Attached files
| file | filename |
|---|---|
| EX-31.1 - EXHIBIT - iPayment, Inc. | exhibit311093014.htm |
| EX-32.2 - EXHIBIT - iPayment, Inc. | exhibit322093014.htm |
| EX-32.1 - EXHIBIT - iPayment, Inc. | exhibit321093014.htm |
| EX-31.2 - EXHIBIT - iPayment, Inc. | exhibit312093014.htm |
| EXCEL - IDEA: XBRL DOCUMENT - iPayment, Inc. | Financial_Report.xls |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014
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
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 þ No ¨ | |||
iPayment, Inc. | Yes þ 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 þ No ¨ | |||
iPayment, Inc. | Yes þ 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 þ | Smaller reporting company ¨ | ||||
iPayment, Inc. | Large accelerated filer ¨ | Accelerated filer ¨ | Non-accelerated filer þ | 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 þ | |||
iPayment, Inc. | Yes ¨ No þ | |||
Title of each class | Shares Outstanding at November 14, 2014 | |
iPayment Holdings, Inc. (Common stock, $0.01 par value) | 4,875,000 | |
iPayment, Inc. (Common stock, $0.01 par value) | 100 | |
Page | ||
PART I—FINANCIAL INFORMATION | ||
Item 1. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
PART II—OTHER INFORMATION | ||
Item 1. | ||
Item 1A. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item 5. | ||
Item 6. | ||
3
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.” 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, 2013, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 28, 2014 (our “2013 Annual 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.
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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
iPAYMENT, INC. | iPAYMENT HOLDINGS, INC. | ||||||||||||||
September 30, 2014 | December 31, 2013 | September 30, 2014 | December 31, 2013 | ||||||||||||
(Dollars in thousands) | |||||||||||||||
(Unaudited) | (Audited) | (Unaudited) | (Audited) | ||||||||||||
ASSETS | |||||||||||||||
Current assets: | |||||||||||||||
Cash and cash equivalents | $ | 1,041 | $ | 8,005 | $ | 1,041 | $ | 8,005 | |||||||
Accounts receivable, net of allowance for doubtful accounts of $556 and $453 at September 30, 2014, and December 31, 2013, respectively | 22,163 | 27,495 | 22,163 | 27,495 | |||||||||||
Income taxes receivable, net | — | — | 2,211 | 2,646 | |||||||||||
Prepaid expenses and other current assets | 4,951 | 5,050 | 3,136 | 4,472 | |||||||||||
Total current assets | 28,155 | 40,550 | 28,551 | 42,618 | |||||||||||
Restricted cash | 803 | 825 | 803 | 825 | |||||||||||
Property and equipment, net | 6,939 | 6,902 | 6,939 | 6,902 | |||||||||||
Merchant portfolio and other intangible assets, net of accumulated amortization of $169,248 and $143,533 at September 30, 2014, and December 31, 2013, respectively | 163,475 | 184,799 | 163,475 | 184,799 | |||||||||||
Goodwill | 684,241 | 678,704 | 685,041 | 679,504 | |||||||||||
Investment in 15.00%/15.00% Holdings notes, held to maturity | 26,682 | 24,661 | — | — | |||||||||||
Other assets, net | 21,641 | 24,161 | 23,506 | 26,252 | |||||||||||
Total assets | $ | 931,936 | $ | 960,602 | $ | 908,315 | $ | 940,900 | |||||||
LIABILITIES and STOCKHOLDERS' EQUITY | |||||||||||||||
Current liabilities: | |||||||||||||||
Accounts payable | $ | 5,806 | $ | 4,187 | $ | 5,806 | $ | 4,187 | |||||||
Income taxes payable, net | 6,427 | 5,992 | — | — | |||||||||||
Accrued interest | 17,264 | 7,028 | 25,697 | 9,711 | |||||||||||
Accrued liabilities and other | 19,891 | 24,078 | 19,891 | 24,078 | |||||||||||
Deferred tax liabilities | 2,839 | 2,839 | 2,185 | 2,185 | |||||||||||
Total current liabilities | 52,227 | 44,124 | 53,579 | 40,161 | |||||||||||
Deferred tax liabilities, net | 25,731 | 24,627 | 26,386 | 25,282 | |||||||||||
Long-term debt | 768,091 | 785,357 | 899,741 | 910,893 | |||||||||||
Other liabilities | 3,738 | 3,062 | 3,738 | 3,062 | |||||||||||
Total liabilities | 849,787 | 857,170 | 983,444 | 979,398 | |||||||||||
Commitments and contingencies (Note 9) | — | — | — | — | |||||||||||
Equity | |||||||||||||||
Common stock of iPayment, Inc., $0.01 par value; 1,000 shares authorized, 100 shares issued and outstanding at September 30, 2014, and December 31, 2013 | 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 September 30, 2014, and December 31, 2013 | — | — | 45,268 | 45,268 | |||||||||||
Additional paid-in capital | 9,131 | 8,032 | 9,131 | 8,032 | |||||||||||
Accumulated deficit | (92,746 | ) | (70,364 | ) | (129,528 | ) | (91,798 | ) | |||||||
Total stockholders' equity (deficit) | 82,149 | 103,432 | (75,129 | ) | (38,498 | ) | |||||||||
Total liabilities and stockholders' equity | $ | 931,936 | $ | 960,602 | $ | 908,315 | $ | 940,900 | |||||||
5
iPAYMENT, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(Dollars in thousands) | 2014 | 2013 | 2014 | 2013 | |||||||||||
Revenues | $ | 178,641 | $ | 167,777 | $ | 519,623 | $ | 497,667 | |||||||
Operating expenses: | |||||||||||||||
Interchange | 99,648 | 89,952 | 282,989 | 262,396 | |||||||||||
Other costs of services | 61,436 | 60,153 | 183,327 | 181,918 | |||||||||||
Selling, general and administrative | 6,816 | 6,071 | 20,053 | 25,793 | |||||||||||
Embezzlement recoveries | (118 | ) | (126 | ) | (390 | ) | (2,903 | ) | |||||||
Total operating expenses | 167,782 | 156,050 | 485,979 | 467,204 | |||||||||||
Income from operations | 10,859 | 11,727 | 33,644 | 30,463 | |||||||||||
Other expense: | |||||||||||||||
Interest expense, net | 16,511 | 16,411 | 49,458 | 47,265 | |||||||||||
Other expense (income), net | 13 | (154 | ) | (55 | ) | 2,572 | |||||||||
Loss before income taxes | (5,665 | ) | (4,530 | ) | (15,759 | ) | (19,374 | ) | |||||||
Income tax provision (benefit) | (1,015 | ) | 2,454 | 747 | 12,860 | ||||||||||
Net and comprehensive loss | $ | (4,650 | ) | $ | (6,984 | ) | $ | (16,506 | ) | $ | (32,234 | ) | |||
See accompanying notes to consolidated financial statements.
6
iPAYMENT HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(Dollars in thousands) | 2014 | 2013 | 2014 | 2013 | |||||||||||
Revenues | $ | 178,641 | $ | 167,777 | $ | 519,623 | $ | 497,667 | |||||||
Operating expenses: | |||||||||||||||
Interchange | 99,648 | 89,952 | 282,989 | 262,396 | |||||||||||
Other costs of services | 61,436 | 60,184 | 183,327 | 181,995 | |||||||||||
Selling, general and administrative | 6,854 | 6,090 | 20,175 | 25,840 | |||||||||||
Embezzlement recoveries | (118 | ) | (126 | ) | (390 | ) | (2,903 | ) | |||||||
Total operating expenses | 167,820 | 156,100 | 486,101 | 467,328 | |||||||||||
Income from operations | 10,821 | 11,677 | 33,522 | 30,339 | |||||||||||
Other expense: | |||||||||||||||
Interest expense, net | 23,672 | 22,527 | 70,560 | 66,579 | |||||||||||
Other expense (income), net | 13 | (154 | ) | (55 | ) | 2,572 | |||||||||
Loss before income taxes | (12,864 | ) | (10,696 | ) | (36,983 | ) | (38,812 | ) | |||||||
Income tax provision (benefit) | (1,015 | ) | 1,833 | 747 | 12,809 | ||||||||||
Net and comprehensive loss | $ | (11,849 | ) | $ | (12,529 | ) | $ | (37,730 | ) | $ | (51,621 | ) | |||
See accompanying notes to consolidated financial statements.
7
iPAYMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30, | ||||||||
(Dollars in thousands) | 2014 | 2013 | ||||||
Cash flows from operating activities | ||||||||
Net loss | $ | (16,506 | ) | $ | (32,234 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities | ||||||||
Depreciation and amortization | 29,203 | 36,363 | ||||||
Share-based compensation | 1,099 | 5,238 | ||||||
Noncash interest and other expense | 2,260 | (4,331 | ) | |||||
Loss on disposal of property and equipment | 317 | 603 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 5,332 | 9,669 | ||||||
Prepaid expenses and other current assets | 189 | (5,634 | ) | |||||
Other assets | (1,912 | ) | 176 | |||||
Accounts payable and income taxes payable | 2,054 | 3,032 | ||||||
Accrued interest | 10,236 | 10,498 | ||||||
Deferred tax liabilities, net | 1,104 | 10,308 | ||||||
Accrued liabilities and other | (3,511 | ) | (3,925 | ) | ||||
Net cash provided by operating activities | 29,865 | 29,763 | ||||||
Cash flows from investing activities | ||||||||
Change in restricted cash | 22 | 3 | ||||||
Expenditures for property and equipment | (3,148 | ) | (2,258 | ) | ||||
Acquisitions of businesses and portfolios | (8,022 | ) | (5,582 | ) | ||||
Payments on notes receivable | 217 | — | ||||||
Payments for prepaid residual expenses | (2,522 | ) | (4,598 | ) | ||||
Net cash used in investing activities | (13,453 | ) | (12,435 | ) | ||||
Cash flows from financing activities | ||||||||
Net repayments on line of credit | (17,500 | ) | (12,000 | ) | ||||
Repayments of debt | — | (5,000 | ) | |||||
Dividends paid to parent company | (5,876 | ) | (5,235 | ) | ||||
Net cash used in financing activities | (23,376 | ) | (22,235 | ) | ||||
Net decrease in cash and cash equivalents | (6,964 | ) | (4,907 | ) | ||||
Cash and cash equivalents, beginning of period | 8,005 | 6,572 | ||||||
Cash and cash equivalents, end of period | $ | 1,041 | $ | 1,665 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid (refunds received) during the period for income taxes, net | $ | (1,506 | ) | $ | 498 | |||
Cash paid during the period for interest | $ | 40,060 | $ | 43,036 | ||||
See accompanying notes to consolidated financial statements.
8
iPAYMENT HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30, | ||||||||
(Dollars in thousands) | 2014 | 2013 | ||||||
Cash flows from operating activities | ||||||||
Net loss | $ | (37,730 | ) | $ | (51,621 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities | ||||||||
Depreciation and amortization | 29,203 | 36,363 | ||||||
Share-based compensation | 1,099 | 5,238 | ||||||
Noncash interest and other expense | 10,621 | 2,126 | ||||||
Loss on disposal of property and equipment | 317 | 603 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 5,332 | 9,669 | ||||||
Prepaid expenses and other current assets | 1,426 | (4,434 | ) | |||||
Other assets | (1,912 | ) | 1,068 | |||||
Accounts payable and income taxes receivable | 2,054 | 2,409 | ||||||
Accrued interest | 15,986 | 16,154 | ||||||
Deferred tax liabilities, net | 1,104 | 10,878 | ||||||
Accrued liabilities and other | (3,511 | ) | (3,925 | ) | ||||
Net cash provided by operating activities | 23,989 | 24,528 | ||||||
Cash flows from investing activities | ||||||||
Change in restricted cash | 22 | 3 | ||||||
Expenditures for property and equipment | (3,148 | ) | (2,258 | ) | ||||
Acquisitions of businesses and portfolios | (8,022 | ) | (5,582 | ) | ||||
Payments on notes receivable | 217 | — | ||||||
Payments for prepaid residual expenses | (2,522 | ) | (4,598 | ) | ||||
Net cash used in investing activities | (13,453 | ) | (12,435 | ) | ||||
Cash flows from financing activities | ||||||||
Net repayments on line of credit | (17,500 | ) | (12,000 | ) | ||||
Repayments of debt | — | (5,000 | ) | |||||
Net cash used in financing activities | (17,500 | ) | (17,000 | ) | ||||
Net decrease in cash and cash equivalents | (6,964 | ) | (4,907 | ) | ||||
Cash and cash equivalents, beginning of period | 8,005 | 6,572 | ||||||
Cash and cash equivalents, end of period | $ | 1,041 | $ | 1,665 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Cash paid (refunds received) during the period for income taxes, net | $ | (1,506 | ) | $ | 498 | |||
Cash paid during the period for interest | $ | 45,814 | $ | 43,036 | ||||
See accompanying notes to consolidated financial statements.
9
Notes to Consolidated Financial Statements
(Unaudited)
(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 issued and outstanding capital stock of Holdings is owned by Carl A. Grimstad, iPayment's Chairman and Chief Executive Officer, Harold H. Stream, III, and certain entities and family trusts affiliated with Mr. Grimstad or Mr. Stream.
As used in these notes to the consolidated financial statements, 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.
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 card-not-present transactions, such as those conducted over the phone or through the internet. We market and sell our services to merchants throughout the United States through various channels, including a network of Independent Sales Groups, or "ISGs", which are non-employee, external sales organizations with which we have contractual relationships, and directly to merchants through our employee sales force, partnerships with various associations and agents banks, through the use of electronic media, telemarketing and other programs 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 and MasterCard associations and to settle transactions with merchants. We perform core functions for small merchants such as application processing, underwriting, account set-up, risk management, fraud detection, merchant assistance and support, equipment deployment, and chargeback services primarily from our operating facility in Westlake Village, California.
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 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.
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.
Revenue and Cost Recognition
Substantially all of our revenues are generated from fees charged to merchants for card-based payment processing services. We typically charge these merchants a rate primarily based upon each merchant’s charge volume and risk profile as well as certain fixed charges for various products and services on a monthly or annual basis. Our fees principally consist of discount fees, which are a percentage of the dollar amount of each transaction. We recognize discount fees 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.
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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 ultimate responsibility for the merchant, as evidenced by our liability for merchant losses or credit risk, or portability with respect to such 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 merchant contracts where we do not have liability for merchant losses or rights of portability, such as certain portfolios we acquired from First Data Merchant Services ("FDMS") and certain of our other portfolios and merchant contracts, are reported net of interchange, as required by ASC Topic 605.
Other Costs of Services
Other costs of services include costs directly attributable to our provision of payment processing and related services to our merchants. The primary components of other costs of services includes residual payments to ISGs, which are commissions we pay to our ISGs based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which are a percentage of the charge volume we generate from Visa and MasterCard. In addition, other costs of services include telecommunications costs, personnel costs, occupancy costs, losses due to merchant defaults, other miscellaneous merchant supplies and services expenses, bank sponsorship costs and other third-party processing costs. Other costs of services also include depreciation expense, which is recognized generally on a straight-line basis over the estimated useful life of the assets, and amortization expense, the substantial majority of which is recognized using an accelerated method over a 15-year period.
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 from third parties, buyouts of residual payment obligations related to our merchant portfolios, or residual buyouts or acquisitions of any business where we allocated a portion of the purchase price to such business' 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 2.2% 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 portfolios. All other intangible assets are amortized using the straight-line method over an estimated life of three to seven years. For the three and nine months ended September 30, 2014, amortization expense related to our merchant portfolios and other intangible assets was $8.4 million and $27.1 million, respectively. For the three and nine months ended September 30, 2013, amortization expense related to our merchant portfolios and other intangible assets was $10.7 million and $34.5 million, respectively.
In addition, we have implemented both quarterly and annual procedures to determine whether a significant change in the trend of the current attrition rates being used has occurred on a portfolio-by-portfolio basis. In reviewing the current attrition rate trends, we consider relevant benchmarks such as 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 treated as a change in estimate and accounted for prospectively. There were no related adjustments to amortization expense for the three and nine months ended September 30, 2014 and 2013.
Our intangible assets are amortized over their estimated lives, except our trade name intangibles, which were determined to have indefinite lives as there are no legal, regulatory, contractual, economic or other factors that limit the useful life to us of such intangible assets, and we have no plans to cease using such names. We believe our trade names have an inherent value due to brand strength.
We engage, on a periodic 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
11
being evaluated and their fair value, calculated as the sum of the expected cash flows discounted at a market rate, represents the impairment loss.
We performed a qualitative assessment of goodwill and trade name as of May 31, 2014. We determined based on relevant events and circumstances in our qualitative assessment that it is more likely than not that the fair value of the reporting unit is at least equal to its carrying value; therefore, the goodwill of the reporting unit is not impaired and no further testing was performed.
During the quarter ended June 30, 2014, the Company voluntarily changed the date of its annual goodwill and indefinite-lived intangible assets impairment testing from May 31 to October 1. This voluntary change is preferable under the circumstances as it provides the Company with appropriate time to complete its annual goodwill and indefinite-lived intangible asset impairment testing in advance of its year-end reporting and results in better alignment with the Company’s strategic planning and forecasting process. The voluntary change in accounting principle related to the annual testing date will not delay, accelerate or avoid an impairment charge. This change is not applied retrospectively as it is impracticable to do so because retrospective application would require application of significant estimates and assumptions with the use of hindsight. Accordingly, the change will be applied prospectively.
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 September 30, 2014 approximate fair value. Due to the short maturities of the cash and cash equivalents and accounts receivable, carrying amounts approximate their respective fair values. At September 30, 2014, the carrying value of the term facility under the Senior Secured Credit Facilities, net of a discount of $0.9 million, was $346.6 million and the carrying value of the revolving facility was $21.5 million. We estimate the fair value of the term facility to be approximately $344.9 million, considering executed trades occurring around September 30, 2014, and we believe that the fair value of the revolver facility approximates carrying value due to its short maturities. The carrying value of the 10.25% Notes was $400.0 million as of September 30, 2014. We estimate their fair value to be approximately $355.0 million based on consideration of executed trades occurring around September 30, 2014. The carrying value of the 15.00%/15.00% Notes, net of discount of $0.6 million was $131.7 million as of September 30, 2014. We estimate their fair value to be approximately $43.7 million, considering executed trades occurring around September 30, 2014. The fair value of the Senior Secured Credit Facilities, the 10.25% Notes, 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 there can be no certainty that the creditors under our borrowing arrangements would be willing to settle these instruments with us at the estimated fair values indicated herein.
Common Stock
iPayment and Holdings had 100 and 4,875,000 shares of common stock, respectively, issued and outstanding at September 30, 2014. 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 Holdings common stock or for the Warrants. No Warrants were exercised as of September 30, 2014.
Stock-Based Compensation
We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date estimated fair value of the award. That cost is to be recognized over the period during which the employee is required to provide service in exchange for the award, which generally equals the vesting period. For the three and nine months ended September 30, 2014 we recognized $0.4 million and $1.1 million, respectively, in expense related to vested service units. For
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the three and nine months ended September 30, 2013 we recognized $0.5 million and $5.2 million, respectively, in expense related to vested service units. For performance stock units, we re-assess the probability of vesting at each reporting period and if the target is not attained, we do not recognize any expense. The performance condition is not considered in determining the grant date fair value. For the three and nine months ended September 30, 2014 and 2013, we did not recognize any expense for performance-based phantom stock units.
(2) Restatement of Consolidated Financial Statements
In August 2012, as disclosed in the Company's Current Reports on Form 8-K filed on September 12, 2012 and November 5, 2012 and in the Company's amended 2011 Annual Report on Form 10-K/A filed on January 29, 2013, the Company and Holdings were presented with accusations from one of the Company's employees that certain of the Company's employees and outside contractors had engaged in financial misconduct. Following an initial inquiry into these accusations by the Company, the Board of Directors of the Company and management conducted an internal investigation of the alleged misconduct. During the course of the Company's investigation, certain executives of the Company and Holdings were terminated or resigned.
The Company's internal investigation revealed financial misconduct by certain former officers and employees of the Company and certain of its outside contractors. Such financial misconduct occurred in three principal areas: (i) creation of false obligations to make residual and other payments (which resulted in the Company making such payments in respect of merchant accounts that were not subject to legitimate payment obligations); (ii) overstatement of certain vendor invoices, principally in the information technology area; and (iii) falsification of certain employee expense reimbursements and other payments. Factors contributing to the ability of the individuals to engage in the misconduct were: (i) the failure to maintain an adequate control environment that set a proper ethical culture and (ii) the posting of manual journal entries without sufficient supporting documentation or adequate review and approval. The Company believes that the foregoing activities, which generally occurred over a period from the third quarter of 2008 through September 2012, involved a total loss of funds to the Company of approximately $12.1 million.
Based on the results of the Company's internal investigation, and the financial impact thereof on prior financial periods, on November 1, 2012, the Boards of Directors of the Company and Holdings determined that the Company's financial statements (i) for the fiscal years ended December 31, 2009, 2010, and 2011, included in the Company's Annual Reports on Form 10-K for the years then ended and Ernst & Young LLP's reports thereon, (ii) for the interim periods within such fiscal years included in the Company's Quarterly Reports on Form 10-Q, and (iii) for the quarters ended March 31, 2012, and June 30, 2012, included in the Company's Quarterly Reports on Form 10-Q (the "Affected Financial Statements"), should no longer be relied upon. As a result, the Company restated the Affected Financial Statements to reflect the effect of such financial misconduct on the Affected Financial Statements. On January 29, 2013, the Company filed Amendment No. 1 to Form 10-K for the year ended December 31, 2011 and on January 31, 2013, the Company filed Amendment No. 1 to Form 10-Q for the period ended March 31, 2012 and Amendment No. 1 to Form 10-Q for the period ended June 30, 2012 with such restated financial statements.
As disclosed in the Company's 2013 Annual Report, the Company has entered into cooperation and restitution and/or settlement agreements with all the material participants in the misconduct. Under the terms of the various agreements, the participants in the misconduct have agreed to certain restrictive covenants and, collectively, to repay to the Company $8.4 million. Of this amount, the Company had collected $5.6 million as of September 30, 2014, including $0.4 million during the nine months ended September 30, 2014. Of the remaining $2.8 million, substantially all of which is secured by liens on real property owned by various participants in the misconduct, approximately $0.9 million is scheduled to be repaid to the Company by no later than July 1, 2016. There can be no assurance, however, that we will be able to recover all or a material portion of the remaining amounts described above. In addition, on May 1, 2013, the Company recovered $3 million under its crime insurance policy in connection with the misconduct described above.
(3) Acquisitions
On July 14, 2014 the Company acquired 100% of the capital stock of a mobile application and digital loyalty developer for total consideration of $5.0 million. We have preliminarily determined that this acquisition resulted in increases to goodwill of $4.5 million, tradename of $0.1 million, and intellectual property of $0.4 million.
There were no material acquisitions of businesses or other assets during the three months ended September 30, 2013.
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(4) Other Intangibles
Payments for Prepaid Residual Expenses
For the nine months ended September 30, 2014 and the nine months ended September 30, 2013, we made payments totaling $2.5 million and $4.6 million, respectively, to several ISGs in exchange for contract modifications which, among other provisions, lowered our obligations for future payments of residuals to them. These payments were assigned to intangible assets in the accompanying consolidated balance sheets and are amortized over their expected useful lives.
(5) Long-Term Debt
Our long-term debt is comprised of the following:
iPAYMENT, INC. | iPAYMENT HOLDINGS, INC. | ||||||||||||||
(Dollars in thousands) | As of September 30, 2014 | As of December 31, 2013 | As of September 30, 2014 | As of December 31, 2013 | |||||||||||
(unaudited) | (audited) | (unaudited) | (audited) | ||||||||||||
Senior Secured Credit Facilities | |||||||||||||||
Term facility | $ | 347,500 | $ | 347,500 | $ | 347,500 | $ | 347,500 | |||||||
Revolving facility | 21,500 | 39,000 | 21,500 | 39,000 | |||||||||||
Discount on Senior Secured Credit Facilities - Term Facility | (909 | ) | (1,143 | ) | (909 | ) | (1,143 | ) | |||||||
10.25% Notes | 400,000 | 400,000 | 400,000 | 400,000 | |||||||||||
15.00%/15.00% Notes | — | — | 132,288 | 126,289 | |||||||||||
Discount on 15.00%/15.00% Notes, net of amortization of $529 as of 9/30/14 and $412 as of 12/31/2013 | — | — | (638 | ) | (753 | ) | |||||||||
768,091 | 785,357 | 899,741 | 910,893 | ||||||||||||
Less: Current portion of long-term debt | — | — | — | — | |||||||||||
Total long-term debt | $ | 768,091 | $ | 785,357 | $ | 899,741 | $ | 910,893 | |||||||
The terms of our long-term debt contain various financial and non-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 thereunder immediately due and payable. We currently do not have available cash or other similar liquid resources available to repay all of our debt obligations if they were to become immediately due and payable. As of September 30, 2014, our Senior Secured Leverage Ratio, as defined in the Senior Secured Credit Facilities, was 3.60 to 1.00 compared to the allowed maximum of 3.75 to 1.00. As of September 30, 2014, our Consolidated Interest Coverage Ratio, as defined in the Senior Secured Credit Facilities, was 1.33 to 1.00 compared to the allowed minimum of 1.25 to 1.00.
During the first nine months of 2014, we made net repayments of $17.5 million under the revolving facility of the Senior Secured Credit Facilities.
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.
Senior Secured Credit Facilities
iPayment 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 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, 5 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. On July 20, 2012, concurrent with iPayment's purchase of approximately $23.9 million of the outstanding principal amount of the 15.00%/15.00% Notes from a third party for $20.0 million in a privately negotiated transaction, we requested and obtained a
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$20.0 million increase in the aggregate revolving facility commitment. The aggregate commitment of the lenders under the revolving facility following such increase was $95.0 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 September 30, 2014, iPayment had approximately $346.6 million of term loans outstanding (net of discount of $0.9 million) at a weighted average interest rate of 6.75% and $21.5 million of borrowings under its revolving facility at a weighted average interest rate of 5.49%.
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 financial 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.
On July 25, 2013 (the "Amendment Date"), iPayment, Inc. entered into an amendment (the "Amendment") to the Credit Agreement. Pursuant to the Amendment, the applicable margin for the revolving facility was amended as follows: (i) if the consolidated leverage ratio as at the last test date is less than 4.0:1.0, 3.75% (for Eurodollar rate loans) or 2.75% (for base rate loans), (ii) if the consolidated leverage ratio as at the last test date is greater than or equal to 4.0:1.0 but less than 4.5:1.0, 4.25% (for Eurodollar rate loans) or 3.25% (for base rate loans), (iii) if the consolidated leverage ratio as at the last test date is greater than or equal to 4.5:1.0 but less than 5.0:1.0, 4.75% (for Eurodollar rate loans) or 3.75% (for base rate loans), and (iv) if the consolidated leverage ratio as at the last test date is greater than or equal to 5.0:1.0, 5.25% (for Eurodollar rate loans) or 4.25% (for base rate loans). The applicable margin for the term facility was increased to 5.25% (for Eurodollar rate loans) and 4.25% (for base rate loans).
Pursuant to the Amendment, the financial covenants set forth in the Credit Agreement were amended as follows: (i) the minimum Consolidated Interest Coverage Ratio is required to be not less than (1) 1.25x as of the end of each fiscal quarter through December 31, 2015, (2) 1.30x for each fiscal quarter ending between January 1, 2016 and December 31, 2016, and (3) 1.35x for each fiscal quarter ending thereafter and (ii) the maximum Senior Secured Leverage Ratio is required to be less than (1) 4.00x as of the end of each fiscal quarter through March 31, 2014, (2) 3.75x as of the end of each fiscal quarter ending between April 1, 2014 and March 31, 2015, (3) 3.50x as of the end of each fiscal quarter ending between April 1, 2015 and March 31, 2016, (4) 3.25x as of the end of each fiscal quarter ending between April 1, 2016 and March 31, 2017 and (5) 3.00x for each fiscal quarter ending thereafter.
Pursuant to the Amendment, certain voluntary prepayments made in connection with any modification of the Credit Agreement that reduces the applicable margin with respect to any Term Loans, or in connection with any refinancing of any Term Loans in whole or in part with proceeds of Indebtedness having lower applicable margins or applicable total yield than the applicable margin or applicable total yield for the Term Loans prior to the first year anniversary of the Amendment Date will be subject to a 1.00% prepayment penalty. In addition, the Amendment included certain other changes to the restricted payments and investments negative covenants in the Credit Agreement.
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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.
The 10.25% Notes are fully and unconditionally guaranteed by all of iPayment’s subsidiaries. However, the guarantees of iPayment’s subsidiaries may be released and iPayment’s future subsidiaries may not be required to guarantee the 10.25% Notes upon occurrence of any of the following events, all pursuant to the provisions of the 10.25% Notes Indenture: (i) any direct or indirect sale or other disposition of any interest or participation, such as corporate stock, in a guarantor subsidiary, following which such guarantor subsidiary is no longer considered a restricted subsidiary of the Company; (ii) the designation of a guarantor subsidiary as an unrestricted subsidiary by the Company; (iii) the release, discharge or termination of the guarantee which resulted in the creation of the notes’ guarantees, as defined by the 10.25% Notes Indenture; and (iv) the legal defeasance of the 10.25% Notes or satisfaction and discharge of the 10.25% Notes Indenture.
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 accrues from and includes the issue date of the 15.00%/15.00% Notes. 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 solely 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.
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 additional PIK interest. For the quarter ended September 30, 2014 we determined that our leverage ratio was 8.80 to 1.00; accordingly, we have recognized $1.2 million of additional 2.00% PIK interest expense during the nine months ended September 30, 2014 with respect to the interest period from May 15, 2014 to November 15, 2014. We are obligated to pay additional 2% PIK interest until the next interest payment date on which the Company's leverage ratio is equal to, or less than, 7.25 to 1.00 as of the most recent quarter end prior to such subsequent interest payment date. 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.
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.
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The 125,000 Units issued by Holdings on May 6, 2011, consist 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 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 were $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.
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.
On July 20, 2012, iPayment purchased approximately $23.9 million principal amount of the 15.00%/15.00% Notes from a third party for $20.0 million in a privately negotiated transaction. The purchase of such 15.00%/15.00% Notes and the expenses associated therewith were funded with cash on hand and borrowings under the revolving facility under the Senior Secured Credit Facilities and are carried on our balance sheet at face value as they are considered held to maturity investments. As a result of the purchase of the 15.00%/15.00% Notes, Holdings recognized a gain of $3.3 million, net of the write-off of unamortized debt issuance costs of $0.6 million. Concurrent with the purchase of such 15.00%/15.00% Notes, we requested and obtained a $20.0 million increase in the aggregate revolving facility commitment. The aggregate commitment of the lenders under the revolving facility following such increase was $95.0 million.
iPayment and its consolidated subsidiaries had net capitalized debt issuance costs related to the Senior Secured Credit Facilities of $7.9 million, 10.25% Notes of $6.5 million, and the purchase of Holdings 15.00%/15.00% Notes of $0.5 million, as of September 30, 2014. Holdings and its consolidated subsidiaries had net capitalized debt issuance costs related to the 15.00%/15.00% Notes of $1.9 million and a debt discount related to the Warrants of $0.6 million as of September 30, 2014.
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, the 10.25% Notes and the purchase of Holdings 15.00%/15.00% Notes were $0.7 million, $0.4 million and $0.1 million, respectively, for the three months ended September 30, 2014 and $2.1 million, $1.1 million and $0.3 million, respectively, for the nine months ended September 30, 2014. Amortization expense of Holdings and its consolidated subsidiaries related to the debt issuance costs for the 15.00%/15.00% Notes was $0.1 million and $0.2 million, respectively, for the three and nine months ended September 30, 2014.
Exchange Offers and Consent Solicitations
On November 7, 2014, the Companies launched exchange offers (the "Exchange Offers") and related consent solicitations (the "Consent Solicitations") to holders of iPayment’s outstanding 10.25% Senior Notes due 2018 (the "Opco Notes") and holders of Holding’s outstanding 15.00%/15.00% Senior Notes due 2018 (the "Holdco Notes" and, together with the Opco Notes, the "Existing Notes") pursuant to an Offers to Exchange and Consent Solicitation Statement, dated as of November 7, 2014 (as it may be amended from time to time, the "Statement") in accordance with the terms of the previously announced Exchange Offer Support Agreement (as it may be amended from time to time, the "Support Agreement") described in the Companies’ Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2014. For further information on
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the exchange offers and their anticipated impact please see Note 12 "Subsequent Events" to our consolidated financial statements.
(6) Segment Information and Geographical Information
We consider our business activities to be in a single reporting segment. For the years ended December 31, 2013, and 2012, we derived greater than 90% and 88%, respectively, of our revenue and results of operations from processing revenues from card-based payments. Substantially all of our revenues are generated in the United States.
(7) Supplemental Guarantor Financial Information
On May 6, 2011 the Company issued the 10.25% Notes pursuant to the 10.25% Notes indenture. The 10.25% Notes mature on May 15, 2018. The 10.25% Notes are fully and unconditionally guaranteed by all of iPayment's subsidiaries. However, the guarantees of iPayment's subsidiaries may be released and iPayment's future subsidiaries may not be required to guarantee the 10.25% Notes upon occurrence of any of the following events, all pursuant to the provisions of the 10.25% Notes Indenture (i) any direct or indirect sale or other disposition of any interest or participation, such as corporate stock, in a guarantor subsidiary, following which such guarantor subsidiary is no longer considered a restricted subsidiary of the Company; (ii) the designation of a guarantor subsidiary as an unrestricted subsidiary by the Company; (iii) the release, discharge or termination of the guarantee which resulted in the creation of the notes' guarantees as defined by the 10.25% Notes Indenture; and (iv) the legal defeasance of the 10.25% Notes or satisfaction and discharge of the 10.25% Notes Indenture.
The following supplemental financial information sets forth for the Company and its guarantor and non-guarantor subsidiaries the condensed consolidating balance sheets as of September 30, 2014 and December 31, 2013 and the related consolidated statements of comprehensive income (loss) for the three and nine months ended September 30, 2014 and 2013 and the consolidated statements of cash flows for the nine months ended September 30, 2014 and 2013.
Effective December 31, 2013 a number of subsidiaries which were guarantors of the 10.25% Notes were merged into iPayment, Inc. The effects of these mergers are reflected in the “iPayment, Inc.” column of the following condensed consolidating balance sheets as of September 30, 2014 and December 31, 2013, and consolidated statements of comprehensive income (loss) for the three and nine months ended September 30, 2014, and the consolidated statements of cash flows for the nine months ended September 30, 2014. The activities of the merged entities are reflected in the "Guarantor Subsidiaries" column of the following consolidated statements of comprehensive income (loss) for the three and nine months ended September 30, 2013 and cash flows for the nine months ended September 30, 2013.
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iPAYMENT, INC. | ||||||||||||||||||||
CONSOLIDATED BALANCE SHEETS | ||||||||||||||||||||
September 30, 2014 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
ASSETS | ||||||||||||||||||||
Current Assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 1,041 | $ | — | $ | — | $ | — | $ | 1,041 | ||||||||||
Accounts receivable, net | 20,505 | 1,658 | — | — | 22,163 | |||||||||||||||
Prepaid expenses and other current assets | 4,053 | 898 | — | — | 4,951 | |||||||||||||||
Total current assets | 25,599 | 2,556 | — | — | 28,155 | |||||||||||||||
Restricted cash | 803 | — | — | — | 803 | |||||||||||||||
Property and equipment, net | 5,508 | 1,431 | — | — | 6,939 | |||||||||||||||
Intercompany receivable | — | 48,255 | — | (48,255 | ) | — | ||||||||||||||
Merchant portfolios and other intangible assets, net | 147,314 | 16,161 | — | — | 163,475 | |||||||||||||||
Goodwill | 632,688 | 51,553 | — | — | 684,241 | |||||||||||||||
Investment in subsidiaries | 113,705 | — | — | (113,705 | ) | — | ||||||||||||||
Investment in 15.00%/15.00% Notes | 26,682 | — | — | — | 26,682 | |||||||||||||||
Other assets, net | 21,620 | 21 | — | — | 21,641 | |||||||||||||||
Total assets | $ | 973,919 | $ | 119,977 | $ | — | $ | (161,960 | ) | $ | 931,936 | |||||||||
LIABILITIES AND EQUITY | ||||||||||||||||||||
Current Liabilities: | ||||||||||||||||||||
Accounts payable | $ | 4,619 | $ | 1,187 | $ | — | $ | — | $ | 5,806 | ||||||||||
Income taxes payable, net | 6,427 | — | — | — | 6,427 | |||||||||||||||
Accrued interest | 17,264 | — | — | — | 17,264 | |||||||||||||||
Accrued liabilities and other | 18,454 | 1,437 | — | — | 19,891 | |||||||||||||||
Deferred tax liabilities, net | 2,055 | 784 | — | — | 2,839 | |||||||||||||||
Total current liabilities | 48,819 | 3,408 | — | — | 52,227 | |||||||||||||||
Deferred tax liabilities, net | 23,367 | 2,364 | — | — | 25,731 | |||||||||||||||
Intercompany payable | 48,255 | — | — | (48,255 | ) | — | ||||||||||||||
Long-term debt | 768,091 | — | — | — | 768,091 | |||||||||||||||
Other liabilities | 3,238 | 500 | — | — | 3,738 | |||||||||||||||
Total stockholders' equity | 82,149 | 113,705 | — | (113,705 | ) | 82,149 | ||||||||||||||
Total liabilities and equity | $ | 973,919 | $ | 119,977 | $ | — | $ | (161,960 | ) | $ | 931,936 | |||||||||
19
iPAYMENT, INC. | ||||||||||||||||||||
CONSOLIDATED BALANCE SHEETS | ||||||||||||||||||||
December 31, 2013 | ||||||||||||||||||||
(Audited) | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
ASSETS | ||||||||||||||||||||
Current Assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | 8,005 | $ | — | $ | — | $ | — | $ | 8,005 | ||||||||||
Accounts receivable, net | 26,366 | 1,129 | — | — | 27,495 | |||||||||||||||
Prepaid expenses and other current assets | 2,788 | 2,262 | — | — | 5,050 | |||||||||||||||
Total current assets | 37,159 | 3,391 | — | — | 40,550 | |||||||||||||||
Restricted cash | 825 | — | — | — | 825 | |||||||||||||||
Property and equipment, net | 6,031 | 871 | — | — | 6,902 | |||||||||||||||
Intercompany receivable | — | 40,216 | — | (40,216 | ) | — | ||||||||||||||
Merchant portfolios and other intangible assets, net | 168,683 | 16,116 | — | — | 184,799 | |||||||||||||||
Goodwill | 632,688 | 46,016 | — | — | 678,704 | |||||||||||||||
Investment in subsidiaries | 99,921 | — | — | (99,921 | ) | — | ||||||||||||||
Investment in 15.00%/15.00% Notes | 24,661 | — | — | — | 24,661 | |||||||||||||||
Other assets, net | 24,141 | 20 | — | — | 24,161 | |||||||||||||||
Total assets | $ | 994,109 | $ | 106,630 | $ | — | $ | (140,137 | ) | $ | 960,602 | |||||||||
LIABILITIES AND EQUITY | ||||||||||||||||||||
Current Liabilities: | ||||||||||||||||||||
Accounts payable | $ | 3,371 | $ | 816 | $ | — | $ | — | $ | 4,187 | ||||||||||
Income taxes payable, net | 5,992 | — | — | — | 5,992 | |||||||||||||||
Accrued interest | 7,028 | — | — | — | 7,028 | |||||||||||||||
Accrued liabilities and other | 19,868 | 4,210 | — | — | 24,078 | |||||||||||||||
Deferred tax liabilities | 2,055 | 784 | 2,839 | |||||||||||||||||
Total current liabilities | 38,314 | 5,810 | — | — | 44,124 | |||||||||||||||
Deferred tax liabilities, net | 23,728 | 899 | — | — | 24,627 | |||||||||||||||
Intercompany payable | 40,216 | — | — | (40,216 | ) | — | ||||||||||||||
Long-term debt | 785,357 | — | — | — | 785,357 | |||||||||||||||
Other liabilities | 3,062 | — | — | — | 3,062 | |||||||||||||||
Total stockholders' equity | 103,432 | 99,921 | — | (99,921 | ) | 103,432 | ||||||||||||||
Total liabilities and equity | $ | 994,109 | $ | 106,630 | $ | — | $ | (140,137 | ) | $ | 960,602 | |||||||||
20
iPAYMENT, INC. | ||||||||||||||||||||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) | ||||||||||||||||||||
Three Months Ended September 30, 2014 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Revenues | $ | 125,099 | $ | 53,542 | $ | — | $ | — | $ | 178,641 | ||||||||||
Operating expenses: | ||||||||||||||||||||
Interchange | 68,496 | 31,152 | — | — | 99,648 | |||||||||||||||
Other costs of services | 47,542 | 13,894 | — | — | 61,436 | |||||||||||||||
Selling, general and administrative | 4,318 | 2,498 | — | — | 6,816 | |||||||||||||||
Embezzlement recoveries | (118 | ) | — | — | — | (118 | ) | |||||||||||||
Total operating expenses | 120,238 | 47,544 | — | — | 167,782 | |||||||||||||||
Income from operations | 4,861 | 5,998 | — | — | 10,859 | |||||||||||||||
Other expense: | ||||||||||||||||||||
Interest expense, net | 16,511 | — | — | — | 16,511 | |||||||||||||||
Other expense, net | 13 | — | — | — | 13 | |||||||||||||||
Income (loss) before income taxes | (11,663 | ) | 5,998 | — | — | (5,665 | ) | |||||||||||||
Income tax (benefit) provision | (1,126 | ) | 111 | — | — | (1,015 | ) | |||||||||||||
Equity in subsidiary earnings, net | 5,887 | — | — | (5,887 | ) | — | ||||||||||||||
Net and comprehensive income (loss) | $ | (4,650 | ) | $ | 5,887 | $ | — | $ | (5,887 | ) | $ | (4,650 | ) | |||||||
Three Months Ended September 30, 2013 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Revenues | $ | 123,033 | $ | 44,744 | $ | — | $ | — | $ | 167,777 | ||||||||||
Operating expenses: | ||||||||||||||||||||
Interchange | 63,641 | 26,311 | — | — | 89,952 | |||||||||||||||
Other costs of services | 49,031 | 11,122 | — | — | 60,153 | |||||||||||||||
Selling, general and administrative | 4,520 | 1,551 | — | — | 6,071 | |||||||||||||||
Embezzlement recoveries | (126 | ) | — | — | — | (126 | ) | |||||||||||||
Total operating expenses | 117,066 | 38,984 | — | — | 156,050 | |||||||||||||||
Income from operations | 5,967 | 5,760 | — | — | 11,727 | |||||||||||||||
Other expense: | ||||||||||||||||||||
Interest expense, net | 16,409 | 2 | — | — | 16,411 | |||||||||||||||
Other expense (income), net | (155 | ) | 1 | — | — | (154 | ) | |||||||||||||
Income (loss) before income taxes | (10,287 | ) | 5,757 | — | — | (4,530 | ) | |||||||||||||
Income tax provision | 2,454 | — | — | — | 2,454 | |||||||||||||||
Equity in subsidiary earnings, net | 5,757 | — | — | (5,757 | ) | — | ||||||||||||||
Net and comprehensive income (loss) | $ | (6,984 | ) | $ | 5,757 | $ | — | $ | (5,757 | ) | $ | (6,984 | ) | |||||||
21
iPAYMENT, INC. | ||||||||||||||||||||
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) | ||||||||||||||||||||
Nine Months Ended September 30, 2014 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Revenues | $ | 370,628 | $ | 148,995 | $ | — | $ | — | $ | 519,623 | ||||||||||
Operating expenses: | ||||||||||||||||||||
Interchange | 197,967 | 85,022 | — | — | 282,989 | |||||||||||||||
Other costs of services | 143,258 | 40,069 | — | — | 183,327 | |||||||||||||||
Selling, general and administrative | 12,834 | 7,219 | — | — | 20,053 | |||||||||||||||
Embezzlement recoveries | (390 | ) | — | — | — | (390 | ) | |||||||||||||
Total operating expenses | 353,669 | 132,310 | — | — | 485,979 | |||||||||||||||
Income from operations | 16,959 | 16,685 | — | — | 33,644 | |||||||||||||||
Other expense: | ||||||||||||||||||||
Interest expense, net | 49,458 | — | — | — | 49,458 | |||||||||||||||
Other income, net | (55 | ) | — | — | — | (55 | ) | |||||||||||||
Income (loss) before income taxes | (32,444 | ) | 16,685 | — | — | (15,759 | ) | |||||||||||||
Income tax provision | (817 | ) | 1,564 | — | — | 747 | ||||||||||||||
Equity in subsidiary earnings, net | 15,121 | — | — | (15,121 | ) | — | ||||||||||||||
Net and comprehensive income (loss) | $ | (16,506 | ) | $ | 15,121 | $ | — | $ | (15,121 | ) | $ | (16,506 | ) | |||||||
Nine Months Ended September 30, 2013 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Revenues | $ | 379,571 | $ | 118,096 | $ | — | $ | — | $ | 497,667 | ||||||||||
Operating expenses: | ||||||||||||||||||||
Interchange | 194,611 | 67,785 | — | — | 262,396 | |||||||||||||||
Other costs of services | 150,396 | 31,522 | — | — | 181,918 | |||||||||||||||
Selling, general and administrative | 13,613 | 12,180 | — | — | 25,793 | |||||||||||||||
Embezzlement recoveries | (2,903 | ) | — | — | — | (2,903 | ) | |||||||||||||
Total operating expenses | 355,717 | 111,487 | — | — | 467,204 | |||||||||||||||
Income from operations | 23,854 | 6,609 | — | — | 30,463 | |||||||||||||||
Other expense: | ||||||||||||||||||||
Interest expense, net | 47,262 | 3 | — | — | 47,265 | |||||||||||||||
Other expense, net | 2,516 | 56 | — | — | 2,572 | |||||||||||||||
Income (loss) before income taxes | (25,924 | ) | 6,550 | — | — | (19,374 | ) | |||||||||||||
Income tax provision | 12,860 | — | — | — | 12,860 | |||||||||||||||
Equity in subsidiary earnings, net | 6,550 | — | — | (6,550 | ) | — | ||||||||||||||
Net and comprehensive income (loss) | $ | (32,234 | ) | $ | 6,550 | $ | — | $ | (6,550 | ) | $ | (32,234 | ) | |||||||
22
iPAYMENT, INC. | ||||||||||||||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||||||||||||||
Nine Months Ended September 30, 2014 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Net cash provided by | ||||||||||||||||||||
operating activities | $ | 20,835 | $ | 9,030 | $ | — | $ | — | $ | 29,865 | ||||||||||
Investing activities: | ||||||||||||||||||||
Change in restricted cash | 22 | — | — | — | 22 | |||||||||||||||
Expenditures for property and equipment | (2,140 | ) | (1,008 | ) | — | — | (3,148 | ) | ||||||||||||
Acquisitions of business and portfolios | — | (8,022 | ) | — | — | (8,022 | ) | |||||||||||||
Payments on notes receivable | 217 | — | — | — | 217 | |||||||||||||||
Payments for prepaid residual expenses | (2,522 | ) | — | — | — | (2,522 | ) | |||||||||||||
Net cash used in investing activities | (4,423 | ) | (9,030 | ) | — | — | (13,453 | ) | ||||||||||||
Financing activities: | ||||||||||||||||||||
Net repayments on line of credit | (17,500 | ) | — | — | — | (17,500 | ) | |||||||||||||
Dividends to parent company | (5,876 | ) | — | — | — | (5,876 | ) | |||||||||||||
Net cash used in financing activities | (23,376 | ) | — | — | — | (23,376 | ) | |||||||||||||
Net decrease in cash and cash equivalents | (6,964 | ) | — | — | — | (6,964 | ) | |||||||||||||
Cash and cash equivalents, beginning of period | 8,005 | — | — | — | 8,005 | |||||||||||||||
Cash and cash equivalents, end of period | $ | 1,041 | $ | — | $ | — | $ | — | $ | 1,041 | ||||||||||
Nine Months Ended September 30, 2013 | ||||||||||||||||||||
iPayment, Inc. | Guarantor Subsidiaries | Non-Guarantor Subsidiaries | Eliminations | iPayment, Inc. Consolidated | ||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||
Net cash provided by | ||||||||||||||||||||
operating activities | $ | 29,381 | $ | 382 | $ | — | $ | — | $ | 29,763 | ||||||||||
Investing activities: | ||||||||||||||||||||
Change in restricted cash | 3 | — | — | — | 3 | |||||||||||||||
Expenditures for property and equipment | (1,875 | ) | (383 | ) | — | — | (2,258 | ) | ||||||||||||
Acquisitions of business and portfolios | (5,582 | ) | — | — | — | (5,582 | ) | |||||||||||||
Payments for prepaid residual expenses | (4,598 | ) | — | — | — | (4,598 | ) | |||||||||||||
Net cash used in investing activities | (12,052 | ) | (383 | ) | — | — | (12,435 | ) | ||||||||||||
Financing activities: | ||||||||||||||||||||
Net repayments on line of credit | (12,000 | ) | — | — | — | (12,000 | ) | |||||||||||||
Repayments of debt | (5,000 | ) | — | — | — | (5,000 | ) | |||||||||||||
Dividends to parent company | (5,235 | ) | — | — | — | (5,235 | ) | |||||||||||||
Net cash used in financing activities | (22,235 | ) | — | — | — | (22,235 | ) | |||||||||||||
Net decrease in cash and cash equivalents | (4,906 | ) | (1 | ) | — | — | (4,907 | ) | ||||||||||||
Cash and cash equivalents, beginning of period | 6,571 | 1 | — | — | 6,572 | |||||||||||||||
Cash and cash equivalents, end of period | $ | 1,665 | $ | — | $ | — | $ | — | $ | 1,665 | ||||||||||
23
(8) Income Taxes
We account for income taxes in interim periods pursuant to the provisions of ASC 740 Income Taxes. Under this method, our provision for or benefit from income taxes is computed at an estimated annual effective tax rate and the effects of any discrete income tax items are recognized in the periods in which they occur.
We have reported a cumulative pretax book loss for the current year and the two preceding years. Considering the likelihood of realization of deferred tax assets, in 2013 we reached the determination that a valuation allowance was appropriate. Management assesses the realizability of the deferred tax assets based on the criteria of authoritative guidance each reporting period. If future events differ from management’s estimates, the valuation allowance may change in future periods.
Authoritative guidance requires the recording of a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Under this guidance, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Such objective evidence limits the ability to consider other evidence such as our projections for future growth.
For iPayment and its consolidated subsidiaries, our effective tax rate for the nine months ended September 30, 2014 was (4.7)% and we recorded a tax expense of $0.7 million on pretax loss of $15.8 million. The inverse effective tax rate was due to the recording of a valuation allowance against our deferred tax assets, decreased by a $1.5 million tax benefit from a state tax refund received during the second quarter of 2014.
For Holdings and its consolidated subsidiaries, our effective tax rate for the nine months ended September 30, 2014 was (2.0)% and we recorded a tax expense of $0.7 million on pretax loss of $37.0 million. The difference between the effective tax rates for Holdings and its consolidated subsidiaries and iPayment and its consolidated subsidiaries relates to the interest deductibility limitations with respect to Holdings' 15.00%/15.00% Notes, which constitute an "Applicable High Yield Discount Obligation" for U.S. federal income tax purposes.
For the nine months ended September 30, 2014, we accrued $0.3 million of interest and penalties related to our uncertain tax positions. As of September 30, 2014, the total amount of our unrecognized tax benefits was $2.7 million. Net of related deferred tax assets, unrecognized tax benefits were $0.9 million to date. If we were to recognize these net benefits, our income tax expense would reflect a favorable net impact of $0.4 million. As of September 30, 2014, we do not anticipate a significant change to the total amount of unrecognized tax benefits in the next twelve months.
On March 13, 2014, the Internal Revenue Service notified us that they plan to audit the tax return of the predecessor holding company, iPayment Investors, LP and its subsidiaries, for the year ended December 31, 2010. No other notifications have been received as of September 30, 2014 and no date has been set for the beginning of the audit.
(9) Commitments and Contingencies
Legal Proceedings
We are party to certain legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, as discussed in our 2013 Annual Report. While the ultimate outcome of these matters cannot be predicted with certainty, based on information currently available, advice of counsel, and available insurance coverage, we do not believe that the outcome of any of these claims will have a material adverse effect on our business, financial condition or results of operations. However, the results of legal proceedings cannot be predicted with certainty, and in the event of unexpected future developments the ultimate resolution of one or more of these matters could be unfavorable. Should we fail to prevail in any of these legal matters or should several of these legal matters be resolved against us in the same reporting period, our consolidated financial position or operating results could be materially adversely affected. 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 loss.
(10) Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.
The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently
24
evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
(11) Related Party Transactions
None.
(12) Subsequent Events
Appointment of Officer
On October 14, 2014, iPayment and Holdings (collectively, the “Companies”) appointed Greg Cohen as President of the Companies. Under the terms of his employment, Mr. Cohen will receive a base salary of $400,000 per annum, and will be eligible to receive an annual performance-based bonus of up to 75% his annual base salary. In addition, Mr. Cohen will receive an initial grant of 125,000 phantom units pursuant to Holdings’ Equity Incentive Plan within thirty (30) days of the commencement of his employment, and is eligible for future additional phantom unit grants based on satisfaction of certain conditions. Mr. Cohen also serves on the Executive Committee of the Board of Directors of the Electronic Transaction Association, for which he will assume the role of President-Elect as of January 1, 2015.
Exchange Offering
On November 7, 2014, the Companies launched exchange offers (the "Exchange Offers") and related consent solicitations (the "Consent Solicitations") to holders of iPayment’s outstanding 10.25% Senior Notes due 2018 (the "Opco Notes") and holders of Holding’s outstanding 15.00%/15.00% Senior Notes due 2018 (the "Holdco Notes" and, together with the Opco Notes, the "Existing Notes") pursuant to an Offers to Exchange and Consent Solicitation Statement, dated as of November 7, 2014 (as it may be amended from time to time, the "Statement") in accordance with the terms of the previously announced Exchange Offer Support Agreement (as it may be amended from time to time, the "Support Agreement") described in the Companies’ Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2014. Pursuant to the Exchange Offers, (i) holders of Opco Notes will exchange their existing Opco Notes for their pro rata share of (a) up to $285 million aggregate principal amount of new 8.50% Senior Secured Notes due 2019 (the "New Notes") and (b) up to 61.5% of the common stock of Holdings (the "Common Stock") to be issued and outstanding (without giving effect to the exercise of any Warrants (defined below)) if the Exchange Offers are completed and (ii) holders of Holdco Notes will exchange their existing Holdco Notes for their pro rata share of (a) up to $30 million aggregate principal amount of New Notes, (b) up to 18.5% of the Common Stock to be issued and outstanding (without giving effect to the exercise of any Warrants) if the Exchange Offers are completed, and (c) warrants to purchase Common Stock (the "Warrants") representing up to 40.0% of the Common Stock on a fully diluted basis. In connection with the Exchange Offers, existing holders of equity securities of Holdings will be issued Warrants representing 47.5% of the Common Stock on a fully diluted basis assuming 100% participation in the Exchange Offers by holders of the Existing Notes.
Upon the consummation of the Exchange Offers, holders of the Opco Notes will be paid all accrued and unpaid interest on their Opco Notes and holders of the Holdco Notes will be paid the cash portion of all accrued and unpaid interest on their Holdco Notes, in each case through the closing date of the Exchange Offers. In connection with the Exchange Offers, Holdings will also issue Warrants to the existing holders of Common Stock (the “Existing Equity Holders”).
Pursuant to the Support Agreement, the Companies have agreed to, among other things, amend (the “Bank Amendment”) the Credit Agreement, dated May 6, 2011, governing iPayment’s existing senior secured credit facility (as amended from time to time, the “Credit Agreement”), in order to, among other things, amend (i) certain financial covenants and (ii) certain other covenants and defined terms to permit the Exchange Offers and to reflect the ownership structure that will result from the Exchange Offers.
In order to participate in the Exchange Offers, holders of the Existing Notes will be required to consent in the related Consent Solicitation to amend (the "Proposed Amendments") the indenture governing the Holdco Notes or the indenture governing the Opco Notes, as applicable. If implemented, the Proposed Amendments will eliminate substantially all of the covenants and related events of default and other related provisions contained in such indentures.
The closing of the Exchange Offers is conditioned upon, among other things, (i) at least 95% of the aggregate principal amount of each of the Opco Notes and the Holdco Notes being validly tendered and not validly withdrawn (the "Minimum Tender Conditions"), and (ii) execution of the Bank Amendment on such terms as are set forth in the Support Agreement. The Minimum Tender Conditions may be modified by mutual agreement of the Companies and the holders of Existing Notes as set forth in the Support Agreement and the Statement.
The Exchange Offers are scheduled to expire at 5:00 P.M., New York City time, on December 7, 2014, unless extended or earlier terminated by the Companies with the consent of holders of Existing Notes as set forth in the Support Agreement and
25
the Statement. Tendered Existing Notes may be validly withdrawn at any time before the expiration or termination of the Exchange Offers. Subject to the consent requirements under the Support Agreement, the Companies may terminate or withdraw the Offers at any time for any reason, including if certain conditions described in the Statement are not satisfied.
The Exchange Offers are being made pursuant to the exemption provided for under Section 4(a)(2) of the Securities Act, and the New Notes, the Common Stock and the Warrants are being offered and issued only to qualified institutional buyers as defined in Rule 144A and accredited investors as defined in 506 Regulation D under the Securities Act of 1933, as amended (the “Securities Act”). Consequently, the Common Stock, the Warrants and the New Notes offered have not been, and except as described in the Statement will not be, registered under the Securities Act , and may not be offered or sold in the United States absent registration under the Securities Act and applicable state securities laws or an applicable exemption therefrom.
The above description of the Exchange Offers does not purport to be a complete statement of the parties’ rights and obligations thereunder. The Companies can provide no assurance that the Exchange Offers will occur on the terms described in this Quarterly Report, or at all. We are determining the proper accounting treatment, however, if the exchange offers are completed pursuant to the terms described above, the transaction may result in the application of ASC 805: Business Combination accounting.
26
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. 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. During the three months ended September 30, 2014, we generated revenue from approximately 150,000 merchants. Of these merchants, approximately 104,000 were active merchants that had each processed at least one Visa or MasterCard transaction during that month. We market and sell our services through independent sales groups, or “ISGs,” which are non-employee, external sales organizations, an employee sales force, telesales, marketing directly to merchants using electronic media, and other third party resellers of our products and services. In addition, we partner with banks such as Wells Fargo to sponsor us for membership in the Visa, MasterCard or other card brand associations and to settle card payment transactions with our 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 at our main operating facility in Westlake Village, California.
Our strategy has been to increase profits by increasing our penetration of the small merchant marketplace for payment services. Our charge volume increased by 1.9% to $16.9 billion for the nine months ended September 30, 2014 from $16.5 billion for the nine months ended September 30, 2013. This increase in charge volume was due primarily to higher transactions per merchant per month partially offset by lower number of billed merchants for the first nine months of 2014 compared to 2013. Our revenues increased $22.0 million or 4.4% to $519.6 million in the first nine months of 2014 from $497.7 million in the same period in 2013. The increase in revenues was due primarily to an increase in average revenue per merchant and slightly higher volume. Our net revenue increased $0.1 million or 0.1% to $198.2 million for the nine months ended September 30, 2014 from $198.1 million during the same period in 2013. Our net revenue is composed of total revenue reduced by interchange fees and network fees. Income from operations increased $3.2 million, or 10.4%, to $33.6 million for the nine months ended September 30, 2014, from $30.5 million during the same period in 2013. This increase in income from operations was primarily due to higher net revenues and lower one-time charges related to an amended purchase agreement and the related employment agreements related to the acquisition of Flagship Merchant Services in 2012, offset by a decrease in embezzlement recoveries received by the Company. Excluding stock based compensation, the Flagship one-time charges, and embezzlement recoveries and costs, income from operations for the first nine months would have been $36.2 million or 9.7% lower than the comparable period in 2013. Our loss before income taxes was $15.8 million for iPayment and its consolidated subsidiaries and $37.0 million for Holdings and its consolidated subsidiaries during the nine months ended September 30, 2014, compared to $19.4 million of loss before income taxes for iPayment and its consolidated subsidiaries and $38.8 million of loss before income taxes for Holdings and its consolidated subsidiaries in the same period in 2013.
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 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 periodic 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.
Based on an analysis we performed during the fourth quarter of 2013, we concluded that our "iPayment Inc." trade name was impaired by $5.0 million and recognized the applicable charge in the year ended December 31, 2013.
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During the quarter ended June 30, 2014, the Company voluntarily changed the date of its annual goodwill and indefinite-lived intangible assets impairment testing from May 31 to October 1. This voluntary change is preferable under the circumstances as it provides the Company with appropriate time to complete its annual goodwill and indefinite-lived intangible asset impairment testing in advance of its year-end reporting and results in better alignment with the Company’s strategic planning and forecasting process. The voluntary change in accounting principle related to the annual testing date will not delay, accelerate or avoid an impairment charge. This change is not applied retrospectively as it is impracticable to do so because retrospective application would require application of significant estimates and assumptions with the use of hindsight. Accordingly, the change will be applied prospectively.
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 2.2% 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 treated as a change in estimate and accounted for prospectively.
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 bundled 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.
Generally, where we have ultimate responsibility for the merchant, as evidenced by our liability for merchant losses or credit risk, or portability with respect to such 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 pursuant to ASC 605. 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 merchant contracts where we do not have liability for merchant losses or credit risk or rights of portability, such as certain merchant portfolios we acquired from FDMS and certain of our other portfolios and merchant contracts, are reported net of interchange, as required by ASC 605.
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 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 sales partners based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which are a percentage of the charge volume we generate from Visa and MasterCard. In addition, other costs of services include telecommunications costs, personnel costs, occupancy costs, bonuses and commissions to our sales employees, losses due to merchant defaults, other miscellaneous merchant supplies and services expenses, bank sponsorship costs and other third-
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party processing costs. Other costs of services also include depreciation expense, which is recognized on a straight-line basis over the estimated useful life of the assets, and amortization expense which is primarily recognized using an accelerated method over a 15-year period. Amortization of intangible assets results from our acquisitions of portfolios of merchant contracts or acquisitions of a business where we allocated a portion of the purchase price to the existing merchant processing portfolios and other intangible assets.
Selling, general and administrative expenses 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. During the three months ended September 30, 2014, we reduced our reserve by $0.8 million as a result of $0.4 million in known losses which were previously reserved for and $0.4 million to adjust the reserve to an appropriate level based upon our estimates of known probable losses and incurred but not yet reported losses at September 30, 2014. At September 30, 2014, and December 31, 2013, our reserve for losses on merchant accounts included in accrued liabilities and other totaled $0.4 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 September 30, 2014.
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.
Authoritative guidance requires the recording of a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Under this guidance, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Such objective evidence limits the ability to consider other evidence such as our projections for future growth.
We have reported a cumulative pretax book loss for the current and two preceding years. Considering the likelihood of realization of deferred tax assets, in 2013 we reached the determination that a valuation allowance was appropriate. Management assesses the ability to realize the deferred tax assets based on the criteria of authoritative guidance each reporting period. If future events differ from management’s estimates, the valuation allowance may change in future periods.
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 be less than 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 or 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 in our financial statements.
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Results of Operations
Three Months Ended September 30, 2014, Compared to Three Months Ended September 30, 2013
Three months ended September 30, | Change | |||||||||||||||||||
(Dollars in thousands, except percentages) | 2014 | % of Total Revenue | 2013 | % of Total Revenue | Amount | % | ||||||||||||||
Revenues | $ | 178,641 | 100.0 | % | $ | 167,777 | 100.0 | % | $ | 10,864 | 6.5 | % | ||||||||
Operating expenses | ||||||||||||||||||||
Interchange | 99,648 | 55.8 | % | 89,952 | 53.6 | % | 9,696 | 10.8 | % | |||||||||||
Other costs of services (1) | 61,436 | 34.4 | % | 60,153 | 35.9 | % | 1,283 | 2.1 | % | |||||||||||
Selling, general and administrative (2) | 6,816 | 3.8 | % | 6,071 | 3.6 | % | 745 | 12.3 | % | |||||||||||
Embezzlement costs | (118 | ) | (0.1 | )% | (126 | ) | (0.1 | )% | 8 | (6.3 | )% | |||||||||
Total operating expenses (3) | 167,782 | 93.9 | % | 156,050 | 93.0 | % | 11,732 | 7.5 | % | |||||||||||
Income from operations | 10,859 | 6.1 | % | 11,727 | 7.0 | % | (868 | ) | (7.4 | )% | ||||||||||
Other expense | ||||||||||||||||||||
Interest expense, net (4) | 16,511 | 9.2 | % | 16,411 | 9.8 | % | 100 | 0.6 | % | |||||||||||
Other expense (income), net | 13 | — | % | (154 | ) | (0.1 | )% | 167 | (108.4 | )% | ||||||||||
Total other expense (5) | 16,524 | 9.2 | % | 16,257 | 9.7 | % | 267 | 1.6 | % | |||||||||||
Loss before income taxes (6) | (5,665 | ) | (3.2 | )% | (4,530 | ) | (2.7 | )% | (1,135 | ) | 25.1 | % | ||||||||
Income tax provision (benefit) (7) | (1,015 | ) | (0.6 | )% | 2,454 | 1.5 | % | (3,469 | ) | (141.4 | )% | |||||||||
Net loss (8) | $ | (4,650 | ) | (2.6 | )% | $ | (6,984 | ) | (4.2 | )% | $ | 2,334 | (33.4 | )% | ||||||
(1) | Other costs of services of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $61.4 million and $60.2 million, respectively. |
(2) | Selling, general and administrative expense of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $6.9 million and $6.1 million, respectively. |
(3) | Total operating expenses of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $167.8 million and $156.1 million, respectively. |
(4) | Net interest expense of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $23.7 million and $22.5 million, respectively. |
(5) | Total other expense of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $23.7 million and $22.4 million, respectively. |
(6) | Loss before income taxes of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $12.9 million and $10.7 million, respectively. |
(7) | Income taxes of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, consists of an income tax benefit of $1.0 million and an income tax expense of $1.8 million, respectively. |
(8) | Net loss of Holdings and its consolidated subsidiaries for the three months ended September 30, 2014, and September 30, 2013, are $11.8 million and $12.5 million, respectively. |
Revenues. Revenues increased 6.5% to $178.6 million in the third quarter of 2014 from $167.8 million during the same period in 2013. This increase was driven by a higher number of transactions processed and average volume per merchant, partially mitigated by a lower number of billed merchants, year over year.
Interchange Expenses. Interchange expense was $99.6 million in the third quarter of 2014, compared with $90.0 million for the same period in 2013. Interchange expenses increased due to an increase in the average interchange rate as a percentage of merchant processing volume from 1.6% during the third quarter of 2013 to 1.7% for the same period in 2014, as well as, due to an increase in credit type transactions as opposed to debit type transactions during the third quarter of 2014 compared to the same period in 2013.
Other Costs of Services. Other costs of services increased 2.1% to $61.4 million for iPayment and its consolidated subsidiaries in the third quarter of 2014 as compared to $60.2 million during the same period in 2013. The increase in other costs of services was primarily due to higher residual expense and higher marketing expense, offset by lower portfolio amortization and depreciation expense for the three months ended September 30, 2014.
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Selling, General and Administrative. Selling, general and administrative expenses increased 12.3% to $6.8 million for iPayment and its consolidated subsidiaries in the third quarter of 2014 as compared to $6.1 million during the same period in 2013. This increase was primarily driven by higher marketing expenses.
Other Expense. Total other expense increased $0.3 million to $16.5 million for iPayment and its consolidated subsidiaries and increased $1.3 million to $23.7 million for Holdings and its consolidated subsidiaries in the third quarter of 2014, from $16.3 million for iPayment and its consolidated subsidiaries and $22.4 million for Holdings and its consolidated subsidiaries during the same period in 2013. Other expense in the third quarter of 2014 primarily consisted of interest expense. Interest expense increased to $16.5 million for iPayment and its consolidated subsidiaries and increased to $23.7 million for Holdings and its consolidated subsidiaries in the third quarter of 2014 from $16.4 million for iPayment and its consolidated subsidiaries and $22.5 million for Holdings and its consolidated subsidiaries in the same period in 2013.
Income Tax. iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries each had an income tax benefit of $1.0 million during the third quarter of 2014, compared to an income tax expense of $2.5 million and $1.8 million, respectively, during the same period in 2013. iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries had effective tax rates of 17.9% and 7.9%, respectively, during the third quarter of 2014, compared to effective tax rates of (54.2)% and (17.1)% respectively, during the same period in 2013. For both iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries, the effective tax rate for the third quarter of 2013 was primarily due to the recording of a valuation allowance against our deferred tax assets.
The difference between the effective tax rates for Holdings and its consolidated subsidiaries and iPayment and its consolidated subsidiaries relates to the interest deductibility limitations with respect to Holdings' 15.00%/15.00% Notes, which constitute an "Applicable High Yield Discount Obligation" for U.S. federal income tax purposes.
We have reported a cumulative pretax book loss for 2014, 2013 and 2012. Considering the likelihood of realization of deferred tax assets, in the second quarter of 2013 we reached the determination that a valuation allowance was appropriate. Management assesses the realizability of the deferred tax assets based on the criteria of authoritative guidance each reporting period. If future events differ from management’s estimates, the valuation allowance may change in future periods.
Nine Months Ended September 30, 2014, Compared to Nine Months Ended September 30, 2013
Nine months ended September 30, | Change | |||||||||||||||||||
(Dollars in thousands, except percentages) | 2014 | % of Total Revenue | 2013 | % of Total Revenue | Amount | % | ||||||||||||||
Revenues | $ | 519,623 | 100.0 | % | $ | 497,667 | 100.0 | % | $ | 21,956 | 4.4 | % | ||||||||
Operating expenses | ||||||||||||||||||||
Interchange | 282,989 | 54.5 | % | 262,396 | 52.7 | % | 20,593 | 7.8 | % | |||||||||||
Other costs of services (1) | 183,327 | 35.3 | % | 181,918 | 36.6 | % | 1,409 | 0.8 | % | |||||||||||
Selling, general and administrative (2) | 20,053 | 3.9 | % | 25,793 | 5.2 | % | (5,740 | ) | (22.3 | )% | ||||||||||
Embezzlement costs | (390 | ) | (0.1 | )% | (2,903 | ) | (0.6 | )% | 2,513 | (86.6 | )% | |||||||||
Total operating expenses (3) | 485,979 | 93.5 | % | 467,204 | 93.9 | % | 18,775 | 4.0 | % | |||||||||||
Income from operations | 33,644 | 6.5 | % | 30,463 | 6.1 | % | 3,181 | 10.4 | % | |||||||||||
Other expense | ||||||||||||||||||||
Interest expense, net (4) | 49,458 | 9.5 | % | 47,265 | 9.5 | % | 2,193 | 4.6 | % | |||||||||||
Other expense (income), net | (55 | ) | — | % | 2,572 | 0.5 | % | (2,627 | ) | (102.1 | )% | |||||||||
Total other expense (5) | 49,403 | 9.5 | % | 49,837 | 10.0 | % | (434 | ) | (0.9 | )% | ||||||||||
Loss before income taxes (6) | (15,759 | ) | (3.0 | )% | (19,374 | ) | (3.9 | )% | 3,615 | (18.7 | )% | |||||||||
Income tax provision (benefit) (7) | 747 | 0.1 | % | 12,860 | 2.6 | % | (12,113 | ) | (94.2 | )% | ||||||||||
Net loss (8) | $ | (16,506 | ) | (3.2 | )% | $ | (32,234 | ) | (6.5 | )% | $ | 15,728 | (48.8 | )% | ||||||
(1) | Other costs of services of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, are $183.3 million and $182.0 million, respectively. |
(2) | Selling, general and administrative expense of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, are $20.2 million and $25.8 million, respectively. |
(3) | Total operating expenses of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, are $486.1 million and $467.3 million, respectively. |
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(4) | Net interest expense of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, are $70.6 million and $66.6 million, respectively. |
(5) | Total other expense of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, are $70.5 million and $69.2 million, respectively. |
(6) | Loss before income taxes of Holdings and its consolidated subsidiaries for the six months ended September 30, 2014 and 2013, are $37.0 million and $38.8 million, respectively. |
(7) | Income taxes of Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014 and 2013, consists of an income tax expense of $0.7 million and $12.8 million, respectively. |
(8) | Net loss of Holdings and its consolidated subsidiaries for the six months ended September 30, 2014 and 2013, are $37.7 million and $51.6 million, respectively. |
Revenues. Revenues increased 4.4% to $519.6 million for the nine months ended September 30, 2014 from $497.7 million during the same period in 2013. This increase was driven by a higher number of transactions processed and average volume per merchant, partially mitigated by a lower number of billed merchants, year over year.
Interchange Expenses. Interchange expense was $283.0 million for the nine months ended September 30, 2014, compared to $262.4 million for the same period in 2013. Interchange expenses increased due to an increase in the average interchange rate as a percentage of merchant processing volume from 1.6% during the third quarter of 2013 to 1.7% for the same period in 2014.
Other Costs of Services. Other costs of services increased 0.8% to $183.3 million for iPayment and its consolidated subsidiaries for the nine months ended September 30, 2014 as compared to $181.9 million during the same period in 2013. The increase in other costs of services was primarily due to higher residual expense and higher marketing expense offset by lower portfolio amortization and depreciation expense for the nine months ended September 30, 2014.
Selling, General and Administrative. Selling, general and administrative expenses decreased 22.3% to $20.1 million for iPayment and its consolidated subsidiaries for the nine months ended September 30, 2014 as compared to $25.8 million during the same period in 2013. This decrease was driven by lower expense due to one-time charges of $8.2 million incurred in the second quarter of 2013 related to the amendment of the Flagship purchase agreement and related employment agreements, lower professional services fees for legal and accounting, offset by higher marketing expenses for the nine months ended September 30, 2014. The decline in professional services was largely due to $1.0 million in expenses associated with the embezzlement during the nine months ended September 30, 2013. Excluding charges in 2013 and 2014 for stock based compensation of $0.8 million and $0.6 million, respectively, the Flagship-related charges of $8.2 million and $0.8 million, respectively, and remediation costs of $1.0 and $0.2 million, respectively, selling, general and administrative expense increased $2.7 million or 16.9% from $15.8 million to $18.5 million during the nine months ended September 30, 2013 and 2014, respectively.
Other Expense. Total other expense decreased $0.4 million to $49.4 million for iPayment and its consolidated subsidiaries from $49.8 million during the same period in 2013, and increased $1.4 million to $70.5 million for Holdings and its consolidated subsidiaries from $69.2 million during the same period in 2013. Other expense for the nine months ended September 30, 2014 primarily consisted of interest expense. Interest expense increased to $49.5 million for iPayment and its consolidated subsidiaries and increased to $70.6 million for Holdings and its consolidated subsidiaries for the nine months ended September 30, 2014, from $47.3 million for iPayment and its consolidated subsidiaries and $66.6 million for Holdings and its consolidated subsidiaries in the same period in 2013. Non-interest other expense for both iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries decreased $2.6 million compared to the same period in 2013 due to a legal settlement we incurred in the second quarter of 2013.
Income Tax. iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries each had an income tax expense of $0.7 million for the nine months ended September 30, 2014, compared to an income tax expense of $12.9 million and $12.8 million, respectively, during the same period in 2013. iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries had effective tax rates of (4.7)% and (2.0)%, respectively, for the nine months ended September 30, 2014, compared to effective tax rates of (66.4)% and (33.0)%, respectively, during the same period in 2013. For both iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries, the inverse effective tax rate for the nine months ended September 30, 2014 was primarily due to the recording of a valuation allowance against our deferred tax assets, decreased by a $1.5 million tax benefit from a state tax refund received in the second quarter of 2014.
The difference between the effective tax rates for Holdings and its consolidated subsidiaries and iPayment and its consolidated subsidiaries relates to the interest deductibility limitations with respect to Holdings' 15.00%/15.00% Notes, which constitute an "Applicable High Yield Discount Obligation" for U.S. federal income tax purposes.
We have reported a cumulative pretax book loss for 2014, 2013 and 2012. Considering the likelihood of realization of deferred tax assets, in 2013 we reached the determination that a valuation allowance was appropriate. Management assesses the realizability of the deferred tax assets based on the criteria of authoritative guidance each reporting period. If future events differ from management’s estimates, the valuation allowance may change in future periods.
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Liquidity and Capital Resources
As of September 30, 2014 and December 31, 2013, we had cash and cash equivalents of approximately $1.0 million and $8.0 million, respectively. We usually minimize cash balances in order to minimize borrowings and, therefore, interest expense.
As of September 30, 2014, iPayment and its consolidated subsidiaries had a net working capital deficit (current liabilities in excess of current assets) of $24.1 million compared to a net deficit of $3.6 million as of December 31, 2013. The increase in current deficit is primarily due to decreases in cash and cash equivalents of $7.0 million due to our use of free cash to retire debt, decreases in accounts receivable of $5.3 million due to seasonal differences in volume and periodic billings, an increase in accrued interest payable of $10.2 million as the semi-annual interest payment on the 10.25% Notes approaches in November, and an increase in accounts payable of $1.6 million as a result of increased operating expenses. This increase was partially offset by a decrease in accrued liabilities of $4.2 million as a result of seasonal differences in ISG residuals payable and payment in January 2014 of $2.8 million in connection with the amendment of the Flagship purchase agreement in the second quarter of 2013.
As of September 30, 2014, Holdings and its consolidated subsidiaries had a net working capital deficit of $25.0 million compared to working capital of $2.5 million as of December 31, 2013. The increase in current deficit is primarily due to decreases in cash and cash equivalents of $7.0 million due to our use of free cash to retire debt, decreases in accounts receivable of $5.3 million due to seasonal differences in volume and periodic billings, decreases in prepaid and other current assets of $1.3 million due to collections of agent loans and the amortization of deferred charges, an increase in accrued interest payable of $16.0 million as the semi-annual interest payments on the 10.25% Notes and the 15.00%/15.00% Notes approach in November, and an increase in accounts payable of $1.6 million as a result of increased operating expenses. This increase was partially offset by a decrease in accrued liabilities of $4.2 million as a result of seasonal differences in ISG residuals payable and payment in January 2014 of $2.8 million in connection with the amendment of the Flagship purchase agreement in the second quarter of 2013.
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 September 30, 2014. 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 resulting 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 September 30, 2014, our Senior Secured Leverage Ratio, as defined in the Senior Secured Credit Facilities, was 3.60 to 1.00 compared to the allowed maximum of 3.75 to 1.00. As of September 30, 2014, our Consolidated Interest Coverage Ratio, as defined in the Senior Secured Credit Facilities, was 1.33 to 1.00 compared to the allowed minimum of 1.25 to 1.00.
If we do not generate sufficient cash flow from operations to satisfy our debt obligations, including interest payments and the payment of principal at maturity, we may have to undertake alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. We cannot be sure that any refinancing or sale of assets would be possible on commercially reasonable terms or at all. In addition, any refinancing of our debt could be at higher interest rates and may require us to comply with more burdensome covenants, which could further restrict our business operations.
In addition, the 15.00%/15.00% Notes also include a leverage ratio test with which we must comply or pay additional interest. 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. For the quarter ended September 30, 2014 we determined that Holdings' leverage ratio was 8.80 to 1.00 as of the most recent quarter end prior to such subsequent interest payment date and we will be required to pay 2.00% additional PIK interest on November 15, 2014. For further information on the 15.00%/15.00% Notes, see Note 5 to our consolidated financial statements.
On November 7, 2014, the Companies launched exchange offers (the "Exchange Offers") and related consent solicitations (the "Consent Solicitations") to holders of iPayment’s outstanding 10.25% Senior Notes due 2018 (the "Opco Notes") and holders of Holding’s outstanding 15.00%/15.00% Senior Notes due 2018 (the "Holdco Notes" and, together with the Opco Notes, the "Existing Notes") pursuant to an Offers to Exchange and Consent Solicitation Statement, dated as of November 7, 2014 (as it may be amended from time to time, the "Statement") in accordance with the terms of the previously announced Exchange Offer Support Agreement (as it may be amended from time to time, the "Support Agreement") described in the Companies’ Current Report on Form 8-K filed with the Securities and Exchange Commission on September 29, 2014. For further information on
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the exchange offers and their anticipated impact please see Note 12 "Subsequent Events" to our consolidated financial statements.
Operating activities
Net cash provided by operating activities was $29.9 million for iPayment and its consolidated subsidiaries during the nine months ended September 30, 2014. For iPayment and its consolidated subsidiaries, net cash provided by operating activities consisted of net loss of $16.5 million adjusted by depreciation and amortization of $29.2 million, share-based compensation of $1.1 million, non-cash interest expense and other of $2.3 million, loss on disposal of property and equipment of $0.3 million, and a net favorable change in operating assets and liabilities of $13.5 million. The net favorable change in operating assets and liabilities is due to increases in accounts and income taxes payable, deferred tax liabilities and accrued interest payable of $2.1 million, $1.1 million and $10.2 million, respectively, and decreases in accounts receivable and prepaid expenses and other current assets of $5.3 million and $0.2 million, respectively, offset by decreases in accrued liabilities of $3.5 million and increases in other assets of $1.9 million.
For Holdings and its consolidated subsidiaries, net cash provided by operating activities of $24.0 million consisted of a net loss of $37.7 million adjusted by depreciation and amortization of $29.2 million, share based compensation of $1.1 million, non-cash interest expense and other of $10.6 million, loss on disposal of property and equipment of $0.3 million, and a net favorable change in operating assets and liabilities of $20.5 million. The net favorable change in operating assets and liabilities is due to increases in accounts payable, deferred tax liabilities, and accrued interest of $1.6 million, $1.1 million, $16.0 million, respectively, and decreases in accounts receivable, income taxes receivable and prepaid and other current assets of $5.3 million, $0.4 million and $1.3 million, respectively, offset by a decrease in accrued liabilities and other of $3.5 million and an increase in other assets of $1.9 million.
Net cash provided by operating activities was $29.8 million for iPayment and its consolidated subsidiaries during the nine months ended September 30, 2013. For iPayment and its consolidated subsidiaries, net cash provided by operating activities consisted of net loss of $32.2 million adjusted by depreciation and amortization of $36.4 million, share-based compensation of $5.2 million, non-cash interest income and other of $4.3 million, loss on disposal of property and equipment of $0.6 million, and a net favorable change in operating assets and liabilities of $24.1 million. The net favorable change in operating assets and liabilities is primarily due to a decrease in accounts receivable and increases in deferred tax liabilities, income tax payable and interest expense; offset by decreases in accounts payable and accrued liabilities and other, and an increase in prepaid and other current assets.
For Holdings and its consolidated subsidiaries, net cash provided by operating activities of $24.5 million during the nine months ended September 30, 2013 consisted of a net loss of $51.6 million adjusted by depreciation and amortization of $36.4 million, share based compensation of $5.2 million, non-cash interest expense and other of $2.1 million, loss on disposal of property and equipment of $0.6 million, and a net favorable change in operating assets and liabilities of $31.8 million. The net favorable change in operating assets and liabilities is primarily due to a decrease in accounts receivable and increases in deferred tax liabilities, income taxes payable and interest payable; offset by decreases in accounts payable and accrued liabilities and other, and increases in prepaid and other current assets.
Investing activities
Net cash used in investing activities for both iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries was $13.5 million during the nine months ended September 30, 2014, consisting primarily of capital expenditures of $3.1 million, acquisitions of $8.0 million, payments for prepaid residual expenses of $2.5 million and payments received on notes receivable of $0.2 million.
Net cash used in investing activities for both iPayment and its consolidated subsidiaries and Holdings and its consolidated subsidiaries was $12.4 million during the nine months ended September 30, 2013, consisting primarily of $2.3 million of capital expenditures and $10.2 million of acquisitions of portfolios and payments for prepaid residual expenses.
Financing activities
Net cash used in financing activities for iPayment and its consolidated subsidiaries was $23.4 million during the nine months ended September 30, 2014, consisting of $17.5 million net repayments on the revolving facility under the Senior Secured Credit Facilities and dividends to Holdings of $5.9 million for the payment of interest on the 15.00%/15.00% Notes and certain expenses of Holdings.
Net cash used in financing activities for Holdings and its consolidated subsidiaries was $17.5 million during the nine months ended September 30, 2014, consisting of net repayments on the revolving facility under the Senior Secured Credit Facilities.
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Net cash used in financing activities for iPayment and its consolidated subsidiaries was $22.2 million during the nine months ended September 30, 2013, consisting of $5.0 million of repayments on the term loan under the Senior Secured Credit Facilities, $12.0 million of net repayments on the revolving facility thereunder and a $5.2 million dividend to Holdings which was used for the payment of interest on the 15.00%/15.00% Notes and directors fees.
Net cash used in financing activities for Holdings and its consolidated subsidiaries was $17.0 million during the nine months ended September 30, 2013, consisting of $5.0 million of repayments on the term loan under the Senior Secured Credit Facilities and $12.0 million of borrowings on the revolving facility thereunder.
See Note 5 to the consolidated financial statements for further detail regarding the Company's long-term debt.
Contractual Obligations
The following table of our material contractual obligations as of September 30, 2014, summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated.
Payments due by period | ||||||||||||||
(Dollars in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||
Contractual Obligations of iPayment | ||||||||||||||
Senior Secured Credit Facilities | 369,000 | — | 369,000 | — | — | |||||||||
10.25% Notes | 400,000 | — | — | 400,000 | — | |||||||||
Interest, net of discount and amortization (1) | 212,055 | 66,445 | 121,179 | 24,431 | — | |||||||||
Operating lease obligations | 20,181 | 2,733 | 5,365 | 5,553 | 6,530 | |||||||||
Purchase obligations and other (2) | 2,602 | 1,462 | 1,140 | — | — | |||||||||
Total contractual obligations | 1,003,838 | 70,640 | 496,684 | 429,984 | 6,530 | |||||||||
Contractual Obligations of Holdings | ||||||||||||||
15.00%/15.00% Notes(3) | 132,288 | — | — | 132,288 | ||||||||||
Interest(1)(3) | 86,362 | 10,157 | 43,546 | 32,659 | — | |||||||||
Total contractual obligations | 218,650 | 10,157 | 43,546 | 164,947 | — | |||||||||
(1) | Future interest obligations are calculated using current interest rates on existing debt balances as of September 30, 2014, 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 minimum monthly management charges due under a fractional ownership arrangement and certain office equipment leases. |
(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 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 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues
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when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP.
The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of our pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2017.
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.
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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.
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 September 30, 2014, we had $369.0 million of loans outstanding under our Senior Secured Credit Facilities, substantially 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 September 30, 2014 of approximately $3.7 million.
We do not hold any derivative financial or commodity instruments, nor do we engage in any foreign currency denominated transactions, and all of our cash and cash equivalents are held in money market and checking funds.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) that are designed to provide reasonable assurance that information required to be disclosed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Our management, under the supervision and with the participation of our Board of Directors, Chief Executive Officer and Chief Financial Officer, conducted an evaluation, pursuant to Rule 13a-15(b) and 15d-15(b) promulgated under the Exchange Act, of the effectiveness of our disclosure controls and procedures. As a result, the Board of Directors and management concluded that our disclosure controls and procedures were effective as of September 30, 2014.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal controls over financial reporting during the first nine months of 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
Item 1. Legal Proceedings
We are party to certain legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. For further information, see Note 9 “Commitments and Contingencies” to our consolidated financial statements.
Item 1A. Risk Factors
Certain risks associated with our business, our indebtedness, and acquisitions we have made or may make are discussed in our 2013 Annual Report on Form 10-K under the heading “Risk Factors” in Item 1A of that report. In addition, we note the following risks related to the Offers as defined herein.
On November 7, 2014, we commenced exchange offers (the “Exchange Offers”) to holders of our 10.25% Notes and 15.00%/15.00% Notes (together, the “Existing Notes”) that, if consummated, would substantially reduce our total long-term debt. However, the Exchange Offers are subject to conditions that may not be satisfied and there can be no assurance that the Exchange Offers will be consummated.
As further described in our Current Report on Form 8-K filed with the SEC on November 10, 2014, on November 7, 2014, we commenced Exchange Offers and related consent solicitations (together with the Exchange Offers, the “Offers”) to holders of our Existing Notes, pursuant to which such holders may tender their Existing Notes in exchange for a combination of new 8.50% Senior Secured Notes due 2019, common stock of Holdings and/or warrants, as applicable, to purchase such common stock of Holdings. If the Offers are consummated, our total long-term debt would be substantially reduced and substantially all of the restrictive covenants and related events of default in the 10.25% Notes Indenture and the 15.00%/15.00% Notes Indenture would be eliminated. However, the consummation of the Offers is subject to the satisfaction of certain conditions, including, but not limited to, the tender of a minimum aggregate principal amount of 95% (the “Minimum Tender Conditions”) of each series of Existing Notes. There can be no assurance that the Minimum Tender Conditions or any other condition to the Offers will be satisfied and, therefore, the Offers may not be consummated. If we do not consummate the Offers, we will continue to have our current high level of indebtedness, which could have a material adverse effect on our business, financial condition and results of operations, and we may be forced to seek alternative methods of refinancing our existing indebtedness, including the Existing Notes.
Even if the Offers are consummated, we will continue to have a high level of indebtedness, which could adversely affect our financial condition and ability to obtain financing in the future and react to changes in our business.
Although the consummation of the Offers would substantially reduce our debt burden and related interest expense and extend the debt maturity of certain of our debt, following the consummation of the Offers, we will continue to have a high level of indebtedness. As of September 30, 2014, after giving pro forma effect to the consummation of the Offers and assuming 100% participation therein, our total consolidated debt would have been approximately $683.1 million. Such a level of debt and the related payment obligations could continue to have important consequences for our financial condition, including:
• | continuing to have limited ability to incur additional indebtedness other than certain types of refinancings or extensions; |
• | retaining to a significant degree our vulnerability to general adverse economic, competitive and industry conditions; |
• | limiting our access to capital to fund future working capital needs, capital expenditures, execution of our business strategy, acquisitions, operations and other general corporate requirements; |
• | limiting our ability to retain key employees or attract new employees, including by potentially limiting the funds available for compensation; and |
• | limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate. |
In addition, borrowings under the Credit Agreement bear interest at variable rates. If market interest rates increase, variable-rate debt will create higher debt service requirements, which could adversely affect our cash flow. While we may enter into agreements limiting our exposure to higher interest rates, any such agreements may not offer complete protection from this risk, and may create additional costs or risks of their own.
Our ability to make payments on and refinance our debt, fund capital expenditures and execute our business strategy depends on our ability to generate cash flow in the future. To some extent, this is subject to general economic, financial, competitive and other factors that are beyond our control. Even if the Offers are consummated, there can be no assurance that our business will generate cash flows at or above current levels or that we will be able to meet our cash needs, including with respect to the
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payment of interest or the repayment of our indebtedness, including any cash payments due upon the maturity of such indebtedness.
If we are unable to service our debt, we could face difficulty in funding fixed operating expenses, be forced to pare back operations, further restructure our debt or seek additional equity capital, and we may be unable to take any of these actions on satisfactory terms or in a timely manner, or at all. Further, any of these actions may not be sufficient to allow us to service our debt obligations or may have a materially adverse effect on our results of operations and financial condition. In addition, the agreements that would govern our outstanding debt if the Offers are consummated would continue to limit our ability to take certain of these actions. If we cannot make scheduled payments on our debt, we would be in default, and as a result, holders of such debt could declare all outstanding principal and interest to be due and payable and our existing and future lenders could, under certain circumstances, terminate their commitments to lend us money and foreclose against the assets securing our borrowings.
If the Offers are consummated but less than all of the Existing Notes are exchanged in the Offers, we will continue to have certain ongoing obligations with respect to such remaining Existing Notes.
With respect to any Existing Notes that may remain outstanding following the Offers (if consummated), the 10.25% Notes Indenture will continue to require iPayment, among other things, to make semiannual cash interest payments on the 10.25% Notes, and the 15.00%/15.00% Notes Indenture will continue to require Holdings, among other things, to make cash and/or payment-in-kind interest payments on the 15.00%/15.00% Notes on a semiannual basis. To the extent that the Offers are consummated but less than all of the Existing Notes are exchanged in the Exchange Offers, Holdings and/or iPayment, as applicable, will continue to be subject to these ongoing obligations until such Existing Notes mature, are repaid in full or otherwise cease to be outstanding.
There can be no assurance that these obligations, or a failure by us to comply with any of these obligations, will not have a material adverse effect on our results of operations and financial condition, including because the Credit Agreement has certain cross-default provisions that could be triggered by any default with respect to such obligations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
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.
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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: November 14, 2014 | By: | /s/ Carl A. Grimstad | ||
Carl A. Grimstad | ||||
Chairman and Chief Executive Officer | ||||
Date: November 14, 2014 | By: | /s/ Mark C. Monaco | ||
Mark C. Monaco | ||||
Executive Vice President, Chief Financial Officer, | ||||
Treasurer and Director | ||||
(Principal Financial 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: November 14, 2014 | By: | /s/ Carl A. Grimstad | ||
Carl A. Grimstad | ||||
Chairman and Chief Executive Officer | ||||
Date: November 14, 2014 | By: | /s/ Mark C. Monaco | ||
Mark C. Monaco | ||||
Executive Vice President, Chief Financial Officer, | ||||
Treasurer and Director | ||||
(Principal Financial Officer) | ||||
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EXHIBIT INDEX
Exhibit | Incorporated herein by reference | |||||
Number | Description | Form | Date | |||
18.1 | Preferability Letter of Independent Registered Public Accounting Firm dated August 13, 2014. | 10-Q | August 14, 2014 | |||
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† | 1.1.1 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. |
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