated lives of 3 to 7 years. For the period
from May 24 through June 30, 2011, amortization expense related to our merchant processing
portfolios and other intangible assets was $5.7 million. For the period from April 1 through May
23, 2011, amortization expense related to our merchant processing portfolios and other intangible
assets was $5.6 million. For the period from January 1 through May 23, 2011, amortization expense
related to our merchant processing portfolios and other intangible assets was $15.5 million. For
the three and six months ended June 30, 2010, amortization expense related to our merchant
processing portfolios and other intangible assets was $9.6 million and $19.7 million, respectively.
In addition, we have implemented both quarterly and annual procedures to determine whether a
significant change in the trend of the current attrition rates being used has occurred on a
portfolio-by-portfolio basis. In reviewing the current attrition rate trends, we consider relevant
benchmarks such as merchant processing volume, revenues, gross profit and future expectations of
the aforementioned factors compared to historical amounts and rates. If we identify any
significant changes or trends in the attrition rate of any portfolio, we will adjust our current
and prospective estimated attrition rates so that the amortization expense better approximates the
distribution of actual cash flows generated by the merchant processing portfolios. Any adjustments
made to the amortization schedules would be reported in the current consolidated statements of
operations and on a prospective basis until further evidence becomes apparent. There were no
unfavorable trends identified in the attrition rates used for the three-month period ended March
31, 2011, the three-month period ended March 31, 2010, or the six-month period ended June 30, 2010.
Consequently, there were no related increases to amortization expense for these periods. Please
refer to Note 2 below for further discussion.
Common Stock
The Company has 100 shares of common stock outstanding at June 30, 2011. The Company has elected
not to present earnings per share data as management believes such presentation would not be
meaningful.
(2) Equity Redemption, Refinancing and Change in Control
In May 2009, a jury in the Superior Court of the State of California for the County of Los Angeles
handed down a verdict in the amount of $300 million, plus punitive damages in the amount of $50
million, against Gregory Daily, our former Chairman and Chief Executive Officer, in connection with
litigation over Mr. Dailys beneficial ownership in us. This lawsuit was brought against Mr. Daily
individually and not in his capacity as the Chairman and Chief Executive Officer or Director of the
Company. Neither the Company, nor any other shareholders, officers, employees or directors were a
party to this action. The Company did not then, nor does it now, have any indemnification,
reimbursement or any other contractual obligation to Mr. Daily in connection with this legal
matter. In response to the verdict, Mr. Daily filed for personal bankruptcy protection under
Chapter 11 of the United States Bankruptcy Code in Nashville, Tennessee. On April 8, 2010, the
United States Bankruptcy Court for the Middle District of Tennessee (the Bankruptcy Court)
ordered the appointment of a trustee (the Daily Bankruptcy Trustee) to administer the estate of
Mr. Daily.
9
On April 12, 2011, Investors and the General Partner, entered into a redemption agreement (the
Redemption Agreement) with (i) Mr. Daily, (ii) the Daily Bankruptcy Trustee and (iii) the trusts
for the benefit of, and other entities controlled by, members of Mr. Dailys family that held
equity interests in Investors (together with Mr. Daily
and the Daily Bankruptcy Trustee, on behalf of the Daily bankruptcy estate, the Daily Parties).
Pursuant to the Redemption Agreement, Investors and the General Partner agreed to redeem from the
Daily Parties, and the Daily Parties agreed to transfer and surrender to Investors and the General
Partner, as applicable, all of the equity interests of the Daily Parties in Investors and the
General Partner, representing approximately 65.8% of the outstanding equity of Investors, for an
aggregate price of $118.5 million. The interests redeemed pursuant to the Redemption Agreement
constituted all of the direct and indirect equity interests of the Daily Parties in the Company.
On May 6, 2011, the Company completed the offering of the New Senior Notes and the closing of the
New Senior Secured Credit Facilities. Also on May 6, 2011, Holdings completed an offering of
125,000 units (the Units), consisting of $125 million in aggregate principal amount of
15.00%/15.00% Senior Notes due 2018 (Holdings Notes) and 125,000 warrants (the Warrants) to
purchase common stock of Holdings. The Warrants represent an aggregate 2.5% of the outstanding
common stock of Holdings on a fully diluted basis (after giving effect to the Warrants).
The majority of the proceeds from the offerings of the New Senior Notes and the Units, together
with borrowings under the New Senior Secured Credit Facilities, were used to (i) permanently repay
all of the outstanding indebtedness under the Companys then existing senior secured credit
facilities; (ii) redeem and satisfy and discharge all of the Companys then existing senior
subordinated notes; (iii) redeem and satisfy and discharge all of Investors then existing PIK
toggle notes and (iv) pay fees and expenses in connection with the offerings. All of the remainder
of such proceeds and borrowings were used to consummate the Equity Redemption on May 23, 2011,
including payment of the transaction fees and other related fees and expenses described below in
Note 11.
Upon the closing of the Equity Redemption, Mr. Daily resigned as a director and officer, as
applicable, of the General Partner, Investors and each of Investors subsidiaries, including his
position as our Chairman and Chief Executive Officer. In connection with Mr. Dailys resignation,
Carl Grimstad became the new Chairman and Chief Executive Officer of the Company and Mark Monaco,
the Companys Chief Financial Officer, became a member of the Companys board of directors. The
Redemption Agreement includes covenants on the part of Mr. Daily not to compete with the Company
and its affiliates for one year, and not to solicit employees, independent sales agents and
independent sales organizations and merchants of the Company and its affiliates for three years, in
each case from May 23, 2011, the closing date of the Equity Redemption.
The description set forth above is intended to be a summary only, is not complete and is qualified
in its entirety by reference to the full and complete terms contained in the Redemption Agreement,
a copy of which is included as Exhibit 99.1 to the Current Report on Form 8-K filed with the Securities and Exchange Commission (SEC) on
April 13, 2011, which is incorporated herein by reference.
In accordance with ASC 805, Business Combinations the Company determined that a change of control
occurred as a result of the Equity Redemption requiring assets and liabilities to be recorded
at a fair value and an allocation of the Companys estimated fair value to its assets
and liabilities to be made based upon managements current estimate as of June 30, 2011 of their respective fair values. As part
of this allocation, approximately $694.7 million was assigned to goodwill and $249.3 million to
merchant portfolio and other intangible assets, resulting in an increase of $166.8 million and
$103.1 million in goodwill and merchant portfolio and other intangible assets, respectively, over
the historical basis prior to the Equity Redemption. Of the amount allocated to merchant portfolio
and other intangible assets, $246.7 million relates to the Companys merchant processing portfolios
and residual cash flow streams and the remaining $2.6 million is primarily attributable to software
development and other.
The amount allocated to intangible assets related to merchant processing portfolios is an estimate
as of June 30, 2011. The Company has engaged an independent, third party valuation firm to assist
in valuing these assets and expects their valuation to be completed during the third quarter of
this year. Adjustments, if any, to the carrying values of the intangible assets described above
will be made in the third quarter based on the results of that valuation work.
If the Equity Redemption had occurred on January 1, 2010, we would have recorded additional
amortization expense on our merchant processing portfolios of approximately $16.8 million for the
six months ended June 30, 2010. If the Equity Redemption had occurred on January 1, 2011, we would
have recorded additional amortization expense on our merchant processing portfolios of
approximately $5.6 million for the six months ended June 30, 2011.
10
(3) Acquisitions
There were no acquisitions of businesses during 2011 or 2010 that were significant enough to
require pro forma disclosure.
In November 2010, we entered into a purchase and sale agreement with the shareholders of Flagship
Merchant Services (Flagship), whereby we acquired a merchant portfolio of approximately 8,400
merchant accounts from Flagship. Total consideration at closing was $20 million in cash, which was
funded from our cash on hand and from borrowings under our then existing revolving facility.
In December 2010, we entered into a purchase and sale agreement with an existing ISG, whereby we
acquired a merchant portfolio of approximately 2,500 merchant accounts. Consideration at closing
was $5 million in cash, which was funded at closing from borrowings under our then existing
revolving facility.
In June 2011, we entered into a purchase and sale agreement with a new ISG, whereby we acquired a
merchant portfolio of approximately 1,250 merchant accounts. Consideration at closing was $3.6
million in cash, which was funded at closing from cash on hand.
(4) Other Intangibles
Payments for Prepaid Residual Expenses
During
the first six months of 2011, we made payments totaling $0.9 million to
several ISGs in exchange for contract modifications which lower our obligations for future payments
of residuals to them. These payments have been assigned to intangible assets in the accompanying
consolidated balance sheets and are amortized over their expected useful lives.
(5) Long-Term Debt
On May 6, 2011, we completed an offering of $400 million in aggregate principal amount of 10.25%
Senior Notes due 2018. We also completed the closing of our $450 million New Senior Secured Credit
Facilities. We used a portion of the proceeds from the offering of the New Senior Notes together with
borrowings under the New Senior Secured Credit Facilities to (i) permanently repay all of the
outstanding indebtedness under the Companys then existing
senior secured credit facilities; (ii)
redeem and satisfy and discharge all of the Companys then
existing senior subordinated notes; and (iii) pay a dividend to Holdings which was ultimately used to fund the Equity Redemption.
The New Senior Notes were issued pursuant to an indenture, dated as of May 6, 2011 (the
Indenture), among the Company, each of the guarantors identified therein and Wilmington Trust
FSB, as trustee (the Trustee). The Company will pay interest on the New Senior Notes in cash on
November 15 and May 15 of each year at a rate of 10.25% per annum. Interest on the New Senior Notes
will accrue from and including the issue date of the New Senior Notes, and the first interest
payment date will be November 15, 2011. The New Senior Notes will mature on May 15, 2018. The
Indenture contains covenants that, among other things, restrict the Companys and its restricted
subsidiaries ability to pay dividends, redeem stock or make other distributions or restricted
payments, make certain investments, incur or guarantee additional indebtedness, create liens, agree
to dividend and payment restrictions affecting restricted subsidiaries, consummate mergers,
consolidations or other business combinations, designate subsidiaries as unrestricted, change its
or their line of business, or enter into certain transactions with affiliates. The covenants in the
Indenture generally permit the Company to distribute funds to Holdings, the Companys direct
parent, to make interest payments on Holdings Notes (defined below) to the extent required to be
paid in cash by the terms of the indenture governing such notes and for certain other operating
expenses of Holdings.
The Indenture also provides for customary events of default including non-payment of principal,
interest or premium, failure to comply with covenants, and certain bankruptcy or insolvency events.
11
The Company also entered into a Credit Agreement, dated May 6, 2011 (the Credit Agreement), with
Holdings, the subsidiaries of the Company identified therein as guarantors, JPMorgan Chase Bank,
N.A. and the other lenders party thereto. The New Senior Secured Credit Facilities consist of (i) a
six-year, $375 million term facility and (ii) a
five-year, $75 million revolving facility, which includes a swing line loan facility and letter of
credit facility and is available from time to time until the fifth anniversary of the closing date
of the New Senior Secured Credit Facilities (or in the case of the letter of credit facility, five
business days prior to the fifth anniversary). The terms of the New Senior Secured Credit
Facilities give the Company the ability, subject to certain conditions, to request an increase in
the amount of the revolving facility in an aggregate amount of up to $25 million.
The interest rates under the New Senior Secured Credit Facilities (other than in respect to swing
line loans, which will accrue interest at the base rate described below) are calculated, at the
Companys option, at either the Eurodollar rate (which is the higher of BBA LIBOR, and in respect
of the term facility, 1.50%) or the base rate (which is the highest of JPMorgan Chase Bank, N.A.s
prime rate, the Federal Funds effective rate plus 0.50%, the one-month Eurodollar rate plus 1.00%,
and in respect of the term facility, 2.50%) plus, in each case, the applicable margin which differs
for the term facility and the revolving facility (and, which in the case of the revolving facility
is subject to adjustment based on a pricing grid set forth in the Credit Agreement). Overdue
principal, interest, fees and other amounts bear interest at a rate that is 2.00% above the rate
then borne by such borrowing or the base rate in respect of the term facility, as applicable. A
commitment fee equal to 0.625% on the unused portion of the New Senior Secured Credit Facilities
accrued from the closing date of the New Senior Secured Credit Facilities and will be payable until
the Company delivers the accompanying consolidated financial statements for the fiscal quarter
ended June 30, 2011, and thereafter, a percentage per annum equal to 0.625% and declining to 0.375%
based upon our consolidated leverage ratio as determined in accordance with the related pricing
grid set forth in the Credit Agreement.
At June 30, 2011, we had $369.7 million of term loans outstanding, net of discount of $1.8 million
at a weighted average interest rate of 5.75% and no outstanding borrowings under our new revolving
facility.
The Credit Agreement contains certain customary covenants that, subject to certain exceptions,
restrict the Company and its subsidiaries ability to, among other things (i) declare dividends or
redeem or repurchase equity interests by the Company or its subsidiaries; (ii) prepay, redeem or
purchase certain debt; (iii) incur liens and engage in sale-leaseback transactions; (iv) make loans
and investments; (v) incur additional indebtedness; (vi) amend or modify specified debt and other
material agreements; (vii) engage in mergers, acquisitions and asset sales; (viii) change
accounting policies; (ix) become a general partner; (x) enter into speculative transactions; (xi)
transact with affiliates; and (xii) engage in businesses that are not related to the Companys
existing business. In addition, under the Credit Agreement, the Company will be required to comply
(subject to a right to cure in certain circumstances) with specified financial ratios and tests,
including a minimum consolidated interest coverage ratio and a maximum senior secured leverage
ratio.
In addition, the Credit Agreement contains certain customary affirmative covenants, including
requirements for financials reports and other notices from the Company.
Events of default, which are subject to grace periods and exceptions, as set forth in the Credit
Agreement include, among others: (i) the Companys failure to pay principal or interest or any
other amount when due under the Credit Agreement; (ii) any representation or warranty proving to
have been materially incorrect; (iii) covenant defaults; (iv) judgment defaults; (v) customary
ERISA defaults; (vi) invalidity of loan documents or impairment of collateral; (vii) events of
bankruptcy; (viii) a change of control; (ix) cross-default to material debt; and (x) cancellation
or termination of a material contract, in certain circumstances.
The descriptions set forth above are intended to be summaries only, are not complete and are
qualified in their entirety by reference to the full and complete terms contained in the Indenture
(including the form of the notes attached thereto) and the Credit Agreement, copies of which are
included as Exhibits 4.1 and 10.1, respectively, to the Current Report on Form 8-K filed with the
SEC on May 12, 2011 and are incorporated herein by
reference.
We had net capitalized debt issuance costs related to the New Senior Secured Credit Facilities of
$10.7 million and net capitalized debt issuance costs related to the New Senior Notes of $10.0
million as of June 30, 2011. These costs are being amortized to interest expense with amounts
computed using an effective interest method over the life of the related debt instruments.
Amortization expense related to the debt issuance costs for the New Senior Secured Credit
Facilities and the New Senior Notes were $0.2 million and $0.1 million, respectively, for the
period from May 24 through June 30, 2011. Amortization expense related to our then existing senior
secured credit facilities and senior subordinated notes were $0.1 million and $0.1 million,
respectively, for the period from April 1 through May 23, 2011. Amortization expense related to
our then existing senior secured credit facilities and senior subordinated
notes were $0.4 million and $0.4 million, respectively, for the period from January 1 through May
23, 2011. The remaining unamortized balance of debt issuance costs related to our previously
existing senior secured credit facilities and senior subordinated notes, as well as the remaining
unamortized net discount on our senior subordinated notes in the amount of $2.2 million,
$3.3 million and $1.0 million, respectively, were written off to other expense as a result of the
refinancing described in Note 2 above.
12
(6) 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. No single merchant accounted for more than 3% of our revenue during the second
quarter of 2011. Substantially all revenues are generated in the United States.
(7) Income Taxes
We account for income taxes pursuant to the provisions of ASC 740 Income Taxes. Under this
method, deferred tax assets and liabilities are recorded to reflect the future tax consequences
attributable to the effects of differences between the carrying amounts of existing assets and
liabilities for financial reporting and for income tax purposes.
Our income taxes currently payable for federal and state purposes have been reduced by tax benefits
totaling approximately $6.3 million that we obtained from non-recurring expenses incurred related
to the write off of the unamortized balance of debt issuance costs and a payment made for strategic
advisory fees. Our effective income tax rate was 38.1%, excluding the aforementioned tax benefits
for the first six months of 2011, compared to 42.4% for the
quarter ended June 30, 2010.
During the first six months of 2011 and 2010, we accrued less than $0.1 million of interest related
to our uncertain tax positions. As of June 30, 2011, our liabilities for unrecognized tax benefits
totaled $2.4 million and are included in other long-term liabilities in our consolidated balance
sheets. Interest and penalties related to income tax liabilities are included in income tax
expense. The balance of accrued interest and penalties recorded in the consolidated balance sheets
at June 30, 2011 was approximately $0.3 million.
We file federal income tax returns and various state income tax returns. With limited exception,
we are no longer subject to federal, state and local income tax audits by taxing authorities for
the years through 2005.
At June 30, 2011, we had approximately $1.4 million of federal net operating loss carryforwards
that will be available to offset regular taxable income through 2018, subject to annual limitations
of up to $0.2 million per year. We had state net operating loss carryforwards of approximately
$30.3 million as of June 30, 2011.
(8) Comprehensive Income (Loss)
Comprehensive income (loss) includes our net income plus the net-of-tax impact of fair market value
changes in our interest rate swap agreements, which expired on December 31, 2010. Accordingly,
there was no other comprehensive income (loss) during 2011. The accumulated elements of other
comprehensive loss, net of tax, are included within stockholders equity on the consolidated
balance sheets. Comprehensive income for the three-month period ended June 30, 2010
was $10.4 million. Changes in fair value, net of tax, on our swap agreements amounted to $2.1
million during the three-month period ended June 30, 2010.
Comprehensive income
for the six-month period ended June 30, 2010 was $14.2 million.
Changes in fair value, net of tax, on our swap agreements amounted to $3.7 million during the
six-month period ended June 30, 2010.
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(9) Commitments and Contingencies
Legal Proceedings
We are subject to certain legal proceedings that have arisen in the ordinary course of our business
and have not been fully adjudicated. Although the ultimate outcome of such legal proceedings cannot
be predicted with certainty, based on information currently available, advice of counsel, and
available insurance coverage, in our opinion, the outcome of such legal proceedings is not expected
to have a material adverse effect on our business, financial condition or results of operations.
However, the outcome of any such legal proceedings cannot be predicted with certainty and in the
event of unexpected future developments, it is possible that the ultimate resolution of one or more
of these matters could be unfavorable. Our failure to prevail in one or more of these legal matters
could, individually or in the aggregate, materially adversely affect our consolidated financial
position or operating results. Regardless of the outcome, any litigation may require us to incur
significant litigation expenses and may result in significant diversion of managements attention.
All litigation settlements are recorded within other expense on our consolidated statements of
operations.
(10) Recent Accounting Pronouncements
The Company did not adopt any new accounting pronouncements during the second quarter of 2011, nor
are there accounting pronouncements pending adoption that would have a significant effect on our
financial accounting and reporting. Please refer to our Annual Report for the year ended December
31, 2010, filed on Form 10-K with the SEC on March 21, 2011, for all recently adopted accounting
pronouncements.
(11) Related Party Transactions
At June 30, 2011, we had a receivable of $0.4 million due from Investors that is included in our
consolidated balance sheets within accounts receivable. During 2009 and 2010, the Company funded
certain expenses of Investors. The Companys initial accounting was to treat this funding as an
inter-company receivable. In August 2010, the board of directors of iPayment, Inc. declared a $1.0
million dividend to our indirect parent company, Investors, to cover operating costs. The dividend
was required by Investors to cover certain operating and legal costs, including reimbursement to
the Company of certain costs previously paid for by the Company on behalf of Investors. Subsequent
to the dividend payment, Investors settled $1.0 million of the intercompany receivable outstanding
at that time.
In November 2010, we entered into a sublease agreement with Fortis Payment Systems, LLC, an ISG
owned by an iPayment employee, through Cambridge Acquisition Sub, LLC, a wholly owned subsidiary.
The lease agreement extends through 2013, with an option of extending the contract through 2015.
The lease agreement provides for minimum annual payments of $60,000 beginning November 2010 for
three years.
In 2010, iPayment and the financial services firm Perella Weinberg Partners LP (Perella Weinberg)
entered into an engagement letter providing for Perella Weinberg to act as our financial advisor in
connection with a potential change of control or similar transaction involving the Company. In
March 2010, Adearo Holdings, LLC (Adearo), an entity majority owned and controlled by Mark
Monaco, entered into a consulting agreement with Perella Weinberg. Mr. Monaco became Chief
Financial Officer of the Company in October 2010 and a member of the Companys board of directors
in May 2011. When the Equity Redemption was consummated, we paid to Perella Weinberg a transaction
fee of approximately $7.5 million pursuant to such engagement letter and, following such payment,
Perella Weinberg made a payment of $1.0 million to Adearo pursuant to the consulting agreement
described above.
(12) Subsequent Events
In August 2011, we entered into purchase and sale agreements with two different ISGs. We acquired
a merchant portfolio of 665 merchant accounts through the first purchase and sale agreement.
Consideration at closing was $2.5 million in cash, which was funded at closing from borrowings
under our new revolving facility. We acquired a merchant portfolio of 2,758 merchant accounts
through the second purchase and sale agreement. Consideration at closing was $11.0 million in cash,
which was funded at closing from borrowings under our new revolving facility.
14
On August 1, 2011, we entered into a separation agreement and release (the Separation Agreement)
with Afshin
Yazdian, iPayments former Executive Vice President, General Counsel and Secretary. The Separation
Agreement provides for Mr. Yazdians resignation from all of his positions with the
Company as of August 12, 2011. Mr. Yazdian will remain as an at-will employee of the
Company until December 31, 2011 and will assist with the relocation described below and the
transitioning of his responsibilities to other executives. A description of certain terms of the
Separation Agreement is included in the Current Report on Form 8-K filed with the SEC on August 15,
2011, and a copy of the Separation Agreement is attached thereto as Exhibit 10.1.
On August 15, 2011, the Company announced its intention to relocate its corporate headquarters from
Nashville, Tennessee to New York, New York. The Company expects the relocation to be completed in
January 2012.
The Company also announced that Holdings intends to appoint John A.
Vickers to its board of directors, effective September 1, 2011. Mr. Vickers is currently Chairman
and Chief Executive Officer of Tishman Realty Corporation and the Tishman Hotel
Corporation, having served the Tishman organization for 27 years in
positions in increasing responsibility. He is responsible for Tishman’s
owned portfolio of hotels and for overseeing all of the firm’s service
divisions. Mr. Vickers was also Vice Chairman and Principal of Tishman
Construction Corporation prior to its sale to AECOM in July 2010.
15
|
|
|
Item 2. |
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
(MD&A). |
Forward-Looking Statements May Prove Inaccurate
This report includes various forward-looking statements regarding the Company that are subject to
risks and uncertainties, including, without limitation, the factors set forth below and under the
caption Risk Factors in our Annual Report on Form 10-K filed with the SEC on March 21, 2011.
These factors could affect our future financial results and could cause actual results to differ
materially from those expressed in forward-looking statements contained or incorporated by
reference in this document. Forward-looking statements include, but are not limited to,
discussions regarding our operating strategy, growth strategy, acquisition strategy, cost savings
initiatives, industry, economic conditions, financial condition, debt compliance, liquidity and
capital resources and results of operations. Such statements include, but are not limited to,
statements preceded by, followed by or that otherwise include the words believes, expects,
anticipates, intends, estimates or similar expressions. For those statements, we claim the
protection of the safe harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
Executive Overview
We are a leading provider of credit and debit card payment processing services to small merchants
across the United States. During June 2011, we generated revenue from approximately 188,000 small
merchants located across the United States. Of these merchants, approximately 133,000 were active
merchants that had each processed at least one Visa or MasterCard transaction in that month. Our
payment processing services enable our merchants to accept credit cards as well as other forms of
card-based payment, including debit cards, checks, gift cards and loyalty programs in both
traditional card-present, or swipe transactions, as well as card-not-present transactions. We
market and sell our services primarily through independent sales groups, or ISGs, which are
non-employee, external sales organizations and other third party resellers. We also partner with
banks such as Wells Fargo to sponsor us for membership in the Visa, MasterCard or other card
associations and to settle transactions with merchants. We perform core functions for small
merchants such as application processing, underwriting, account set-up, risk management, fraud
detection, merchant assistance and support, equipment deployment, and chargeback services in our
main operating center in Westlake Village, California.
Our strategy has been to increase profits by increasing our penetration of the small merchant
marketplace for payment services. Our charge volume decreased 1.8% to $11,193 million for the six
months ended June 30, 2011 from $11,394 million for the six months ended June 30, 2010. This
decline in charge volume was due primarily to a lower number of active merchants in 2011 compared
to 2010. However, our revenues increased $10.7 million or 3.1% to $354.2 million in the first six months of 2011 from $343.5 million in the same period of the
prior year. Our net revenue increased to $139.9 million for the six months ended June 30, 2011
from $131.6 million during the same period in 2010. Our net revenue is composed of total revenue
reduced by interchange and debit-interchange fees and network fees. Despite the lower number of
active merchants, revenues increased as a result of higher processing volumes per merchant and
increases in other revenues. Income from operations decreased 0.5% to $41.1 million for the six
months ended June 30, 2011 from $41.3 million for the six months ended June 30, 2010. Income from
operations for the six months ended June 30, 2011, includes $1.7 million of estimated incremental
amortization expense as the result of the estimated revaluation of intangible assets resulting from
the Equity Redemption. Excluding this increase in amortization expenses, income from operations
would have increased 3.5%. Loss before income taxes was $0.5 million for the six months ended June
30, 2011, compared with $18.1 million of income before income taxes in the same period in 2010.
Loss before income taxes for the six months ended June 30, 2011 is net of expenses totaling $18.7
million related to the refinancing described in Note 2 to the consolidated financial statements and
the Equity Redemption, including $6.5 million of expenses attributable to the write off of the
unamortized balance of debt issuance costs and discount for the then existing senior secured credit
facilities and senior subordinated notes, $4.7 million for a premium paid for early redemption of
our senior subordinated notes and $7.5 million of strategic advisory fees. Excluding these items,
income before income taxes would have been approximately $18.1 million for the six months
ended June 30, 2011, representing a 0.5% increase over the comparable period in 2010.
16
Critical Accounting Policies
The accompanying consolidated financial statements have been prepared in accordance with GAAP,
which require that management make numerous estimates and assumptions. Actual results could differ
from those estimates and assumptions, impacting our reported results of operations and financial
position. The critical accounting policies described here are those that are most important to the
depiction of our financial condition and results of operations and their application requires
managements most subjective judgment in making estimates about the effect of matters that are
inherently uncertain.
Accounting for Goodwill and Intangible Assets. We follow ASC 350 Intangibles Goodwill and Other
Topics, which addresses financial accounting and reporting for acquired goodwill and other
intangible assets, and requires that goodwill is subject to at least an annual assessment for
impairment. If facts and circumstances indicate goodwill may be impaired, we perform a
recoverability evaluation. In accordance with ASC 350, the recoverability analysis is based on fair
value. The calculation of fair value includes a number of estimates and assumptions, including
projections of future income and cash flows, the identification of appropriate market multiples and
the choice of an appropriate discount rate.
We engage, on a regular basis, an independent third party to aid management in determining the fair
value of our goodwill. We completed our most recent annual goodwill impairment review as of
December 31, 2010, using the present value of future cash flows to determine whether our fair value
exceeds the carrying amount of our net assets, including goodwill. We determined that no impairment
charge to goodwill was required. We are currently in the process of revaluing our intangible
assets and goodwill as a result of the Equity Redemption, in accordance with ASC 805, and expect
such valuation to be completed during the third quarter of this year.
We periodically evaluate the carrying value of long-lived assets in relation to the respective
projected future undiscounted cash flows to assess recoverability. An impairment loss is recognized
if the sum of the expected net cash flows is less than the carrying amount of the long-lived assets
being evaluated. The difference between the carrying amount of the long-lived assets being
evaluated and the fair value, calculated as the sum of the expected cash flows discounted at a
market rate, represents the impairment loss. We last evaluated the carrying value of our intangible
assets as of March 31, 2011, and determined no impairment charge was required. Purchased merchant
processing portfolios are recorded at cost and are evaluated by management for impairment at the
end of each fiscal quarter through review of actual attrition and cash flows generated by the
portfolios in relation to the expected attrition and cash flows and the recorded amortization
expense. The estimated useful lives of our merchant processing portfolios are assessed by
evaluating each portfolio to ensure that the recognition of the costs of revenues, represented by
amortization of the intangible assets, approximate the distribution of the expected revenues from
each processing portfolio. If, upon review, actual attrition and cash flows indicate impairment of
the value of the merchant processing portfolios, an impairment loss would be recognized.
Historically, we have experienced monthly volume attrition ranging from 1.0% to 3.0% of our total
charge volume on our various merchant portfolios. We utilize an accelerated method of amortization
over a fifteen-year period, which we believe approximates the distribution of actual cash flows
generated by our merchant processing portfolios. All other intangible assets are amortized using
the straight-line method over an estimated life of three to seven years.
In addition, we have implemented both quarterly and annual procedures to determine whether a
significant change in the trend of the current attrition rates being used exists. In reviewing the
current attrition rate trends, we consider relevant benchmarks such as merchant processing volume,
revenues, gross profit and future expectations of the aforementioned factors compared to historical
amounts and rates. If we identify any significant changes or trends in the attrition rate of any
portfolio, we will adjust our current and prospective estimated attrition rates so that the
amortization expense would better approximate the distribution of actual cash flows generated by
the merchant processing portfolios. Any adjustments made to the amortization schedules would be
reported in our current consolidated statements of operations and on a prospective basis until
further evidence becomes apparent. In 2010 and during the three-month period ended March 31, 2011,
we did not identify any unfavorable trend in attrition rates and accordingly, we did not record any
increase to amortization expense.
As previously noted, as a result of the Equity Redemption, the intangible assets related to
merchant processing portfolios are managements current estimates as of June 30, 2011. The
Company has engaged an independent, third party valuation firm to assist in valuing these assets
and expects their valuation to be completed during the third quarter of this year.
17
Revenue and Cost Recognition. Substantially all of our revenues are generated from fees charged to
merchants for card-based payment processing services. We typically charge these merchants a bundled rate,
primarily based upon each merchants monthly charge volume and risk profile. Our fees principally
consist of discount fees, which are a percentage of the dollar amount of each credit or debit
transaction. We charge all merchants higher discount rates for card-not-present transactions than
for card-present transactions in order to compensate ourselves for the higher risk of underwriting
these transactions. We derive the balance of our revenues from a variety of fixed transaction or
service fees, including fees for monthly minimum charge volume requirements, statement fees, annual
fees, technology fees, and fees for other miscellaneous services, such as handling chargebacks. We
recognize discounts and other fees related to payment transactions at the time the merchants
transactions are processed. Related interchange and assessment costs are also recognized at that
time. We recognize revenues derived from service fees at the time the service is performed.
We follow the requirements included in the Revenue Recognition Topic of ASC 605, Reporting Revenue
Gross as a Principal Versus Net as an Agent. Generally, where we have merchant portability, credit
risk and ultimate responsibility for the merchant, revenues are reported at the time of sale on a
gross basis equal to the full amount of the discount charged to the merchant. This amount includes
interchange paid to card issuing banks and assessments paid to payment card associations pursuant
to which such parties receive payments based primarily on processing volume for particular groups
of merchants. Interchange fees are set by Visa and MasterCard and are based on transaction
processing volume and are recognized at the time transactions are processed. Revenues generated
from certain bank portfolios acquired from First Data Merchant Services Corporation (FDMS) are
reported net of interchange, as required by ASC Topic 605, because we may not have credit risk,
portability or the ultimate responsibility for the merchant accounts.
The most significant component of operating expenses is interchange fees, which are amounts we pay
to the card issuing banks. Interchange fees are based on transaction processing volume and are
recognized at the time transactions are processed.
Other costs of services include costs directly attributable to our provision of payment processing
and related services to our merchants and primarily includes residual payments to ISGs, which are
commissions we pay to our ISGs 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
charge volume we generate from Visa and MasterCard. In addition, other costs of services include
telecommunications costs, personnel costs, occupancy costs, losses due to merchant defaults, other
miscellaneous merchant supplies and services expenses, bank sponsorship costs and other third-party
processing costs. Other costs of services also include depreciation expense, which is recognized on
a straight-line basis over the estimated useful life of the assets, and amortization expense, which
is recognized using an accelerated method over a fifteen-year period. Amortization of intangible
assets results from our acquisitions of portfolios of merchant contracts or acquisitions of a
business where we allocated a portion of the purchase price to the existing merchant processing
portfolios and other intangible assets.
Selling, general and administrative expenses consist primarily of salaries and wages, as well as
other general administrative expenses such as marketing expenses and professional fees.
Reserve for Merchant Losses. Disputes between a cardholder and a merchant periodically arise as a
result of, among other things, cardholder dissatisfaction with merchandise quality or merchant
services. Such disputes may not be resolved in the merchants favor. In these cases, the
transaction is charged back to the merchant, which means the purchase price is refunded to the
customer through the merchants acquiring bank and charged to the merchant. If the merchant has
inadequate funds, we or, under limited circumstances, the acquiring bank and us, must bear the
credit risk for the full amount of the transaction. We evaluate the merchants risk for such
transactions and estimate its potential loss for chargebacks based primarily on historical
experience and other relevant factors and record a loss reserve accordingly. At June 30, 2011 and
December 31, 2010, our reserve for losses on merchant accounts included in accrued liabilities and
other totaled $1.3 million and $1.4 million, respectively. We believe our reserve for charge-back
and other similar processing-related merchant losses is adequate to cover both the known probable
losses and the incurred but not yet reported losses at June 30, 2011 and December 31, 2010.
Income Taxes. We account for income taxes pursuant to the provisions of ASC 740 Income Taxes.
Under this method, deferred tax assets and liabilities are recorded to reflect the future tax
consequences attributable to the effects of differences between the carrying amounts of existing
assets and liabilities for financial reporting and for income tax purposes.
18
Seasonality
Our revenues and earnings are impacted by the volume of consumer usage of credit and debit cards at
the point of sale. For example, we experience increased point of sale activity during the
traditional holiday shopping period in the fourth quarter. Revenues during the first quarter tend
to decrease in comparison to the remaining three quarters of our fiscal year on a same store basis,
particularly in comparison to our fourth quarter.
Off-Balance Sheet Arrangements
We do not have transactions, arrangements and other relationships with unconsolidated entities that
are reasonably likely to affect our liquidity or capital resources. We have no special purpose or
limited purpose entities that provide off-balance sheet financing, liquidity or market or credit
risk support, engage in leasing, hedging, research and development services, or other relationships
that expose us to liability that is not reflected on the face of the financial statements.
19
Results of Operations:
The results of operations for the three months ended June 30, 2011 and the six months ended June
30, 2011 are the combined results of the predecessor and successor entities to facilitate
comparison of operations. See Note 2 to the consolidated financial statements.
Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010 (in thousands, except
percentages)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
% of Total |
|
|
Three months ended |
|
|
% of Total |
|
|
Change |
|
|
|
June 30, 2011 |
|
|
Revenue |
|
|
June 30, 2010 |
|
|
Revenue |
|
|
Amount |
|
|
% |
|
|
|
Combined |
|
|
|
|
|
|
Predecessor |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
184,596 |
|
|
|
100.0 |
% |
|
$ |
183,933 |
|
|
|
100.0 |
% |
|
$ |
663 |
|
|
|
0.36 |
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interchange |
|
|
99,313 |
|
|
|
53.8 |
|
|
|
98,544 |
|
|
|
53.6 |
|
|
|
769 |
|
|
|
0.78 |
|
Other costs of services |
|
|
59,837 |
|
|
|
32.4 |
|
|
|
55,605 |
|
|
|
30.2 |
|
|
|
4,233 |
|
|
|
7.61 |
|
Selling, general and
administrative |
|
|
4,174 |
|
|
|
2.3 |
|
|
|
3,303 |
|
|
|
1.8 |
|
|
|
871 |
|
|
|
26.37 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
163,324 |
|
|
|
88.5 |
|
|
|
157,452 |
|
|
|
85.6 |
|
|
|
5,873 |
|
|
|
3.73 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
|
21,272 |
|
|
|
11.5 |
|
|
|
26,481 |
|
|
|
14.4 |
|
|
|
(5,210 |
) |
|
|
(19.67 |
) |
Other expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net |
|
|
14,914 |
|
|
|
8.1 |
|
|
|
11,449 |
|
|
|
6.2 |
|
|
|
3,465 |
|
|
|
30.26 |
|
Other expenses, net |
|
|
18,830 |
|
|
|
10.2 |
|
|
|
602 |
|
|
|
0.3 |
|
|
|
18,227 |
|
|
|
3,027.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense |
|
|
33,744 |
|
|
|
18.3 |
|
|
|
12,051 |
|
|
|
6.6 |
|
|
|
21,692 |
|
|
|
180.00 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(12,472 |
) |
|
|
(6.8 |
) |
|
|
14,430 |
|
|
|
7.8 |
|
|
|
(26,902 |
) |
|
|
(186.43 |
) |
Income tax (benefit) provision |
|
|
(3,776 |
) |
|
|
(2.0 |
) |
|
|
6,121 |
|
|
|
3.3 |
|
|
|
(9,897 |
) |
|
|
(161.69 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
(8,696 |
) |
|
|
(4.7 |
) |
|
$ |
8,309 |
|
|
|
4.5 |
|
|
$ |
(17,005 |
) |
|
|
(204.66 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues. Revenues increased 0.4% to $184.6 million in the second quarter of 2011 from $183.9
million during the same period in 2010. The increase in revenues was largely due to an increase in
other revenue due to a new program that was implemented during the second quarter of 2010. Our
merchant processing volume, which represents the total value of transactions processed by us,
declined 0.8% to $5,808 million during the second quarter of 2011 from $5,853 million during the
same period in 2010, due to a lower average merchant base and as a result, lower number of
transactions processed during the quarter.
Interchange Expenses. Interchange expenses increased 0.8% to $99.3 million in the second quarter
of 2011 from $98.5 million during the same period in 2010. Despite a decrease in merchant
processing volume, interchange expenses increased due to an increase in the average interchange
rate as a percentage of merchant processing volume.
Other Costs of Services. Other costs of services increased 7.6% to $59.8 million in the second
quarter of 2011 from $55.6 million during the same period in 2010. The increase in other costs of
services was primarily due to higher sales expenses, network fees and depreciation and
amortization.
Selling, General and Administrative. Selling, general and administrative expenses increased 26.4%
to $4.2 million in the second quarter of 2011 as compared to $3.3 million during the same period in
2010. The increase was due to increased compensation expense for the second quarter of 2011
compared to the same period in 2010.
20
Other Expense. Other expenses increased $21.7 million to $33.7 million in the second quarter of
2011 from $12.1 million during the same period in 2010. Other expense in 2011 primarily consisted
of $18.7 million of expenses related to the refinancing described in Note 2 to the consolidated
financial statements and the Equity Redemption, including $6.5 million of expenses attributable to
the write off of the unamortized balance of debt issuance costs and discount for the then existing
senior secured credit facilities and senior subordinated notes, $4.7 million for a premium paid for
the redemption of all our senior subordinated notes in connection with the refinancing and $7.5
million of strategic advisory fees described in Note 11 to the consolidated financial statements.
Interest expense increased $3.5 million to $14.9 million in the second quarter of 2011 from $11.4
million during the same period in 2010, largely due to a higher average debt balance as a result of
the refinancing and the Equity Redemption as well as a higher weighted average interest rate.
Income Tax. Income tax benefit was $3.8 million in the second quarter of 2011, compared to income
tax expense of $6.1 million during the same period in 2010, due to a decrease in taxable income.
Income tax benefit as a percentage of loss before taxes was 30.3% during the second quarter of
2011, compared to income tax expense as a percentage of income before taxes of 42.4% for the same
period in 2010. Our income taxes currently payable for federal and state purposes have been
reduced by tax benefits totaling approximately $6.3 million that we obtained during the second
quarter of 2011 from non-recurring expenses incurred related to the write off of the unamortized
balance of debt issuance costs and a payment made for strategic advisory fees, a majority of which
are deductible for tax purposes.
21
Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010 (in thousands, except
percentages)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six months ended |
|
|
% of Total |
|
|
Six months ended |
|
|
% of Total |
|
|
Change |
|
|
|
June 30, 2011 |
|
|
Revenue |
|
|
June 30, 2010 |
|
|
Revenue |
|
|
Amount |
|
|
% |
|
|
|
Combined |
|
|
|
|
|
|
Predecessor |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
354,209 |
|
|
|
100.0 |
% |
|
$ |
343,473 |
|
|
|
100.0 |
% |
|
$ |
10,736 |
|
|
|
3.1 |
|
Operating Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interchange |
|
|
190,041 |
|
|
|
53.7 |
|
|
|
189,541 |
|
|
|
55.2 |
|
|
|
500 |
|
|
|
0.3 |
|
Other costs of services |
|
|
114,578 |
|
|
|
32.3 |
|
|
|
106,206 |
|
|
|
30.9 |
|
|
|
8,372 |
|
|
|
7.9 |
|
Selling, general and
administrative |
|
|
8,464 |
|
|
|
2.4 |
|
|
|
6,385 |
|
|
|
1.9 |
|
|
|
2,079 |
|
|
|
32.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
313,083 |
|
|
|
88.4 |
|
|
|
302,132 |
|
|
|
88.0 |
|
|
|
10,951 |
|
|
|
3.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
|
41,126 |
|
|
|
11.6 |
|
|
|
41,341 |
|
|
|
12.0 |
|
|
|
(215 |
) |
|
|
(0.5 |
) |
Other expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net |
|
|
22,815 |
|
|
|
6.4 |
|
|
|
22,820 |
|
|
|
6.6 |
|
|
|
(5 |
) |
|
|
(0.0 |
) |
Other expenses, net |
|
|
18,799 |
|
|
|
5.3 |
|
|
|
372 |
|
|
|
0.1 |
|
|
|
18,427 |
|
|
|
4,953.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other expense |
|
|
41,614 |
|
|
|
11.7 |
|
|
|
23,192 |
|
|
|
6.8 |
|
|
|
18,422 |
|
|
|
79.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(488 |
) |
|
|
(0.1 |
) |
|
|
18,149 |
|
|
|
5.3 |
|
|
|
(18,637 |
) |
|
|
(102.7 |
) |
Income tax provision |
|
|
646 |
|
|
|
0.2 |
|
|
|
7,619 |
|
|
|
2.2 |
|
|
|
(6,973 |
) |
|
|
(91.5 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
(1,134 |
) |
|
|
(0.3 |
) |
|
$ |
10,530 |
|
|
|
3.1 |
|
|
$ |
(11,664 |
) |
|
|
(110.8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues. Revenues increased 3.1% to $354.2 million in the first six months of 2011 from $343.5
million during the same period in 2010. The increase in revenues was largely due to an increase in
other revenue due to a new program that was implemented during the second quarter of 2010. Our
merchant processing volume, which represents the total value of transactions processed by us,
declined 1.8% to $11,193 million during the first six months of 2011 from $11,394 million during
the same period in 2010, due to a lower average merchant base and as a result, lower number of
transactions processed during 2011.
Interchange Expenses. Interchange expenses increased 0.3% to $190.0 million in the first six
months of 2011 from $189.5 million during the same period in
2010. Despite a decrease in merchant
processing volume, interchange expenses increased due to an increase in the average interchange
rate as a percentage of merchant processing volume.
Other Costs of Services. Other costs of services increased 7.9% to $114.6 million in the first six
months of 2011 from $106.2 million during the same period in 2010. The increase in other costs of
services was primarily due to higher sales expenses, network fees and depreciation and
amortization.
Selling, General and Administrative. Selling, general and administrative expenses increased 32.6%
to $8.5 million in the first six months of 2011 as compared to $6.4 million during the same period
in 2010. The increase was due to increased compensation expense for the first six months of 2011
compared to the same period in 2010.
Other Expense. Other expenses increased $18.4 million to $41.6 million in the first six months of
2011 from $23.2 million during the same period in 2010. The increase in other expense in 2011
primarily consisted of $18.7 million of expenses related to the refinancing described in Note 2 to
the consolidated financial statements and the Equity Redemption, including $6.5 million of expenses
attributable to the write off of the unamortized balance of debt issuance costs and discount for
the then existing senior secured credit facilities and senior subordinated notes, $4.7 million for
a premium paid for the redemption of all our senior subordinated notes in connection with the
refinancing and $7.5 million of strategic advisory fees described in Note 11 to the consolidated
financial statements.
Income Tax. Income tax expense was $0.6 million in the first six months of 2011 compared to $7.6
million during the same period in 2010. Our income taxes currently payable for federal and state
purposes have been reduced by tax benefits totaling approximately $6.3 million that we obtained
during the second quarter of 2011 from non-recurring expenses incurred related to the write off of
the unamortized balance of debt issuance costs and a payment
made for strategic advisory fees, a majority of which are deductible for tax purposes. Our
effective income tax rate was 38.1%, excluding the aforementioned tax benefits for the six months
ended June 30, 2011, compared to 42.0% for the same period in 2010.
22
Liquidity and Capital Resources
As of June 30, 2011 and December 31, 2010, we had cash and cash equivalents of $1.1 million and
less than $0.1 million, respectively. We usually minimize cash balances in order to minimize
borrowings and, therefore, interest expense. We had a net working capital (current assets in
excess of current liabilities) of $2.1 million as of June 30, 2011, compared to a $9.7 million
deficit as of December 31, 2010. The working capital increase resulted primarily from a reduction
in income taxes payable of $11.5 million, $5.6 million of paydowns on our current portion of long
term debt and a reduction in accounts payable and accrued liabilities and other of $0.8 million,
offset by an increase in accrued interest of $5.1 million. We have consistently had positive cash
flow provided by operations and expect that our cash flow from operations and proceeds from
borrowings under our new revolving facility will be our primary sources of liquidity and will be
sufficient to cover our current obligations. See Contractual Obligations below for a description
of future required uses of cash.
We have significant outstanding long-term debt as of June 30, 2011. The terms of our long-term
debt contain various nonfinancial and financial covenants as further described in Note 5 to the
consolidated financial statements. If we fail to comply with these covenants and are unable to
obtain a waiver or amendment or otherwise cure the breach, an event of default would result. If an
event of default were to occur, the trustee under the Indenture or the lenders under our New Senior
Secured Credit Facilities could, among other things, declare outstanding amounts immediately due
and payable. We currently do not have available cash and similar liquid resources available to
repay all of our debt obligations if they were to become due and payable. Our Senior Secured
Leverage Ratio, as defined in our New Senior Secured Credit Facilities, was 2.77 to 1.00 as of June
30, 2011, compared to the allowed maximum of 3.75 to 1.00. Our Consolidated Interest Coverage
Ratio, as defined in our New Senior Secured Credit Facilities, was
2.15 to 1.00 as of June 30,
2011, compared to the allowed minimum of 1.40 to 1.00.
If we do not generate sufficient cash flow from operations to satisfy our debt obligations,
including interest payments and the payment of principal at maturity, we may have to undertake
alternative financing plans, such as refinancing or restructuring our debt, selling assets,
reducing or delaying capital investments or seeking to raise additional capital. We cannot be sure
that any refinancing or sale of assets would be possible on commercially reasonable terms or at
all. In addition, any refinancing of our debt could be at higher interest rates and may require us
to comply with more onerous covenants, which could further restrict our business operations.
Operating activities
Net cash used in operating activities was $16.8 million during the first six months of 2011,
consisting of net loss of $1.1 million adjusted by depreciation and amortization of $22.4 million,
non-cash interest expense and other of $8.1 million, and a net unfavorable change in operating
assets and liabilities of $29.5 million primarily due to decreases in accounts payable and income taxes payable as a result of
federal and state tax payments made during 2011.
Net cash provided by operating activities was $23.7 million during the first six months of 2010,
consisting of net income of $10.5 million adjusted by depreciation and amortization of $20.8
million, non-cash interest expense of $1.3 million and a net increase in working capital of $8.9
million primarily of payments of accrued bonuses, decreases in accounts payable and income taxes
payable offset by a decrease in accounts receivable.
Investing activities
Net cash used in investing activities was $6.7 million during the first six months of 2011. Net
cash used in investing activities consisted of $2.2 million of property and equipment expenditures,
$3.6 million for acquisitions of businesses and portfolios, and $0.9 million for payments for
contract modifications for prepaid residual expenses.
Net cash used in investing activities was $5.8 million during the first six months of 2010. Net
cash used in investing
activities consisted of $4.5 million of payments for contract modifications for prepaid residual
expenses and $0.6 million of capital expenditures.
23
Financing activities
Net cash used in financing activities was $9.1
million during the first six months of 2011, consisting of net proceeds from the issuance of long term debt
of $768.1 million related to the New Senior Secured Credit Facilities and New Senior Notes, $135.6 million
paid as a dividend to Holdings in connection with the consummation of the Equity Redemption, $618.6 million
of net repayments on our term loans, of which $615.1 million was paid under our previously existing senior
secured credit facilities and $3.5 million under our New Senior Secured Credit Facilities, and $23.0 million
of net repayments under our revolving facility, of which $11.0 million of net payment was made under our
previously existing revolving facility and $12 .0 million under our new revolving facility.
Net cash used in financing activities was $18.0 million during the first six months of 2010,
consisting of net repayments under our previously existing revolving facility of $7.5 million.
See Notes 2 and 5 to the consolidated financial statements for further detail regarding the
Companys long-term debt and the refinancing and other transactions that closed during the second
quarter of 2011.
Contractual Obligations
The following table of our material contractual obligations as of June 30, 2011 summarizes the
aggregate effect that these obligations are expected to have on our cash flows in the periods
indicated. We currently have no contingent payments in connection with earnouts related to
completed acquisitions.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period |
|
|
|
|
|
|
|
Less than 1 |
|
|
|
|
|
|
|
|
|
|
More than 5 |
|
Contractual Obligations |
|
Total |
|
|
year |
|
|
1-3 years |
|
|
3-5 years |
|
|
years |
|
|
|
(in thousands) |
|
New Senior Secured Credit Facilities |
|
$ |
371,500 |
|
|
$ |
250 |
|
|
$ |
7,500 |
|
|
$ |
7,500 |
|
|
$ |
356,250 |
|
New Senior Notes |
|
|
400,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
400,000 |
|
Interest (1) |
|
|
408,035 |
|
|
|
62,830 |
|
|
|
125,660 |
|
|
|
125,588 |
|
|
|
93,957 |
|
Operating lease obligations |
|
|
10,565 |
|
|
|
1,352 |
|
|
|
2,534 |
|
|
|
2,344 |
|
|
|
4,335 |
|
Purchase obligations (2)(3)(4) |
|
|
2,630 |
|
|
|
2,614 |
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations |
|
$ |
1,192,730 |
|
|
$ |
67,046 |
|
|
$ |
135,710 |
|
|
$ |
135,432 |
|
|
$ |
854,542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Future interest obligations are calculated using current interest
rates on existing debt balances as of June 30, 2011, and assume no
principal reduction other than mandatory principal repayments in
accordance with the terms of the debt instruments as described in Note
5 to our consolidated financial statements. |
|
(2) |
|
Purchase obligations represent costs of contractually guaranteed
minimum processing volumes with certain of our third-party transaction
processors. |
|
(3) |
|
We are required to pay FDMS an annual processing fee through 2011
related to the FDMS Merchant Portfolio and the FDMS Bank Portfolio.
The minimum fee for 2011 will be at least 70% of such fee paid to FDMS
in 2010, or at least $3.8 million. |
|
(4) |
|
We have agreed to utilize FDMS to process at least 75% of our
consolidated transaction sales volume in any calendar year through
2011. The minimum commitments for such years are not calculable as of
June 30, 2011, and are excluded from this table. |
As of June 30, 2011, we expect to be able to fund our operations, capital expenditures and the
contractual obligations above (other than the repayment at maturity of the aggregate principal
amount of (i) term loans under our New Senior Secured Credit Facilities and (ii) our New Senior
Notes) using our cash from operations. To the extent we are unable to fund our operations, capital
expenditures and contractual obligations using cash from operations, we intend to use borrowings
under our New Senior Secured Credit Facilities or future debt or equity
financings. In addition, we may seek to sell additional equity or arrange debt financing to give us
financial flexibility to pursue attractive opportunities that may arise in the future. If we raise
additional funds through the sale of equity or convertible debt securities, these transactions may
dilute the value of our outstanding common stock. We may also decide to issue securities, including
debt securities, which have rights, preferences and privileges senior to our common stock. If
future financing is not available or is not available on acceptable terms, we may not be able to
fund our future needs, which may prevent us from increasing our market share, capitalizing on new
business opportunities or remaining competitive in our industry.
24
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. The rate of inflation can also affect our
revenues by affecting our merchant charge volume and corresponding changes to processing revenue.
|
|
|
Item 3. |
|
Quantitative and Qualitative Disclosure about Market Risk. |
In addition to the effects of inflation described above under Managements Discussion and Analysis
of Financial Condition and Results of Operations (MD&A)Effects of Inflation, the following is a
description of additional market risks to which we may be exposed.
We transact business with merchants exclusively in the United States and receive payment for our
services exclusively in United States dollars. As a result, our financial results are unlikely to
be affected by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets.
Our interest expense is sensitive to changes in the general level of interest rates in the credit
markets because a significant amount of our indebtedness is subject to variable rates. As of June
30, 2011, we had $369.7 million of term loans outstanding, all of which was at a variable interest
rate based on LIBOR, subject to a floor equal to 1.50%. Accordingly, a one percent increase in the
applicable LIBOR rate above the floor would result in net additional annual interest expense on our
outstanding borrowings as of June 30, 2011 of approximately $3.7 million.
We do not hold any derivative financial or commodity instruments, nor do we engage in any foreign
currency denominated transactions, and all of our cash and cash equivalents are held in money
market and checking funds.
|
|
|
Item 4. |
|
Controls and Procedures. |
Evaluation of disclosure controls and procedures
An evaluation was conducted under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of June 30, 2011. Based on that
evaluation, our principal executive officer and principal financial officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended, (the Exchange Act)) were effective as of such date
to ensure that information required to be disclosed by us in reports that we file or submit under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms and that such information is accumulated and communicated to management,
including our principal executive officer and principal financial officer, as appropriate, to allow
timely decisions regarding required disclosures.
Changes in internal control over financial reporting
There was no change in our internal control over financial reporting during the second fiscal
quarter of 2011 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Management assessed the effectiveness of the Companys internal control over financial reporting as
of June 30, 2011, based on the criteria set forth by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment
and those criteria, management believes that the Company maintained effective internal control over
financial reporting as of June 30, 2011.
25
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Bruns v. E-Commerce Exchange Inc.
(“ECX”), et al, Orange County Superior Court, State of California,
Case No. 00CC02450 (coordinated under the caption “TCPA
Cases,” Los Angeles County Superior Court, State of California, Case
No. JCCO 43500) (the “Bruns Lawsuit”) and related case Truck
Insurance Exchange v. E-Commerce Exchange, Inc. et al, Superior Court of Orange
County, State of California, Civil Action No. 30-2010- 00340649 (the
“TIC Declaratory Action”)
The
Bruns Lawsuit and the related declaratory judgment action filed by Truck
Insurance Exchange (“TIE”) against E-Commerce Exchange, Inc.
(“ECX”) (the “TIC Declaratory Action”) were last
updated in our Quarterly Report for the first quarter ended March 30,
2011, filed on Form 10-Q with the Securities and Exchange Commission on
May 12, 2011. Since we last reported on this matter, supplemental briefing
in the California Court of Appeals was completed and on August 2, 2011,
oral argument was presented to the Appellate Court panel assigned to the case.
The Appellate Court has ninety days from August 2, 2011, which is until
October 31, 2011, to issue its opinion.
We continue to believe that the claims
asserted against us in the Bruns Lawsuit are without merit, that the trial
court properly granted our Motion for Mandatory Dismissal and properly granted
judgment dismissing the lawsuit with prejudice. However, we cannot predict with
any certainty how the California Court of Appeals might rule, nor can we
predict with any certainty the likely outcome it may have on the lawsuit and
the claims asserted against ECX. We intend to continue to vigorously defend
ourselves in this matter. However, there can be no assurance that we will be
successful or prevail in our defense, therefore, there can be no assurance that
a failure to prevail will not have a material adverse effect on our business,
financial condition or results of operations.
We
last reported in regards to the TIC Declaratory Action, that the parties were
engaged in certain settlement discussions, that the Court had continued the
hearing on TIE’s Motion for Summary Adjudication (the
“MSA”) to June 16, 2011 and the Trial Date to August 1,
2011, along with all related trial date matters. Since we last reported, the
parties have continued to engage in settlement discussions, the June 16,
2011 hearing on TIE’s MSA was taken off calendar, the August 1,
2011 Trial Date was vacated by the Court, and the Court set an order to show
cause for dismissal, for August 16, 2011.
As of the date of this Quarterly Report
the parties are continuing to pursue such settlement possibility but have not
reached an understanding for terms of settlement. Although we intend to
vigorously defend ourselves and we believe that we have meritorious defenses to
assert to the claims, the ultimate outcome of the TIC Declaratory Action and
the associated potential liability cannot be predicted with certainty and there
can be no assurance that we will be successful or prevail in our defenses.
Should TIE prevail on its MSA, or later at trial, ECX will be responsible for
paying the costs and expenses incurred in defending the underlying Bruns
Lawsuit, and in the event we are not successful and judgment is awarded against
ECX in the underlying Bruns Lawsuit there will be no funds provided by
insurance for payment of any judgment that may be awarded against our
subsidiary, ECX, and therefore, there can be no assurance that a failure to
prevail will not have a material adverse effect on our business, financial
condition or results of operations.
L. Green d/b/a Tisas Cakes v. Northern Leasing Systems, Inc., Online Data Corporation, and
iPayment, Inc., United States District Court, Eastern District of New York, Case No.
09CV05679-RJD-SMG.
This matter was last updated in our Quarterly Report for the quarter ended March 30, 2011, filed on
Form 10-Q with the SEC on May 12, 2011. As we previously reported, this matter relates to a
purported class action lawsuit initially filed in December 2009 by plaintiff L. Green d/b/a Tisas
Cakes in the U.S. District Court for the Eastern District of New York, naming us, and one of our
subsidiaries, Online Data Corporation (ODC), and Northern Leasing Systems, Inc. (NLS) as
defendants. As we previously reported, in October 2010 we filed a motion to dismiss count one
(unjust enrichment) of plaintiffs First Amended Class Action Complaint (FAC), plaintiff filed an
opposition to our motion and the Court set June 29, 2011 as the hearing date for our motion to
dismiss. On June 29, 2011, the hearing on our motion to dismiss was conducted, and on August 3,
2011, the Court issued an order denying our motion to dismiss the unjust enrichment claim. Our
answer to the FAC must now be filed by August 19, 2011.
We intend to continue to vigorously defend ourselves against the claims asserted; however, at this
time, the ultimate outcome of the lawsuit and our potential liability associated with the claims
asserted against us cannot be predicted with any certainty and there can be no assurance that we
will be successful in our defense or that a failure to prevail will not have a material adverse
effect on our business, financial condition or results of operations.
Vericomm v. iPayment, Inc., et al., United States District Court, Central District of California,
Case No. 2:2011-cv-00608-MMM-AGR
This matter was last updated in our Quarterly Report for the quarter ended March 30, 2011, filed on
Form 10-Q with the SEC on May 12, 2011. As we previously reported, Vericomm, Inc. (Vericomm), one
of our ISGs, filed a purported class action complaint (the Complaint) against us on January 20,
2011 in the District Court for the Central District of California, Western Division. On June 20,
2011 we filed a motion to dismiss the second, third, seventh, and eighth causes of action alleged
in Vericomms Complaint, and to strike Vericomms request for attorneys fees under California Code
of Civil Procedure section 1021.5. The Court set September 26, 2011 as the date for the hearing on
our motion to dismiss and to strike, which is also the date set by the Court for a scheduling
conference.
We intend to continue to vigorously defend ourselves against the claims asserted; however, at this
time, the ultimate outcome of the lawsuit and our potential liability associated with the claims
asserted against us cannot be predicted with any certainty, and there can be no assurance that we
will be successful in our defense or that a failure to prevail will not have a material adverse
effect on our business, financial condition or results of operations.
Certain risks associated with our business are discussed in our Annual Report for the year ended
December 31, 2010, filed on Form 10-K with the SEC on March 21, 2011, under the heading Risk
Factors Relating to Our Business in Item 1A of that report. Except as set forth below, we do not
believe there have been any material changes in these risks during the six months ended June 30,
2011.
Our business could be adversely affected by a deteriorating economic environment that causes our
merchants to experience adverse business conditions, as they may generate fewer transactions for us
to process or may become insolvent, thereby increasing our exposure to chargeback liabilities.
We believe that challenging economic conditions have caused some of the merchants we serve to
experience difficulty in supporting their current operations and implementing their business plans,
and any deterioration in economic conditions has the potential to negatively impact consumer
confidence and consumer spending. 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 the current difficult economic environment, the merchants we serve could be subject
to a higher rate of business failure which could adversely affect us financially. We bear credit
risk for chargebacks related to billing disputes between credit or debit 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.
27
Due to the refinancing of our debt that was completed in the second quarter of 2011, the risk
factors included under
the heading Risks Relating to Our Indebtedness in our Annual Report for the year ended December
31, 2010, filed on Form 10-K with the SEC on March 21, 2011 should be replaced with the following
risk factors.
Our substantial debt, and any funds we may distribute to Holdings to service its debt, could
adversely affect our financial condition and prevent us from fulfilling our obligations to holders
of the New Senior Notes.
As of June 30, 2011, we had approximately $769.7 million of total debt outstanding. Our
substantial debt could adversely affect our financial condition and operating results and make it
more difficult for us to satisfy our obligations with respect to holders of the New Senior Notes.
Our substantial debt, any new debt we may incur as described below and the resulting reduction in
our available cash could also:
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increase our vulnerability to adverse general economic and industry conditions; |
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require us to dedicate a substantial portion of our cash flow from operations to
payments on our debt, thereby reducing the availability of our cash flow to fund
investments, capital expenditures, working capital and for other general corporate
purposes; |
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limit our ability to make required payments under our debt agreements, including the
indenture governing the New Senior Notes, or the Indenture, and the credit agreement
governing our New Senior Secured Credit Facilities; |
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limit our flexibility in planning for, or reacting to, changes in our business and the
industry in which we operate; |
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limit our ability to withstand competitive pressures; |
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place us at a competitive disadvantage compared to our competitors that have
proportionately less debt than we have; |
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create a perception that we may not continue to support and develop certain products or
services; |
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increase our exposure to rising interest rates because a portion of our debt is at
variable interest rates; and |
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limit our ability to borrow additional funds on terms that are satisfactory to us or at
all. |
In addition, we will be permitted to distribute funds to Holdings, our direct parent, to pay
interest on Holdings Notes to the extent required to be paid in cash. For the first four years,
at least 50% of the interest on Holdings Notes must be paid in cash, and thereafter, subject to
limited exceptions, 100% of the interest on Holdings Notes generally must be paid in cash. The
covenants in the indenture governing Holdings Notes generally require Holdings to pay interest in
cash to the extent permitted by our debt agreements, including the Indenture. Holdings is a
holding company with no material assets of its own, and we will serve as the primary source of
funds for payments on its debt. Any funds we may distribute to Holdings to service its debt could
increase the risks associated with our substantial debt, including making it more difficult for us
to satisfy our obligations to holders of the New Senior Notes.
We may incur more debt, which could exacerbate the risks associated with our substantial leverage.
Subject to the limitations contained in the agreements governing our debt, we are able to incur
significantly more debt in the future, including the ability to issue additional notes under the
Indenture. Although these agreements restrict us and our restricted subsidiaries from incurring
additional debt, these restrictions are subject to important exceptions and qualifications. For
example, our New Senior Secured Credit Facilities provide for aggregate borrowings of up to $450
million, which are secured by liens on substantially all of our and Holdings assets. Furthermore,
our New Senior Secured Credit Facilities and the Indenture permit us to incur significant
additional debt, including additional secured debt that will be effectively senior to the New
Senior Notes to the extent of the value of the collateral securing such debt. If we incur
additional debt, the risks that we face as a result of our high leverage, including our possible
inability to service our debt could increase.
28
We may not be able to generate sufficient cash flow from operations to meet our debt service
obligations.
Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt
obligations will depend on our future financial performance, which will be affected by a range of
economic, competitive, regulatory, legislative and business factors, many of which are outside of
our control. If we do not generate sufficient cash flow from operations to satisfy our debt
obligations, including interest payments and the payment of principal at maturity, we may have to
undertake alternative financing plans, such as refinancing or restructuring our debt, selling
assets, reducing or delaying capital investments or seeking to raise additional capital. We cannot
be sure that any refinancing or sale of assets would be possible on commercially reasonable terms
or at all. In addition, any refinancing of our debt could be at higher interest rates and may
require us to comply with more onerous covenants, which could further restrict our business
operations.
Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our
obligations on commercially reasonable terms, would have an adverse effect on our business,
financial condition and results of operations, as well as on our ability to satisfy our obligations
under our New Senior Secured Credit Facilities and the New Senior Notes. Any failure to make
scheduled payments of interest and principal on our outstanding debt would likely result in a
reduction of our credit rating, which could harm our ability to incur additional debt on
commercially reasonable terms or at all and negatively impact the market value of the New Senior
Notes. In addition, if we are unable to meet our debt service obligations under our New Senior
Secured Credit Facilities or other indebtedness, the holders of such indebtedness would have the
right to cause the entire principal amount of such indebtedness to become immediately due and
payable. If the amounts outstanding under any of our debt instruments are accelerated, we cannot
assure you that our assets will be sufficient to repay in full the money owed to our debt holders,
including holders of the New Senior Notes.
Substantially all of our operations are conducted at the subsidiary level, which may materially
adversely affect our ability to service our debt.
Our principal assets are the equity interests we hold, directly and indirectly, in our
subsidiaries. Our subsidiaries are legally distinct from us and have no obligation to pay amounts
due on our debt or to make funds available to us for such payment, other than through guarantees of
our debt, which may be released under certain circumstances. Because most of our operations are
conducted through our subsidiaries, our ability to service our debt depends upon the earnings of
our subsidiaries and the distribution of those earnings, or upon loans or other payments of funds,
by our subsidiaries to us. Although our New Senior Secured Credit Facilities and the Indenture
limit the ability of our subsidiaries to enter into covenant restrictions on their ability to pay
dividends and make other payments to us, these limitations are subject to a number of significant
qualifications. If our subsidiaries do not have sufficient earnings or cannot distribute their
earnings or other funds to us, our ability to service our debt may be materially adversely
affected.
The Indenture, as well as other agreements governing our debt, include financial and other
covenants that impose restrictions on our financial and business operations.
The Indenture and our New Senior Secured Credit Facilities contain negative covenants customary for
such financings, such as limiting our and our restricted subsidiaries ability to pay dividends,
redeem stock or make other distributions or restricted payments, make certain investments, incur or
guarantee additional debt, create liens, agree to dividend and payment restrictions affecting
restricted subsidiaries, consummate mergers, consolidations or other business combinations,
designate subsidiaries as unrestricted, change our or their line of business, or enter into certain
transactions with affiliates. Our New Senior Secured Credit Facilities have various financial and
other covenants that require us to maintain minimum coverage ratios. We may also incur future debt
obligations, which might subject us to additional restrictive covenants that could affect our
financial and operational flexibility.
These covenants could adversely affect our ability to finance our future operations or capital
needs, pursue available business opportunities or make payments on the New Senior Notes. Our
ability to comply with these covenants may be subject to events outside our control. Moreover, if
we fail to comply with these covenants and are unable to obtain a waiver or amendment, an event of
default would result. If an event of default were to occur, the trustee under the Indenture or the
lenders under our New Senior Secured Credit Facilities could, among other things, declare
outstanding amounts immediately due and payable. We cannot provide assurance that we would have
sufficient liquidity to repay or refinance the New Senior Notes or borrowings under our New Senior
Secured Credit Facilities if such amounts were accelerated upon an event of default. In addition,
an event of default or declaration of acceleration under the Indenture or our New Senior Secured
Credit Facilities could also result in an event of default under other financing agreements.
29
Payment of principal and interest on the New Senior Notes will be effectively subordinated to our
secured debt to the extent of the value of the assets securing that debt.
The New Senior Notes are not secured. Therefore, the New Senior Notes will be effectively
subordinated to claims of our secured creditors, and the related guarantees will be effectively
subordinated to the claims of the secured creditors of such guarantors. As of June 30, 2011, we
have approximately $370 million of total secured debt outstanding and $75 million of additional
capacity under the revolving portion of our New Senior Secured Credit Facilities. Holders of our
secured obligations, including obligations under our New Senior Secured Credit Facilities, will
have claims that are prior to claims of the holders of the New Senior Notes with respect to the
assets securing those obligations. In the event of a liquidation, dissolution, reorganization,
bankruptcy or any similar proceeding, our assets and those of the guarantors will be available to
pay obligations on the New Senior Notes and the related guarantees only after holders of our
secured debt have been paid in full from the proceeds of the assets securing such debt.
Accordingly, there may not be sufficient funds remaining to pay amounts due on all or any of the
New Senior Notes.
The New Senior Notes and related guarantees will be structurally subordinated to debt of our
nonguarantor subsidiaries.
As of June 30, 2011, all of our subsidiaries were guarantors of the New Senior Notes. However,
under certain circumstances, the guarantees of our subsidiaries may be released and our future
subsidiaries may not be required to guarantee the New Senior Notes. The New Senior Notes will be
structurally subordinated to all debt and other liabilities and commitments, including trade
payables, of our subsidiaries that do not guarantee the New Senior Notes. We rely substantially
upon distributions from our subsidiaries to meet our debt obligations, including our obligations
with respect to the New Senior Notes. Any right of the holders of the New Senior Notes to
participate in the assets of a nonguarantor subsidiary upon any liquidation or reorganization of
the subsidiary will be subject to the prior claims of such subsidiarys creditors.
We may be unable to repay or repurchase the New Senior Notes at maturity.
At maturity, the entire outstanding principal amount of the New Senior Notes, together with accrued
and unpaid interest, will become due and payable. We may not have the funds to fulfill these
obligations or the ability to refinance these obligations. If the maturity date occurs at a time
when other arrangements prohibit us from repaying the New Senior Notes, we could try to obtain
waivers of such prohibitions from the lenders and holders under those arrangements, or we could
attempt to refinance the borrowings that contain the restrictions. In these circumstances, if we
cannot obtain such waivers or refinance these borrowings, we would be unable to repay the New
Senior Notes.
Under certain circumstances, a court could cancel the New Senior Notes or void the related
guarantees under fraudulent conveyance laws.
Our issuance of the New Senior Notes and the related guarantees may be subject to review under
federal or state fraudulent transfer laws, in particular due to the Equity Redemption and because
all of the net proceeds from the offering of Investors previously existing PIK toggle notes were
distributed to Investors equity holders and a portion of the proceeds of the offering of the New
Senior Notes was used to fund the Equity Redemption and to redeem and satisfy and discharge such
PIK toggle notes. If we become a debtor in a case under the United States Bankruptcy Code or
encounter other financial difficulty, a court might avoid (that is, cancel) our obligations under
the New Senior Notes. The court might do so if it finds that when we issued the New Senior Notes
and the related guarantees, (i) we or any guarantor of the New Senior Notes issued the New Senior
Notes or incurred the guarantee, as applicable, with actual intent of hindering, delaying or
defrauding creditors or (ii) we or any guarantor received less than reasonably equivalent value or
fair consideration in return for either issuing the New Senior Notes or incurring the guarantee, as
applicable, (which may be deemed to be zero, because we distributed a portion of the
funds from the offering to Investors to fund the Equity Redemption and to redeem and satisfy and
discharge Investors PIK toggle notes) and, in the case of (ii) only, one of the following is also
true at the time thereof:
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we or any guarantor were insolvent or rendered insolvent by reason of the issuance of
the New Senior Notes or the incurrence of the guarantee, as applicable; |
30
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the issuance of the New Senior Notes or the incurrence of the guarantee left us or any
guarantor, as applicable, with an unreasonably small amount of capital to carry on our or
its business; or |
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we or any guarantor intended to, or believed that we or such guarantor would, incur
debts beyond our or such guarantors ability to pay such debts as they mature. |
The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon
the governing law. Generally, however, an entity would be considered insolvent if:
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the sum of its debts, including contingent liabilities, were greater than the fair
saleable value of all of its assets; or |
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if the present fair saleable value of its assets were less than the amount that would be
required to pay its probable liability on its existing debts, including contingent
liabilities, as they become absolute and mature; or |
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it could not pay its debts as they become due. |
For this analysis, debts include contingent and unliquidated debts. If a court avoided our
obligations under the New Senior Notes and the obligations of all of the guarantors under their
guarantees, holders of the New Senior Notes would cease to be our creditors or creditors of the
guarantors and likely have no source from which to recover amounts due under the New Senior Notes.
In addition, a court could avoid any payment by us or any guarantor pursuant to the New Senior
Notes or a related guarantee, as the case may be, and require any payment to be returned to us or
the guarantor, as the case may be, or to be paid to a fund for the benefit of our or the
guarantors creditors. Further, the avoidance of the New Senior Notes could result in an event of
default with respect to our other debt that could result in the acceleration of such debt. Even if
the guarantee of a guarantor is not avoided as a fraudulent transfer, a court may subordinate the
guarantee to that guarantors other debt. In that event, the guarantees would be structurally
subordinated to all of that guarantors other debt. If the court were to avoid any guarantee, we
cannot assure that funds would be available to pay the New Senior Notes from another guarantor or
from any other source.
The guarantees of the New Senior Notes contain a provision intended to limit each guarantors
liability to the maximum amount that it could incur without causing its guarantee to be a
fraudulent transfer. However, this provision may automatically reduce one or more of the
guarantors obligations to an amount that effectively makes the guarantee worthless and, in any
case, this provision may not be effective to protect a guarantee from being avoided under
fraudulent transfer laws.
Our unrestricted subsidiaries under the Indenture will not be subject to any of the covenants in
the Indenture and will not guarantee the New Senior Notes, and we may not be able to rely on the
cash flow or assets of those unrestricted subsidiaries to pay any of our debt, including the New
Senior Notes.
Our unrestricted subsidiaries will not be subject to the covenants under the Indenture and will not
guarantee the New Senior Notes. As of June 30, 2011, none of our subsidiaries were unrestricted
subsidiaries. However, subject to compliance with the covenants contained in the Indenture, we
will be permitted to designate our subsidiaries as unrestricted subsidiaries. If we designate a
guarantor as an unrestricted subsidiary in accordance with the Indenture, the guarantee of the New
Senior Notes by such guarantor will be released under the Indenture. The creditors of the
unrestricted subsidiary and its subsidiaries will generally be entitled to payment of their claim
from the assets of such unrestricted subsidiary and its subsidiaries before those assets would be
available for distribution to us. In addition, our unrestricted subsidiaries may enter into
financing arrangements that limit their ability to make loans or other payments to fund payments in
respect of the New Senior Notes. Accordingly, we cannot assure you that the
cash flow or assets of our unrestricted subsidiaries will be available to pay any of our debt,
including the New Senior Notes.
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We may not have the ability to raise the funds necessary to finance the change of control offer
required by the Indenture.
Upon the occurrence of a change of control, as defined in the Indenture, we must offer to buy
back the New Senior Notes at a price equal to 101% of the principal amount of the New Senior Notes,
together with any accrued and unpaid interest, if any, to the date of the repurchase. Our failure
to purchase the New Senior Notes, or to give notice of the offer to repurchase the New Senior
Notes, would be an event of default under the Indenture.
The definition of a change of control in the Indenture includes a phrase relating to the sale,
conveyance, transfer or lease of all or substantially all of our assets. There is no precise
established definition of the phrase all or substantially all and it will likely be interpreted
under New York State law, which is the law that governs the Indenture, and will be dependent upon
the particular facts and circumstances. As a result, there may be a degree of uncertainty in
ascertaining whether a sale or disposition of all or substantially all of our capital stock or
assets has occurred, in which case, the ability of a holder of the New Senior Notes to obtain the
benefit of an offer to repurchase all or a portion of the New Senior Notes held by such holder may
be impaired.
If a change of control occurs, it is possible that we may not have sufficient assets at the time of
the change of control to make the required repurchase of notes or to satisfy all obligations under
our other debt instruments. In order to satisfy our obligations, we could seek to refinance our
debt or obtain a waiver from the other lenders or the holders of the New Senior Notes. We cannot
assure you that we would be able to obtain a waiver or refinance our debt on terms acceptable to
us, if at all. Our failure to pay the change of control purchase price when due constitutes an
event of default under the Indenture and gives the holders of the New Senior Notes certain rights
and remedies described in the Indenture. The same events constituting a change of control under the
Indenture may also constitute an event of default under our New Senior Secured Credit Facilities
and permit the lenders thereunder to accelerate any and all outstanding debt. If such debt is not
paid, the lenders may enforce security interests in the collateral securing such debt, thereby
limiting our ability to raise cash to purchase the New Senior Notes and reducing the practical
benefit to the holders of the New Senior Notes of the offer to purchase provisions of the
Indenture.
The interests of our equity holders may not be aligned with the interests of the holders of the New
Senior Notes.
All of our issued and outstanding equity interests are held indirectly by Investors. As of June
30, 2011, Mr. Grimstad, our Chairman and Chief Executive Officer, together with equity interests
held by, in trust for or for the benefit of certain of his family members and other related
entities, are deemed to collectively beneficially own all of the outstanding equity interests of
iPayment. Messrs. Grimstad and Monaco are the sole members of iPayments board of directors, as
well as the sole members of the board of directors of iPayment GP, LLC, the general partner of
Investors.
Circumstances may occur in which the interests of Investors and its equity holders could be in
conflict with the interests of the holders of the New Senior Notes. Moreover, Investors equity
holders may have interests in their other respective investments that could also be in conflict
with the interests of the holders of the New Senior Notes. In addition, Investors and its equity
holders may have an interest in pursuing acquisitions, divestitures or other transactions that
could enhance their equity investment, even though such transactions might involve risks to holders
of the New Senior Notes. For example, Investors and its equity holders may cause us to pursue a
growth strategy (including acquisitions which are not accretive to earnings), which could impact
our ability to make payments on the New Senior Notes and our New Senior Secured Credit Facilities
or cause a change of control. To the extent permitted by the Indenture and our New Senior Secured
Credit Facilities, Investors and its equity holders may cause us to pay dividends rather than make
capital expenditures.
Changes in the financial and credit markets or in our credit ratings could adversely affect the
market prices of the New Senior Notes and, if issued, the exchange notes.
The future market prices of our New Senior Notes and, if issued, the exchange notes (contemplated
by the registration rights agreement entered into by the Company in connection with the offering of
the New Senior Notes) will depend on a number of factors, including:
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the prevailing interest rates being paid by companies similar to us; |
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our ratings with major credit rating agencies; and |
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the overall condition of the financial and credit markets. |
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The condition of the financial and credit markets and prevailing interest rates have fluctuated in
the past and are likely to fluctuate in the future. Fluctuations in these factors have had adverse
effects on the market prices of our debt instruments in the past, and further fluctuation may have
adverse effects on the market prices of the New Senior Notes and the exchange notes in the future.
In addition, credit rating agencies continually revise their ratings for companies that they
follow, including us. We cannot be sure that any credit rating agencies that rate the New Senior
Notes or the exchange notes will maintain their ratings on the New Senior Notes and the exchange
notes. A negative change in our rating could have an adverse effect on the market prices of the
New Senior Notes and the exchange notes.
Historically, the market for non-investment grade debt has been subject to disruptions that have
caused substantial volatility in the prices of securities similar to the New Senior Notes and the
exchange notes. The market for the New Senior Notes and the exchange notes may be subject to
similar disruptions, which could adversely affect their value.
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Item 2. |
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Unregistered Sales of Equity Securities and Use of Proceeds. |
None
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Item 3. |
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Defaults Upon Senior Securities. |
None
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Item 4. |
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(Removed and Reserved). |
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Item 5. |
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Other Information. |
None
The exhibits to this Quarterly Report are listed in the Exhibit Index.
33
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.
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iPayment, Inc.
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Date: August 15, 2011 |
By: |
/s/ Carl A. Grimstad
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Carl A. Grimstad |
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Chairman, Chief Executive Officer and President
(Principal Executive Officer) |
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Date: August 15, 2011 |
By: |
/s/ Mark C. Monaco
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Mark C. Monaco |
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Chief Financial Officer
(Principal Financial and Accounting Officer) |
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EXHIBIT INDEX
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Exhibit No. |
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Description |
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10.1 |
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Credit Agreement, dated as of May 6, 2011, among iPayment, Inc., iPayment Holdings, Inc., the
guarantors and lenders party thereto and JP Morgan Chase Bank, N.A., as administrative agent,
incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC
on May 12, 2011. |
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10.2 |
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Security Agreement, dated as of May 6, 2011, among iPayment, Inc., iPayment Holdings, Inc.,
the guarantors party thereto and JPMorgan Chase Bank N.A., as administrative agent,
incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC
on May 12, 2011. |
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10.3 |
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Pledge Agreement, dated as of May 6, 2011, among iPayment, Inc., iPayment Holdings, Inc., the
guarantors party thereto and JPMorgan Chase Bank N.A., as administrative agent, incorporated
by reference to Exhibit 10.3 of the Current Report on Form 8-K filed with the SEC on May 12,
2011. |
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31.1 |
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Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a
14(a) (as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002), filed herewith. |
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31.2 |
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Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a
14(a) (as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002), filed herewith. |
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32.1 |
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Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a
14(b) and 18 U.S.C. 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002), filed herewith. |
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32.2 |
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Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a
14(b) and 18 U.S.C. 1350 (as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002), filed herewith. |
35