Attached files

file filename
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER TO SECTION 906 - iPayment, Inc.d337599dex322.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER TO SECTION 302 - iPayment, Inc.d337599dex312.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER TO SECTION 906 - iPayment, Inc.d337599dex321.htm
EXCEL - IDEA: XBRL DOCUMENT - iPayment, Inc.Financial_Report.xls
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R5.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R7.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R8.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R1.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R2.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R3.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R9.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R4.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R11.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R12.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R10.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R13.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R15.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R16.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R14.htm
XML - IDEA: XBRL DOCUMENT - iPayment, Inc.R6.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER TO SECTION 302 - iPayment, Inc.d337599dex311.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

OR

 

¨ 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: 333-177233-19 and 000-50280

 

 

 

LOGO

iPayment Holdings, Inc.

iPayment, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

Delaware

 

20-4777880

62-1847043

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

126 East 56th Street, 33rd Floor

New York, New York

  10022
(Address of principal executive offices)   (Zip Code)

Registrants’ telephone number, including area code: (212) 802-7200

 

 

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.

 

iPayment Holdings, Inc.    Yes  x    No  ¨
iPayment, Inc.    Yes  x    No  ¨

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).

 

iPayment Holdings, Inc.    Yes  x    No  ¨
iPayment, Inc.    Yes  x    No  ¨

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.

 

iPayment Holdings, Inc.   Large accelerated filer ¨   Accelerated filer ¨   Non-accelerated filer x   Smaller reporting company ¨
iPayment, Inc.   Large accelerated filer ¨   Accelerated filer ¨   Non-accelerated filer x   Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

iPayment Holdings, Inc.    Yes  ¨    No  x
iPayment, Inc.    Yes  ¨    No  x

 

Title of each class    Shares Outstanding at May 11, 2012
iPayment Holdings, Inc. (Common stock, $0.01 par value)    4,875,000
iPayment, Inc. (Common stock, $0.01 par value)    100

 

 

 


         Page  
Introductory Note     
  PART I – FINANCIAL INFORMATION   
Item 1.   Financial Statements   
 

Consolidated Balance Sheets as of March 31, 2012 (successor, unaudited) and December  31, 2011 (successor, audited)

     4   
 

Unaudited Consolidated Statements of comprehensive income for the three months ended March  31, 2012 (successor) and 2011(predecessor)

     5   
 

Unaudited Consolidated Statements of Cash Flows for the three months ended March  31, 2012 (successor) and 2011(predecessor)

     6   
 

Notes to Consolidated Financial Statements

     7   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      18   
Item 3.   Quantitative and Qualitative Disclosures about Market Risk      25   
Item 4.   Controls and Procedures      26   
  PART II – OTHER INFORMATION   
Item 1.   Legal Proceedings      27   
Item 1A.   Risk Factors      27   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      27   
Item 3.   Defaults Upon Senior Securities      28   
Item 4.   Mine Safety Disclosures      28   
Item 5.   Other Information      28   
Item 6.   Exhibits      28   

SIGNATURES

     29   

EXHIBIT INDEX

     30   


Introductory Note

Forwarding-Looking Statements

Certain statements in this Quarterly Report on Form 10-Q (this “Quarterly Report”) are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include, without limitation, estimates, projections and other statements regarding our operating, growth and acquisition strategies, cost savings initiatives, industry dynamics, economic conditions, regulatory environment, debt compliance, liquidity and capital resources, and operating results, and the assumptions upon which those statements are based.

Forward-looking statements may be included or incorporated by reference throughout this Quarterly Report, including, without limitation, in the sections under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions.

Forward-looking statements are based on current expectations and assumptions, which are subject to risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 23, 2012 (our “2011 Annual Report”) and in Part II, Item 1A of this Quarterly Report.

Presentation of Information

As used in this Quarterly Report, the terms “we,” “us,” “our,” “the Company,” “our Company” or similar terms refer to iPayment Holdings, Inc. and its subsidiaries, unless otherwise stated or required by the context. The term “iPayment” refers to iPayment, Inc. and “Holdings” refers to iPayment Holdings, Inc., in each case, without their subsidiaries. Holdings is a holding company that does not have any operations or material assets other than the direct and indirect ownership of all of the capital stock of iPayment and its subsidiaries, respectively.

This report includes financial information for Holdings and its consolidated subsidiaries and iPayment and its consolidated subsidiaries. Except as otherwise indicated, the results of operations of Holdings and its consolidated subsidiaries and iPayment and its consolidated subsidiaries are the same.

 

3


PART I FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

 

     iPAYMENT, INC.
AND SUBSIDIARIES
    iPAYMENT HOLDINGS, INC.
AND SUBSIDIARIES
 

(Dollars in thousands, except share data)

   March 31,
2012
    December 31,
2011
    March 31,
2012
    December 31,
2011
 
     Successor     Successor     Successor     Successor  
     (Unaudited)     (Audited)     (Unaudited)     (Audited)  
ASSETS         

Current assets:

        

Cash and cash equivalents

   $ 201      $ 1      $ 201      $ 1   

Accounts receivable, net of allowance for doubtful accounts of $940 and $973 at March 31, 2012 and December 31, 2011, respectively

     32,955        33,961        32,955        33,961   

Prepaid expenses and other current assets

     2,296        2,221        2,296        2,221   

Deferred tax assets

     3,306        3,306        3,306        3,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

     38,758        39,489        38,758        39,489   

Restricted cash

     537        542        537        542   

Property and equipment, net

     7,224        6,636        7,224        6,636   

Merchant portfolio and other intangible assets, net of accumulated amortization of $57,288 and $43,220 at March 31, 2012 and December 31, 2011, respectively

     246,846        259,980        246,846        259,980   

Goodwill

     669,483        669,483        670,283        670,283   

Other assets, net

     23,019        23,798        26,142        26,987   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ 985,867      $ 999,928      $ 989,790      $ 1,003,917   
  

 

 

   

 

 

   

 

 

   

 

 

 
LIABILITIES and STOCKHOLDER’S EQUITY         

Current liabilities:

        

Accounts payable

   $ 3,412      $ 5,826      $ 3,412      $ 5,826   

Income taxes payable, net

     3,688        6,445        2,243        3,615   

Accrued interest

     16,934        6,750        24,242        9,186   

Accrued liabilities and other

     22,602        23,195        22,690        23,231   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

     46,636        42,216        52,587        41,858   

Deferred tax liabilities, net

     28,604        29,178        28,396        28,970   

Long-term debt

     755,852        774,284        884,747        903,141   

Other liabilities

     1,477        1,440        1,478        1,440   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     832,569        847,118        967,208        975,409   
  

 

 

   

 

 

   

 

 

   

 

 

 

Commitments and contingencies (Note 8)

        

Equity

        

Common stock of iPayment, Inc., $0.01 par value; 1,000 shares authorized, 100 shares issued and outstanding at March 31, 2012 and December 31, 2011

     165,764        165,764        —          —     

Common stock of iPayment Holdings, Inc., $0.01 par value; 8,000,000 shares authorized, 4,875,000 shares issued and outstanding at March 31, 2012 and December 31, 2011

     —          —          45,268        45,268   

Accumulated Deficit

     (12,466     (12,954     (22,686     (16,760
  

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholder’s equity

     153,298        152,810        22,582        28,508   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholder’s equity

   $ 985,867      $ 999,928      $ 989,790      $ 1,003,917   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

4


CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     iPAYMENT, INC.
AND SUBSIDIARIES
    iPAYMENT HOLDINGS, INC.
AND SUBSIDIARIES
 

(Dollars in thousands)

   Three Months Ended
March  31,
2012
    Three Months Ended
March  31,
2011
    Three Months Ended
March  31,
2012
    Three Months Ended
March  31,
2011
 
     Successor     Predecessor     Successor     Predecessor  

Revenues

   $ 165,362      $ 169,613      $ 165,362      $ 169,613   

Operating expenses:

        

Interchange

     81,858        90,728        81,858        90,728   

Other costs of services

     63,664        54,741        63,697        54,741   

Selling, general and administrative

     4,232        4,290        4,250        4,290   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     149,754        149,759        149,805        149,759   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     15,608        19,854        15,557        19,854   

Other expense:

        

Interest expense, net

     16,386        7,901        21,362        7,901   

Other income, net

     (581     (30     (581     (30
  

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes

     (197     11,983        (5,224     11,983   

Income tax (benefit) provision

     (684     4,421        701        4,421   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 487      $ 7,562      $ (5,925   $ 7,562   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

   $ 487      $ 7,562      $ (5,925   $ 7,562   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

5


CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     iPAYMENT, INC.
AND SUBSIDIARIES
    iPAYMENT HOLDINGS, INC.
AND SUBSIDIARIES
 

(Dollars in thousands)

   Three Months Ended
March  31,
2012
    Three Months Ended
March  31,
2011
    Three Months Ended
March  31,
2012
    Three Months Ended
March  31,
2011
 
     Successor     Predecessor     Successor     Predecessor  

Cash flows from operating activities

        

Net income (loss)

   $ 487      $ 7,562      $ (5,925   $ 7,562   

Adjustments to reconcile net income (loss) to net cash provided by operating activities

        

Depreciation and amortization

     14,801        10,523        14,801        10,523   

Noncash interest expense and other

     754        646        3,294        646   

Loss on disposal of property and equipment

     364        —          364        —     

Changes in assets and liabilities, excluding effects of redemption:

        

Accounts receivable

     1,006        (876     1,006        (876

Prepaid expenses and other current assets

     (75     (263     (75     (263

Other assets

     (1,447     (162     (1,447     (162

Accounts payable and income taxes

payable

     (5,170     (8,285     (3,785     (8,285

Accrued interest

     10,184        4,621        12,620        4,621   

Accrued liabilities and other

     (557     (964     (507     (964
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     20,347        12,802        20,346        12,802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities

        

Change in restricted cash

     5        (2     5        (2

Expenditures for property and equipment

     (1,653     (739     (1,653     (739

Payments for prepaid residual expenses

     —          (488     —          (488
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (1,648     (1,229     (1,648     (1,229
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities

        

Net repayments on revolving facility

     (10,500     (5,750     (10,500     (5,750

Repayments of debt

     (8,000     (5,823     (8,000     (5,823
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (18,500     (11,573     (18,500     (11,573
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     200        —          200        —     

Cash and cash equivalents, beginning of period

     1        1        1        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 201      $ 1      $ 201      $ 1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

        

Cash paid during the period for income taxes

   $ 2,647      $ 11,924      $ 2,647      $ 11,924   

Cash paid during the period for interest

   $ 5,448      $ 2,635      $ 5,448      $ 2,635   

See accompanying notes to consolidated financial statements.

 

6


Notes to Consolidated Financial Statements

(1) Organization, Business and Basis of Presentation

Organization

We are a provider of credit and debit card payment processing services to small merchants across the United States. We conduct all of our operations through our operating company, iPayment, Inc. (“iPayment”), and its subsidiaries. iPayment and its direct parent, iPayment Holdings, Inc. (“Holdings”), are incorporated in Delaware. Holdings is a holding company that does not have any operations or material assets other than the direct and indirect ownership of all of the capital stock of iPayment and its subsidiaries, respectively. All of the capital stock of Holdings is owned by iPayment Investors, L.P. (“iPayment Investors”). All of the partnership interests of iPayment Investors are owned by Carl A. Grimstad, iPayment’s Chairman and Chief Executive Officer, and certain entities and persons affiliated with him.

On May 23, 2011, iPayment Investors and its general partner, iPayment GP, LLC (“iPayment GP”), completed the redemption (the “Equity Redemption”) of all of the direct and indirect equity interests in iPayment Investors and iPayment GP of (i) Gregory Daily, iPayment’s former Chairman and Chief Executive Officer and (ii) the trusts for the benefit of, and other entities controlled by, members of Mr. Daily’s family that held equity interests in iPayment Investors. The Equity Redemption resulted in a change in control and accordingly has been accounted for as a business combination in accordance with ASC 805 “Business Combinations.”

The Equity Redemption, together with a refinancing of substantially all of iPayment’s and iPayment Investors’ then existing debt, were funded with the proceeds of new senior secured credit facilities entered into, and securities issued, on May 6, 2011, which we define in Note 2 below as the “Refinancing.” Please refer to Notes 2 and 5 for a further discussion of the Equity Redemption and the Refinancing.

Business

Our payment processing services enable our merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards and loyalty programs in traditional card-present, or swipe transactions, as well as in card-not-present transactions, such as those done over the phone or through the internet. We market and sell our services primarily through independent sales groups (“ISGs”), which are non-employee, external sales organizations and other third party resellers of our products and services. We also market our services directly to merchants through electronic media, telemarketing and other programs, including utilizing partnerships with other companies that market products and services to small businesses. In addition, we 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, primarily in our main operating center in Westlake Village, California.

In May 2011, iPayment completed an offering of $400.0 million in aggregate principal amount of 10.25% Senior Notes due 2018 (the “10.25% Notes”) and entered into its new senior secured credit facilities consisting of (i) a $375.0 million term facility and (ii) a $75.0 million revolving facility (the “Senior Secured Credit Facilities”). The new revolving facility will mature on May 6, 2016, and the new term facility will mature on May 8, 2017. Also in May 2011, Holdings completed an offering of 125,000 units (the “Units”), consisting of $125.0 million in aggregate principal amount of 15.00%/15.00% Senior Notes due 2018 (the “15.00%/15.00% 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. The Senior Secured Credit Facilities, the 10.25% Notes and the 15.00%/15.00% Notes are discussed further in Note 5.

Basis of Presentation

The accompanying consolidated financial statements of iPayment and Holdings have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. 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 the

 

7


consolidated financial position and results of operations for the related periods. All significant intercompany transactions and balances have been eliminated in consolidation. The consolidated results of operations for any interim periods are not necessarily indicative of results to be expected for the full year.

As a result of the Equity Redemption, as further discussed in Note 2, our 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 our results of operations, financial position and cash flows following the Equity Redemption are presented as the “Successor.” Accordingly, as used in these notes to the consolidated financial statements, the terms “first three months of 2012” and “three months ended March 31, 2012” refer to the results of the Successor entities and the terms “first three months of 2011” and “three months ended March 31, 2011” refer to the results of the Predecessor entities for such periods.

Use of Estimates

The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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 discussed in Note 2 and the application of ASC 805, we engaged an independent, third party valuation firm to assist in evaluating the fair value of certain assets and liabilities as of May 23, 2011. The results of this valuation are further discussed in Note 2 below.

Revenue and Cost Recognition

Substantially all of our revenues are generated from fees charged to merchants for payment processing services. We typically charge these merchants a rate, primarily based upon each merchant’s monthly charge volume and risk profile. Our fees principally consist of discount fees, which are a percentage of the dollar amount of each transaction. We recognize discounts and other fees related to payment transactions at the time the merchant’s 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, ancillary products and fees for other miscellaneous services, such as handling chargebacks. 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 ownership of the merchant agreement, 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 recognized at the time transactions are processed. Revenues generated from certain bank portfolios acquired from First Data Merchant Services Corporation and other sources 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.

Other Costs of Services

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 includes telecommunications costs, personnel costs, occupancy costs, losses due to merchant defaults, other miscellaneous merchant supplies and services expenses, amortization, depreciation, bank sponsorship costs and other third-party processing costs.

 

8


Financial Instruments

ASC 820 “Fair Value Measurement and Disclosures” establishes a framework for measuring fair value and 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:

 

   

Level 1: Observable quoted prices in active markets for identical assets and liabilities.

 

   

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.

 

   

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 March 31, 2012 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 the 10.25% Notes was $400.0 million as of March 31, 2012. We estimate its fair value to be approximately $367.0 million, considering executed trades occurring around March 31, 2012. The carrying value of the term loan under the Senior Secured Credit Facilities, net of discount, was $350.9 million as of March 31, 2012. We estimate its fair value to be approximately $351.7 million, considering executed trades occurring around March 31, 2012. The carrying value of the 15.00%/ 15.00% Notes was $128.9 million as of March 31, 2012. We estimate its fair value to be approximately $107.0 million, considering executed trades occurring around March 31, 2012. The fair value of the 10.25% Notes, the Senior Secured Credit Facilities, and the 15.00%/15.00% Notes 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. We are contractually obligated to repay our borrowings in full and we do not believe the creditors under our borrowing arrangements are willing to settle these instruments with us at their estimated fair values indicated herein.

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. Amortization of intangible assets results from our acquisitions of portfolios of merchant contracts, revenue streams related to residual agreements related to merchant portfolios, or residual buyouts or acquisitions of a business where we allocated a portion of the purchase price to the existing merchant processing portfolios and other intangible assets. 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 1.5% to 2.5% of our total charge volume.

We utilize an accelerated method of amortization over a 15-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. For the three months ended March 31, 2012, amortization expense related to our merchant processing portfolios and other intangible assets was $14.1 million. For the three months ended March 31, 2011, amortization expense related to our merchant processing portfolios and other intangible assets was $10.0 million.

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 charge volume, revenues, number of merchant accounts, 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

 

9


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 comprehensive income and on a prospective basis until further evidence becomes apparent. As a result of the Equity Redemption, we appraised merchant processing portfolios as of May 23, 2011. There were no material favorable or unfavorable trends identified in the attrition rates used for the three-months ended March 31, 2012. Consequently, there were no related adjustments to amortization expense for these periods. Please refer to Note 2 for further discussion.

Our intangible assets are amortized over their estimated lives, except the “iPayment, Inc.” trade name, which was determined to have an indefinite life as there are no legal, regulatory, contractual, economic or other factors that limit the useful life of the intangible asset to us, and we have no plans to cease using such name. We believe the trade name has an inherent value due to brand strength.

Common Stock

iPayment and Holdings have 100 and 4,875,000 shares of common stock, respectively, that are issued and outstanding at March 31, 2012. The Company has elected not to present earnings per share data as management believes such presentation would not be meaningful. There is no established public trading market for our common stock or for the Warrants. No warrants were exercised as of March 31, 2012.

(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 $300.0 million, plus punitive damages in the amount of $50.0 million, against Gregory Daily, iPayment’s former Chairman and Chief Executive Officer, in connection with litigation over Mr. Daily’s beneficial ownership in us. This lawsuit was brought against Mr. Daily individually and not in his previous capacities as the Chairman and Chief Executive Officer of iPayment. Neither iPayment, nor any other shareholders, officers, employees or directors were a party to this action. 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 ordered the appointment of a trustee (the “Daily Bankruptcy Trustee”) to administer the estate of Mr. Daily.

On April 12, 2011, iPayment Investors and iPayment GP 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. Daily’s family that held equity interests in iPayment 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, iPayment Investors and iPayment GP agreed to redeem from the Daily Parties, and the Daily Parties agreed to transfer and surrender to iPayment Investors and iPayment GP, as applicable, all of the equity interests of the Daily Parties in iPayment Investors and iPayment GP, representing approximately 65.8% of the outstanding equity of iPayment 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, iPayment completed the offering of the 10.25% Notes and the closing of the Senior Secured Credit Facilities. Also on May 6, 2011, Holdings completed the offering of the Units. The majority of the proceeds from the offerings of the 10.25% Notes and the Units, together with borrowings under the Senior Secured Credit Facilities, were used to (i) permanently repay all of the outstanding indebtedness under iPayment’s then existing senior secured credit facilities; (ii) redeem and satisfy and discharge all of iPayment’s then existing senior subordinated notes; (iii) redeem and satisfy and discharge all of iPayment 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 fee discussed in Note 10 and other related fees and expenses. In these notes to the consolidated financial statements, we refer to the entry into the Senior Secured Credit Facilities, the offer and sale of the 10.25% Notes and the Units, including the application of the net proceeds of the 10.25% Notes and the Units and borrowings under the Senior Secured Credit Facilities as described above, as the “Refinancing.”

 

10


Upon the closing of the Equity Redemption, Mr. Daily resigned as a director and officer, as applicable, of iPayment GP, iPayment Investors and each of iPayment Investors’ subsidiaries, including his former positions as iPayment’s Chairman and Chief Executive Officer. In connection with Mr. Daily’s resignation, Carl Grimstad became the new Chairman and Chief Executive Officer of iPayment and Mark Monaco, iPayment’s Chief Financial Officer, became a member of iPayment’s and Holdings’ boards of directors. The Redemption Agreement includes covenants on the part of Mr. Daily not to compete with iPayment and its affiliates for one year, and not to solicit employees, independent sales agents and independent sales organizations and merchants of iPayment 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 iPayment’s Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on April 13, 2011, which is incorporated herein by reference.

In accordance with ASC 805, the Company determined that a change of control occurred as a result of the Equity Redemption requiring assets and liabilities to be recorded at fair value. As part of the purchase accounting for the Equity Redemption for iPayment and its consolidated subsidiaries, approximately $274.5 million was assigned to merchant portfolios and other intangible assets and $669.5 million was assigned to goodwill. Of the amount assigned to merchant portfolios and other intangible assets, $206.4 million related to merchant portfolios, $65.5 million related to a trade name for iPayment and $2.6 million was primarily attributable to software development and other intangible assets. The aforementioned amounts resulted in increases over the historical basis prior to the Equity Redemption, of $131.8 million and $141.5 million in merchant portfolios and other intangible assets and goodwill, respectively. In addition, $32.8 million was assigned to deferred tax liabilities on the cumulative step-up of assets and liabilities that were adjusted to fair value using combined federal and state tax rates.

As part of the purchase accounting for the Equity Redemption for Holdings and its consolidated subsidiaries, approximately $274.5 million was assigned to merchant portfolios and other intangible assets and $670.3 million was assigned to goodwill. Of the amount assigned to merchant portfolios and other intangible assets, $206.4 million related to merchant portfolios, $65.5 million related to a trade name for iPayment and $2.6 million was primarily attributable to software development and other intangible assets. The aforementioned amounts resulted in increases over the historical basis prior to the Equity Redemption, of $131.8 million and $142.3 million in merchant portfolios and other intangible assets and goodwill, respectively. In addition, $32.8 million was assigned to deferred tax liabilities on the cumulative step-up of assets and liabilities that were adjusted to fair value using combined federal and state tax rates.

(3) Acquisitions

There were no acquisitions of businesses during the first three months of 2012 that were significant enough to require pro forma disclosure.

(4) Other Intangibles

Payments for Prepaid Residual Expenses

There were no payments for prepaid residual expenses during the first three month period ended March 31, 2012. During the three-month period ended March 31, 2011, we made payments totaling $0.5 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.

 

11


(5) Long-Term Debt

Our long-term debt is comprised of the following:

 

     iPAYMENT, INC.
AND SUBSIDIARIES
    iPAYMENT HOLDINGS, INC.
AND SUBSIDIARIES
 

(Dollars in thousands)

   As of March 31, 2012     As of December 31, 2011     As of March 31, 2012     As of December 31, 2011  
     (unaudited)     (audited)     (unaudited)     (audited)  

Senior Secured Credit Facilities

        

Term facility

   $ 352,500      $ 360,500      $ 352,500      $ 360,500   

Revolving facility

     5,000        15,500        5,000        15,500   

Discount on Senior Secured Credit Facilities

     (1,648     (1,716     (1,648     (1,716

10.25% Notes

     400,000        400,000        400,000        400,000   

15.00%/15.00% Notes

     —          —          129,922        129,922   

Discount on 15.00%/15.00% Notes, net of

amortization of $139

     —          —          (1,027     (1,065
  

 

 

   

 

 

   

 

 

   

 

 

 
     755,852        774,284        884,747        903,141   

Less: Current portion of long-term debt

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total long-term debt

   $ 755,852      $ 774,284      $ 884,747      $ 903,141   
  

 

 

   

 

 

   

 

 

   

 

 

 

The terms of our long-term debt contain various nonfinancial and financial covenants as further discussed 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 indentures governing the Notes or the lenders under the 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. As of March 31, 2012, our Senior Secured Leverage Ratio, as defined in the Senior Secured Credit Facilities, was 2.73 to 1.00 compared to the allowed maximum of 3.50 to 1.00. As of March 31, 2012, our Consolidated Interest Coverage Ratio, as defined in the Senior Secured Credit Facilities, was 2.07 to 1.00 compared to the allowed minimum of 1.40 to 1.00.

During the first three months of 2012, we have made net repayments of $8.0 million on the term loan under the Senior Secured Credit Facilities and $10.5 million of net repayments on the revolving facility.

The shares of iPayment’s common stock held by Holdings have been pledged by Holdings to secure the obligations of iPayment under the Senior Secured Credit Facilities.

10.25% Notes

The 10.25% Notes were issued pursuant to an indenture, dated as of May 6, 2011 (the “10.25% Notes Indenture”), among the Company, the guarantors party thereto and Wilmington Trust, National Association (as successor by merger to Wilmington Trust FSB), as trustee (the “Trustee”). iPayment will pay interest on the 10.25% Notes in cash on November 15 and May 15 of each year at a rate of 10.25% per annum. Interest on the 10.25% Notes will accrue from and including the issue date of the 10.25% Notes The first interest payment date was November 15, 2011. The 10.25% Notes will mature on May 15, 2018. The 10.25% Notes Indenture contains covenants that, among other things, restrict iPayment 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 10.25% Notes Indenture generally permit iPayment to distribute funds to Holdings to make interest payments on the 15.00%/15.00% Notes to the extent required to be paid in cash by the terms of the 15.00%/15.00% Notes Indenture (as defined below) and for certain other operating expenses of Holdings.

The 10.25% Notes 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.

Senior Secured Credit Facilities

iPayment also entered into a Credit Agreement, dated May 6, 2011 (the “Credit Agreement”), with Holdings, the subsidiaries of iPayment identified therein as guarantors, JPMorgan Chase Bank, N.A. and the other lenders party thereto. The Senior Secured Credit Facilities consist of (i) a six-year, $375.0 million term facility and (ii) a five-year, $75.0 million revolving facility, which includes a swing line loan facility and letter of credit facility and is

 

12


available from time to time until the fifth anniversary of the closing date of the 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 Senior Secured Credit Facilities give iPayment the ability, subject to certain conditions, to request an increase in the amount of the revolving facility in an aggregate amount of up to $25.0 million.

The interest rates under the 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 iPayment’s 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. iPayment also pays a quarterly commitment fee equal to 0.625% on the unused portion of the revolving facility which can decline to 0.375% of such unused portion based upon our consolidated leverage ratio as determined in accordance with the related pricing grid set forth in the Credit Agreement.

At March 31, 2012, iPayment had $350.9 million of term loans outstanding, net of discount of $1.6 million at a weighted average interest rate of 5.75% and $5.0 million of borrowings under its revolving facility at a weighted average interest rate of 4.50%.

The Credit Agreement contains certain customary covenants that, subject to certain exceptions, restrict iPayment and its subsidiaries’ ability to, among other things (i) declare dividends or redeem or repurchase equity interests by iPayment 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 iPayment’s existing business. In addition, under the Credit Agreement, iPayment is 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 iPayment.

Events of default, which are subject to grace periods and exceptions, as set forth in the Credit Agreement include, among others: (i) iPayment’s 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.

15.00%/15.00% Notes

The 15.00%/15.00% Notes were issued pursuant to an indenture, dated as of May 6, 2011 (the “15.00%/15.00% Notes Indenture”), between Holdings and the Trustee. Interest on the 15.00%/15.00% Notes will accrue from and including the issue date of the 15.00%/15.00% Notes, and the first interest payment date was November 15, 2011. The 15.00%/15.00% Notes will mature on November 15, 2018. For any interest period through and including May 15, 2015, Holdings may elect to pay interest on the 15.00%/15.00% Notes (i) entirely in cash (“cash interest”) or (ii) pay interest on 50% of the outstanding principal amount of the 15.00%/15.00% Notes in cash interest and on 50% of the outstanding principal amount of the 15.00%/ 15.00% Notes by increasing the principal amount of the outstanding 15.00%/15.00% Notes or by issuing additional 15.00%/15.00% Notes (“PIK interest”). Notwithstanding the foregoing, Holdings will pay cash interest on the 15.00%/15.00% Notes to the extent that iPayment would, on the date notice of such election is required to be made, be permitted pursuant to its debt agreements to pay a dividend or distribution to Holdings in an amount sufficient to pay such cash interest on the relevant interest payment date. After May 15, 2015, Holdings will pay cash interest on the 15.00%/15.00% Notes, subject to certain rights to pay partial PIK interest for up to two additional interest periods.

 

13


Cash interest and PIK interest each accrue at a rate of 15.00% per annum. If Holdings’ leverage ratio exceeds 7.25 to 1.00 as of the most recent quarter end prior to an interest payment date, then for the interest period ending on such date, the interest rate will be retroactively increased by 2.00% in the form of PIK interest. The 15.00%/15.00% Notes will bear interest on the increased principal amount thereof from and after the applicable interest payment date on which a payment of PIK interest is made. Holdings must elect the form of interest payment with respect to each interest period not later than the beginning of each interest period. In the absence of such an election, Holdings will pay interest according to the election for the previous interest period. Interest for the first interest period will be paid 50% as cash interest and 50% as PIK interest.

The 15.00%/15.00% Notes Indenture contains covenants that, among other things, restrict Holdings 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 15.00%/15.00% Notes 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.

The 125,000 Units issued by Holdings on May 6, 2011, consists of $125.0 million in aggregate principal amount of 15.00%/15.00% Notes and Warrants to purchase 125,000 shares of common stock at $0.01 per share, subject to adjustment upon the occurrence of certain events described in the warrant agreement entered into by Holdings and Wilmington Trust, National Association (as successor by merger to Wilmington Trust FSB) (the “Warrant Agreement”). The proceeds from the issuance of the Units were allocated between the 15.00%/15.00% Notes and the Warrants based on the relative fair value of the items. The fair value of the Warrants was computed using the following assumptions:

 

     As of May 23, 2011  

Common stock at fair market value

   $ 9.43   

Exercise Price

   $ 0.01   

Term

     7.5 years   

Volatility

     42.68

Risk-free interest rate

     2.54

Dividend yield

     —     

The total proceeds from the issuance of the Units was $121.7 million, net of issuance costs of $3.3 million. The valuation resulted in $1.2 million of the gross proceeds being allocated to the Warrants and accordingly, was recorded as a debt discount as of May 23, 2011. In accordance with the terms of the Warrant Agreement, the 15.00%/15.00% Notes and the Warrants separated on November 2, 2011, which is 180 days after the issue date of the Units. The Warrants are exercisable as of the opening of business on such date until 5:00 p.m., New York City time, on November 15, 2018. Each Warrant not exercised during such period will become void and all rights thereunder and all rights in respect thereof under the Warrant Agreement will cease as of such time.

The descriptions set forth in this Note 5 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 10.25% Notes Indenture (including the form of the notes attached thereto), the 15.00%/15.00% Notes Indenture (including the form of the notes attached thereto), the Credit Agreement and the Warrant Agreement. Copies of the 10.25% Notes Indenture and the Credit Agreement are included as Exhibits 4.1 and 10.1, respectively, to iPayment’s Current Report on Form 8-K filed with the SEC on May 12, 2011, and copies of the 15.00%/15.00% Notes Indenture and the Warrant Agreement are included as Exhibits 4.3 and 10.29, respectively, to the Company’s Registration Statement on Form S-4 filed with the SEC on October 11, 2011, which, in each case, are incorporated herein by reference.

iPayment and its consolidated subsidiaries had net capitalized debt issuance costs related to the Senior Secured Credit Facilities and 10.25% Notes of $10.0 million and $9.7 million, respectively, as of March 31, 2012. Holdings and its consolidated subsidiaries had net capitalized debt issuance costs related to the 15.00%/15.00% Notes of $3.1 million and a debt discount related to the Warrants of $1.0 million as of March 31, 2012.

 

14


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 of iPayment and its consolidated subsidiaries related to the debt issuance costs for the Senior Secured Credit Facilities and the 10.25% Notes were $0.4 million and $0.3 million, respectively, for the three months ended March 31, 2012. Amortization expense of Holdings and its consolidated subsidiaries related to the debt issuance costs for the 15.00%/15.00% Notes was less than $0.1 million for the three months ended March 31, 2012.

(6) Segment Information and Geographical Information

We consider our business activities to be in a single reporting segment, as we derive approximately 90% of our revenue and results of operations from processing revenues and other fees from electronic forms of payment. 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. As of March 31, 2012, we have net income taxes payable of $3.7 million and $2.2 million, for iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries, respectively.

We have an income tax benefit of $0.7 million and income tax expense of $0.7 million for iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries, respectively, during the first three months of 2012, in each case, compared to income tax expense of $4.4 million for the comparative period in 2011. Our full year forecasted effective tax rates are 44.9% for iPayment and its consolidated subsidiaries and -24.8% for Holdings and its consolidated subsidiaries with the difference resulting from a portion of Holdings’ interest expense. The difference between the statutory federal rate of 34.0% and the 44.9% is attributable to disallowed expenses. First quarter 2012 income tax expense was benefited by $0.7 million of adjustments related to the prior year. We are subject to interest deductibility limitations with respect to interest accruing on the 15.00%/15.00% Notes, which constitute an “Applicable High Yield Discount Obligation” for U.S. federal income tax purposes. Consequently, a portion of the interest expense under the 15.00%/15.00% Notes is non-deductible by Holdings.

During the first three months of 2012 and 2011, we accrued less than $0.1 million of interest related to our uncertain tax positions. As of March 31, 2012, our liabilities for unrecognized tax benefits totaled $1.5 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 March 31, 2012 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 prior to 2007.

At March 31, 2012, we had approximately $0.6 million of federal net operating loss carryforwards that will be available to offset regular taxable income through 2020, subject to annual limitations per year. We had state net operating loss carryforwards of approximately $29.6 million as of March 31, 2012.

(8) 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

 

15


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 management’s attention. All litigation settlements are recorded within other expense on our consolidated statements of comprehensive income.

(9) Recent Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The provisions of ASU No. 2011-04 result in a consistent definition of fair value and common requirements for the measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). The changes to U.S. GAAP as a result of ASU No. 2011-04 are as follows: (1) The concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets. ASU No. 2011-04 extends that prohibition to all fair value measurements; (3) An exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks. This exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) Aligns the fair value measurement of instruments classified within an entity’s shareholders’ equity with the guidance for liabilities; and (5) Disclosure requirements have been enhanced for Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to qualitatively describe the sensitivity of fair value measurements to changes in unobservable inputs and the interrelationships between those inputs. In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed. The Company adopted the provisions of ASU No. 2011-04 effective January 1, 2012. The fair value measurement provisions of ASU No. 2011-04 had no impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” The provisions of ASU No. 2011-05 allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Under either method, entities are required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU No. 2011-05 also eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 was effective for the Company’s interim reporting period beginning on or after January 1, 2012, with retrospective application required. In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The provisions of ASU No. 2011-12 defer indefinitely the requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. ASU No. 2011-12, which shares the same effective date as ASU No. 2011-05, does not defer the requirement for entities to present components of comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted the provisions of ASU No. 2011-05 and ASU No. 2011-12 which resulted in a new statement of comprehensive income for the interim period ended March 31, 2012. 

 

16


(10) Related Party Transactions

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, Adaero Holdings, LLC (“Adaero”), an entity majority owned and controlled by Mark Monaco, entered into a consulting agreement with Perella Weinberg. Mr. Monaco became Chief Financial Officer of iPayment in October 2010 and a member of the boards of directors of iPayment and Holdings following the Refinancing. 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 Adaero pursuant to the consulting agreement described above.

(11) Subsequent Events

On May 2, 2012, we entered into a definitive asset purchase agreement with CardServ, Inc., a Massachusetts corporation doing business as Flagship Merchant Services (“Flagship”). Pursuant to the definitive agreement, one of our wholly owned subsidiaries has agreed to purchase substantially all of the assets of Flagship for a purchase price of approximately $14 million. If all conditions to closing are satisfied or waived, this transaction is expected to close within 30 days of the date of this filing. Flagship is an independent sales organization with headquarters in Charlestown, Massachusetts.

 

17


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Overview

We are a provider of credit and debit card payment processing services to small merchants across the United States. During March 2012, we generated revenue from approximately 186,000 merchants. Of these merchants, approximately 130,000 were active merchants that had each processed at least one Visa or MasterCard transaction during that month. Our payment processing services enable our merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards and loyalty programs in traditional card-present, or swipe transactions, as well as card-not-present transactions, such as those done over the phone or through the internet. 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 of our products and services. We also market our services directly to merchants through electronic media, telemarketing and other programs, including utilizing partnerships with other companies that market products and services to small businesses. In addition, we 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, primarily in our main operating center in Westlake Village, California.

Our strategy is to increase profits by increasing our penetration of the small merchant marketplace for payment services. Our charge volume increased 2.8% to $5,538 million for the three months ended March 31, 2012 from $5,385 million for the three months ended March 31, 2011. This increase in charge volume was due primarily to a higher number of transactions per merchant in the first three months of 2012 compared to 2011. However, our revenues decreased $4.3 million or 2.5% to $165.4 million in the first three months of 2012 from $169.6 million in the same period in 2011. The decrease in revenues was primarily due to a reduction in the average discount rate charged to merchants as a percentage of merchant processing volume, driven in large part by the impact from the Durbin Amendment to the Dodd-Frank Act (the “Durbin Amendment”) that became effective on October 1, 2011. Revenues, net of interchange, increased 5.9% to $83.5 million for the first quarter of 2012 from $78.9 million for the first quarter of 2011. Income from operations decreased 21.4% to $15.6 million for the three months ended March 31, 2012 from $19.9 million during the same period in 2011. The decline in Income from operations was primarily due to increases in depreciation and amortization as a result of the Equity Redemption and resulting change of control. Loss before income taxes was $0.2 million for iPayment and its consolidated subsidiaries and $5.2 million for Holdings and its consolidated subsidiaries during the three months ended March 31, 2012, in each case, compared to $12.0 million of income before income taxes in the same period in 2011.

In May 2011, we consummated refinancing transactions, which we collectively refer to as the “Refinancing,” and a redemption, which we refer to as the “Equity Redemption,” of all of the direct and indirect equity interests in us and our affiliates held by Gregory Daily, iPayment’s former Chairman and Chief Executive Officer, and certain persons and entities affiliated with or controlled by him. Please refer to Notes 1, 2 and 5 of the accompanying consolidated financial statements for a description of the Equity Redemption and the Refinancing, which is incorporated herein by reference.

Critical Accounting Policies

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. 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 management’s 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

 

18


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 also 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 their fair value, calculated as the sum of the expected cash flows discounted at a market rate, represents the impairment loss.

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. Amortization of intangible assets results from our acquisitions of portfolios of merchant contracts, revenue streams related to residual agreements related to merchant portfolios, or residual buyouts or acquisitions of a business where we allocated a portion of the purchase price to the existing merchant processing portfolios and other intangible assets. 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 1.5% to 2.5% of our total charge volume on our various merchant portfolios. We utilize an accelerated method of amortization over a 15-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 has occurred on a portfolio-by-portfolio basis. In reviewing the current attrition rate trends, we consider relevant benchmarks such as charge volume, revenues, number of merchant accounts, 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 our current consolidated statements of comprehensive income and on a prospective basis until further evidence becomes apparent.

As a result of the Equity Redemption, we have determined the fair value of our intangible assets and goodwill in accordance with ASC 805, and we engaged an independent, third party valuation firm to assist in evaluating the fair value of certain assets as of May 23, 2011.

Revenue and Cost Recognition. Substantially all of our revenues are generated from fees charged to merchants for payment processing services. We typically charge these merchants a rate, primarily based upon each merchant’s monthly charge volume and risk profile. Our fees principally consist of discount fees, which are a percentage of the dollar amount of each credit or debit transaction. We charge merchants higher discount rates for card-not-present transactions than for card-present transactions in order to provide compensation 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, payment card industry compliance fees, ancillary products, and fees for other miscellaneous services, such as handling chargebacks. We recognize discounts and other fees related to payment transactions at the time a merchant’s 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 ownership of the merchant agreement, 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 recognized at the time transactions are processed. Revenues generated from certain bank portfolios acquired from First Data Merchant Services Corporation and other sources 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.

 

19


The most significant component of operating expenses is interchange fees, which are amounts we pay to the card issuing banks. Interchange fees are primarily based on transaction processing volume, except in the case of regulated debit transactions, where they are based primarily on a per transaction basis and are recognized at the time transactions are processed.

Other costs of services includes 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 includes telecommunications costs, personnel costs, occupancy costs, losses due to merchant defaults, other miscellaneous merchant supplies and services expenses, bank sponsorship costs and other third-party processing costs. Other costs of services also includes depreciation 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, revenue streams related to residual agreements related to merchant portfolios, or residual buyouts 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 consists 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 merchant’s favor. In these cases, the transaction is “charged back” to the merchant, which means the purchase price is refunded to the customer through the merchant’s acquiring bank and charged to the merchant. If the merchant has inadequate funds, we or, under limited circumstances, the acquiring bank and us, must bear the credit risk for the full amount of the transaction. We evaluate the merchant’s 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 March 31, 2012 and December 31, 2011, our reserve for losses on merchant accounts included in accrued liabilities and other totaled $1.3 million and $1.2 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 March 31, 2012 and December 31, 2011.

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.

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.

 

20


Results of Operations:

As a result of the Equity Redemption, our 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 our results of operations, financial position and cash flows following the Equity Redemption are presented as the “Successor.” Accordingly, as used in this Quarterly Report, the terms “first three months of 2012” and “three months ended March 31, 2012” refer to the results of the Successor entities and the terms “first three months of 2011” and “three months ended March 31, 2011” refer to the results of the Predecessor entities for such periods.

Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

 

     Three months ended March 31,     Change  

(Dollars in thousands, except percentages)

   2012     % of Total
Revenue
    2011     % of Total
Revenue
    Amount     %  

Revenues

   $ 165,362        100.0   $ 169,613        100.0   $ (4,251     (2.5 )% 

Operating Expenses

            

Interchange

     81,858        49.5        90,728        53.5        (8,870     (9.8

Other costs of services

     63,664        38.5        54,741        32.3        8,923        16.3   

Selling, general and administrative(1)

     4,232        2.6        4,290        2.5        (58     (1.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     149,754        90.6        149,759        88.3        (5     (0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     15,608        9.4        19,854        11.7        (4,246     (21.4

Other expense

            

Interest expense, net(2)

     16,386        9.9        7,901        4.7        8,485        107.4   

Other (income), net

     (581     (0.4     (30     (0.1     (551     1,836.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense(3)

     15,805        9.5        7,871        4.6        7,934        100.8   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income taxes(4)

     (197     (0.1     11,983        7.1        (12,180     (101.6

Income tax (benefit) provision (5)

     (684     (0.4     4,421        2.6        (5,105     (115.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income (6)

   $ 487        0.3   $ 7,562        4.5   $ (7,075     (93.6 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Selling, general and administrative expense of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $4.3 million.
(2) Net interest expense of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $21.4 million.
(3) Total other expense of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $20.8 million.
(4) Loss before income taxes of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $5.2 million.
(5) Income tax expense of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $0.7 million.
(6) Net loss of Holdings and its consolidated subsidiaries for the three months ended March 31, 2012 is $5.9 million.

Revenues. Revenues decreased 2.5% to $165.4 million in the first three months of 2012 from $169.6 million during the same period in 2011. The decrease in revenues was primarily due to a reduction in the average discount rate charged to merchants as a percentage of merchant processing volume, driven in large part by the impact from the Durbin Amendment, which regulates interchange levels for certain debt transactions. Merchant processing volume, which represents the total value of transactions processed by us, increased by 2.8%, to $5,538 million during the first three months of 2012 from $5,385 million during the same period in 2011.

Interchange Expenses. Interchange expenses decreased 9.8% to $81.9 million in the first three months of 2012 from $90.7 million during the same period in 2011. Interchange expenses decreased due to a reduction in the average interchange rate as a percentage of merchant processing volume, driven in large part by changes in debit card interchange rates that card issuing banks may charge as a result of the Durbin Amendment

Other Costs of Services. Other costs of services increased 16.3% to $63.7 million in the first three months of 2012 from $54.7 million during the same period in 2011. The increase in other costs of services was primarily due to higher sales expenses and amortization expenses as a result of the application of ASC 805 in May 2011. See Note 2 to the consolidated financial statements.

Selling, General and Administrative. Selling, general and administrative expenses decreased 1.4% to $4.2 million in the first three months of 2012 as compared to $4.3 million during the same period in 2011.

Other Expense. Other expense increased $7.9 million for iPayment and its consolidated subsidiaries and $12.9 million for Holdings and its consolidated subsidiaries in the first three months of 2012, in each case, from $7.9

 

21


million during the same period in 2011. Interest expense, the primary component of total other expense, increased $8.5 million for iPayment and its consolidated subsidiaries and $13.5 million for Holdings and its consolidated subsidiaries in the first three months of 2012 from $7.9 million for iPayment and its consolidated subsidiaries and $7.9 million for Holdings and its consolidated subsidiaries during the same period in 2011, largely due to a higher average debt balance as a result of the Refinancing (see Note 2 to the consolidated financial statements) as well as a higher weighted average interest rate.

Income Tax. We have an income tax benefit of $0.7 million and income tax expense of $0.7 million for iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries, respectively, during the first three months of 2012, in each case, compared to income tax expense of $4.4 million for the comparative period in 2011. Our full year forecasted effective tax rates are 44.9% for iPayment and its consolidated subsidiaries and -24.8% for Holdings and its consolidated subsidiaries with the difference resulting from a portion of Holdings’ interest expense. The difference between the statutory federal rate of 34.0% and the 44.9% is attributable to disallowance expenses. First quarter 2012 income tax expense was benefited by $0.7 million of adjustments related to the prior year. We are subject to interest deductibility limitations with respect to interest accruing on the 15.00%/15.00% Notes, which constitute an “Applicable High Yield Discount Obligation” for U.S. federal income tax purposes. Consequently, a portion of the interest expense under the 15.00%/15.00% Notes is non-deductible by Holdings.

Liquidity and Capital Resources

As of March 31, 2012 and December 31, 2011, we had cash and cash equivalents of approximately $0.2 million and less than $0.1 million, respectively. We usually minimize cash balances in order to minimize borrowings and, therefore, interest expense. As of March 31, 2012, iPayment and its consolidated subsidiaries had a net working capital deficit (current liabilities in excess of current assets) of $7.9 million compared to a net deficit of $2.7 million as of December 31, 2011. The net deficit increase resulted primarily from a reduction in accounts receivable of $1.0 million and an increase in accrued interest of $10.2 million, offset by an increase in cash and cash equivalents of $0.2 million, a reduction in accrued liabilities and other of $0.6 million, and reductions in accounts payable and income taxes payable of $2.4 million and $2.8 million, respectively.

As of March 31, 2012, Holdings and its consolidated subsidiaries had a net working capital deficit of $13.8 million compared to a capital deficit of $2.4 million as of December 31, 2011. The capital deficit increase resulted primarily from a reduction in accounts receivable of $1.0 million and an increase in accrued interest of $12.6 million, offset by an increase in cash and cash equivalents of $0.2 million, a reduction in accrued liabilities and other of $0.5 million, and reductions in accounts payable and income taxes payable of $2.4 million and $1.4 million, respectively.

We expect that our cash flow from operations and proceeds from borrowings under our revolving facility will be our primary sources of liquidity and will be sufficient to fund our cash requirements for at least the next twelve months. See “Contractual Obligations” below for a description of future required uses of cash.

We have significant outstanding long-term debt as of March 31, 2012. The terms of our long-term debt contain various nonfinancial and financial covenants as further discussed 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 indentures governing the Notes or the lenders under the 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. As of March 31, 2012, our Senior Secured Leverage Ratio, as defined in the Senior Secured Credit Facilities, was 2.73 to 1.00 compared to the allowed maximum of 3.50 to 1.00. As of March 31, 2012, our Consolidated Interest Coverage Ratio, as defined in the Senior Secured Credit Facilities, was 2.07 to 1.00 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

 

22


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 provided by operating activities was $20.3 million during the first three months of 2012. For iPayment and its consolidated subsidiaries, net cash provided by operating activities consisted of net income of $0.5 million adjusted by depreciation and amortization of $14.8 million, non-cash interest expense and other of $0.8 million, loss on disposal of property and equipment of $0.4 million, and a net favorable change in operating assets and liabilities of $3.9 million primarily due to an increase in accrued interest offset by decreases in accounts payable and income taxes payable as a result of federal and state tax payments made during 2012. For Holdings and its consolidated subsidiaries, net cash provided by operating activities consisted of a net loss of $5.9 million adjusted by depreciation and amortization of $14.8 million, non-cash interest expense and other of $0.9 million, loss on disposal of property and equipment of $0.4 million, and a net favorable change in operating assets and liabilities of $10.2 million primarily due to an increase in accrued interest offset by decreases in accounts payable and income taxes payable as a result of federal and state tax payments made during 2012.

Net cash provided by operating activities was $12.8 million during the first three months of 2011, consisting of net income of $7.6 million adjusted by depreciation and amortization of $10.5 million, non-cash interest expense of $0.6 million, and a net increase in working capital of $5.9 million, primarily caused by decreases in accounts payable and income taxes payable due to federal and state tax payments made in the first three months of 2011, partially offset by an increase in accrued interest.

Investing activities

Net cash used in investing activities was $1.6 million during the first three months of 2012. Net cash used in investing activities consisted primarily of $1.7 million of property and equipment expenditures.

Net cash used in investing activities was $1.2 million during the first three months of 2011. Net cash used in investing activities consisted of $0.5 million of payments for contract modifications for prepaid residual expenses and $0.7 million of capital expenditures. We currently have no material capital spending or purchase commitments, but expect to continue to engage in capital spending in the ordinary course of business.

Financing activities

Net cash used in financing activities was $18.5 million during the first three months of 2012, consisting of $8.0 million of repayments on the term loan under the Senior Secured Credit Facilities and $10.5 million of net repayments on the revolving facility thereunder.

Net cash used in financing activities was $11.6 million during the first three months of 2011, consisting of $5.8 million of repayments on the term loan under iPayment’s then existing senior secured credit facilities and $5.8 million of net repayments on the then existing revolving facility thereunder.

See Notes 2 and 5 to the consolidated financial statements for further detail regarding the Company’s long-term debt and the Refinancing.

Contractual Obligations

The following table of our material contractual obligations as of March 31, 2012 summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated.

 

23


     Payments due by period  

(Dollars in thousands)

   Total      Less than 1 year      1-3 years      4-5 years      More than 5 years  

Contractual Obligations of iPayment

              

Senior Secured Credit Facilities

   $ 357,500       $ —         $ —         $ 357,500       $ —     

10.25% Notes

     400,000         —           —           —           400,000   

Interest, net of discount and amortization(1)

     357,538         62,213         124,425         123,829         47,071   

Operating lease obligations

     14,057         1,719         3,318         3,313         5,707   

Purchase obligations and other(2)

     2,873         734         1,231         908         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 1,131,968       $ 64,666       $ 128,974       $ 485,550       $ 452,778   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Contractual Obligations of Holdings

              

15.00%/15.00% Notes(3)

   $ 168,112       $ —         $ —         $ —         $ 168,112   

Interest(1)(3)

     126,449         9,927         22,187         43,901         50,434   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 294,561       $ 9,927       $ 22,187       $ 43,901       $ 218,546   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Future interest obligations are calculated using current interest rates on existing debt balances as of March 31, 2012, and assume no principal reduction other than mandatory principal repayments in accordance with the terms of the debt instruments as discussed in Note 5 to the consolidated financial statements.
(2) Purchase obligations represent costs of contractually guaranteed minimum payments pursuant to third party contracts and other service related obligations.
(3) Assumes that (i) for all interest periods through and including May 15, 2015, Holdings will pay interest on 50% of the outstanding principal amount of its 15.00%/15.00% Notes in cash and 50% in kind and (ii) after May 15, 2015, Holdings will make all interest payments on the 15.00%/15.00% Notes entirely in cash.

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 the Senior Secured Credit Facilities and (ii) the Notes) using our cash from operations. We intend to use our revolving facility primarily to fund temporary working capital needs and additional acquisition opportunities as they arise. To the extent we are unable to fund our operations, capital expenditures and the contractual obligations above using cash from operations, we intend to use borrowings under our revolving facility 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.

New Accounting Standards

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The provisions of ASU No. 2011-04 result in a consistent definition of fair value and common requirements for the measurement of and disclosure about fair value between U.S. GAAP and International Financial Reporting Standards (“IFRS”). The changes to U.S. GAAP as a result of ASU No. 2011-04 are as follows: (1) The concepts of highest and best use and valuation premise are only relevant when measuring the fair value of nonfinancial assets (that is, it does not apply to financial assets or any liabilities); (2) U.S. GAAP currently prohibits application of a blockage factor in valuing financial instruments with quoted prices in active markets. ASU No. 2011-04 extends that prohibition to all fair value measurements; (3) An exception is provided to the basic fair value measurement principles for an entity that holds a group of financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk that are managed on the basis of the entity’s net exposure to either of those risks. This exception allows the entity, if certain criteria are met, to measure the fair value of the net asset or liability position in a manner consistent with how market participants would price the net risk position; (4) Aligns the fair value measurement of instruments classified within an entity’s shareholders’ equity with the guidance for liabilities; and (5) Disclosure requirements have been

 

24


enhanced for Level 3 fair value measurements to disclose quantitative information about unobservable inputs and assumptions used, to describe the valuation processes used by the entity, and to qualitatively describe the sensitivity of fair value measurements to changes in unobservable inputs and the interrelationships between those inputs. In addition, entities must report the level in the fair value hierarchy of items that are not measured at fair value in the statement of condition but whose fair value must be disclosed. The Company adopted the provisions of ASU No. 2011-04 effective January 1, 2012. The fair value measurement provisions of ASU No. 2011-04 had no impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” The provisions of ASU No. 2011-05 allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both options, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Under either method, entities are required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. ASU No. 2011-05 also eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity but does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU No. 2011-05 was effective for the Company’s interim reporting period beginning on or after January 1, 2012, with retrospective application required. In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The provisions of ASU No. 2011-12 defer indefinitely the requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented. ASU No. 2011-12, which shares the same effective date as ASU No. 2011-05, does not defer the requirement for entities to present components of comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted the provisions of ASU No. 2011-05 and ASU No. 2011-12 which resulted in a new statement of comprehensive income for the interim period ended March 31, 2012.

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 other operating expenses, 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 Disclosures About Market Risk.

In addition to the effects of inflation described above under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Effects of Inflation,” the following is a description of additional market risks to which we may be exposed.

 

25


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 materially 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 March 31, 2012, we had $357.5 million of loans outstanding under our Senior Secured Credit Facilities, all of which were 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 above the floor would result in net additional annual interest expense on our outstanding borrowings as of March 31, 2012 of approximately $3.6 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

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2012. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures 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 (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) accumulated and communicated to management, including our Chief Executive Officer and Chief 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 first three months of 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management assessed the effectiveness of our internal control over financial reporting as of March 31, 2012, 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 we maintained effective internal control over financial reporting as of March 31, 2012.

 

26


PART II — OTHER INFORMATION

Item 1. Legal Proceedings

As of the filing date of this Quarterly Report, there have been no material developments in the legal proceedings described in Item 3 of our 2011 Annual Report.

Proceedings and claims in the ordinary course of business

We are subject to certain other 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 management’s attention. All litigation settlements are recorded within other expense on our consolidated statements of comprehensive income.

Item 1A. Risk Factors.

Certain risks associated with our business, our indebtedness, and acquisitions we have made or may make are discussed in our 2011 Annual Report under the heading “Risk Factors” 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 three months ended March 31, 2012.

We are subject to numerous regulations that affect the electronic payments industry. Regulation and proposed regulation of the payments industry has increased significantly in recent years. Failure to comply with regulations may have an adverse effect on our business, including the limitation, suspension or termination of services provided to, or by, third parties, and the imposition of penalties, including fines. We are also subject to U.S. financial services regulations, numerous consumer protection laws, escheat regulations, and privacy and information security regulations, among others. Changes to legal rules and regulations, or the interpretation or enforcement thereof, could have a negative financial effect on the Company. We are also subject to the rules of Visa, MasterCard and various other credit and debit networks. Furthermore, we are subject to the Housing Assistance Tax Act of 2008, which requires information returns to be filed by merchant acquiring entities for each calendar year starting in 2011.

Interchange fees, which are typically paid by the acquirer to the issuer in connection with transactions, are subject to increasingly intense legal, regulatory, and legislative scrutiny. In particular, the Dodd-Frank Act, which was signed into law in July 2010, significantly changes the U.S. financial regulatory system, including by regulating and limiting debit card fees charged by certain issuer banks and allowing merchants to offer discounts for different payment methods, as well as other measures. The impact of the Dodd-Frank Act on the Company resulted in reduction of revenue as well as reduction in interchange.

Regulatory actions such as these, even if not directed at us, may require us to make significant efforts to change our products and services and may require that we change how we price our services to customers. Furthermore, regulatory actions may cause changes in business practices by us and other industry participants which could affect how we market, price and distribute our products and services. These regulations may materially and adversely affect the Company’s business or operations, either directly or indirectly.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

27


Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None

Item 6. Exhibits.

See the Exhibit Index following the signature page to this Quarterly Report for a list of exhibits filed or furnished with this report, which Exhibit Index is incorporated herein by reference.

 

28


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.

 

    iPayment Holdings, Inc.
Date: May 11, 2012     By:  

/s/ Carl A. Grimstad

     

Carl A. Grimstad

Chief Executive Officer, President and Director

(Principal Executive Officer)

Date: May 11, 2012     By:  

/s/ Mark C. Monaco

     

Mark C. Monaco

Executive Vice President, Chief Financial Officer,

Treasurer and Director

(Principal Financial and Accounting Officer)

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.

 

    iPayment, Inc.
Date: May 11, 2012     By:  

/s/ Carl A. Grimstad

     

Carl A. Grimstad

Chairman, Chief Executive Officer and President

(Principal Executive Officer)

Date: May 11, 2012     By:  

/s/ Mark C. Monaco

     

Mark C. Monaco

Executive Vice President, Chief Financial Officer,

Treasurer and Director

(Principal Financial and Accounting Officer)

 

29


EXHIBIT INDEX

 

Exhibit

Number

 

Description

  

Incorporated herein by reference

    

Form

  

Date

    3.1   Restated Certificate of Incorporation of iPayment Holdings, Inc.    Registration Statement
on Form S-4
   October 11, 2011
    3.2   Bylaws of iPayment Holdings, Inc.    Registration Statement
on Form S-4
   October 11, 2011
    3.3   Certificate of Incorporation of iPayment, Inc., attached as Exhibit A to the Certificate of Merger of iPayment Merger Co., Inc. into iPayment, Inc.    Registration Statement
on Form S-4
   July 21, 2006
    3.4   Bylaws of Merger Co., as adopted by iPayment, Inc.    Registration Statement
on Form S-4
   July 21, 2006
  31.1*   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).      
  31.2*   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).      
  32.1**   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).      
  32.2**   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).      
101.INS†   XBRL Instance Document      
101.SCH†   XBRL Taxonomy Extension Schema Document      
101.CAL†   XBRL Taxonomy Extension Calculation Linkbase Document      
101.DEF†   XBRL Taxonomy Extension Definition Linkbase Document      
101.LAB†   XBRL Taxonomy Extension Label Linkbase Document      
101.PRE†   XBRL Taxonomy Extension Presentation Linkbase Document      

 

* Filed herewith.
** Furnished herewith.

XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act, is deemed not filed for purposes of section 18 of the Exchange Act, and otherwise is not subject to liability under these sections.

 

30