10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K


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

For the fiscal year ended December 31, 2008


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

For the transition period from to

Commission file number 000-50280

iPayment Inc.

(Exact name of Registrant as specified in its charter)


Delaware		62-1847043

(State or other jurisdiction		(IRS Employer
of incorporation or organization)		Identification No.)

40 Burton Hills Boulevard, Suite 415
Nashville, Tennessee		37215

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (615) 665-1858

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes þ No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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. (Check one):


Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ (Do not check if a smaller reporting company)		Smaller reporting company o

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

Aggregate market value of registrant’s common stock held by non-affiliates of the registrant as of February 28, 2009, was NONE.

There is no trading market for the common stock of the Registrant.

Number of shares of the registrant’s common stock outstanding as of February 28, 2009, was 100.

Documents incorporated by reference: NONE

Caution Regarding Forward-Looking Statements

This Form 10-K contains forward-looking statements about iPayment, Inc. within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. For example, statements in the future tense, words such as “anticipates,” “estimates,” “expects,” “intends,” “plans,” “believes,” and words and terms of similar substance used in connection with any discussion of future results, performance or achievements identify such forward-looking statements. Those forward-looking statements involve risks and uncertainties and are not guarantees of future results, performance or achievements, and actual results, performance or achievements could differ materially from the Company’s current expectations as a result of numerous factors, including those discussed in the “Risk Factors” section in Item 1 of this Form 10-K and elsewhere in this Form 10-K and the documents incorporated by reference in this Form 10-K.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially including but not limited to the following: acquisitions; liability for merchant chargebacks; reserve for merchant advance losses; violations of covenants governing the Company’s indebtedness; weakening consumer spending and a generally weak economy; actions taken by its bank sponsors; migration of merchant portfolios to new bank sponsors; the Company’s reliance on card payment processors and on independent sales groups; changes in interchange fees; risks associated with the unauthorized disclosure of data; imposition of taxes on Internet transactions; actions by the Company’s competitors; and risks related to the integration of companies and merchant portfolios the Company has acquired or may acquire. Any forward-looking statements contained in this Form 10-K or in the documents incorporated herein by reference reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We have no intention, and disclaim any obligation, to update or revise any forward-looking statements, whether as a result of new information, future results or otherwise. Readers should not place undue reliance on forward-looking statements, which reflect our view only as of the date of this Form 10-K.

Throughout this document, the terms “iPayment”, the “Company”, “we”, “us”, “our” and similar terms refer to iPayment, Inc., and, unless the context indicates otherwise, its consolidated subsidiaries.

PART I

ITEM 1 Business

We are a provider of credit and debit card-based payment processing services focused on small merchants across the United States. As of December 31, 2008, we provided our services to approximately 145,000 active small merchants. We define a merchant as “active” if the merchant processes at least one Visa or MasterCard transaction in a given month. The small merchants we serve have an average charge volume of approximately $185,000 per year and typically have an average transaction value of approximately $70. These merchants have traditionally been underserved by larger payment processors due to the difficulty in identifying, servicing and managing the risks associated with them. As a result, these merchants have historically paid higher transaction fees than larger merchants.

Our payment processing services enable merchants to process both traditional card-present, or “swipe,” transactions, as well as card-not-present transactions. A traditional card-present transaction occurs whenever a cardholder physically presents a credit or debit card to a merchant at the point-of-sale. A card-not-present transaction occurs whenever the customer does not physically present a payment card at the point-of-sale and may occur over the Internet, mail, fax or telephone.

We believe our experience and knowledge in providing payment processing services to small merchants gives us the ability to effectively evaluate and manage the payment processing needs and risks that are unique to small businesses. In order to identify small merchants, we market and sell our services primarily through independent sales groups, which gives us a non-employee, external sales force, as well as a direct sales force. Our relationships with the independent sales groups allow us to access a large and experienced sales force with a local presence providing access to small merchants over a broad geographic area without incurring the additional overhead costs associated with an internal sales force. Independent sales groups and sales agents may market and sell our services to merchants under their own brand name and directly approach merchants and enroll them for our services. We enable merchants to accept credit and debit cards as payment for their merchandise and services by providing processing, risk management, fraud detection, merchant assistance and support and chargeback services in connection with disputes with cardholders. In addition, we rely on third-party processors to provide card authorization and data capture, and banks to sponsor us for membership in the Visa and MasterCard associations and to settle transactions with merchants. We believe that this structure allows us to maintain an efficient operating structure, and enables us to easily expand our operations without significantly increasing our fixed costs.

The Nilson Report, a publication specializing in consumer payment systems worldwide, listed us in its 2007 ranking of the top bank card acquirers, or owners of merchant card processing contracts, as one of the largest providers of card-based payment processing services in the United States. Due to the challenging economic environment, our merchant processing volume, which represents the total value of transactions processed by us, declined slightly to $26,783 million in 2008 compared to $26,797 million in 2007. Corresponding to the decrease in charge volume in the fourth quarter of 2008, our revenues also decreased. We currently expect this trend to continue in 2009. However, we believe our ability to recruit and retain independent sales groups, combined with our experience in identifying, completing and integrating acquisitions, provides us with significant opportunities for future growth in an economic recovery.

Historical Developments

In December 2004, we entered into an Asset Purchase Agreement with First Data Merchant Services Corporation (“FDMS”), a subsidiary of First Data Corporation, pursuant to which we acquired a portfolio of merchant contracts (the “FDMS Merchant

Portfolio”) from FDMS for a price of $130.0 million in cash. The portfolio had over 25,000 small merchant accounts representing approximately $9 to $10 billion in annual bankcard volume. The transaction strengthened our existing strategic relationship with First Data’s merchant services unit.

Pursuant to the Asset Purchase Agreement and one in 2003, we also entered into service agreements (the “Service Agreements”) with FDMS pursuant to which FDMS agreed to perform certain data processing and related services with respect to the merchant contracts acquired through 2011. In consideration for entering into the Service Agreements, we were required to pay FDMS an annual processing fee related to the acquired merchant contracts of at least $7.4 million in 2008, and for subsequent years, at least 70% of the amount of the actual processing fees paid during the immediately preceding year. We are also required to pay FDMS certain additional amounts in accordance with the terms of the Service Agreements, including certain special fees for amounts paid to third-party providers. We also have agreed to utilize FDMS to process at least 75% of our consolidated transaction sales volume in any calendar year for the term of the Service Agreements and are required to pay FDMS an amount representing the fees that it would have received if we had submitted the required minimum number of transactions. We do not currently expect that we will be required to pay such a fee based on our present business plan.

Industry Overview

The use of card-based forms of payment, such as credit and debit cards, by consumers in the United States has increased steadily over the past ten years and is expected to continue to increase. According to The Nilson Report, total purchases by U.S. consumers using Visa and MasterCard card-based systems grew from approximately $2.5 trillion in 2006 to $2.7 trillion in 2007, and are expected to grow to approximately $3.8 trillion by 2012, representing a compound annual growth rate of approximately 7.1% from 2007 to 2012. The proliferation of credit and debit cards has made the acceptance of card-based payment a necessity for businesses, both large and small, in order to remain competitive.

According to The Nilson Report, in 2007, there were approximately 6.1 million merchant locations in the United States which generated approximately $2,690 billion of annual Visa and MasterCard charge volume. We focus exclusively on the small merchant segment, which we believe generates a disproportionate amount of the payment processing industry’s net revenue. Based on estimates from First Annapolis, we believe that although small merchants (defined by First Annapolis to be merchants with less than $10 million of annual charge volume) generate only approximately 40% of Visa and MasterCard annual charge volume, they account for approximately 80% of annual revenue (net of interchange and assessment fees) generated from payment processing.

The weakening economy has affected the card-based payment industry. Visa and MasterCard noted both declining charge volumes and declining purchase transactions in the fourth quarter of 2008. In a generally weak economy, continued decreases in consumer spending could affect the performance and growth of the card-based payment industry.

Services

We provide a comprehensive solution for merchants accepting credit cards, including the various services described below:

Application Evaluation Underwriting. We recognize that there are varying degrees of risk associated with different merchants based on the nature of their businesses, processing volume and average transaction amounts. We apply varying levels of scrutiny in our application evaluation and underwriting of prospective merchant accounts, ranging from basic due diligence for merchants with a low risk profile to a more thorough and detailed review for higher risk merchants. The results of this review serve as the basis for our decision whether to accept or reject a merchant account and also provide the criteria for establishing reserve requirements, processing limits, average transaction amounts and pricing, which assist us in monitoring merchant transactions for those accounts that exceed pre-determined criteria.

Merchant Set-up and Training. After we establish a contract with a merchant, we create the software configuration that is downloaded to the merchant’s credit card terminal or computer. This configuration includes the merchant identification number, which allows the merchant to accept Visa and MasterCard as well as any other payment cards such as American Express, Discover and Diners Club provided for in the contract. The configuration might also accommodate check verification and gift and loyalty programs. If a merchant requires a pin-pad to accept debit cards, the configuration allows for the terminal or computer to communicate with the peripheral device. After the download has been completed, we conduct a training session on use of the products.

Transaction Processing. A transaction begins with authorization of the customer’s credit or debit card. The transaction data is captured by the processor and electronically transmitted to the issuer of the card, which then determines availability of credit or debit funds. The issuer then communicates an approval decision back to the merchant through the processor. This process typically takes less than five seconds. After the transaction is completed, the processor transmits the final transaction data to the card issuer for settlement of funds. Generally, we outsource these services to third-party processors.

Risk Management/ Detection of Fraudulent Transactions. Our risk management staff relies on the criteria set by the underwriting department to assist merchants in identifying and avoiding fraudulent transactions by monitoring exceptions and providing access to other resources for fraud detection. By employing these and other risk management procedures, we enable our merchants to balance the risk of fraud against the loss of a valid transaction.

Merchant Service and Support. We provide merchants with ongoing service and support. Customer service and support includes answering billing questions, responding to requests for supplies, resolving failed payment transactions, troubleshooting and repair of equipment, educating merchants on Visa and MasterCard compliance, and assisting merchants with pricing changes and purchases of additional products and services. We maintain a toll-free help-line, which is staffed by our customer service representatives. The

information access and retrieval capabilities of our proprietary decision support systems provide our customer service representatives prompt access to merchant account information and customer call history. This data allows them to quickly respond to inquiries relating to fees, charges and funding of accounts as well as technical issues.

Chargeback Service. In the event of a billing dispute between a cardholder and a merchant, we assist the merchant in investigating and resolving the dispute as quickly and as accurately as possible. Before instructing the cardholder’s bank to debit the merchant’s account for the chargeback, we provide the merchant with the opportunity to demonstrate that the transaction was valid. If the merchant is unable to demonstrate that the transaction was valid and the dispute is resolved in favor of the cardholder, the transaction is charged back to the merchant, and that amount is credited to the cardholder. For the year ended December 31, 2008, chargeback losses as a percentage of our total charge volume were approximately 1.6 basis points.

Merchant Reporting. We organize our merchants’ transaction data into various files for merchant accounting purposes. We use this data to provide merchants with information, such as charge volume, discounts, fees and funds held for reserves to help them track their account activity. Merchants may access this archived information through our customer service representatives or online through our Internet-based customer service system.

The transactions for which we provide processing services involve the following third parties:

	•		Merchants. Merchants are the businesses that accept payment cards, including Visa and MasterCard, as payment for their merchandise and services.

	•		Sponsoring Banks. Sponsoring banks are financial institutions that are Visa and MasterCard association members and provide the funds on behalf of the card user, enabling merchants to accept payment cards.

	•		Processing Vendors. Processing vendors, which may include banks, gather sales information from merchants, obtain authorization for merchants’ transactions from card issuers, facilitate the collection of funds from sponsoring banks for payment to merchants and provide merchant accounting and settlement services on our behalf.

The following diagram illustrates the relationship between a merchant, a processing vendor, a sponsoring bank and us:

We derive the majority of our revenues from fee income related to transaction processing, which is primarily comprised of a percentage of the dollar amount of each transaction we process, as well as a flat fee per transaction. The percentage we charge varies upon several factors, including the transaction amount, as well as whether the transaction process is a swipe transaction or a non-swipe transaction. On average, the gross revenue we generate from processing transactions equals approximately $2.50 for every $100 transaction we process, excluding costs and expenses. The following diagram illustrates the percentage of a typical transaction amount paid to the processing bank, the Visa and MasterCard card associations and us:

An Example of Typical $100 Transaction


Purchase amount	$	100.00
Less cash to merchant		97.50
Average iPayment gross revenue		2.50
Average iPayment processing margin		0.40

Distribution of $2.50 Revenue

Visa and MasterCard credit card transactions represent substantially all of the total card transaction volume generated by all of our merchant accounts.

Marketing and Sales

We market and sell our services to merchants primarily through a network of independent sales groups throughout the United States. As of December 31, 2008, we marketed and sold our services through independent sales groups, a non-employee, external sales force with which we have contractual relationships. These relationships are typically mutually non-exclusive, permitting us to establish relationships with multiple independent sales groups and permitting our groups to enter into relationships with other providers of payment processing services. We believe that this sales approach provides us with access to an experienced sales force to market our services with limited investment in sales infrastructure and management time. We believe our focus on the unique needs of small merchants allows us to develop compelling offerings for our independent sales groups to bring to prospective merchants and provides us with a competitive advantage in our target market. Among the services and capabilities we provide are rapid application response time, merchant application acceptance by fax or on-line submission, superior customer service and merchant reporting. We keep an open dialogue with our independent sales groups to address their concerns as quickly as possible and to work with them in investigating chargebacks or potentially suspicious activity with the aim of ensuring their merchants do not unduly suffer downtime or the unnecessary withholding of funds.

As compensation for their referral of merchant accounts, we pay our independent sales groups an agreed-upon residual, or percentage of the revenues we derive from the transactions we process from the merchants they refer to us. The amount of the residuals we pay to our independent sales groups varies on a case-by-case basis and depends on several factors, including the number of merchants each group refers to us. We provide additional incentives to our independent sales groups, including, from time to time, loans that are secured by and repayable from future compensation that may be earned by the groups in respect of the merchants they have referred to us. As of December 31, 2008, we had outstanding loans to independent sales groups in an aggregate amount of $1.0 million, and we may decide to loan additional amounts in the future. We have a limit of $20.0 million on the amount of loans we may make to independent sales groups in accordance with the terms of our senior secured credit facility. The notes representing these loans bear interest in amounts ranging from 6% to 12% and are due through 2010. We secure the loans by attaching the independent sales groups’ assets, including the rights they have to receive residuals and fees generated by the merchants they refer to us and any other accounts receivable and typically by obtaining personal guarantees from the individuals who operate the independent sales groups. In addition, we offer the independent sales groups more rapid and consistent review and acceptance of merchant applications than may be available from other service providers.

Relationships with Sponsors and Processors

In order to provide payment processing services for Visa and MasterCard transactions, we must be sponsored by a financial institution that is a principal member of the Visa and MasterCard card associations. Additionally, we must be registered with Visa as an independent sales organization and with MasterCard as a member service provider.

Sponsoring Banks. We have agreements with several banks that sponsor us for membership in the Visa and MasterCard card associations and settle card transactions for our merchants. The principal sponsoring bank through which we process the significant majority of our transactions is Wells Fargo, and our other sponsoring banks are HSBC Bank USA and JPMorgan Chase. The initial term of our agreement with Wells Fargo lasts through June 2010 and will thereafter automatically continue unless either party provides the other at least six months notice of its intent to terminate. These sponsoring banks may terminate their agreements with us if we materially breach the agreements and do not cure the breach within an established cure period, if our membership with Visa or MasterCard terminates, if we enter bankruptcy or file for bankruptcy, or if applicable laws or regulations, including Visa and MasterCard regulations, change to prevent either the applicable bank or us from performing its services under the agreement. The agreements generally define a material breach as a failure to perform a material obligation under the agreement, specifically any breach of any warranty, representation or covenant or condition or term of the agreement, such as noncompliance with applicable laws, failure to provide relevant documentation as to certain account related data, failure to provide a marketing plan upon request, failure to maintain a transfer account or failure to pay for services. From time to time, we may enter into agreements with additional banks. If these sponsorships are terminated and we are unable to secure a bank sponsor, we will not be able to process bankcard transactions. Furthermore, our agreements with our sponsoring banks provide the sponsoring banks with substantial discretion in approving certain elements of our business practices, including our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants, the processing fees that we charge, our customer service levels and our use of independent sales groups. We cannot guarantee that our sponsoring banks’ actions under these agreements will not be detrimental to us, nor can we guarantee that any of our sponsoring banks will not terminate their sponsorship of us in the future.

Processing Vendors. We have agreements with several processing vendors to provide to us, on a non-exclusive basis, transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. Our primary processing vendor is FDMS through which we have undertaken to process 75% of our annual transactions. Pursuant to the terms of our Asset Purchase Agreement with FDMS, we commenced receiving revenue from these accounts on January 1, 2004. For a further summary of the key terms of our agreement with FDMS, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” We also use the services of TSYS Acquiring Solutions and Global Payments Direct, Inc., and certain of our agreements with these processing vendors include minimum commitments for transaction processing. If we submit a number of transactions that is lower than the minimum, we are required to pay to the processing vendor the fees that it would have received if we had submitted the required minimum number of transactions. FDMS, TSYS Acquiring Solutions and Global Payments Direct agreements may be terminated by the processing vendor if we materially breach certain sections of the agreements and we do not cure the breach within 30 days, if our membership with Visa or MasterCard terminates, if we enter bankruptcy or file for bankruptcy, or if applicable laws or regulations, including Visa and MasterCard regulations, change to prevent either the applicable processing vendor or us from performing its services under these agreements. In addition, Global Payments

Direct may terminate upon 60 days notice prior to the end of the current term.

Our Merchant Base

We serve a diverse portfolio of small merchants. As of December 31, 2008, we provided processing services to approximately 145,000 active small merchants located across the United States and engaged in a wide variety of businesses. We define a merchant as “active” if the merchant processes at least one Visa or MasterCard transaction in a given month.

Primary Merchant Categories Based on Our Historical Charge Volume

No single merchant accounted for more than 3% of our aggregate transaction volume for 2008. We believe that this merchant diversification makes us less sensitive to shifting economic conditions in the industries or regions in which our merchants operate. We believe that the loss of any single merchant would not have a material adverse effect on our financial condition or results of operations.

Generally, our agreements with merchants are for one or two years and automatically renew for additional one year periods unless otherwise terminated. Our sponsoring banks are also a party to these agreements. The merchants are obligated to pay for all chargebacks, fines, assessments, and fees associated with their merchant account, and in some cases, annual fees and early termination fees. Generally, the sponsoring bank may terminate the agreement for any reason on 30 days notice, and the merchant may terminate the agreement on 30 days notice, subject to the payment of any applicable early termination fees. Typically, the agreement may also be terminated by the sponsoring bank immediately upon a breach by the merchant of any of its terms. Generally, the agreement may not be assigned by the merchant without the prior written consent of the sponsoring bank.

Merchant attrition is expected in the payment processing industry in the ordinary course of business; however, we believe the low average transaction volume of the merchants whose accounts we service makes them less likely to change providers because of the inconvenience associated with a transfer. During 2008, we experienced monthly attrition ranging from 1.0% to 3.0% of our total charge volume. Declining merchant charge volume due to weakening general economic conditions may increase attrition. Much of our attrition is related to newly formed small businesses that ultimately fail. Because the transaction volumes of these unsuccessful businesses typically never reach meaningful levels, they do not significantly contribute to the profitability of our business. Accordingly, our merchant attrition related to failed businesses does not significantly reduce our revenues.

We believe that we have extensive experience and resources which allow us to assess the risks associated with providing payment processing services to small merchants. These risks include the limited operating history of many of the small merchants we serve and the risk that these merchants could be subject to a higher rate of insolvency, which could adversely affect us financially. In addition, because a larger portion of their sales are card-not-present transactions in relation to transactions of larger merchants, small merchants are more vulnerable to customer fraud.

Risk Management

As a result of our exposure to potential liability for merchant fraud, chargebacks, and other losses created by our merchant services business, we view our risk management and fraud avoidance practices as integral to our operations and overall success.

We currently have a staff of approximately 34 employees dedicated to risk management operations, which encompasses underwriting new accounts, monitoring and investigating merchant account activity for suspicious transactions or trends and avoiding or recovering losses. Effective risk management helps us minimize merchant losses for the mutual benefit of our merchant customers and ourselves. Our risk management procedures also help protect us from fraud perpetrated by our merchants. We believe our knowledge and experience in dealing with attempted fraud, established as a result of our management’s extensive experience with higher risk market segments, has resulted in our development and implementation of highly effective risk management and fraud prevention systems and procedures.

We employ the following systems and procedures to minimize our exposure to merchant fraud and card-not-present transaction fraud:

	•		Underwriting. Our sales agents send new applications to our underwriting department for their review and screening. All of our underwriters have previous industry underwriting experience and have the authority to render judgment on new applications or to take additional actions such as adjusting processing limits, average charge per transaction or reserve requirements for new and existing merchants. We obtain a personal guaranty from most of the owners of new merchants we enroll.

	•		Proprietary Management Information Systems. Our proprietary systems automatically generate credit reports on new applicants, categorize risk based on all of the information provided and place the applications in a queue to be processed by our underwriting staff. The underwriting staff can access all of the collected information on a merchant online in order to render a decision on whether to approve or reject an application or whether to seek additional information.

	•		Merchant Monitoring. We provide several levels of merchant account monitoring to help us identify suspicious transactions and trends. Daily merchant activity is downloaded to our Bankcard Application Manager system from our third-party processors such as FDMS and is sorted into a number of customized reports by our proprietary systems. Our risk management team also generates daily reports that highlight all exceptions to the established daily merchant parameters such as average ticket size, total processing volume or expected merchandise returns. Our risk management team also reviews daily reports regarding our merchant advances to monitor processing volume and expected return of capital.

	•		Risk Review Department. We have established an in-house risk review department that monitors the sales activities of all of the merchants that we service. Our risk review department focuses particular attention on fewer than 2,000 merchants in our portfolio, measured by volume, average ticket and other criteria, which accounted for approximately 2% of our total charge volume in 2008, and which we believe represent a higher risk group of merchants. The risk review department conducts background checks on these merchants, interviews merchants, anonymously purchases products and services, reviews sales records and follows developments in risk management procedures and technology. The risk review department reports to the risk committee, consisting of our President, Chief Executive Officer and Chief Financial Officer.

	•		Investigation and Loss Prevention. If a merchant exceeds any approved parameter as established by our underwriting and/or risk management staff or violates regulations established by the applicable card association or the terms of our agreement with the merchant, an investigator will identify the incident and take appropriate action to reduce our exposure to loss, as well as the exposure of our merchants. This action may include requesting additional transaction information, instructing the merchant acquirer/processor to retrieve, withhold or divert funds, verifying delivery of merchandise or even deactivating the merchant account.

	•		Reserves. We require some of our merchants to post reserves (cash deposits) that we use to offset against chargebacks we incur. Our sponsoring banks hold reserves related to our merchant accounts as long as we are exposed to loss resulting from a merchant’s processing activity. In the event that a small company finds it difficult to post a cash reserve upon opening an account with us, we may build the reserve by retaining a percentage of each transaction the merchant performs. This solution permits the merchant to fund our reserve requirements gradually as its business develops. As of December 31, 2008, these reserves (which are not included in our accompanying consolidated balance sheet) totaled approximately $59.9 million.

Technology

In the course of our operations, we solicit, compile and maintain a large database of information relating to our merchants and their transactions. We place significant emphasis on providing a high level of security in order to protect the information of our merchants and their customers. We have complied with Visa and Mastercard’s security standards for the last four years. We have deployed the latest generation of network intrusion detection technology and system monitoring appliances to enhance our level of protection.

Our internal network configuration provides multiple layers of security to isolate our databases from unauthorized access and implements detailed security rules to limit access to all critical systems. We cannot be sure that these security measures will be sufficient to prevent unauthorized access to our internal network. Application components communicate using sophisticated security protocols and are directly accessible by a limited number of employees on a need-only basis. Our operation and customer support systems are primarily located at our facilities in Calabasas, California.

We also rely on connections to the systems of our third-party processing providers. In all cases, we install encrypted or tunneled communications circuits with backup connectivity to withstand telecommunications problems.

Competition

The payment processing industry is highly competitive. We compete with other providers of payment processing services on the basis of the following factors:

	•		quality of service;

	•		reliability of service;

	•		ability to evaluate, undertake and manage risk;

	•		speed in approving merchant applications; and

	•		price.

Many small and large companies compete with us in providing payment processing services and related services for card-not-present and card-present transactions to a wide range of merchants. There are a number of large transaction processors, including FDMS, National Processing Company, Global Payments, Inc. and NOVA Information Systems, Inc. (a subsidiary of U.S. Bancorp), that serve a broad market spectrum from large to small merchants and provide banking, ATM and other payment-related services and systems in addition to card-based payment processing. There are also a large number of smaller transaction processors that provide various services to small and medium sized merchants. Many of our competitors have substantially greater capital resources than we have and operate as subsidiaries of financial institutions or bank holding companies, which may allow them on a consolidated basis to own and conduct depository and other banking activities that we do not have the regulatory authority to own or conduct. This may allow our competitors to offer more attractive fees to our current and prospective merchants, or other products or services that we do not offer. We believe that our specific focus on smaller merchants, in addition to our understanding of the needs and risks associated with providing payment processing services to small merchants and smaller independent sales groups, gives us a competitive advantage over larger competitors, which have a broader market perspective and over competitors of a similar or smaller size that may lack our extensive experience and resources.

Segment Information and Geographical Information

We consider our business activities to be in a single reporting segment as we realize greater than 90% of our revenue and results of operations from one business segment representing processing revenues and other fees from card-based payments. During 2008, 2007 and 2006, no single merchant represented 3% or more of our revenues. All revenues are generated and all of our long-lived assets are located in the United States. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of the impact of seasonality on our business.

Our History

iPayment Technologies, Inc., (“Technologies”) was formed in 1992 as a California corporation. In February 2001, we were formed by the majority stockholders of Technologies, as a Tennessee corporation, under the name iPayment Holdings, Inc. as a holding company for Technologies and other card processing businesses. We then appointed Gregory S. Daily as our Chief Executive Officer and Chairman of the Board.

In August 2002, we were reincorporated in Delaware under the name iPayment, Inc. and in May 2003 we completed an initial public offering of 5,625,000 shares of common stock raising net proceeds of approximately $75.6 million. Immediately prior to the offering we effected a reverse split of our outstanding common stock of 0.4627 shares for each share outstanding.

On May 10, 2006, pursuant to an Agreement and Plan of Merger dated as of December 27, 2005, by and among two new entities, iPayment, MergerCo and iPayment Holdings, MergerCo was merged with and into iPayment, Inc., with iPayment, Inc. remaining as the surviving corporation and a wholly-owned subsidiary of iPayment Holdings. Holdings is a wholly-owned subsidiary of iPayment Investors, which is a Delaware limited partnership formed by Gregory S. Daily, the Chairman and Chief Executive Officer of iPayment, Carl M. Grimstad, the President of iPayment, and certain parties related to them.

The total amount of consideration required to consummate the merger and the related transactions was approximately $895.4 million, consisting of (1) approximately $800.0 million to fund the payment of the merger consideration and payments in respect of the cancellation of outstanding stock options, (2) approximately $70.0 million to repay certain existing indebtedness of iPayment and (3) approximately $25.4 million to pay transaction fees and expenses. These funds were obtained from equity and debt financings as follows:

	•		equity financing in an aggregate amount of $170.0 million provided through (1) the delivery of an aggregate of $166.6 million of iPayment common stock by Mr. Daily, on his own behalf and on behalf of certain related parties, and by Mr. Grimstad, on his own behalf and on behalf of certain related parties, and (2) approximately $3.4 million of cash provided by Mr. Daily;

	•		a term loan of $515.0 million pursuant to a credit facility entered into between iPayment and a syndicate of lenders, which also included a $60.0 million revolving credit facility;

	•		approximately $202.2 million raised through the private issuance by iPayment of senior subordinated notes; and

	•		approximately $8.2 million funded by cash on hand and borrowings under the revolving credit facility described above.

Employees

As of December 31, 2008, we and our wholly-owned subsidiaries employed 329 full-time personnel, including 16 information systems and technology employees, 34 risk management employees, 213 in operations and 66 in sales and administration. Many of our employees are highly skilled, and we believe our future success will depend in large part on our ability to attract and retain such

Item 1A. Risk Factors

Risks Relating to our Indebtedness

Our substantial debt could adversely affect our financial condition and prevent us from fulfilling our obligations to our debtholders.

As of December 31, 2008, we had consolidated debt of $687.3 million, $494.6 million of which was senior indebtedness. Our substantial indebtedness could adversely affect our financial condition and make it more difficult for us to satisfy our obligations with respect to the debtholders. Our substantial indebtedness and significant reduction in available cash could also:

	•		increase our vulnerability to adverse general economic and industry conditions;

	•		require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, investments, capital expenditures and other general corporate purposes;

	•		limit our ability to make required payments under our existing contractual commitments (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”);

	•		limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

	•		place us at a competitive disadvantage compared to our competitors that have less debt;

	•		create a perception that we may not continue to support and develop certain services;

	•		increase our exposure to rising interest rates because a portion of our borrowings is at variable interest rates; and

	•		limit our ability to borrow additional funds on terms that are satisfactory to us or at all.

We may not be able to generate sufficient cash flow to meet our debt service obligations.

Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt obligations will depend on our future financial performance, which will be affected by a range of economic, competitive, regulatory, legislative and business factors, many of which are outside of our control. For example, one factor impacting our cash flow is earnout payments owed under the terms of our previously consummated acquisitions of businesses and portfolios of merchant accounts. If we do not generate sufficient cash flow from operations to satisfy our debt obligations, including payments on our senior subordinated notes, 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 would be possible or that any assets could be sold on acceptable terms or otherwise. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, would have an adverse effect on our business, financial condition and results of operations, as well as on our ability to satisfy our obligations under our senior secured credit facility and senior subordinated notes. In addition, any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations.

Despite our level of indebtedness, our current credit arrangements allow us to incur substantially more debt. Incurring such debt could further exacerbate the risks to our financial condition.

Although the indenture governing our senior subordinated notes and the credit agreement governing our senior secured credit facility each contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. For example, we are able to incur additional indebtedness if the “fixed charge coverage ratio,” as defined in the indenture governing our senior subordinated notes is above 2 to 1 for the periods set forth in the indenture, and, under certain circumstances, if the indebtedness is of a person acquired by us and we did not incur the indebtedness in contemplation of the acquisition. In addition, we may also incur an aggregate principal amount of additional indebtedness not to exceed $50.0 million. As of December 31, 2008, we would have been able to borrow an additional $60.0 million under our senior secured credit facility, and we and the subsidiary guarantors may be able to incur additional senior debt in the future, including under the senior secured credit facility. To the extent new debt is added to our current debt levels, our substantial leverage risks would increase.

The indenture governing our senior subordinated notes and the credit agreement governing the senior secured credit facility contain covenants that limit our flexibility and prevent us from taking certain actions.

The indenture governing our senior subordinated notes and the credit agreement governing our senior secured credit facility include a number of significant restrictive covenants. These covenants could adversely affect us by limiting our ability to plan for or react to market conditions, meet our capital needs and execute our business strategy. These covenants, among other things, limit our ability and the ability of our restricted subsidiaries to:

	•		incur additional debt;

	•		pay dividends on, redeem or repurchase capital stock;

	•		issue capital stock of restricted subsidiaries;

	•		make certain investments;

	•		sell assets;

	•		enter into certain types of transactions with affiliates;

	•		engage in material unrelated businesses;

	•		incur certain liens; and

	•		consolidate, merge or sell all or substantially all of our assets.

In addition, the credit agreement’s restrictions on us and the subsidiary guarantors are stricter than the indenture governing our senior subordinated notes. Examples of such restrictions are as follows:

	•		The scope of permitted liens under the credit agreement is narrower than under the indenture. For example, the indenture permits us to incur liens to secure up to $5.0 million of additional permitted indebtedness, while the credit agreement permits us to incur liens to secure only up to $1.0 million of additional permitted indebtedness.

	•		The credit agreement contains a general prohibition on restricted payments subject to certain exceptions, while the indenture permits us to make restricted payments up to an amount that is based, in part, on our cumulative consolidated net income since the date of the indenture.

	•		The credit agreement generally prohibits the incurrence of additional indebtedness subject to certain exceptions, while the indenture permits us to incur additional indebtedness provided we maintain a fixed charge coverage ratio of 2:1.

	•		The credit agreement requires us to maintain an agreed consolidated interest coverage ratio and consolidated leverage ratio at the end of each fiscal quarter. There is no comparable requirement in the indenture.

	•		The credit agreement prohibits us from making dispositions of our property other than for cash and not in excess of $2.0 million in any fiscal year. The indenture does not prohibit such dispositions, but requires us to apply the net proceeds therefrom to repay senior debt, make certain investments or expenditures, and otherwise repay our senior subordinated notes.

	•		The credit agreement prohibits us from prepaying our other debt, including our senior subordinated notes, while borrowings under our senior secured credit facility are outstanding.

Our failure to comply with any of these covenants could result in an event of default, which, if not cured or waived, could result in our being required to repay these borrowings before their scheduled due date. If we were unable to make this repayment or otherwise refinance these borrowings, the lenders under the senior secured credit facility could elect to declare all amounts borrowed under the senior secured credit facility, together with accrued interest, to be due and payable, which would be an event of default under the indenture governing our senior subordinated notes. In addition, these lenders could foreclose on our assets. Any future refinancing of the senior secured credit facility is likely to contain similar restrictive covenants and financial tests.

Substantially all of our operations are conducted at the subsidiary level, which may materially adversely affect our ability to service our indebtedness.

The principal assets of iPayment, the issuer of our senior subordinated notes, are the equity interests it holds, directly and indirectly, in its subsidiaries. Our subsidiaries are legally distinct from us and have no obligation to pay amounts due on our debt or to make funds available to us for such payment, other than through guarantees of our debt. Because much of our operations are conducted through our subsidiaries, our ability to service our indebtedness depends upon the earnings of our subsidiaries and the distribution of those earnings, or upon loans or other payments of funds, by our subsidiaries to us. If our subsidiaries do not have sufficient earnings or cannot distribute their earnings or other funds to us, our ability to service our indebtedness may be materially adversely affected.

Additionally, not all of our subsidiaries guarantee our senior subordinated notes. Our subsidiaries that do not guarantee any of our other debt and subsidiaries we designate as unrestricted subsidiaries under the indenture do not guarantee the notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us. As of December 31, 2008, our non-guarantor subsidiaries had total assets of $3.5 million, and total liabilities of $0.9 million, and for the year then ended had total revenues of $35.8 million.

Our senior subordinated notes and the related guarantees are subordinated in right of payment to all of our and the subsidiary guarantors’ existing and future senior debt, and are effectively subordinated to all of our and the subsidiary guarantors’ existing and future secured debt.

Our senior subordinated notes and the related guarantees rank junior in right of payment to all of our existing and future senior debt, including the borrowings under our senior secured credit facility, and all existing creditors and future senior debt of our subsidiary guarantors, respectively. As of December 31, 2008, we had approximately $494.6 million of debt that was senior to our senior subordinated notes and $60.0 million of additional borrowing available under our senior secured credit facility. We may also

incur additional senior or secured debt in the future, consistent with the terms of the indenture governing our senior subordinated notes and our other debt agreements.

As a result of the subordination, upon any distribution to creditors in a bankruptcy, liquidation or reorganization or similar proceeding, the holders of our senior debt or senior debt of any of our subsidiary guarantors will be entitled to be paid in full before we or our subsidiary guarantors make any payment on our senior subordinated notes or related guarantees. Holders of our secured debt and the secured debt of any of our subsidiary guarantors similarly will have claims that are prior to claims of holders of our senior subordinated notes to the extent of the value of the assets securing such debt. The indenture governing the senior subordinated notes requires that amounts otherwise payable to holders of the notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead. As a result, holders of our senior subordinated notes may receive less, ratably, than other creditors. We cannot be sure that sufficient assets will remain after making payments on our senior or secured debt to allow us to make any payments on our senior subordinated notes.

We may not pay principal, premium, if any, interest or other amounts on account of our senior subordinated notes in the event of a payment default or other defaults permitting the acceleration of our designated senior indebtedness, including debt under the senior secured credit facility, unless the designated senior indebtedness has been paid in full, the default has been cured or, in the case of any such nonpayment defaults, a designated period of time has passed.

Fraudulent conveyance laws could void the guarantees of our senior subordinated notes.

Under U.S. bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of that guarantor if, among other things, the subsidiary guarantor, at the time it incurred the indebtedness evidenced by its guarantee either (i) intended to hinder, delay or defraud any present or future creditor; or (ii) received less than reasonably equivalent value or fair consideration for the incurrence of the guarantee and (a) was insolvent or rendered insolvent by reason of the incurrence of the guarantee; (b) was engaged in a business or transaction for which the subsidiary guarantor’s remaining assets constituted unreasonably small capital; or (c) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature.

Moreover, any payments made by a subsidiary guarantor pursuant to its guarantee could be voided and required to be returned to the subsidiary guarantor, or to a fund for the benefit of the creditors of the subsidiary guarantor. To the extent that any guarantee is voided as a fraudulent conveyance, the claims of holders of our senior subordinated notes with respect to such guarantee would be materially adversely affected.

In addition, a legal challenge of a guarantee on fraudulent transfer grounds will focus on, among other things, the benefits, if any, realized by the relevant subsidiary guarantor as a result of the issuance of our senior subordinated notes. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the governing law. Generally, however, a subsidiary guarantor would be considered insolvent if:

	•		the sum of its debts, including contingent liabilities, were greater than the fair saleable value of all of its assets; or

	•		if the present fair saleable value of its assets were less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

	•		it could not pay its debts as they become due.

On the basis of historical financial information, recent operating history and other factors, we believe that the subsidiary guarantees are being incurred for proper purposes and in good faith and that each subsidiary guarantor, after giving effect to its guarantee of our senior subordinated notes, will not be insolvent, will not have unreasonably small capital for the business in which it is engaged and will not have incurred debts beyond its ability to pay such debts as they mature. There can be no assurance, however, as to what standard a court would apply in making such determinations or that a court would agree with our conclusions in this regard.

The interests of our stockholders may not be aligned with the interests of the holders of our senior subordinated notes.

All of our issued and outstanding equity interests are held indirectly by iPayment Investors, a limited partnership controlled jointly by Gregory S. Daily, our Chairman and Chief Executive Officer, and Carl A. Grimstad, our President. Messrs. Daily and Grimstad own substantially all of the economic interests in iPayment Investors, and are the sole members of the board of directors of its general partner and are the sole members of our board of directors. Circumstances may occur in which the interests of iPayment Investors and its equity holders could be in conflict with the interests of the holders of our senior subordinated notes. Moreover, iPayment Investors’ equity holders may have interests in their other respective investments that could also be in conflict with the interests of the holders of our senior subordinated notes. In addition, iPayment Investors may have an interest in pursuing acquisitions, divestitures or other transactions that, in its judgment, could enhance its equity investment, even though such transactions might involve risks to holders of our senior subordinated notes. For example, iPayment Investors and its equity holders may cause us to pursue a growth strategy (including acquisitions which are not accretive to earnings), which could impact our ability to make payments under the indenture governing our senior subordinated notes and the senior secured credit facility or cause a change of control. In July 2006, iPayment Investors issued $75.0 million of notes payable in 2014, which are subordinated to all debt issued by us, and the net proceeds of which were used by iPayment Investors to pay a dividend to its equity holders. To the extent permitted by the indenture governing our senior subordinated notes and the senior secured credit facility, iPayment Investors may cause us to pay dividends rather than make capital expenditures.

In the event of a change of control, we may not be able to repurchase our senior subordinated notes as required by the indenture, which would result in a default under our indenture.

Upon a change of control under the indenture, we will be required to offer to repurchase all of our senior subordinated notes then outstanding at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest, if any, up to but excluding the repurchase date. Our senior secured credit facility provides that certain change of control events will be an event of default that will permit the required lenders to accelerate the maturity of all borrowings thereunder and terminate commitments to lend thereunder. An acceleration of the maturity of our senior secured credit facility would result in an event of default under our indenture. Any of our future debt agreements may contain similar provisions. We cannot be sure that we will have the financial resources to repurchase the senior subordinated notes, particularly if that change of control event triggers a similar repurchase requirement for, or results in the acceleration of other indebtedness. Our senior secured credit facility also prohibits us from redeeming or repurchasing our senior subordinated notes if a default exists under the senior secured credit facility and if we do not meet specified leverage ratios.

Changes in the financial and credit markets or in our credit ratings could adversely affect the market prices of our senior secured credit facility and our senior subordinated notes.

The future market prices of our senior secured credit facility and our senior subordinated notes depend on a number of factors, including:

	•		the prevailing interest rates being paid by companies similar to us;

	•		our ratings with major credit rating agencies; and

	•		the overall condition of the financial and credit markets.

The condition of the financial and credit markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future. Fluctuations in these factors had adverse effects on the market prices of our senior secured credit facility and our senior subordinated notes in 2008, and further fluctuation may continue these adverse effects. In addition, credit rating agencies continually revise their ratings for companies that they follow, including us. We cannot be sure that any credit rating agencies that rate the senior secured credit facility and senior subordinated notes will maintain their ratings on our credit instruments. A negative change in our rating could have an adverse effect on the market price of the senior secured credit facility and the senior subordinated notes.

Historically, the market for non-investment grade debt has been subject to disruptions that have caused substantial volatility in the prices of securities similar to the senior subordinated notes. The market for the senior subordinated notes, if any, may be subject to similar disruptions. Any such disruptions may adversely affect the value of the senior subordinated notes.

We cannot be sure that an active trading market will be maintained for our senior subordinated notes.

While the senior subordinated notes are eligible for trading in The PORTAL Market, a screen-based automated market for trading securities for qualified institutional buyers, there is no public market for the senior subordinated notes. We do not intend to apply for a listing of any of the senior subordinated notes on any securities exchange. We do not know if an active market will develop for the senior subordinated notes, or if developed, will continue. If an active market is not developed or maintained, the market price and the liquidity of the senior subordinated notes may be adversely affected. In addition, the liquidity and the market price of the senior subordinated notes may be adversely affected by changes in the overall market for high yield securities and by changes in our financial performance or prospects, or in the prospects of the companies in our industry.

Risks Relating to Our Business

We have faced, and may face in the future, significant chargeback liability if our merchants refuse or cannot reimburse chargebacks resolved in favor of their customers, and we face potential liability for merchant or customer fraud; we may not accurately anticipate these liabilities.

We have potential liability for chargebacks associated with the transactions we process. If a billing dispute between a merchant and a cardholder is not ultimately resolved in favor of the merchant, the disputed transaction is “charged back” to the merchant’s bank and credited to the account of the cardholder. If we or our sponsoring banks are unable to collect the chargeback from the merchant’s account, or, if the merchant refuses or is financially unable, due to bankruptcy or other reasons, to reimburse the merchant’s bank for the chargeback, we bear the loss for the amount of the refund paid to the cardholder’s bank. For example, our largest chargeback loss resulted in 2001 and 2002 from the substantial non-compliance by a merchant with the Visa and MasterCard card association rules. We were obligated to pay the resulting chargebacks and losses that the merchant was unable to fund, which totaled $4.7 million.

We also have potential liability for losses caused by fraudulent credit card transactions. Card fraud occurs when a merchant’s customer uses a stolen card (or a stolen card number in a card-not-present transaction) to purchase merchandise or services. In a traditional card-present transaction, if the merchant swipes the card, receives authorization for the transaction from the card issuing bank and verifies the signature on the back of the card against the paper receipt signed by the customer, the card issuing bank remains liable for any loss. In a fraudulent card-not-present transaction, even if the merchant receives authorization for the transaction, the merchant is liable for any loss arising from the transaction. Many of the small merchants that we serve are small businesses that transact a substantial percentage of their sales over the Internet or in response to telephone or mail orders. Because their sales are card-not-present transactions, these merchants are more vulnerable to customer fraud than larger merchants. Because we target these merchants, we experience chargebacks arising from cardholder fraud more frequently than providers of payment processing services that service larger merchants.

Merchant fraud occurs when a merchant, rather than a customer, knowingly uses a stolen or counterfeit card or card number to

record a false sales transaction, or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Anytime a merchant is unable to satisfy a chargeback, we are responsible for that chargeback. We have established systems and procedures to detect and reduce the impact of merchant fraud, but we cannot be sure that these measures are or will be effective. It is possible that incidents of fraud could increase in the future. Failure to effectively manage risk and prevent fraud could increase our chargeback liability.

Charges incurred by us relating to chargebacks were $4.2 million, or 0.5% of revenues in 2008, and were $3.6 million, or 0.5% of revenues, in 2007.

We rely on bank sponsors, which have substantial discretion with respect to certain elements of our business practices, in order to process bankcard transactions; if these sponsorships are terminated and we are not able to secure or successfully migrate merchant portfolios to new bank sponsors, we will not be able to conduct our business.

Because we are not a bank, we are unable to belong to and directly access the Visa and MasterCard bankcard associations. Visa and MasterCard operating regulations require us to be sponsored by a bank in order to process bankcard transactions. We are currently registered with Visa and MasterCard through the sponsorship of banks that are members of the card associations. The principal sponsoring bank through which we process the significant majority of our transactions is Wells Fargo, and our other sponsoring banks are HSBC Bank USA and JPMorgan Chase.

The initial term of our agreement with Wells Fargo lasts through June 2010 and will thereafter automatically continue unless either party provides the other at least six months notice of its intent to terminate. Our sponsoring banks may terminate their agreements with us if we materially breach the agreements and do not cure the breach within an established cure period, if our membership with Visa or MasterCard terminates, if we enter bankruptcy or file for bankruptcy, or if applicable laws or regulations, including Visa and MasterCard regulations, change to prevent either the applicable bank or us from performing services under the agreement. If these sponsorships are terminated and we are unable to secure a bank sponsor, we will not be able to process bankcard transactions. Furthermore, our agreements with our sponsoring banks provide the sponsoring banks with substantial discretion in approving certain elements of our business practices, including our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants, the processing fees that we charge, our customer service levels and our use of independent sales groups. We cannot guarantee that our sponsoring banks’ actions under these agreements will not be detrimental to us, nor can we guarantee that any of our sponsoring banks will not terminate their sponsorship of us in the future.

If we or our bank sponsors fail to adhere to the standards of the Visa and MasterCard credit card associations, our registrations with these associations could be terminated and we could be required to stop providing payment processing services for Visa and MasterCard.

Substantially all of the transactions we process involve Visa or MasterCard. If we or our bank sponsors fail to comply with the applicable requirements of the Visa and MasterCard credit card associations, Visa or MasterCard could suspend or terminate our registration. The termination of our registration or any changes in the Visa or MasterCard rules that would impair our registration could require us to stop providing payment processing services.

We rely on card payment processors and service providers; if they fail or no longer agree to provide their services, our merchant relationships could be adversely affected and we could lose business.

We rely on agreements with several large payment processing organizations to enable us to provide card authorization, data capture, settlement and merchant accounting services and access to various reporting tools for the merchants we serve. In particular, we rely on FDMS through which we have undertaken to process 75% of our annual transactions. We are required to pay FDMS an annual processing fee related to the FDMS Merchant Portfolio and the FDMS Bank Portfolio of at least $5.5 million in fiscal 2009, and for each subsequent year through 2011, of at least 70% of the amount of the processing fee paid during the immediately preceding year. Our gross margins would be adversely affected if we were required to pay these minimum fees as a result of insufficient transactions processed by FDMS.

We also rely on third parties to whom we outsource specific services, such as reorganizing and accumulating daily transaction data on a merchant-by-merchant and card issuer-by-card issuer basis and forwarding the accumulated data to the relevant bankcard associations. Many of these organizations and service providers are our competitors and we do not have long-term contracts with most of them. Typically, our contracts with these third parties are for one-year terms and are subject to cancellation upon limited notice by either party. The termination by our service providers of their arrangements with us or their failure to perform their services efficiently and effectively may adversely affect our relationships with the merchants whose accounts we serve and may cause those merchants to terminate their processing agreements with us.

To acquire and retain merchant accounts, we depend on independent sales groups that do not serve us exclusively.

We rely primarily on the efforts of independent sales groups to market our services to merchants seeking to establish an account with a payment processor. Independent sales groups are companies that seek to introduce both newly-established and existing small merchants, including retailers, restaurants and service providers, such as physicians, to providers of transaction payment processing services like us. Generally, our agreements with independent sales groups that refer merchants to us are not exclusive to us and they have the right to refer merchants to other service providers. Our failure to maintain our relationships with our existing independent sales groups and those serving other service providers that we may acquire, and to recruit and establish new relationships with other groups, could adversely affect our revenues and internal growth and increase our merchant attrition.

On occasion, we experience increases in interchange costs; if we cannot pass these increases along to our merchants, our profit margins will be reduced.

We pay interchange fees or assessments to card associations for each transaction we process using their credit and debit cards. From time to time, the card associations increase the interchange fees that they charge processors and the sponsoring banks. At their

sole discretion, our sponsoring banks have the right to pass any increases in interchange fees on to us. In addition, our sponsoring banks may seek to increase their Visa and MasterCard sponsorship fees to us, all of which are based upon the dollar amount of the payment transactions we process. If we are not able to pass these fee increases along to merchants through corresponding increases in our processing fees, our profit margins will be reduced.

Unauthorized disclosure of merchant and cardholder data, whether through breach of our computer systems or otherwise, could expose us to protracted and costly litigation.

We collect and store sensitive data about merchants and cardholders, including names, addresses, social security numbers, drivers license numbers, checking and savings account numbers and payment history records, such as account closures and returned checks. In addition, we maintain a database of cardholder data relating to specific transactions, including payment card numbers and cardholder addresses, in order to process the transactions and for fraud prevention and other internal processes. If a person penetrates our network security or otherwise misappropriates sensitive merchant or cardholder data, we could be subject to liability or business interruption.

Although we generally require that our agreements with our ISGs and service providers who have access to merchant and customer data include confidentiality obligations that restrict these parties from using or disclosing any customer or merchant data except as necessary to perform their services under the applicable agreements, we cannot be sure that these contractual measures will prevent the unauthorized disclosure of merchant or customer data. In addition, our agreements with financial institutions require us to take certain protective measures to ensure the confidentiality of merchant and consumer data. Any failure to adequately take these protective measures could result in protracted and costly litigation.

The loss of key personnel or damage to their reputations could adversely affect our relationships with independent sales groups, card associations, bank sponsors and our other service providers, which would adversely affect our business.

Our success depends upon the continued services of our senior management and other key employees, in particular Gregory Daily, our Chairman and Chief Executive Officer, all of whom have substantial experience in the payment processing industry and the small merchant markets in which we offer our services. In addition, our success depends in large part upon the reputation and influence within the industry of Mr. Daily, who has, along with our other senior managers, over their years in the industry, developed long standing and highly favorable relationships with independent sales groups, card associations, bank sponsors and other payment processing and service providers. We would expect that the loss of the services of one or more of our key employees, particularly Mr. Daily, would have an adverse effect on our operations. We would also expect that any damage to the reputation of our senior managers, including Mr. Daily, would adversely affect our business. We do not maintain any “key person” life insurance on any of our employees other than a $25.0 million policy on Mr. Daily.

The payment processing industry is highly competitive and such competition is likely to increase, which may further adversely influence our prices to merchants, and as a result, our profit margins.

The market for credit and debit card processing services is highly competitive. The level of competition has increased in recent years, and other providers of processing services have established a sizable market share in the small merchant processing sector. Some of our competitors are financial institutions, subsidiaries of financial institutions or well-established payment processing companies that have substantially greater capital and technological, management and marketing resources than we have. There are also a large number of small providers of processing services that provide various ranges of services to small and medium sized merchants. This competition may influence the prices we can charge and requires us to control costs aggressively in order to maintain acceptable profit margins. Further, if the use of cards other than Visa or MasterCard, such as American Express, grows, or if there is increased use of debit cards this could reduce our average profit per transaction. In addition, our competitors continue to consolidate as large banks merge and combine their networks. This consolidation may also require that we increase the consideration we pay for future acquisitions and could adversely affect the number of attractive acquisition opportunities presented to us. The barriers to entry into our business are relatively low. Our future competitors may develop or offer services that have price or other advantages over the services we provide. If they do so and we are unable to respond satisfactorily, our business and financial condition could be adversely affected.

Increased attrition in merchant charge volume due to an increase in closed merchant accounts that we cannot anticipate or offset with new accounts may reduce our revenues.

We experience attrition in merchant charge volume in the ordinary course of business resulting from several factors, including business closures, transfers of merchants’ accounts to our competitors and account “closures” that we initiate due to heightened credit risks relating to, and contract breaches by, a merchant. We target small merchants that generally have a higher rate of insolvency than larger businesses. During 2008, we experienced attrition ranging from 1.0% to 3.0% per month. Declining merchant charge volume due to weakening general economic conditions may increase attrition. In addition, substantially all of our processing contracts with merchants may be terminated by either party on relatively short notice, allowing merchants to move their processing accounts to other providers with minimal financial liability and cost. We cannot predict the level of attrition in the future, particularly in connection with our acquisitions of portfolios of merchant accounts. Increased attrition in merchant charge volume may have a material adverse effect on our financial condition and results of operations.

Our operating results are subject to seasonality, and, if our revenues are below our seasonal norms during our historically stronger second, third, and fourth quarters, our net income and cash flow could be lower than expected.

We have experienced in the past, and expect to continue to experience, seasonal fluctuations in our revenues as a result of consumer spending patterns. Historically, revenues have been weaker during the first quarter of the calendar year and stronger during the second, third and fourth quarters. If, for any reason, our revenues are below seasonal norms during the second, third or fourth

quarter, our net income and cash flow could be lower than expected.

Our systems may fail due to factors beyond our control, which could interrupt our business or cause us to lose business and would likely increase our costs.

We depend on the efficient and uninterrupted operations of our computer network systems, software and data centers. We do not presently have fully redundant systems. Our systems and operations could be exposed to damage or interruption from fire, natural disaster, power loss, telecommunications failure, unauthorized entry and computer viruses. Our property and business interruption insurance may not be adequate to compensate us for all losses or failures that may occur. Defects in our systems, errors or delays in the processing of payment transactions or other difficulties could result in:

	•		additional development costs;

	•		diversion of technical and other resources;

	•		loss of merchants;

	•		loss of merchant and cardholder data;

	•		negative publicity;

	•		harm to our business or reputation; or

	•		exposure to fraud losses or other liability.

If our merchants experience adverse business conditions, they may generate fewer transactions for us to process or become insolvent, increasing our exposure to chargeback liabilities.

Generally weak economic conditions have caused some of the merchants we serve to experience difficulty in supporting their current operations and implementing their business plans. If these merchants make fewer sales of their products and services, we will have fewer transactions to process, resulting in lower revenues. In addition, in the current recessionary environment, the merchants we serve could be subject to a higher rate of insolvency which could adversely affect us financially. We bear credit risk for chargebacks related to billing disputes between credit card holders and bankrupt merchants. If a merchant seeks relief under bankruptcy laws or is otherwise unable or unwilling to pay, we may be liable for the full transaction amount of a chargeback.

If our merchant advance customers stop processing or become insolvent, our merchant advance loss exposure could increase.

The weakening economy has caused some of our merchant advance customers to fail or close their businesses. In the current recessionary environment, the merchant advance customers we serve are subject to a higher rate of insolvency, which could adversely affect us financially. If a merchant seeks relief under bankruptcy laws or is otherwise unable or unwilling to pay, we will experience losses for the remaining balance of the merchant advance. We no longer offer new merchant advances to our customers, and we will seek to recover any potential losses through other collection efforts.

New and potential governmental regulations designed to protect or limit access to consumer information could adversely affect our ability to provide the services we provide our merchants.

Due to the increasing public concern over consumer privacy rights, governmental bodies in the United States and abroad have adopted, and are considering adopting additional laws and regulations restricting the purchase, sale and sharing of personal information about customers. For example, the Gramm-Leach-Bliley Act requires non-affiliated third-party service providers to financial institutions to take certain steps to ensure the privacy and security of consumer financial information. We believe our present activities fall under exceptions to the consumer notice and opt-out requirements contained in this law for third-party service providers to financial institutions. The law, however, is new and there have been very few rulings on its interpretation. We believe that current legislation permits us to access and use this information as we do now. The laws governing privacy generally remain unsettled, however, even in areas where there has been some legislative action, such as the Gramm-Leach-Bliley Act and other consumer statutes, it is difficult to determine whether and how existing and proposed privacy laws or changes to existing privacy laws will apply to our business. Limitations on our ability to access and use customer information could adversely affect our ability to provide the services we offer to our merchants or could impair the value of these services.

Several states have proposed legislation that would limit the uses of personal information gathered using the Internet. Some proposals would require proprietary online service providers and website owners to establish privacy policies. Congress has also considered privacy legislation that could further regulate use of consumer information obtained over the Internet or in other ways. The Federal Trade Commission has also recently settled a proceeding with one on-line service regarding the manner in which personal information is collected from users and provided to third parties. Our compliance with these privacy laws and related regulations could materially affect our operations.

Changes to existing laws or the passage of new laws could, among other things:

	•		create uncertainty in the marketplace that could reduce demand for our services;

	•		limit our ability to collect and to use merchant and cardholder data;

	•		increase the cost of doing business as a result of litigation costs or increased operating costs; or

	•		in some other manner have a material adverse effect on our business, results of operations and financial condition.

If we are required to pay state taxes on transaction processing, it could negatively impact our profitability.

Transaction processing companies may become subject to state taxation of certain portions of their fees charged to merchants for their services. If we are required to pay such taxes and are unable to pass this tax expense through to our merchant clients, or produce increased cash flow to offset the taxes, these taxes would negatively impact our profitability.

The markets for the services that we offer may fail to expand or may contract and this could negatively impact our growth and profitability.

Our growth and continued profitability depend on acceptance of the services that we offer. If demand for our services decreases, our profitability would be negatively impacted. Changes in technology may enable merchants and retail companies to directly process transactions in a cost-efficient manner without the use of our services. Additionally, downturns in the economy or the performance of retailers may result in a decrease in the demand for our services. Further, if our customers make fewer sales of their products and services, we will have fewer transactions to process, resulting in lower revenue. Any decrease in the demand for our services for the reasons discussed above or other reasons could have a material adverse effect on our growth and revenue.

Risks Relating to Acquisitions

We have previously acquired, and expect to continue to acquire, other providers of payment processing services and portfolios of merchant processing accounts. These acquisitions entail risks in addition to those incidental to the normal conduct of our business.

Revenues generated by acquired businesses or account portfolios may be less than anticipated, resulting in losses or a decline in profits, as well as potential impairment charges.

In evaluating and determining the purchase price for a prospective acquisition, we estimate the future revenues from that acquisition based on the historical transaction volume of the acquired provider of payment processing services or portfolio of merchant accounts. Following an acquisition, it is customary to experience some attrition in the number of merchants serviced by an acquired provider of payment processing services or included in an acquired portfolio of merchant accounts. Should the rate of post-acquisition merchant attrition exceed the rate we have forecasted, the revenues generated by the acquired providers of payment processing services or portfolio of accounts may be less than we estimated, which could result in losses or a decline in profits, as well as potential impairment charges.

We may fail to uncover all liabilities of acquisition targets through the due diligence process prior to an acquisition, exposing us to potentially large, unanticipated costs.

Prior to the consummation of any acquisition, we perform a due diligence review of the provider of payment processing services or portfolio of merchant accounts that we propose to acquire. Our due diligence review, however, may not adequately uncover all of the contingent or undisclosed liabilities we may incur as a consequence of the proposed acquisition. For example, in the past we were obligated to fund certain credits and chargebacks after discovering that a merchant account from an acquired merchant processing portfolio was in substantial violation of the Visa and MasterCard card association rules. In the future we may make acquisitions that may obligate us to make similar payments resulting in potentially significant, unanticipated costs.

We may encounter delays and operational difficulties in completing the necessary transfer of data processing functions and connecting systems links required by an acquisition, resulting in increased costs for, and a delay in the realization of revenues from, that acquisition.

The acquisition of a provider of payment processing services, as well as a portfolio of merchant processing accounts, requires the transfer of various data processing functions and connecting links to our systems and those of our own third-party service providers. If the transfer of these functions and links does not occur rapidly and smoothly, payment processing delays and errors may occur, resulting in a loss of revenues, increased merchant attrition and increased expenditures to correct the transitional problems, which could preclude our attainment of, or reduce, our profits.

Special non-recurring and integration costs associated with acquisitions could adversely affect our operating results in the periods following these acquisitions.

In connection with some acquisitions, we may incur non-recurring severance expenses, restructuring charges and change of control payments. These expenses, charges and payments, as well as the initial costs of integrating the personnel and facilities of an acquired business with those of our existing operations, may adversely affect our operating results during the initial financial periods following an acquisition. In addition, the integration of newly acquired companies may lead to diversion of management attention from other ongoing business concerns.

Our facilities, personnel and financial and management systems may not be adequate to effectively manage the future expansion we believe necessary to increase our revenues and remain competitive.

We anticipate that future expansion will be necessary in order to increase our revenues. In order to effectively manage our expansion, we may need to attract and hire additional sales, administrative, operations and management personnel. We cannot be sure that our facilities, personnel and financial and management systems and controls will be adequate to support the expansion of our operations, and provide adequate levels of service to our merchants and independent sales groups. If we fail to effectively manage our growth, our business could be harmed.

ITEM 1B. Unresolved Staff Comments

None.

ITEM 2. Properties

Our principal executive offices are located in approximately 6,700 square feet of leased office space in Nashville, Tennessee. We also lease approximately 27,000 square feet in Calabasas, California, approximately 6,300 square feet in Santa Barbara, California, approximately 9,600 square feet in Minden, Nevada, approximately 16,000 square feet in Phoenix, Arizona, approximately 2,300 square feet in Novi, Michigan, and approximately 13,500 square feet in Akron, Ohio. Our joint venture, CPC, leases approximately 5,500 square feet in Larkspur, California. We believe that these facilities are adequate for our current operations

and, if necessary, can be replaced with little disruption to our business.

ITEM 3. Legal Proceedings

See Note 5 — Commitments and Contingencies of the Notes to Financial Statements (Item 8) for information regarding legal proceedings.

ITEM 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2008.

PART II

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

There is no established public trading market for our common stock. On May 10, 2006, Holdings acquired all of our issued and outstanding common stock. Holdings is a wholly-owned subsidiary of iPayment Investors. Pursuant to the terms of our senior secured credit facility, we are limited in the amount of dividends we can declare or pay on our outstanding shares of common stock. We did not pay any cash dividends in 2008 or 2007. We intend to retain earnings for use in the operation and expansion of our business, and, therefore, we do not anticipate declaring a cash dividend in the foreseeable future.

ITEM 6. Selected Financial Data


							Period from
							January 1			May 11
							through			through			Year Ended			Year Ended
	Year Ended December 31,						May 10,			December 31,			December 31,			December 31,
	2004			2005			2006			2006			2007			2008
	Predecessor			Predecessor			Predecessor			Successor			Successor			Successor
Statement of Operations Data:
Revenues	$	364,182		$	702,712		$	252,514		$	481,474		$	759,109		$	794,825
Operating expenses:
Interchange		176,562			407,736			145,459			279,653			437,955			450,570
Other cost of services		135,316			213,138			76,994			147,055			228,537			241,532
Selling, general and administrative		12,437			18,062			14,432			13,017			21,144			20,289

Total operating expenses		324,315			638,936			236,885			439,725			687,636			712,391

Income from operations		39,867			63,776			15,629			41,749			71,473			82,434
Other income (expenses):
Interest expense, net		(2,707	)		(8,657	)		(5,229	)		(39,591	)		(60,216	)		(56,289	)
Other		279			(1,423	)		(6,729	)		(2,187	)		179			(750	)

Total other expense		(2,428	)		(10,080	)		(11,958	)		(41,778	)		(60,037	)		(57,039	)

Income (loss) before income taxes		37,439			53,696			3,671			(29	)		11,436			25,395
Income tax provision		12,704			20,915			3,343			713			6,005			10,500
Minority interest income (expense)		—			606			522			(148	)		—			(592	)

Net income (loss)	$	24,735		$	33,387		$	850		$	(890	)	$	5,431		$	14,303


Balance Sheet Data (as of period end)
Cash and cash equivalents		888			1,023			N/A			96			33			3,589
Working capital (deficit)		10,889			(4,679	)		N/A			(9,279	)		(8,713	)		(10,591	)
Total assets		336,248			340,981			N/A			784,966			767,545			768,864
Total long-term debt, including current portion		168,440			100,329			N/A			714,656			697,357			687,326
Stockholders’ equity		154,016			209,353			N/A			16,890			17,216			26,605

Financial and Other Data:
Charge volume (in millions) (unaudited) (1)		12,850			25,725			9,072			17,265			26,797			26,783
Capital expenditures		897			1,133			587			1,510			1,110			2,374
Ratio of earnings to fixed charges (2)		14.83			7.32			1.87			1.04			1.20			1.41


(1)		Represents the total dollar volume of all Visa and MasterCard transactions processed by our merchants, which is provided to us by our third-party processing vendors.

(2)		Computed in accordance with Item 503(d) of Regulation S-K. For purposes of computing the ratio of earnings to fixed charges, fixed charges consist of interest expense on long-term debt and capital leases, amortization of deferred financing costs and that portion of rental expense deemed to be representative of interest. Earnings consist of income (loss) before income taxes and minority interest, plus fixed charges and minority interest in pre-tax losses of subsidiaries that have not incurred fixed charges. The ratio of earnings to fixed charges differs from the fixed charge coverage ratio computed for the purposes of the indenture governing our senior subordinated notes and from the consolidated interest coverage ratio computed for the purpose of the credit agreement governing the senior secured credit facility.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the “Notes to Consolidated Financial Statements” for information regarding accounting changes, asset acquisitions and dispositions, litigation matters, and other costs and other items affecting comparability.

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Item 6 — Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this Form 10-K. References in this section to “iPayment, Inc.,” the “Company,” “we,” “us,” and “our” refer to iPayment, Inc. and our direct and indirect subsidiaries on a consolidated basis unless the context indicates otherwise.

Executive Overview

We are a provider of credit and debit card-based payment processing services to small merchants across the United States. As of December 31, 2008, we provided our services to approximately 145,000 small merchants. Our payment processing services enable our merchants to accept credit cards as well as other forms of electronic payment, including debit cards, checks, gift cards and loyalty programs in both traditional card-present, or swipe transactions, as well as card-not-present transactions. We market and sell our services primarily through independent sales groups, which gives us a non-employee, external sales force. We outsource certain processing functions such as card authorization, data capture and merchant accounting to third-party processors such as FDMS and TSYS Acquiring Solutions, and we rely on 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 processing, risk management, fraud detection, merchant assistance and support and chargeback services, in our main operating center in Calabasas, California.

Our strategy has been to increase profits by increasing our penetration of the expanding small merchant marketplace for payment services. Our operating results point to our successful execution of this strategy during 2008. Charge volume remained consistent at $26,783 million in 2008, compared to $26,797 million in 2007. The deterioration in the United States’ economic environment has impacted the growth in charge volumes in the industry. Industry sources indicated weakening charge volume growth in the third quarter of 2008, with charge volume in the fourth quarter declining when compared to the prior year. We currently expect this trend to continue in 2009. Likewise, our revenue declined in the fourth quarter despite the acquisitions of two businesses since the fourth quarter of 2007. Despite the downturn in the economy principally in the fourth quarter, revenues for the year increased 4.7% to $794.8 million in 2008 from $759.1 million in 2007. This increase was due to the acquisitions of two businesses. Income from operations increased to $82.4 million in 2008, from $71.5 million in 2007. Income from operations for the year ended December 31, 2007 included closing costs for the Chicago operating center as discussed in Note 9 of the Notes to Consolidated Financial Statements.

Net interest expense decreased to $56.3 million in 2008 from $60.2 million in 2007, reflecting a lower average interest rate and lower funded debt. Our effective income tax rate also decreased to approximately 41.3% in 2008, from approximately 52.5% in 2007, primarily due to expenses incurred through the adoption of FIN 48 and an increase in the valuation allowance for certain state net operating losses in 2007.

As a result of the Transaction, the consolidated financial statements present our results of operations, financial position and cash flows prior to the date of the Transaction as the “Predecessor.” The financial effects of the Transaction and our results of operations, financial position and cash flows following the closing of the Transaction are presented as the “Successor.” In accordance with generally accepted accounting principles in the United States, or GAAP, our Predecessor results have not been aggregated with our Successor results and, accordingly, our Consolidated Financial Statements do not show results of operations or cash flows for the year ended December 31, 2006. However, in order to facilitate an understanding of our results of operations for the year ended December 31, 2006, in comparison with the years ended December 31, 2007 and 2008, in this section our Predecessor results and our Successor results for calendar 2006 are presented and discussed on a combined basis. The combined results of operations are non-GAAP financial measures and should not be used in isolation or substitution of the Predecessor and Successor results.

Acquisition by iPayment Holdings

On May 10, 2006, pursuant to an Agreement and Plan of Merger dated as of December 27, 2005, by and among two new entities, iPayment, MergerCo and iPayment Holdings, MergerCo was merged with and into iPayment, Inc. (the “Transaction”), with iPayment, Inc. remaining as the surviving corporation and a wholly-owned subsidiary of iPayment Holdings. Holdings is a wholly-owned subsidiary of iPayment Investors, which is a Delaware limited partnership formed by Gregory Daily, the Chairman and Chief Executive Officer of iPayment, Carl Grimstad, the President of iPayment, and certain parties related to them.

•

equity financing in an aggregate amount of $170.0 million provided through (1) the delivery of an aggregate of $166.6 million of iPayment common stock by Mr. Daily, on his own behalf and on behalf of certain related parties, and by Mr. Grimstad, on his own behalf and on behalf of certain related parties, and (2) approximately $3.4 million of cash provided by Mr. Daily;

	•		a term loan of $515.0 million pursuant to a credit facility entered into between iPayment and a syndicate of lenders, which also included a $60.0 million revolving credit facility;

	•		approximately $202.2 million raised through the issuance by iPayment of private notes; and

	•		approximately $8.2 million funded by cash on hand and borrowings under the revolving credit facility described above.

Acquisitions

Since December 2003, we have expanded our card-based payment processing services through the acquisition of five businesses, two significant portfolios and several smaller portfolios of merchant accounts, as set forth below. These acquisitions have significantly impacted our revenues, results of operations, and financial condition. Primarily due to these acquisitions, our merchant portfolio base increased from approximately 56,000 active small merchants on January 1, 2003, to approximately 145,000 on December 31, 2008. In addition, primarily due to these acquisitions, our revenues increased to $794.8 million in 2008, from $759.1 million in 2007 and from $734.0 million in 2006.

The following table lists each of the acquisitions that we have made since December 2003:


Acquired Business or Significant
Portfolio of Merchant Accounts		Date of Acquisition

FDMS Bank Portfolio		December 2003
Transaction Solutions		September 2004
FDMS Merchant Portfolio		December 2004
Petroleum Card Services		January 2005
iPayment ICE of Utah, LLC		June 2005
National Processing Management Group		October 2005
Cambridge Payment Systems		December 2007
Merchant Service Center		April 2008

On December 19, 2003, we entered into an asset purchase agreement with FDMS pursuant to which we acquired the FDMS Bank Portfolio for a price of $55.0 million in cash. Pursuant to the terms of the asset purchase agreement, we commenced receiving revenue from these accounts on January 1, 2004. In order to finance the acquisition, we increased our borrowing capacity under our revolving credit facility from $30.0 million to $65.0 million. We borrowed $45.0 million under our credit facility and used available cash for the balance of the purchase price. We are currently a customer of FDMS for merchant processing services.

On September 15, 2004, we entered into an agreement to purchase substantially all the assets of TS Black and Gold, LP (“Transaction Solutions”). Transaction Solutions is a provider of credit card transaction processing services. Consideration included cash at closing and contingent payments based upon future performance over two years, all of which was paid as of December 31, 2006. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of Transaction Solutions from September 1, 2004, were included in our Consolidated Statements of Operations.

On December 27, 2004, we entered into an asset purchase agreement with FDMS, pursuant to which we acquired the FDMS Merchant Portfolio for a price of $130.0 million in cash. Pursuant to the terms of the asset purchase agreement, the acquisition became effective on December 31, 2004, and we commenced receiving revenue from the merchant accounts on January 1, 2005. We expanded our existing credit facility from $80.0 million to $180.0 million to finance the purchase. The transaction also strengthened our existing strategic relationship with First Data’s merchant services unit. We will continue to utilize processing services from First Data for the acquired portfolio.

In January 2005, we entered into an agreement to purchase substantially all the assets and to assume certain liabilities of Petroleum Card Services. Consideration included cash at closing and a contingent payment based on performance over the first two years. The first year contingent payment criteria was achieved and accrued for in our consolidated balance sheet as of December 31, 2005, and was subsequently paid in January 2006. Petroleum Card Services is a provider of credit card transaction processing services. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of Petroleum Card Services from January 1, 2005, were included in our Consolidated Statements of Operations.

In June 2005, we acquired a 51% interest in the joint venture iPayment ICE of Utah, LLC, a provider of credit card transaction processing services (“ICE”). The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of ICE from June 1, 2005, were included in our Consolidated Statements of Operations. During 2008, we acquired the remaining 49 percent interest in this joint venture for less than $0.1 million, which caused this entity to now be wholly-owned. At that time, we legally dissolved the entity iPayment ICE of Utah, LLC and our subsidiary iPayment ICE Holdings, Inc., which had previously held our 51% interest in ICE.

In October 2005, we entered into an agreement to purchase substantially all the assets and to assume certain liabilities of National Processing Management Group (“NPMG”). Consideration included cash at closing and contingent payment based on performance in 2006 and 2007. The first year contingent payment criteria were achieved and accrued for in our consolidated balance sheet as of December 31, 2006, and subsequently paid in February 2007. NPMG is a provider of credit card transaction processing

services. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of NPMG from October 1, 2005, were included in our Consolidated Statements of Operations.

In December 2007, we entered into an agreement to purchase substantially all the assets and to assume certain liabilities of Cambridge Payment Systems (“Cambridge”). Consideration included cash at closing and contingent payment based on performance in 2008, 2009, and 2010. Cambridge is a provider of credit card transaction processing services. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of Cambridge from January 1, 2008, were included in our Consolidated Statements of Operations.

In April 2008, we entered into an agreement to purchase substantially all of the assets and to assume certain liabilities of Merchant Service Center, an independent sales group with a growing portfolio of over 7,000 merchants. Consideration included cash at closing and contingent payments based on performance in 2008, 2009, and 2010. Merchant Service Center is a provider of credit card transaction processing services. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of Merchant Service Center were included in our Consolidated Statements of Operations beginning April 1, 2008 pursuant to the provisions of the Asset Purchase Agreement.

We accounted for all of the acquisitions described above under the purchase method. For acquisitions of a business, we allocate the purchase price based in part on valuations of the assets acquired and liabilities assumed. For acquisitions of merchant portfolios, we allocate the purchase price to intangible assets. For companies with modest growth prospects, our purchase prices primarily reflect the value of merchant portfolios, which are classified as amortizable intangible assets. Acquisition targets we identified as having entrepreneurial management teams, efficient operating platforms, proven distribution capabilities, all of which contribute to higher growth prospects, commanded purchase prices in excess of their merchant portfolio values. Consequently, purchase price allocations for these targets reflect a greater proportion of goodwill.

Critical Accounting Policies

The accompanying consolidated financial statements have been prepared in accordance with GAAP, which require that management make numerous estimates and assumptions. Actual results could differ from those estimates and assumptions, impacting our reported results of operations and financial position. Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in Item 8 of this Form 10-K. 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 Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, which addresses financial accounting and reporting for acquired goodwill and other intangible assets, and requires that goodwill is no longer subject to amortization over its estimated useful life. Rather, 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 SFAS No. 142, 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 completed our most recent annual goodwill impairment review as of December 31, 2008, using the present value of future cash flows to determine whether the fair value of the reporting unit exceeds the carrying amount of the net assets, including goodwill. We determined that no impairment charge to goodwill was required.

We periodically evaluate the carrying value of long-lived assets, in relation to the respective projected future undiscounted cash flows, to assess recoverability. An impairment loss is recognized if the sum of the expected net cash flows is less than the carrying amount of the long-lived assets being evaluated. The difference between the carrying amount of the long-lived assets being evaluated and the fair value, calculated as the sum of the expected cash flows discounted at a market rate, represents the impairment loss. We evaluated the carrying value of our intangible assets as of December 31, 2008, and determined no impairment charge was required.

Purchased merchant processing portfolios are recorded at cost and are evaluated by management for impairment at the end of each fiscal quarter through review of actual attrition and cash flows generated by the portfolios in relation to the expected attrition and cash flows and the recorded amortization expense. The estimated useful lives of our merchant processing portfolios are assessed by evaluating each portfolio to ensure that the recognition of the costs of revenues, represented by amortization of the intangible assets, approximate the distribution of the expected revenues from each processing portfolio. If, upon review, actual attrition and cash flows indicate impairment of the value of the merchant processing portfolios, an impairment loss would be recognized. Historically, we have experienced monthly attrition ranging from 1.0% to 3.0% of our total charge volume.

For all periods through the period ended May 10, 2006, the straight-line method of amortization over a seven-year period resulted in the proper approximation of the distribution of the actual cash flows generated from our merchant processing portfolios. The adoption of an accelerated method of amortization based on an average historical attrition rate of approximately 15% over a fifteen-year period would have resulted in the recognition of similar amounts of amortization expense as the straight-line method used by us during the same periods. Effective May 11, 2006, we adopted such an accelerated method of amortization over a fifteen-year period, which we believe better 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 3 to 7 years.

will adjust our current and prospective estimated attrition rates so that the amortization expense would better approximate the distribution of actual cash flows generated by the merchant processing portfolios. Any adjustments made to the amortization schedules would be reported in the current Consolidated Income Statements and on a prospective basis until further evidence becomes apparent. We identified an unfavorable trend of the current attrition rates being used during the year ended December 31, 2008 on some of our portfolios. Accordingly, we recorded an increase to amortization expense of approximately $2.4 million to better approximate the distribution of actual cash flows generated by the merchant processing portfolios.

Revenue and Cost Recognition. Substantially all of our revenues are generated from fees charged to merchants for card-based payment processing services. We typically charge these merchants a bundled rate, primarily based upon each 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 all merchants higher discount rates for card-not-present transactions than for card-present transactions in order to compensate ourselves for the higher risk of underwriting these transactions. We derive the balance of our revenues from a variety of fixed transaction or service fees, including fees for monthly minimum charge volume requirements, statement fees, annual fees, discount income on merchant advances and fees for other miscellaneous services, such as handling chargebacks. We recognize discounts and other fees related to payment transactions at the time the merchants’ transactions are processed. We recognize revenues derived from service fees at the time the service is performed. Related interchange and assessment costs are also recognized at that time.

We follow the requirements of EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining our revenue reporting. Generally, where we have merchant portability, credit risk and ultimate responsibility for the merchant, revenues are reported at the time of sale on a gross basis equal to the full amount of the discount charged to the merchant. This amount includes interchange paid to card issuing banks and assessments paid to credit card associations pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants. Interchange fees are set by Visa and MasterCard and are based on transaction processing volume and are recognized at the time transactions are processed. Revenues generated from certain bank portfolios acquired as part of the FDMS acquisition are reported net of interchange, as required by EITF 99-19, where we may not have credit risk, portability or the ultimate responsibility for the merchant accounts.

Other costs of services include costs directly attributable to processing and bank sponsorship costs, which amounted to $38.1 million, $40.1 million, $28.3 million, and $15.8 million in the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, respectively. They also include related services to our merchants such as residual payments to independent sales groups, which are commissions we pay to our independent sales groups based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which is a percentage of the charge volume we generate from Visa and MasterCard. In addition, other costs of services 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 directly attributable to our provision of payment processing and related services to our merchants.

Other costs of services include depreciation expense, which is recognized on a straight-line basis over the estimated useful life of the assets, and amortization expense, which is recognized using an accelerated method based on an average historical attrition rate of approximately 15% over a fifteen-year period. Amortization of intangible assets results from our acquisitions of portfolios of merchant contracts or acquisitions of a business where we allocated a portion of the purchase price to the existing merchant processing portfolios and other intangible assets.

Selling, general and administrative expenses consist primarily of salaries and wages and other administrative expenses such as professional fees.

Share-Based Compensation. Effective January 1, 2006, we adopted SFAS No. 123R, Share-Based Payment, (“SFAS No. 123R”) using the Modified Prospective Approach. SFAS No. 123R revises SFAS No. 123, Accounting for Share-based Compensation (“SFAS No. 123”) and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires the cost of all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at grant date, or the date of later modification, over the requisite service period. In addition, SFAS No. 123R requires unrecognized cost (based on the amounts previously disclosed in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized in the financial statements over the remaining requisite service period.

Under the Modified Prospective Approach, the amount of compensation cost recognized includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123 and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. The incremental pre-tax share-based compensation expense recognized due to the adoption of SFAS No. 123R for the period from January 1, 2006 through May 10, 2006 (Predecessor) was $4,467,000, with an associated tax benefit of $1,742,000. The share-based compensation expense recognized for the period from January 1, 2006, through May 10, 2006 (Predecessor), includes $3,633,000 (with an associated tax benefit of $1,417,000) due to the acceleration of option vesting as a result of the Transaction. There was no compensation expense recognized under SFAS No. 123R for the period from May 11, 2006 to December 31, 2006 (Successor) and all subsequent periods, as all stock options and restricted stock were exercised or redeemed at the closing of the Transaction.

options or issuance of restricted share unit awards are in excess of the compensation expense recognized for financial reporting purposes, the amounts will be presented as a financing cash inflow rather than as a reduction of income taxes paid in our condensed consolidated statement of cash flows.

Reserve for Merchant Losses. Disputes between a cardholder and a merchant periodically arise as a result of, among other things, cardholder dissatisfaction with merchandise quality or merchant services. Such disputes may not be resolved in the merchant’s favor. In these cases, the transaction is “charged back” to the merchant, which means the purchase price is refunded to the customer through the merchant’s acquiring bank and charged to the merchant. If the merchant has inadequate funds, we or, under limited circumstances, the acquiring bank and us, must bear the credit risk for the full amount of the transaction. We evaluate the merchant’s risk for such transactions and estimate its potential loss for chargebacks based primarily on historical experience and other relevant factors and record a loss reserve accordingly. At December 31, 2008 and 2007, our reserve for losses on merchant accounts included in accrued liabilities and other totaled $1.3 million and $1.0 million, respectively.

We also maintain a reserve for merchant advance losses. In 2007, we began, on a selective basis, offering advances to prospective and current merchants based on expected future processing volume. However, we no longer offer new merchant advances to our customers. During the term of our existing advances, there is risk that an advance may be deemed uncollectible. We evaluate the risk of potential loss for each advance and record a loss reserve accordingly. As of December 31, 2008, our reserve for merchant advances was $3.8 million and is included in “Investment in merchant advances” in our Consolidated Balance Sheets.

Income Taxes. We account for income taxes pursuant to the provisions of SFAS No. 109, Accounting for 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. At December 31, 2008, we had approximately $1.3 million of federal net operating loss carryforwards related to prior years that will be available to offset regular taxable income through 2018, subject to annual limitations of up to $0.9 million per year. We had state net operating loss carryforwards of approximately $26.2 million as of December 31, 2008.

Effective January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law by prescribing a comprehensive model for the financial statement recognition, measurement, presentation and disclosure for uncertain tax positions taken or expected to be taken in income tax returns.

Minority Interest. We currently own a 20 percent interest in a joint venture, Central Payment Co, LLC (“CPC”). We previously owned a 51 percent interest in a second joint venture, iPayment ICE of Utah, LLC (“ICE”). However, during the third quarter of 2008, we acquired the remaining 49 percent of ICE for less than $0.1 million, which caused ICE to now be wholly-owned. The minority interest in equity of consolidated subsidiaries was zero on the Consolidated Balance Sheets at December 31, 2007, as the original investments by the minority shareholders had been absorbed by their proportionate share of the losses of the consolidated subsidiaries. In 2008, we recorded a minority interest of $0.6 million in respect of our remaining joint venture, CPC.

We account for our investments pursuant to the provisions of SFAS Interpretation No. 46R, Consolidation of Variable Interest Entities. Under this method, if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. An enterprise that consolidates a variable interest entity is the primary beneficiary of the variable interest entity. As a result, we consider the investment as a variable interest entity, and as the primary beneficiary, we consolidate CPC.

Derivative Financial Instruments. We account for our derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Under SFAS No. 133, we recognize all derivatives as either other assets or other liabilities, measured at fair value. The fair value of these instruments (all interest rate swaps) at December 31, 2008, was $20.4 million, and was included as other liabilities in our consolidated balance sheet. The underlying terms of the interest rate swaps, including the notional amount, interest rate index, duration, and reset dates, are identical to those of the associated debt instruments and therefore the hedging relationship results in no ineffectiveness. Accordingly, such derivative instruments are classified as cash flow hedges. As such, any changes in the fair market value of the derivative instruments are included in accumulated other comprehensive gain in our consolidated balance sheet.

Merger Transaction. We accounted for the Transaction in conformity with SFAS No. 141, Business Combinations, and EITF No. 88-16, Basis in Leveraged Buyout Transactions. The total cost of the purchase was allocated as a partial change in basis to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values as of the date of the merger based upon an independent valuation. The excess of the purchase price over the historical basis of the net assets acquired was $486.7 million and has been allocated to goodwill.

Restructuring. We accounted for our restructuring related to the Westchester, Illinois office closure in 2007 in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities . Under SFAS No. 146, we recognize costs associated with an exit or disposal activity when the liability is incurred and establish the fair value for initial measurement of the liability. We recognized approximately $0.9 million of restructuring costs during 2007. At December 31, 2008 we had no remaining liabilities related to the office closure.

Components of Revenues and Expenses

Substantially all of our revenues are generated from fees charged to merchants for card-based payment processing services. We typically charge these merchants a bundled rate, primarily based upon the 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 all 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, discount income on merchant advances and fees for other miscellaneous services, such as handling chargebacks. We recognize discounts and other fees related to payment transactions at the time the merchants’ transactions are processed. We recognize revenues derived from service fees at the time the service is performed. Related interchange and assessment costs are also recognized at that time. In December 2007, we began, on a selective basis, offering advances to prospective and current merchants based on expected future processing volume that will be collected through reductions in amounts otherwise paid to them on future transactions processed by the Company. These merchant advances are reflected in Investment in merchant advances in the Consolidated Balance Sheets. The merchant advances are generally collected over periods from six months to one year. Our discount income is recognized over the term of the agreement as Revenues in our Consolidated Income Statements using the effective interest method. In connection with the origination of certain of these advances, origination or other fees may be incurred by the Company. The amounts paid are deferred and amortized as a reduction of deferred origination fees over the life of the advance. The objective of the method of income and expense recognition is to record a constant effective yield on the investment in the related advances.

We follow the requirements of EITF 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining our revenue reporting. Generally, where we have merchant portability, credit risk and ultimate responsibility for the merchant, revenues are reported at the time of sale on a gross basis equal to the full amount of the discount charged to the merchant. This amount includes interchange paid to card issuing banks and assessments paid to credit card associations pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants. Revenues generated from certain agent bank portfolios acquired from First Data Merchant Services Corporation (the “FDMS Agent Bank Portfolio”) are reported net of interchange, as required by EITF 99-19, where we may not have credit risk, portability or the ultimate responsibility for the merchant accounts.

The most significant component of operating expenses is interchange fees, which are amounts we pay to the card issuing banks. Interchange fees are based on transaction processing volume and are recognized at the time transactions are processed.

Other costs of services include costs directly attributable to our provision of payment processing and related services to our merchants and primarily includes residual payments to independent sales groups, which are commissions we pay to our independent sales groups based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which is a percentage of the processing volume we generate from Visa and MasterCard. Other costs of services also include depreciation expense, which is recognized on a straight-line basis over the estimated useful life of the assets, and amortization expense, which is recognized using an accelerated method based on an average historical attrition rate of approximately 15% per year over a fifteen-year period. Amortization of intangible assets results from our acquisitions of portfolios of merchant contracts or acquisitions of a business where we allocated a portion of the purchase price to the existing merchant processing portfolio. 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.

Selling, general and administrative expenses consist primarily of salaries and wages, including share-based compensation recognized under SFAS No. 123R, as well as other general administrative expenses such as professional fees.

Seasonality

Our revenues and earnings are impacted by the volume of consumer usage of credit and debit cards at the point of sale. For example, we experience increased point of sale activity during the traditional holiday shopping period in the fourth quarter. Revenues during the first quarter tend to decrease in comparison to the remaining three quarters of our fiscal year on a same store basis.

Off-Balance Sheet Arrangements

We do not have transactions, arrangements and other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity or market or credit risk support, engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the financial statements.

Results of Operations

Years ended December 31, 2008 and 2007 (in thousands, except percentages)

The following table sets forth our operating results for the periods indicated as a percentage of our revenues:


				% of						% of
				Total						Total			Change
	2008			Revenue			2007			Revenue			Amount			%
Statement of Operations Data:
Revenues	$	794,825			100.0	%	$	759,109			100.0	%	$	35,716			4.7	%
Operating expenses:
Interchange		450,570			56.7	%		437,955			57.7	%		12,615			2.9	%
Other cost of services		241,532			30.4	%		228,537			30.1	%		12,995			5.7	%
Selling, general and administrative		20,289			2.6	%		21,144			2.8	%		(855	)		-4.0	%

Total operating expenses		712,391			89.6	%		687,636			90.6	%		24,755			3.6	%

Income from operations		82,434			10.4	%		71,473			9.4	%		10,961			15.3	%
Other (expenses) income:
Interest expense, net		(56,289	)		-7.1	%		(60,216	)		-7.9	%		3,927			-6.5	%
Other, net		(750	)		-0.1	%		179			0.0	%		(929	)		-519.0	%

Total other expense, net		(57,039	)		-7.2	%		(60,037	)		-7.9	%		2,998			-5.0	%

Income before income taxes		25,395			3.2	%		11,436			1.5	%		13,959			122.1	%
Income tax provision		10,500			1.3	%		6,005			0.8	%		4,495			74.9	%
Minority interest expense		(592	)		-0.1	%		—			0.0	%		(592	)		-100.0	%

Net (loss) income	$	14,303			1.8	%	$	5,431			0.7	%	$	8,872			163.4	%

Revenues. Revenues increased 4.7% to $794.8 million in 2008 from $759.1 million in 2007. Revenues increased as a result of the acquisitions of businesses in December 2007 and April 2008. Acquired revenues accounted for all of the growth in revenues for the year ended December 31, 2008, as compared to the same period ended December 31, 2007.

Interchange. Interchange expense increased 2.9% to $450.6 million in 2008 from $438.0 million in 2007. The increase was primarily attributable to increased charge volumes from the acquisitions of businesses in December 2007 and April 2008. Interchange expenses as a percentage of total revenues decreased to 56.7% in 2008 from 57.7% in 2007. Average interchange costs increased in relation to charge volume, but were accompanied by greater corresponding increases in average fees charged to merchants.

Other Costs of Services. Other costs of services increased 5.7% to $241.5 million in 2008 from $228.5 million in 2007. Other costs of services represented 30.4% of revenues in 2008 as compared to 30.1% of revenues in 2007. The increase was primarily attributable to increased expense for merchant losses and merchant advance losses, partially offset by reductions in processing costs.

Selling, General and Administrative. Selling, general and administrative expenses decreased 4.0% to $20.3 million in 2008 from $21.1 million in 2007, despite the acquisitions of two businesses. The decrease was primarily attributable to the elimination of costs associated with the closing of the Chicago operating center in early 2007 and reduced headcount at our other operating centers.

Other Expense. Other expense decreased $3.0 million to $57.0 million in 2008 from $60.0 million in 2007. Other expense in 2008 primarily consisted of $56.3 million of net interest expense. Interest expense in 2008 decreased $3.9 million from 2007, reflecting a lower average interest rate and lower funded debt.

Income Tax. Income tax expense increased $4.5 million to $10.5 million in 2008 from $6.0 million in 2007 due to an increase in taxable income. The increase was the result of increased income from operations, driven by an increase in revenues, and a decrease in interest expense. Income tax expense as a percentage of income before taxes was 41.3% in 2008, compared to 52.5% in 2007. The effective tax rate in 2008 included an increase in the valuation allowance for certain state net operating losses and cancellation of debt income, both of which increased the effective tax rate. The effective tax rate in 2007 included expenses incurred through the adoption of FIN 48 and an increase in the valuation allowance for certain state net operating losses, both of which increased the effective rate.

Minority Interest. Minority interest expense during in 2008 was $0.6 million as compared to no minority interest expense in 2007. Minority interest expense comes from our acquisition of a 20 percent interest in a joint venture that was formed in February 2006, which turned profitable in the second half of 2007. During 2007, we absorbed any additional losses after losses in this entity exceeded the minority partners’ investments.

Years ended December 31, 2007 and 2006 (in thousands, except percentages)

In accordance with GAAP, our predecessor results have not been aggregated with our successor results and, accordingly, our audited financial statements do not show results of operations or cash flows for the year ended December 31, 2007. However, in order to facilitate an understanding of our results of operations for the year ended December 31, 2007 in comparison with the comparable period in 2006, we present and discuss our predecessor results and our successor results on a combined basis. The combined results of operations are non-GAAP financial measures and should not be used in isolation or substitution of the predecessor and successor results.

The following table sets forth our operating results for the periods indicated as a percentage of our revenues:


				% of						% of
				Total						Total			Change
	2007			Revenue			2006			Revenue			Amount			%
Statement of Operations Data:
Revenues	$	759,109			100.0	%	$	733,988			100.0	%	$	25,121			3.4	%
Operating expenses:
Interchange		437,955			57.7	%		425,112			57.9	%		12,843			3.0	%
Other cost of services		228,537			30.1	%		224,049			30.5	%		4,488			2.0	%
Selling, general and administrative		21,144			2.8	%		27,449			3.7	%		(6,305	)		-23.0	%

Total operating expenses		687,636			90.6	%		676,610			92.2	%		11,026			1.6	%

Income from operations		71,473			9.4	%		57,378			7.8	%		14,095			24.6	%
Other income (expenses):
Interest expense, net		(60,216	)		-7.9	%		(44,820	)		-6.1	%		(15,396	)		34.4	%
Other, net		179			0.0	%		(8,916	)		-1.2	%		9,095			-102.0	%

Total other expense, net		(60,037	)		-7.9	%		(53,736	)		-7.3	%		(6,301	)		11.7	%

Income before income taxes		11,436			1.5	%		3,642			0.5	%		7,794			214.0	%
Income tax provision		6,005			0.8	%		4,056			0.6	%		1,949			48.1	%
Minority interest income		—			0.0	%		374			0.1	%		(374	)		-100.0	%

Net (loss) income	$	5,431			0.7	%	$	(40	)		0.0	%	$	5,471			-13677.5	%

Revenues. Revenues increased 3.4% to $759.1 million in 2007 from $734.0 million in 2006. Revenues increased due to an increase in new merchant account activations through our independent sales groups and direct sales channels.

Interchange. Interchange expense increased 3.0% to $438.0 million in 2007 from $425.1 million in 2006. The increase was primarily attributable to increased charge volumes. Interchange expense as a percentage of revenues remained relatively constant at 57.7% in 2007 compared to 57.9% in 2006.

Other Costs of Services. Other costs of services increased 2.0% to $228.5 million in 2007 from $224.0 million in 2006. Other costs of services represented 30.1% of revenues in 2007 as compared to 30.5% of revenues in 2006. Other costs of services as a percentage of revenues decreased primarily due to lower processing costs and lower depreciation and amortization, partially offset by higher residual expense.

Selling, General and Administrative. Selling, general and administrative expenses decreased 23.0% to $21.1 million in 2007 from $27.5 million in 2006. The decrease was primarily due to the recognition of $4.5 million of additional compensation expense due to the adoption of SFAS No. 123R in January 2006 ($3.6 million of which was accelerated as a result of the Transaction), and a $3.2 million increase in amortization of restricted stock due to the accelerated vesting of restricted stock as a result of the Transaction. Selling, general and administrative expenses as a percentage of revenues decreased to 2.8% in 2007 compared to 3.7% in 2006, due to the recognition of the share-based compensation items in 2006.

Other Expense. Other expense increased $6.3 million to $60.0 million in 2007 from $53.7 million in 2006. Other expense in 2007 primarily consisted of $60.2 million of net interest expense. Other expense increased due to a full year of interest expense on the senior secured credit facility.

Income Tax. Income tax expense increased $1.9 million to $6.0 million in 2007 from $4.1 million in 2006 due to an increase in taxable income. The increase was the result of increased revenues and a $9.3 million favorable change in other expense primarily due to Transaction-related expenses in 2006. Income tax expense as a percentage of income before taxes was 52.5% in 2007, compared to 110.9% in 2006. The decrease in the effective tax rate was caused by approximately $7.2 million of Transaction-related expenses which were not deductible for tax purposes in 2006.

Minority Interest. There was no minority interest income compared to $0.4 million of income in 2006. Minority interest income comes from our acquisition of a 51% interest in a joint venture that began in June 2005 as well as a 20% interest in another joint venture that began in February 2006. Both of these entities are presented on a consolidated basis in our consolidated financial statements. In 2006 and 2007, we absorbed the cumulative losses in the direct sales group acquired in 2006 to the extent such losses exceeded the minority partners’ investment.

Liquidity and Capital Resources

As of December 31, 2008, we had cash and cash equivalents totaling $3.6 million, compared to $0.1 million as of December 31, 2007. We had a net working capital deficit (current liabilities in excess of current assets) of $10.6 million at December 31, 2008, compared to $9.9 million as of December 31, 2007. The working capital change consisted primarily of an increase in the current portion of long-term debt as a result of a $12.2 million debt principal payment required by the excess cash flow sweep covenant within our senior secured credit facility. We paid the excess cash flow sweep covenant amount in February 2009. The working capital change also consisted of an increase in merchant advances of $4.3 million and a reduction in accounts payable of $4.0 million which was offset by an increase in cash of $3.6 million.

We consistently have positive cash flow provided by operations and expect that our cash flow from operations and proceeds from borrowings under our revolving credit facility will be our primary sources of liquidity and will be sufficient to cover our current obligations. See “Contractual Obligations” below for a description of future required uses of cash. Our ability to have the necessary liquidity to operate our business may be adversely impacted by a number of general economic factors, including continued decreases in consumer spending, which could lead to deterioration in our operating performance and cash flow. Such deterioration could, among other things, impact our ability to comply with financial covenants in our existing credit facilities. Under such circumstances, a continuation of the difficult conditions in the credit markets could limit the availability of credit and increase the cost of financing. We cannot be certain that any additional required financing would be available on acceptable terms to us, if at all. We currently expect that we will continue to comply with established financial covenants under our debt agreements in 2009. However, if the economic environments in which we operate were to further deteriorate beyond current expectations, it could adversely affect our ability to remain in compliance with our covenants, which could have an adverse effect on our liquidity and results of operations. Any amendment to or waiver of the covenants would likely involve substantial upfront fees, significantly higher annual interest costs and other terms significantly less favorable to us than those contained in our current credit facilities.

Operating activities

Net cash provided by operating activities was $46.4 million in 2008, consisting of net income of $14.3 million, adjusted for depreciation and amortization of $38.0 million, noncash interest expense of $2.4 million and net unfavorable changes in operating assets and liabilities of $8.3 million. The net unfavorable change in operating assets and liabilities was primarily caused by an increase in deferred tax assets, an increase in income taxes payable, and an increase in accounts receivable.

Net cash provided by operating activities was $41.4 million in 2007, consisting of net income of $5.4 million, adjusted for depreciation and amortization of $35.9 million, noncash interest expense of $2.2 million and net unfavorable changes in operating assets and liabilities of $2.2 million. The net unfavorable change in operating assets and liabilities was primarily caused by a decrease in other assets, an increase in accounts receivable, and an increase in income taxes payable.

Net cash provided by operating activities was $58.2 million in 2006, consisting of a net loss of less than $0.1 million, adjusted for depreciation and amortization of $39.6 million, share-based compensation of $7.7 million, noncash interest expense of $4.3 million and net favorable changes in operating assets and liabilities of $6.7 million. The net favorable change in operating assets and liabilities was primarily caused by an increase in accrued interest resulting from the senior subordinated notes issued as part of the Transaction.

Investing activities

Net cash used by investing activities was $32.7 million in 2008. Net cash used by investing activities primarily consisted of $22.1 million for the acquisition of businesses, $4.3 million of investments in merchant advances, $4.2 million of payments for contract modifications for prepaid residual expenses and $2.4 million of capital expenditures. Other than contingent earnout payments described under “Contractual Obligations,” we currently have no significant capital spending or purchase commitments, but expect to continue to engage in capital spending in the ordinary course of business.

Net cash used by investing activities was $24.2 million in 2007. Net cash used by investing activities consisted of $13.5 million for the purchase of a business, $8.8 million paid for earnout payments associated with acquisitions from a prior period, $0.7 million of payments for contract modifications for prepaid residual expenses, $1.1 million of capital expenditures, and a $0.2 million increase in restricted cash.

Net cash used by investing activities was $27.2 million in 2006. Net cash used by investing activities consisted of $26.2 million paid for earnout payments associated with acquisitions from a prior period, $0.9 million of payments for contract modifications for prepaid residual expenses and $2.1 million of capital expenditures, partially offset by a $2.0 million reduction in restricted cash.

Financing activities

Net cash used in financing activities was $10.2 million in 2008, consisting primarily of repayments on our senior secured credit facility of $6.9 million, $2.2 million of repayments on our revolving credit facility, and repurchases of our senior subordinated notes of $1.1 million,

Net cash used in financing activities was $17.2 million in 2007, consisting primarily of repayments on our senior secured credit facility of $9.7 million and repurchases of our senior subordinated notes of $8.9 million, partially offset by $1.4 million of net borrowings on our revolving credit facility.

Net cash used in financing activities was $32.0 million in 2006, consisting primarily of $633.6 million to repurchase common stock as part of the Transaction and net repayments on our revolving credit facility and term loans of $99.2 million and $3.9 million,

respectively, partially offset by $701.0 million of net proceeds from the issuance of debt and approximately $3.4 million contributed by Mr. Daily to affect the Transaction.

On May 10, 2006, we replaced our existing credit facility with a new senior secured credit facility with Bank of America as lead bank. The senior secured credit facility consists of $515.0 million of term loans and a $60.0 million revolving credit facility, further expandable to $100.0 million. The senior secured credit facility contains a $25.0 million letter of credit sublimit and is secured by the Company’s assets. Interest on outstanding borrowings under the term loans is payable at a rate of LIBOR plus a margin of 2.00% to 2.25% (currently 2.00%) depending on our credit rating from Moody’s. Interest on outstanding borrowings under the revolving credit facility is payable at prime plus a margin of 0.50% to 1.25% (currently 1.25%) or at a rate of LIBOR plus a margin of 1.50% to 2.25% (currently 2.25%) depending on our ratio of consolidated debt to EBITDA, as defined in the agreement. Additionally, the senior secured credit facility requires us to pay unused commitment fees of up to 0.50% (currently 0.50%) on any undrawn amounts under the revolving credit facility. The senior secured credit facility contains customary affirmative and negative covenants, including financial covenants requiring maintenance of a debt-to-EBITDA ratio (as defined therein), which is currently 6.25 to 1.00, but which decreases periodically over the life of the agreement to a ratio of 4.00 to 1.00 on December 31, 2011. The required debt-to-EBITDA covenant ratio at December 31, 2009 will be 5.50 to 1.00. The senior secured credit facility also contains an excess cash flow covenant (as defined therein), which requires us to make additional principal payments after the end of every fiscal year. At December 31, 2008, the payment attributable to this covenant was $12.2 million and is included in the current portion of long-term debt. Principal repayments on the term loans are due quarterly in the amount of $1.3 million which began on June 30, 2006, with any remaining unpaid balance due on March 31, 2013. Outstanding principal balances on the revolving credit facility are due when the revolving credit facility matures on May 10, 2012. At December 31, 2008, we had outstanding $494.6 million of term loans at a weighted average interest rate of 5.42% and no borrowings under the revolving credit facility.

Under the senior secured credit facility we were required to hedge at least 50% of the outstanding balance through May 10, 2008. Accordingly, we entered into interest rate swap agreements with a total notional amount of $260.0 million that expire on December 31, 2010. The swap agreements effectively convert an equivalent portion of our outstanding borrowings to a fixed rate of 5.39% (plus the applicable margin) over the entire term of the swaps. In September 2007, we entered into two additional interest rate swap agreements. The first swap was for a notional value of $100.0 million and expired on September 17, 2008. This swap effectively converted an equivalent portion of our outstanding borrowings to a fixed rate of 4.80% (plus the applicable margin) over the entire term of the swap. The second swap was for a notional value of $75.0 million and expired on September 28, 2008. This swap effectively converted an equivalent portion of our outstanding borrowings to a fixed rate of 4.64% (plus the applicable margin) over the entire term of the swap. The swap instruments qualify for hedge accounting treatment under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (see Note 1).

On May 10, 2006, we also issued senior subordinated notes in the aggregate principal amount of $205.0 million. These senior subordinated notes were issued at a discount of 1.36%, with interest payable semi-annually at 9 ³ /4 % on May 15 and November 15 of each year. The senior subordinated notes mature on May 15, 2014, but may be redeemed, in whole or in part, by the Company at any time on or after May 15, 2010, at redemption prices specified in the indenture governing the senior subordinated notes, plus accrued and unpaid interest. The senior subordinated notes contain customary restrictive covenants, including restrictions on incurrence of additional indebtedness if our fixed charge coverage ratio (as defined therein) is not at least 2.0 to 1.

During 2007, the Company spent $8.9 million on repurchases of senior subordinated notes. During 2008, the Company spent an additional $1.1 million on repurchases of senior subordinated notes. The Company intends to hold the senior subordinated notes until maturity. In accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, the repurchase was accounted for as an extinguishment of debt. We reflected these transactions as reductions in long-term debt within the Consolidated Balance Sheets as of December 31, 2007 and 2008. We amended our senior secured credit facility to allow for repurchases of our senior subordinated notes up to $10.0 million, and have now completed note repurchases under that amendment. At December 31, 2008, we had outstanding $194.5 million of senior subordinated notes and $1.9 million of remaining unamortized discount on the senior subordinated notes.

We had net capitalized debt issuance costs related to the senior secured credit facility totaling $4.9 million and net capitalized debt issuance costs related to the senior subordinated notes totaling $5.8 million as of December 31, 2008, which is materially consistent with amounts computed using an effective interest method. These costs are being amortized to interest expense on a straight-line basis over the life of the related debt instruments. Amortization expense related to the debt issuance costs was $2.2 million for the year ended December 31, 2008.

Contractual Obligations

The following table of our material contractual obligations as of December 31, 2008, summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated. The table excludes contingent payments in connection with earnouts related to completed acquisitions. We cannot quantify the exact amounts to be paid because they are based on future EBITDA results. In 2008, we had no earnout payments. We currently estimate that we will pay an aggregate of $3.0 to $5.0 million in earnout payments in 2009, 2010, and 2011 combined.


	Payments due by period
			Less than						More than
Contractual Obligations	Total		1 year		1-3 years		3-5 years		5 years
					(in thousands)
Credit Facility	$	494,638	$	17,324	$	10,300	$	467,014	$	—
Senior Subordinate Notes		194,500		—		—				194,500
Interest (1)		187,144		44,756		75,918		54,618		11,852
Capital lease obligations		56		23		33		—		—
Operating lease obligations		2,741		1,520		927		294		—
Purchase obligations (2)(3)(4)		12,133		5,540		6,593		—		—

Total contractual obligations	$	891,212	$	69,163	$	93,771	$	521,926	$	206,352


(1)		Future interest obligations are calculated using current interest rates on existing debt balances as of December 31, 2008, and assume no principal reduction other than mandatory principal repayments in accordance with the terms of the debt instruments as described in Note 6 to our Consolidated Financial Statements.

(2)		Purchase obligations represent costs of contractually guaranteed minimum processing volumes with certain of our third-party transaction processors.

(3)		We are required to pay FDMS an annual processing fee related to the FDMS Merchant Portfolio and the FDMS Agent Bank Portfolio of at least $5.5 million in fiscal year 2009, and for each subsequent year through 2011 of at least 70% of the amount of the processing fee paid during the immediately preceding year. The minimum commitment for years after 2009, included in the table above, is based on the preceding year minimum amounts. The actual minimum commitments for such years may vary based on actual results in preceding years.

(4)		We have agreed to utilize FDMS to process at least 75% of our consolidated transaction sales volume in any calendar year through 2011. The minimum commitments for such years are not calculable as of December 31, 2008, and are excluded from this table.

We expect to be able to fund our operations, capital expenditures and the contractual obligations above (other than repayment of our senior secured credit facility and revolving credit facility) using our cash from operations. We intend to use our revolving credit facility primarily to fund additional acquisition opportunities as they arise. To the extent we are unable to fund our operations, capital expenditures and the contractual obligations above using cash from operations, we intend to use borrowings under our revolving credit 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 funding 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.

Effects of Inflation

Our monetary assets, consisting primarily of cash and receivables, are not significantly affected by inflation. Our non-monetary assets, consisting primarily of intangible assets and goodwill, are not affected by inflation. We believe that replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and telecommunications, which may not be readily recoverable in the price of services offered by us.

New Accounting Standards

In September 2006, the FASB issued SFAS No. 157 — Fair Value Measurements, which defines fair value, establishes a framework for consistently measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, Effective Date of FASB Statement No. 157, which defers the implementation for the nonrecurring nonfinancial assets and liabilities from fiscal years beginning after November 15, 2007 to fiscal years beginning after November 15, 2008. The provisions of SFAS No. 157 will be applied prospectively. The statement provisions effective as of January 1, 2008, do not have a material effect on the Company’s results of operations, financial position or cash flows. The Company is evaluating the impact, if any, the adoption of the remaining provisions will have on its results of operations, financial position or cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities — Including an amendment of FASB Statement No. 115, which permits entities to choose to measure many financial instruments and certain other items at fair value. The Company did not make this election. As such, the adoption of this statement did not have any impact on its results of operations, financial position or cash flows.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS No. 141(R)”), which establishes a framework for the recognition and measurement of identifiable assets and goodwill acquired in a business combination. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS No. 160”), which establishes a framework for the reporting of a parent company’s interests and noncontrolling interests in a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008, and will be applied prospectively except for the presentation and disclosure requirements that will be applied retrospectively for all periods presented. The Company is evaluating the impact, if any, the adoption of this statement will have on its results of operations, financial position and cash flows.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk

We transact business with merchants exclusively in the United States and receive payment for our services exclusively in United States dollars. As a result, our financial results are unlikely to be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.

Our interest expense is sensitive to changes in the general level of interest rates in the United States because a majority of our indebtedness is at variable rates. As of December 31, 2008, $494.6 million of our outstanding indebtedness was at variable interest rates based on LIBOR. Of this amount, $260.0 million was effectively fixed through the use of interest rate swaps. A rise in LIBOR rates of one percentage point would result in net additional annual interest expense of $2.2 million.

We hold certain derivative financial instruments for the sole purposes of hedging our exposure to interest rate risk. We do not hold any other derivative financial or commodity instruments, nor engage in any foreign currency denominated transactions, and all of our cash and cash equivalents are held in money market and checking funds.

ITEM 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of iPayment, Inc.:

We have audited the accompanying consolidated balance sheets of iPayment, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of iPayment, Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

/s/ ERNST & YOUNG LLP

Los Angeles, California
March 27, 2009

iPAYMENT, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data and per share amounts)


	December 31,			December 31,
	2008			2007
ASSETS
Current assets:
Cash and cash equivalents	$	3,589		$	33
Accounts receivable, net of allowance for doubtful accounts of $998 and $768 at December 31, 2008 and December 31, 2007, respectively		25,693			24,726
Prepaid expenses and other current assets		2,286			2,864
Investment in merchant advances, net of allowance for doubtful accounts of $3,822 and $0 at December 31, 2008 and December 31, 2007, respectively		4,460			116
Deferred tax assets		3,442			1,004

Total current assets		39,470			28,743

Restricted cash, net of allowance for doubtful accounts of $293 and $0 at December 31, 2008 and December 31, 2007, respectively		999			1,266
Property and equipment, net		4,714			3,753
Intangible assets and other, net of accumulated amortization of $95,286 and $59,109 at December 31, 2008 and December 31, 2007, respectively.		176,548			198,003
Goodwill		527,912			518,639
Deferred tax asset		4,991			—
Other assets, net		14,230			17,141

Total assets	$	768,864		$	767,545


LIABILITIES and STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	2,012		$	6,005
Income taxes payable		8,336			6,301
Accrued liabilities and other		22,366			19,406
Current portion of long-term debt		17,347			6,899

Total current liabilities		50,061			38,611

Minority interest in equity of consolidated subsidiaries		592			—
Deferred tax liabilities		—			6,602
Long-term debt		669,979			690,458
Other liabilities		21,627			14,658

Total liabilities		742,259			750,329


Commitments and contingencies (Note 5)

Stockholders’ equity
Common stock, $0.01 par value; 1,000 shares authorized, 100 shares issued and outstanding at December 31, 2008, and December 31, 2007		20,055			20,055
Accumulated other comprehensive loss, net of tax benefits of $8,178 and $4,903 at December 31, 2008, and December 31, 2007, respectively.		(12,268	)		(7,354	)
Retained earnings		18,818			4,515

Total stockholders’ equity		26,605			17,216

Total liabilities and stockholders’ equity	$	768,864		$	767,545

See accompanying notes to consolidated financial statements.

iPAYMENT, INC.
CONSOLIDATED STATEMENTS of CHANGES IN STOCKHOLDERS’ EQUITY and COMPREHENSIVE INCOME
(In thousands, except share data)


	Stockholders’ Equity
										Accumulated
										Other			Retained
	Common Stock						Deferred			Comprehensive			Earnings
	Shares						Compensation			Loss			(Deficit)			Total

Balance at December 31, 2005		17,725,181		$	155,870		$	(3,413	)	$	—		$	56,896		$	209,353
Exercise of stock options and related tax benefits		16,508			10,154			—			—			—			10,154
Amortization of restricted stock		—			—			3,413			—			—			3,413
Issuance of stock options to nonemployees for services rendered		—			42			—			—			—			42
Stock options issued to employees		—			4,467			—			—			—			4,467
Net income		—			—			—			—			850			850


Balance at May 10, 2006		17,741,689		$	170,533		$	—		$	—		$	57,746		$	228,279
Repurchase of common stock		(17,741,689	)		(633,702	)		—			—			—			(633,702	)
Revaluation of equity following change of control		100			483,224			—			—			(57,746	)		425,478
Comprehensive income:
Net loss		—			—			—			—			(890	)		(890	)
Unrealized loss on fair value of derivatives, net of tax benefits of $1,517		—			—			—			(2,275	)		—			(2,275	)

Total comprehensive income																	(3,165	)


Balance at December 31, 2006		100		$	20,055		$	—		$	(2,275	)	$	(890	)	$	16,890
Unrealized loss on fair value of derivatives, net of tax benefits of $3,386		—			—			—			(5,079	)		—			(5,079	)
FIN 48 beginning balance adjustment, net of tax benefits of $13		—			—			—			—			(26	)		(26	)
Net income		—			—			—			—			5,431			5,431


Balance at December 31, 2007		100			20,055			—			(7,354	)		4,515			17,216
Unrealized loss on fair value of derivatives, net of tax benefits of $3,276		—			—			—			(4,914	)		—			(4,914	)
Net income		—			—			—			—			14,303			14,303


Balance at December 31, 2008		100			20,055			—			(12,268	)		18,818			26,605

See accompanying notes to consolidated financial statements.

iPAYMENT, INC.
CONSOLIDATED STATEMENTS of CASH FLOWS
(In thousands)


							Period from
							May 11			January 1
	Year Ended			Year Ended			through			through
	December 31,			December 31,			December 31,			May 10,
	2008			2007			2006			2006
	Successor			Successor			Successor			Predecessor

Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income to net cash provided by operating activities	$	14,303		$	5,431		$	(890	)	$	850
Depreciation and amortization		38,041			35,948			25,558			14,026
Stock-based compensation		—			—			—			7,719
Noncash interest expense and other

Changes in assets and liabilities, excluding effects of acquisitions:		2,433			2,203			1,340			2,958
Accounts receivable		(967	)		(1,792	)		(13,820	)		13,488
Prepaid expenses and other current assets		612			(162	)		319			(461	)
Other assets		(5,851	)		(5,595	)		5,978			(6,017	)
Accounts payable and income taxes payable		(1,958	)		5,865			4,653			(4,444	)
Accrued liabilities and other		(174	)		(487	)		(13,351	)		20,322

Net cash provided by operating activities		46,439			41,411			9,787			48,441


Cash flows from investing activities
Change in restricted cash		267			(230	)		1,004			1,050
Expenditures for property and equipment		(2,374	)		(1,110	)		(1,510	)		(587	)
Investment in merchant advances		(4,344	)		—			—			—
Acquisitions of businesses and portfolios, net of cash acquired, and payments related to businesses previously acquired		(22,063	)		(22,147	)		(14,738	)		(11,500	)
Payments for prepaid residual expenses		(4,160	)		(719	)		(355	)		(524	)

Net cash used in investing activities		(32,674	)		(24,206	)		(15,599	)		(11,561	)


Cash flows from financing activities
Net borrowings (repayments) on line of credit		(2,200	)		1,350			850			(100,000	)
Proceeds received in exchange for ownership interest in Successor company		—			—			3,378			—
Repayments of debt		(8,009	)		(18,618	)		(3,920	)		(28	)
Proceeds from issuance of debt, net of finance costs		—			—			(120	)		701,165
Repurchase of common stock		—			—			(633,702	)		—
Proceeds from issuance of common stock		—			—			—			382

Net cash (used in) provided by financing activities		(10,209	)		(17,268	)		(633,514	)		601,519


Net increase (decrease) in cash and cash equivalents		3,556			(63	)		(639,326	)		638,399
Cash and cash equivalents, beginning of period		33			96			639,422			1,023


Cash and cash equivalents, end of period	$	3,589		$	33		$	96		$	639,422


Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes	$	13,917		$	5,943		$	321		$	4,866
Cash paid during the period for interest	$	54,072		$	57,616		$	35,015		$	2,663

Supplemental schedule of non-cash activities:
Accrual of deferred payments for acquisitions of businesses	$	2,456		$	—		$	5,168		$	—

Non-cash (decreases) increases in assets (liabilities):
Intangible assets	$	—		$	—		$	71,707		$	—
Goodwill	$	(2,277	)	$	—		$	379,091		$	—

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

1. Organization and Business and Basis of Presentation

Organization and Business

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

On May 10, 2006, the Company completed a merger transaction with iPayment Holdings, Inc. (“Holdings”) pursuant to which iPayment MergerCo, Inc. (“MergerCo”) was merged with and into the Company, with the Company remaining as the surviving corporation and a wholly-owned subsidiary of Holdings (the “Transaction”) as further described below. As a result of the Transaction, the Company’s results of operations, financial position and cash flows prior to the date of the Transaction are presented as the “Predecessor.” The financial effects of the Transaction and the Company’s results of operations, financial position and cash flows as the surviving corporation following the Transaction are presented as the “Successor.” The Transaction has been accounted for as a purchase at the parent company level (iPayment Holdings), with the related purchase accounting adjustments pushed down to the Company, as discussed further below.

As used in these Notes to Consolidated Financial Statements, the terms “iPayment,” the “Company,” “we,” “us,” “our” and similar terms refer to iPayment, Inc. and, unless the context indicates otherwise, its consolidated subsidiaries.

Basis of Presentation

The accompanying consolidated financial statements of iPayment have been prepared in accordance with U.S. generally accepted accounting principles. All significant intercompany transactions and balances have been eliminated in consolidation. We consolidate our majority-owned subsidiaries and reflect the minority interest of the portion of the entities that we do not own as “Minority Interest in Equity of Consolidated Subsidiaries” on our consolidated balance sheets. Certain prior year amounts have been reclassified to conform to the current year presentation.

Other costs of services include costs directly attributable to our provision of payment processing and related services to our merchants such as residual payments to independent sales groups, which are commissions we pay to these groups based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which are a percentage of the processing volume we generate from Visa and MasterCard. In addition, other costs of services includes telecommunications costs, personnel costs, occupancy costs, losses due to merchant defaults, other miscellaneous merchant supplies and service expenses, sponsorship costs and other third-party processing costs.

Going Private and Financing Transactions

Pursuant to an Agreement and Plan of Merger dated as of December 27, 2005, by and among the Company, MergerCo, and Holdings, MergerCo was merged with and into the Company on May 10, 2006, with the Company remaining as the surviving corporation and as a wholly-owned subsidiary of Holdings. Holdings is a wholly-owned subsidiary of iPayment Investors, Inc. (“Investors”), which is a Delaware corporation formed by Gregory S. Daily, the Company’s Chairman and Chief Executive Officer, Carl Grimstad, the Company’s President, and certain parties related to them. Pursuant to an exchange agreement, dated as of December 27, 2005, Mr. Daily and his affiliates exchanged all of their equity interests in the Company for equity securities of Holdings, and Mr. Grimstad and his affiliates exchanged 72.9% of their equity interests in the Company for equity securities of Holdings. Our senior subordinated notes resulted in an increase to these shareholders’ residual interests in the Successor company of $16.2 million. In addition, Mr. Daily contributed approximately $3.4 million in cash for equity securities in Holdings. Holdings paid $43.50, without interest, in exchange for each issued and outstanding share of the Company’s common stock (other than shares of the Company’s common stock held by Holdings or any of its subsidiaries immediately prior to the effective time of the merger, shares of the Company’s common stock held by the Company or any of its subsidiaries and shares of the Company’s common stock held by the Company’s stockholders who perfected their appraisal rights under Delaware law). In addition, Holdings paid the excess, if any, of $43.50 over the per share exercise price of each option outstanding at the effective time of the merger to purchase the Company’s common stock granted under any of the Company’s option plans. No merger consideration was paid for shares that were exchanged for equity securities of Holdings. On June 28, 2006, iPayment Investors, Inc. was converted into a limited partnership as iPayment Investors, L.P.

Total consideration given in the Transaction was $800.0 million paid to purchase the outstanding shares of the Company. In addition, the Company paid the outstanding balance of $70.0 million under the Company’s previous credit facility and $25.4 million of transaction costs. The Transaction was funded with $170.0 million of equity financing, approximately $515.0 million from a term loan facility and net proceeds of $202.2 million from the issuance of 9 ³ /4% senior subordinated notes due in 2014, with the balance funded by borrowings under the Company’s new $60.0 million revolving credit facility. The credit agreements and the indenture governing the senior subordinated notes contain significant restrictions and covenants affecting, among other things, the operations and finances of the Company and its subsidiaries. The senior secured credit facility and senior subordinated notes are more fully described in Note 7.

The Company has allocated the purchase price to the assets acquired and liabilities assumed based upon their respective fair values. As part of this allocation, approximately $486.7 million was assigned to goodwill and $251.2 million to identifiable intangible assets, resulting in an increase of $379.1 million and $71.7 million in goodwill and intangible assets, respectively, over the historical basis prior to the Transaction. Of the amount allocated to intangible assets, $250.3 million relates to the Company’s

merchant processing portfolios and residual cash flow streams. In accordance with Emerging Issues Task Force (“EITF”) Issue No. 88-16, Basis in Leverage Buyout Transactions, the continuing residual interest of the owners of Investors has been reflected at its original cost adjusted for their share of the Company’s equity adjustments since the date of the original acquisition (“predecessor basis”). In accordance with EITF Issue No. 90-12, Allocating Basis to Individual Assets and Liabilities within the Scope of Issue 88-16, only a partial step-up of assets and liabilities to fair value has been recorded in purchase accounting. The partial step-up has resulted in the Company’s net assets and liabilities being adjusted by approximately 88.5% of the difference between the fair value at the date of acquisition and the predecessor basis under EITF 88-16.

The following table presents the unaudited pro forma results as if the Transaction and related financing had occurred at the beginning of 2006:


	Year ended
	December 31,
	2006
Gross revenues	$	733,988
Income from operations	$	64,532
Interest expense	$	60,719
Net income	$	2,626

The unaudited pro forma results shown include incremental amortization and interest expense and related tax benefits as if the debt incurred in the Transaction had been incurred on January 1, 2005, and assumes no principal payments. The assumed interest rates are those in effect as of December 31, 2006, and the assumed effective tax rate is 39.0%. The unaudited pro forma results exclude expenses related to the Transaction, including compensation expense related to stock options and restricted stock of $7.9 million and professional fees and other Transaction-related expenses of $8.8 million. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results that would have actually been attained if the Transaction and related financing had occurred at the beginning of 2006.

As a result of the Transaction, the Company had 100 shares of common stock outstanding at December 31, 2008. The Company has elected not to present earnings per share data as management believes such presentation would not be meaningful.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of iPayment, Inc. and its wholly owned subsidiaries iPayment of California, LLC, 1st National Processing Inc, E-Commerce Exchange Inc, iPayment of Maine, Inc, OnLine Data Corporation, CardSync Processing, Inc, CardPayment Solutions, LLC, TS Acquisition Sub, LLC, PCS Acquisition Sub, LLC, Quad City Acquisition Sub, Inc, NPMG Acquisition Sub, LLC, iFunds Cash Solutions, LLC, Cambridge Acquisition Sub, LLC, MSC Acquisition Sub, LLC, iScan Solutions, LLC, iPayment Acquisition Sub, iPayment of Eureka, Inc, and iPayment Central Holdings, Inc., as well as its joint venture subsidiary Central Payment Co., LLC. All significant accounts, transactions and profits between the consolidated companies have been eliminated in consolidation. Significant accounts and transactions between iPayment, Inc., including its subsidiaries, and its directors and officers are disclosed as related party transactions (Note 10).

Use of Estimates

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

Revenue and Cost Recognition

Other costs of services include costs directly attributable to processing and bank sponsorship costs, which amounted to $38.1 million, $40.1 million, $28.3 million, and $15.8 million in the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, respectively. They also include related services to our merchants such as residual payments to sales groups, which are commissions we pay to our sales groups based upon a percentage of the net revenues we generate from their merchant referrals, and assessment fees payable to card associations, which is a percentage of the charge volume we generate from Visa and MasterCard. In addition, other costs of services 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 directly attributable to our provision of payment processing and related services to our merchants.

Selling, general and administrative expenses consist primarily of salaries and wages and other administrative expenses such as professional fees.

Cash and Cash Equivalents and Statements of Cash Flows

For purposes of reporting financial condition and cash flows, cash and cash equivalents include cash and securities with original maturities of three months or less. Our cash accounts at various banks are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. Cash and cash equivalents in excess of FDIC insured limits totaled $3.0 million at December 31, 2008. There were no cash and cash equivalents in excess of FDIC insured limits at December 31, 2007.

Restricted Cash

Restricted cash represents funds held-on-deposit with processing banks pursuant to agreements to cover potential merchant losses, and funds held by lending institutions pursuant to loan agreements to provide additional collateral. Restricted cash in excess of FDIC insured limits totaled $0.6 million and $0.9 million at December 31, 2008 and 2007, respectively. At December 31, 2008, restricted cash on our balance sheet is shown net of allowance for doubtful accounts of $0.3 million. See “Other — Merrick Bank” in Note 5 for further discussion on the allowance for doubtful accounts.

Accounts Receivable, net

Accounts receivable are primarily comprised of amounts due from our clearing and settlement banks from revenues earned, net of related interchange and bank processing fees, as required by Financial Accounting Standards Board (“FASB”) Interpretation No. 39 Offsetting of Amounts Related to Certain Contracts, on transactions processed during the month ending on the balance sheet date. Such balances are typically received from the clearing and settlement banks within 30 days following the end of each month. The allowance for doubtful accounts as of December 31, 2008 and 2007 was $1.0 million and $0.8 million, respectively. We record allowances for doubtful accounts when it is probable that the accounts receivable balance will not be collected.

Property and Equipment, net

Property and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method for financial reporting purposes and primarily accelerated methods for tax purposes. For financial reporting purposes, equipment is depreciated over two to five years. Leasehold improvements and property acquired under capital leases are amortized over the useful life of the asset or the lease term, whichever is shorter. Depreciation expense for property and equipment for the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006 was $1.6 million, $1.2 million, $0.7 million, and $0.3 million, respectively. Maintenance and repairs are charged to expense as incurred. Expenditures for renewals and improvements that extend the useful life are capitalized.

Intangible Assets, net

Intangible assets primarily include merchant accounts from portfolio acquisitions (i.e. the right to receive future cash flows related to transactions of these applicable merchants) (Note 3). For all periods through the period ended May 10, 2006, the straight-line method of amortization over a seven-year period resulted in the proper approximation of the distribution of the actual cash flows generated from our merchant processing portfolios. The adoption of an accelerated method of amortization based on an average historical attrition rate of approximately 15% over a fifteen-year period would have resulted in the recognition of similar amounts of amortization expense as the straight-line method used by us during the same periods. Effective May 11, 2006, we adopted such an accelerated method of amortization over a 15-year period, which we believe better 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 3 to 7 years.

In addition, we have implemented both quarterly and annual procedures to determine whether a significant change in the trend of the current attrition rates being used exists on a portfolio by portfolio basis. In reviewing the current attrition rate trends, we consider relevant benchmarks such as merchant processing volume, revenues, gross profit and future expectations of the aforementioned factors versus historical amounts and rates. If we identify any significant changes or trends in the attrition rate of any portfolio, we will adjust our current and prospective estimated attrition rates so that the amortization expense would better approximate the distribution of actual cash flows generated by the merchant processing portfolios. Any adjustments made to the amortization schedules would be reported in the current Consolidated Income Statements and on a prospective basis until further evidence becomes apparent. We identified an unfavorable trend of the current attrition rates being used during the year ended December 31, 2008 on some of our portfolios. Accordingly, we recorded an increase to amortization expense of approximately $2.4 million to better approximate the distribution of actual cash flows generated by the merchant processing portfolios.

Estimated useful lives are determined for merchant processing portfolios based on the life of the expected cash flows from the underlying merchant accounts and for other intangible assets primarily over the remaining terms of the contracts. During the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, amortization expense related to intangible assets was $36.3 million, $34.5 million, $24.8 million, and $13.5 million, respectively. As of December 31, 2008, estimated amortization expense for each of the five succeeding years is expected to be as follows (in thousands):


Year ended December 31,	Amount
2009	$	36,931
2010		30,070
2011		24,266
2012		19,513
2013		15,469

Estimated future amortization expense is based on intangible amounts recorded as of December 31, 2008. Actual amounts will increase if additional amortizable intangible assets are acquired.

Goodwill

We follow SFAS No. 142, Goodwill and Other Intangible Assets, which addresses financial accounting and reporting for acquired goodwill and other intangible assets, and requires that goodwill is no longer subject to amortization over its estimated useful life. Rather, 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 SFAS No. 142, 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 of other publicly traded institutions in our industry, the current economic environment, and the choice of an appropriate discount rate.

We completed our most recent annual goodwill impairment review as of December 31, 2008, using the present value of future cash flows to determine whether the fair value of the reporting unit exceeded the carrying amount of the net assets, including goodwill. All goodwill impairment testing is performed by an independent third party in conjunction with the Company. We determined that no impairment charge to goodwill was required.

Impairment of Long-Lived Assets

We periodically evaluate the carrying value of long-lived assets, in relation to the respective projected future undiscounted cash flows, to assess recoverability. An impairment loss is recognized if the sum of the expected net cash flows is less than the carrying amount of the long-lived assets being evaluated. The difference between the carrying amount of the long-lived assets being evaluated and the fair value, calculated as the sum of the expected cash flows discounted at a market rate, represents the impairment loss. Based on the analyses we performed as of December 31, 2008 for goodwill and intangible assets, we concluded that none of our long-lived assets were impaired.

Other Assets

Other assets at December 31, 2008 and 2007, include approximately $0.4 million and $1.2 million, respectively, of notes receivable (an additional $0.6 million and $1.2 million are included in prepaid expenses and other current assets at December 31, 2008 and 2007, respectively), representing amounts advanced to sales agents. The notes bear interest at amounts ranging from 6% to 12%, and are payable back to us through 2012. We secure the loans by the independent sales group’s assets, including the rights they have to receive residuals and the fees generated by the merchants they refer to us and any other accounts receivable and typically by obtaining personal guarantees from the individuals who operate the independent sales groups.

Also included in other assets at December 31, 2008 and 2007, are approximately $10.7 million and $12.9 million of debt issuance costs (net of accumulated amortization of $5.9 million and $3.6 million, respectively), which are being amortized over the terms of the related debt agreements using the straight-line method which approximates the effective interest method. Other assets also include sales-type leases held for investment, which are stated at the present value of the future minimum lease payments and estimated residual values discounted at the rate implicit in the lease, net of allowances for losses. Sales-type leases held for investment included in other assets were approximately $0.5 million and $0.7 million at December 31, 2008 and 2007, respectively.

Reserve for Losses on Merchant Accounts

We maintain a reserve for merchant losses necessary to absorb chargeback and other losses for merchant transactions that have been previously processed and which have been recorded as revenue. We analyze the adequacy of our reserve for merchant losses each reporting period. The reserve for merchant losses is comprised of three components: (1) specifically identifiable reserves for merchant transactions for which losses are probable and estimable, (2) a calculated reserve based upon historical loss experience applied to the previously processed transactions, and (3) a management analysis component for concentration issues and general macroeconomic and other factors. The reserve for losses on merchant accounts is decreased by merchant losses (arising primarily from chargebacks) and is increased by provisions for merchant losses and recoveries of merchant losses. Provisions for merchant losses of $4.2 million, $3.6 million, $2.2 million, and $1.4 million for the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, respectively, are included in other costs of services in the accompanying Consolidated Statements of Operations. At December 31, 2008 and 2007, our reserve for losses on merchant accounts included in accrued liabilities and other totaled $1.3 million and $1.0 million, respectively.

advance may be deemed uncollectible. We analyze the adequacy of our reserve for merchant advance losses for each reporting period. We conduct an impairment assessment for each advance and record any necessary loss reserve accordingly. The reserve for merchant advance losses is comprised of two components: (1) a reserve calculated using different reserve percentages for various stratifications of specifically identified merchant advances for which losses are probable and estimable and (2) a reserve on the remaining balance of merchant advances calculated based upon historical loss experience and taking into account general macroeconomic and other factors. As of December 31, 2008, our reserve for merchant advances was $3.8 million and is included in “Investment in merchant advances” in our Consolidated Balance Sheets.

Financial Instruments

We believe the carrying amounts of financial instruments at December 31, 2008, including cash, restricted cash, accounts receivable, sales-type leases held for investment, and accounts payable approximate fair value. Due to the short maturities of the cash and cash equivalents and accounts receivable, carrying amounts approximate the respective fair values. The carrying value of our senior subordinated notes, net of discount, is $193 million at December 31, 2008. We estimate the fair value to be approximately $109 million, considering executed trades occurring around December 31, 2008. The carrying value of the senior secured credit facility is $495 million at December 31, 2008. We estimate the fair value to be approximately $319 million, considering executed trades occurring around December 31, 2008.

Share-Based Compensation

Effective January 1, 2006 we adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment, (“SFAS No. 123R”) using the Modified Prospective Approach. SFAS No. 123R revises SFAS No. 123, Accounting for Share-based Compensation (“SFAS No. 123”) and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). SFAS No. 123R requires the cost of all share-based payments to employees and directors, including grants of employee stock options, to be recognized in the financial statements based on fair values at the date of grant, or the date of later modification, over the requisite service period. In addition, SFAS No. 123R requires unrecognized cost (based on the amounts previously disclosed in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized in the financial statements over the remaining requisite service period.

Under the Modified Prospective Approach, the amount of compensation cost recognized includes: (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123 and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. The incremental pre-tax share-based compensation expense recognized due to the adoption of SFAS No. 123R for the period from January 1, 2006 through May 10, 2006 (Predecessor), was $4.5 million, with an associated tax benefit of $1.7 million. The share-based compensation expense recognized for the period from January 1 through May 10, 2006 (Predecessor), includes $3.6 million (with an associated tax benefit of $1.4 million) due to the acceleration of option vesting as a result of the Transaction. There was no compensation expense recognized in accordance with SFAS No. 123R for the period May 11 to December 31, 2006 (Successor), as all stock options and restricted stock were exercised or redeemed at the closing of the Transaction.

The Company received $0.4 million in cash proceeds related to the exercise of stock options during the period from January 1 to May 10, 2006 (Predecessor). In addition, the Company realized total tax benefits from stock option exercises of $9.8 million for the period from January 1 to May 10, 2006 (Predecessor), which were recorded as increases to additional paid-in capital on the consolidated balance sheets of the Predecessor company. The adoption of SFAS 123R also resulted in reflecting these excess tax benefits from the exercise of share-based compensation awards in cash flows from financing activities in the Consolidated Statements of Cash Flows.

SFAS No. 123R also requires us to change the classification, in our condensed consolidated statement of cash flows, of any tax benefits realized upon the exercise of stock options or issuance of restricted share unit awards in excess of that which is associated with the expense recognized for financial reporting purposes. In periods in which our tax benefits realized upon the exercise of stock options or issuance of restricted share unit awards are in excess of the compensation expense recognized for financial reporting purposes, the amounts will be presented as a financing cash inflow rather than as a reduction of income taxes paid in our condensed consolidated statement of cash flows.

Derivative Financial Instruments

The Company uses certain variable rate debt instruments to finance its operations. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense also decreases. Management believes it is prudent to limit the variability of its interest payments.

To meet this objective and to meet certain requirements of our credit agreements, the Company enters into certain derivative instruments to manage fluctuations in cash flows resulting from interest rate risk. These instruments consist solely of interest rate swaps. Under the interest rate swaps, the Company receives variable interest rate payments and makes fixed interest rate payments, thereby effectively creating fixed-rate debt. The Company enters into derivative instruments solely for cash flow hedging purposes, and the Company does not speculate using derivative instruments.

The Company accounts for its derivative financial instruments in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities . Under SFAS No. 133, the Company recognizes all derivatives as either other assets or other liabilities, measured at fair value. The fair value of these instruments at December 31, 2008, was a liability of $20.4 million, and was included as other liabilities in our consolidated balance sheet. SFAS No. 133 also requires that any ineffectiveness in the hedging relationship, resulting from differences in the terms of the hedged item and the related derivative, be recognized in earnings each period. The underlying terms of our interest rate swaps, including the notional amount, interest rate index, duration, and reset dates, are identical to those of the associated debt instruments and therefore the hedging relationship results in no material ineffectiveness.

Accordingly, such derivative instruments are classified as cash flow hedges, and any changes in the fair market value of the derivative instruments are included in accumulated other comprehensive loss in our consolidated balance sheet.

Income Taxes

We account for income taxes pursuant to the provisions of SFAS No. 109, Accounting for 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.

Deferred taxes are calculated by applying enacted statutory tax rates and tax laws to future years in which temporary differences are expected to reverse. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the rate change is enacted. A deferred tax valuation reserve is established if it is more likely than not that a deferred tax asset will not be realized.

Advertising Costs

We recognize advertising costs as incurred. For the year ended December 31, 2008, year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, advertising costs were $146,000, $161,000, $74,000, and $59,000, respectively, and were included in selling, general and administrative expenses.

Minority Interest

We currently own a 20 percent interest in a joint venture, Central Payment Co., LLC (“CPC”). We previously owned a 51 percent interest in a second joint venture, iPayment ICE of Utah, LLC (“ICE”). However, during the third quarter of 2008, we acquired the remaining 49 percent of ICE for less than $0.1 million, which caused ICE to now be wholly-owned. At that time, we legally dissolved the entity iPayment ICE of Utah, LLC and our subsidiary iPayment ICE Holdings, Inc., which had previously held our 51 percent interest in ICE.

Minority interest in losses of consolidated subsidiaries listed on the Consolidated Statements of Operations represents the minority shareholders’ share of the after-tax net income or loss of these entities. The minority interest in equity of consolidated subsidiaries listed on the Consolidated Balance Sheets reflects the original investments by the minority shareholders, along with their proportionate share of the earnings or losses of the consolidated subsidiaries. The minority interest in equity of consolidated subsidiaries was zero on the Consolidated Balance Sheets at December 31, 2007 as the original investments by the minority shareholders had been absorbed by their proportionate share of the losses of the consolidated subsidiaries. In 2008, we recorded a minority interest of $0.6 million in respect of our remaining joint venture.

We account for our 20 percent interest investment in the joint venture CPC pursuant to the provisions of SFAS Interpretation No. 46R, Consolidation of Variable Interest Entities. Under this method, if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in consolidated financial statements with those of the business enterprise. An enterprise that is the primary beneficiary of the variable interest entity consolidates the variable interest. As a result, we consider the investment as a variable interest entity, and as the primary beneficiary, we consolidate CPC.

Merger Transaction

We accounted for the Transaction in conformity with SFAS No. 141, Business Combinations, and EITF No. 88-16, Basis in Leveraged Buyout Transactions. The total cost of the purchase was allocated as a partial change in basis to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values as of the date of the merger based upon an independent valuation. The excess of the purchase price over the historical basis of the net assets acquired was $486.7 million and has been allocated to goodwill.

Restructuring

We accounted for our restructuring related to the Westchester, Illinois office closure in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Under SFAS No. 146, we recognize costs associated with an exit or disposal activity when the liability is incurred and establish the fair value for initial measurement of the liability. We recognized approximately $0.9 million of restructuring costs during 2007.

New Accounting Pronouncements

3. Acquisitions

The effective date of each of the acquisitions discussed in this Note are the dates the acquisition was recognized in our financial statements, unless otherwise noted. For the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006, amortization expense related to our merchant processing portfolios and other intangible assets was $36.3 million, $34.5 million, $24.8 million, and $13.5 million, respectively.

First Data Merchant Services Merchant Portfolio

On December 28, 2004, we entered into an Asset Purchase Agreement with First Data Merchant Services (“FDMS”), a subsidiary of First Data Corporation, pursuant to which we acquired a portfolio of merchant contracts (the “FDMS Merchant Portfolio”) for a price of $130.0 million in cash, of which $0.9 million related to certain rental equipment. Pursuant to the terms of the Asset Purchase Agreement, the acquisition became effective on December 31, 2004, and we commenced receiving revenue from the merchant contracts on January 1, 2005. We expanded our revolving credit facility with Bank of America and JPMorgan Chase Bank to $180 million from $80 million to finance the acquisition. The purchase price allocated to merchant portfolios of $129.1 million is included in intangible assets in the accompanying consolidated balance sheets and is being amortized using an accelerated method over fifteen years for financial reporting purposes and on a straight-line basis over fifteen years for income tax purposes.

Earnout Payments

Certain purchase agreements for acquisitions made in prior periods contained earnout payments based on the subsequent performance of the business acquired. As the terms of these earnout provisions are met, we accrue the amount owed in our consolidated balance sheets and record an increase to goodwill. We provided for $2.5 million and $3.6 million in earnout payments in 2008 and 2007, respectively.

Other Acquisitions

In February 2006, we acquired a 20 percent interest in CPC, which began its operations during the first quarter of 2006. Central Payment Co., LLC has approximately 71 employees. The remaining 80 percent is owned by two former employees of iPayment, Inc. In 2006 and 2007, we absorbed the cumulative losses in the direct sales group to the extent such losses exceeded the minority partners’ investment.

We made various other purchases of residual cash flow streams and one business — Cambridge Payment Systems LLC (“Cambridge”) — collectively totaling $14.1 million during 2007. Cambridge was acquired on December 28, 2007, and the results of operations were included in our Consolidated Statements of Operations beginning January 1, 2008. Consideration for this acquisition included cash at closing and a contingent payment based upon future performance over three years. The Cambridge acquisition was recorded under the purchase method. The purchase prices for the residual cash flow streams and merchant processing portfolios were primarily assigned to intangible assets in the accompanying consolidated balance sheets and are amortized over their expected useful lives. As a result of the Cambridge acquisition, we recorded approximately $4.6 million of intangible assets and $8.3 million of goodwill during fiscal 2007.

On April 1, 2008, we entered into an agreement to purchase substantially all of the assets and to assume certain liabilities of Merchant Service Center (“MSC”), an independent sales group with a growing portfolio of over 7,000 merchants. Consideration included cash at closing and contingent payments based on performance in 2008, 2009, and 2010. Merchant Service Center is a provider of credit card transaction processing services. The acquisition was recorded under the purchase method with the total consideration allocated to the fair value of assets acquired and liabilities assumed. The operating results of Merchant Service Center were included in our Consolidated Statements of Operations beginning April 1, 2008 pursuant to the provisions of the Asset Purchase Agreement. As a result of the MSC acquisition, we recorded approximately $10.2 million of intangible assets and $11.5 million of goodwill during fiscal 2008.

Pro Forma Disclosure for the Above Business Acquisitions

Other than the Transactions discussed in Note 1, there were no acquisitions of businesses during 2008, 2007 or 2006 that would require a pro forma disclosure.

4. Details of Balance Sheet Accounts


	December 31,
(in thousands)	2008			2007
Property and Equipment, net:
Machinery and equipment	$	1,769		$	1,363
Furniture and fixtures		1,066			961
Leasehold improvements		508			334
Computer software and equipment		4,202			2,567
Terminals		798			539

		8,343			5,764
Less — accumulated depreciation and amortization		(3,629	)		(2,011	)

	$	4,714		$	3,753


Goodwill:
Beginning balance	$	518,639		$	506,078
Acquired during the period		11,486			8,256
Adjustments to goodwill acquired in prior period		(2,213	)		4,305

	$	527,912		$	518,639

5. Commitments and Contingencies

Leases

We lease our office facilities for approximately $149,000 per month under operating leases. Our facilities include locations in Nashville, Tennessee, California locations in Calabasas and Santa Barbara, Minden, Nevada, Phoenix, Arizona, Novi, Michigan, and Akron, Ohio. Our joint venture’s principal executive office is located in Larkspur, California. Our future minimum lease commitments under noncancelable leases are as follows at December 31, 2008 (in thousands):


Year ended December 31,	Amount
2009	$	1,520
2010		706
2011		221
2012		188
2013		106
Thereafter		—

Total	$	2,741

Total rent expense for the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006 was $2.1 million, $2.4 million, $1.3 million, and $0.8 million, respectively.

Minimum Processing Commitments

We have non-exclusive agreements with several processors to provide us services related to transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. Certain of these agreements require us to submit a minimum monthly number of transactions for processing. If we submit a number of transactions that is lower than the minimum, we are required to pay to the processor the fees that it would have received if we had submitted the required minimum number of transactions. As of December 31, 2008, such minimum fee commitments were as follows (in thousands):


Year ended December 31,	Amount
2009	$	5,540
2010		3,878
2011		2,715
2012		—
2013		—
Thereafter		—

Total	$	12,133

In conjunction with the FDMS Merchant Portfolio acquisition (Note 3), we also entered into service agreements with FDMS (the “Service Agreements”), pursuant to which FDMS agreed to perform certain data processing and related services with respect to the

acquired merchant contracts through 2011. In consideration for entering into the Service Agreements, we are required to pay FDMS a processing fee related to these accounts of at least 70% of the amount paid during the immediately preceding year. The minimum commitments for years after 2008 included in the table above are based on the preceding year minimum amounts. The actual minimum commitments for such years may vary based on actual fees paid in the preceding years.

We also have agreed to utilize FDMS to process at least 75% of our consolidated transaction sales volume in any calendar year through 2011. The minimum commitments for such years are not calculable as of December 31, 2008, and are excluded from this table.

Contingent Acquisition Price Obligations

Certain of our acquisitions include purchase price escalations that are contingent upon future performance. We accrue such obligations once all contingencies are met. As of December 31, 2008, $2.5 million related to contingent purchase price obligations was included in Accrued liabilities and other in the accompanying Consolidated Balance Sheets.

Litigation

Robert Aguilard, et al., on behalf of themselves and all persons similarly situated v. E-Commerce Exchange, Inc., A-1 Leasing LLC, and Duvera Billing Services, Civil Action No. 05CC02794 — State of California, Superior Court of Orange County.

This lawsuit (the “Action”), was initially reported in our Annual Report for the year ended December 31, 2004, previously filed on Form 10-K with the Securities and Exchange Commission on February 24, 2005 and was last updated in our Quarterly Report for the third quarter ended September 30, 2008, filed on Form 10-Q with the Securities and Exchange Commission on November 10, 2008. The lawsuit was filed on behalf of ten named plaintiffs and on behalf of all persons similarly situated, as a “class action” and, as amended, names our subsidiary E-Commerce Exchange, Inc. (“ECX”) and third parties, A-1 Leasing LLC, (“A-1 Leasing”), Duvera Billing Services (“Duvera”), Applied Merchant Systems, Inc. (“AMS”), Vandalay Venture Group, Inc. (“Vandalay”) and Michael Lauria (“Lauria”) as named defendants. It alleges a single cause of action for “unfair competition” (pursuant to California Business and Professions Code Sections 17200) arising out of certain alleged marketing activities related to the credit card processing services offered by ECX to merchants that included a lease or purchase of a “payment gateway” allegedly marketed by ECX under the names “Quick Commerce” and “Wonderpay.’’ The Action seeks an order certifying it as a “class action, a declaratory judgment, an injunction, and an accounting, restitution, disgorgement of defendants profits from the “unfair competition” activities, interest, attorney fees and costs of suit. A cross-complaint was also filed against ECX and AMS, by Duvera in February 2007, asserting six causes of action, including negligence, contractual and equitable indemnity, specific performance and seeking declaratory relief and damages according to proof. A-1 also filed a separate cross-complaint against AMS.

As we previously reported, in September 2008, the parties reached an agreement in principle on proposed terms for the settlement of plaintiffs’ claims against defendants, including dismissals with prejudice. After we last reported on this matter, the parties executed a Stipulation of Class Action Settlement, dated January 9, 2009 (the “Class Settlement Agreement”), which set forth the material terms of the settlement of plaintiffs’ claims in the subject Litigation against defendants. We and the other defendants, A-1, Duvera, AMS, and Lauria, also entered into a separate Settlement Agreement and Mutual General Release, dated as of January 15, 2009, (the “Defendants Settlement Agreement”) which sets forth the respective settlement understandings and agreements between the various defendants. Under the Defendants Settlement Agreement, the cross-complaint filed by Duvera against us (ECX) and AMS will be dismissed with prejudice, and we and each of the other defendants will fully and finally settle and release each and all other defendants with respect to the claims asserted or that could have been asserted against each other in connection with the matters alleged by the plaintiffs in the Action. The Defendants Settlement Agreement understandings are conditioned on the proposed settlement of plaintiffs’ claims against Defendants being completed.

On March 5, 2009, the court gave preliminary approval to the terms and conditions of the proposed Class Settlement Agreement and ordered that notice of the proposed Class Settlement Agreement is required to be mailed by April 17, 2009. June 4, 2009 is the date set for the fairness hearing, at which time the court is to consider final approval of the Class Settlement Agreement. The proposed Class Settlement Agreement will not be fully effective and binding unless and until the court grants final. The Class Settlement Agreement is not an admission of liability by the defendants and this summary of the Class Settlement Agreement does not purport to be complete and is qualified in its entirety by the Class Settlement Agreement.

If this matter is settled under the terms of the proposed settlement, when completed, the settlement will not have a material adverse effect on our business, financial condition or results of operations. We can provide no assurance that that final court approval will be obtained, or that the conditions required for settlement will be satisfied. In the event that conditions for the settlement are not satisfied and the proposed settlement of plaintiffs’ claims against the defendants is not completed, all of the settlement understandings will be null and void. In that event, we will be required to continue to defend ourselves in this matter and we currently intend to do so vigorously. There can be no assurance that we would be successful in our defense or that a failure to prevail will not have a material adverse effect on our business, financial condition or results of operations.

Bruns v. E-Commerce Exchange Inc., et al, Orange County Superior Court, State of California, Case No. 00CC02450 (coordinated under the caption “TCPA Cases,” Los Angeles County Superior Court, State of California, Case No. JCCO 43500)

This matter was previously reported in our Annual Report for the year ended December 31, 2007, previously filed on Form 10-K with the Securities and Exchange Commission on March 14, 2008, and was last updated in our Quarterly Report for the second quarter ended June 30, 2008, filed on Form 10-Q with the Securities and Exchange Commission on August 11, 2008. As previously reported, this matter arises from a lawsuit filed in February 2000 by plaintiff Dana Bruns on her own behalf and on behalf of a

purported class of persons in California who, during the five years prior to filing the lawsuit, allegedly received fax transmissions from third-party defendant Fax.Com and its advertisers, including our subsidiary E-Commerce Exchange, Inc. The complaint, as amended, alleges that the defendants sent “fax blast” transmissions to telephone facsimile machines in violation of the provisions of the Telephone Consumer Protection Act of 1991 (“TCPA”) and seeks relief under the TCPA and/or under California’s Unfair Competition Act, Business & Professions Code and for negligence, including for injunctive relief, damages and monetary relief, attorney’s fees and costs of suit and other relief deemed proper.

As previously reported, ECX tendered this claim in early 2000 to Farmer’s Insurance (“Farmers”) under a policy then in effect that provides up to $2,000,000 for “covered” claims and the claim defense. In April 2000, Farmers agreed, subject to a reservation of rights, to assume the defense of ECX in this litigation and has paid all costs of defense since April 2000. As we also reported earlier, in December 2006, ECX and other defendants filed a Motion for Mandatory Dismissal of this lawsuit, based on the failure to bring the case to trial within five years after the action commenced (pursuant to California Code of Civil Procedure), which the Court granted and issued an Order and Opinion on May 14, 2007. Notice of Entry of Final Judgment dismissing the litigation with prejudice was filed on June 26, 2007. On August 30, 2007, plaintiff timely filed her Notice of Appeal and on February 22, 2008 the Court of Appeal filed plaintiff’s opening brief, which was served on ECX, and subsequently, during calendar year 2008, the parties filed all required briefs with the Appellate Court.

Since we last reported on this matter, on December 8, 2008 oral argument was presented on behalf of ECX to the Appellate Court panel assigned to the case. On March 23, 2009, the Appellate Court issued its opinion, voting 2 to 1, in favor of the plaintiff and reversing the Trial Court Notice of Entry of Final Judgment, and dismissing the litigation with prejudice. At this time, we are consulting with our counsel to determine whether to file for either a petition for rehearing with the Appellate Court or a petition for review with the California Supreme Court. We have until April 7, 2009 to file a petition for rehearing and until May 4, 2009 to file a petition for review with the California Supreme Court. We continue to believe that the claims asserted against us in this lawsuit are without merit, and that the Trial Court properly granted the Motion to Dismiss and entered Final Judgment dismissing the litigation with p rejudice. However, at this time, we cannot predict with any certainty whether, in the event we file a petition for rehearing with the Appellate Court or a petition for review with the California Supreme Court, if either would be granted. We also cannot predict how the Appellate Court or Supreme Court would rule on the plaintiff’s appeal or, in the event appellate relief is ordered, the likely outcome it may have on the lawsuit and the claims asserted against us.

There can be no assurance that we will be successful or prevail in our defense, and/or in the event we are not successful that any judgment that may be awarded against us will be “covered” as an “insured” loss under the Farmers insurance policy that the claim was tendered and/or amounts of coverage provided by the Farmers policy will be sufficient to fully satisfy a judgment awarded against us (ECX) and therefore, there can be no assurance that a failure to prevail will not have a material adverse effect on our business, financial condition or results of operations.

Colin Hill v. CardPayment Solutions, L.L.C. and Zachary Daniels, Circuit Court in and for the Sixth Judicial Circuit, in and for Pinellas County, Florida, Case No. 06-8669-CI-0792

This matter was initially reported in our Quarterly Report for the third quarter ended September 30, 2007, filed on Form 10-Q with the Securities and Exchange Commission on November 13, 2007, and was last updated in our Quarterly Report for the third quarter ended September 30, 2008, filed on Form 10-Q with the Securities and Exchange Commission on November 10, 2008. As we previously reported, Colin Hill filed a lawsuit in a Florida state court against our subsidiary CardPayment Solutions, LLC (“CPS”) and after a default was entered by the Clerk, an uncontested trial was conducted which resulted in a judgment (the “Florida Judgment”) entered on September 28, 2007 against CPS in the amount of $0.8 million. After CPS received notice of the judgment, it timely filed an appeal (the “Florida Appeal”). While the Florida Appeal was pending, Hill filed and served CPS with a summons in an action in the Circuit Court for Davidson County, 20th Judicial District, State of Tennessee, Case No. 08-C3284 (the “Tennessee Action”) for sister state judgment entry and enforcement of the Florida Judgment. Since our last update, CPS filed a response to the Tennessee Action, which resulted in the Tennessee Action being placed off calendar pending the outcome of the Florida Appeal. The parties then agreed to participate in mediation on February 12, 2009, which resulted in an agreement for settlement being reached. The parties executed formal settlement documents providing for the complete settlement of all claims in the subject Litigation, full mutual releases as to all claims and all matters in the litigation, filing of a Satisfaction of the Florida Judgment as to CPS and the Tennessee Action was dismissed with prejudice. Accordingly, these related litigation matters are completely settled as between us (CPS) and Hill, and all claims against us (CPS) in the subject litigation have been fully settled and released. The terms of the settlement did not have a material adverse effect on our business, financial condition or results of operations.

Sharyn’s Jewelers, LLC v. iPayment, Inc., iPayment of Valencia, Vericomm and JP Morgan Chase Bank, General Court of Justice, Superior Court Division, County of Carteret, State of North Carolina, File No.: 05-CVS-92 / and related case Judgment Recovery Group, LLC, as assignee of Sharyn’s Jewelers, LLC, v. iPayment, Inc., iPayment of Valencia, Vericomm, and JP Morgan Chase Bank, Superior Court of the State of California, County of Los Angeles, Case No.: PS 009919

damages “in an amount to be proven at trial” to be awarded severally and jointly against the iPayment Defendants and Chase.

In March 2005, plaintiff then obtained from the clerk of the court an entry of “default” against us (and separately against Vericomm) was entered and, on or about April 10, 2006, the Court entered a default judgment against the iPayment Defendants and Vericomm awarding compensatory damages of $74,577.45, attorneys fees of $35,148.75, and punitive damages of $250,000, and issued a judgment against the iPayment Defendants and Vericomm (the “North Carolina Judgment”), imposing joint and several liability against them for a total judgment amount of $359,726.20. Plaintiff then assigned its judgment to Judgment Recovery Group, LLC (“JRG”) and, on or about August 9, 2007, JRG commenced an action in California state court for entry of sister state judgment (the “Sister State Judgment”) in the amount of $404,183, attempting to thereby enforce the North Carolina Judgment against assets of iPayment and Vericomm located in California. We timely filed a motion to vacate the California-issued Sister State Judgment and filed an application to “stay” enforcement of the judgment, pending a December 18, 2007 hearing on our motion to vacate. The court granted our application and “stayed” enforcement of the judgment, pending the hearing set for December 18, 2007. Prior to the December 18, 2007 hearing date, the parties entered into a stipulation, which the court approved, to “stay” the California proceedings pending the final outcome of all challenges filed in North Carolina on the underlying North Carolina Judgment. Vericomm filed an appeal in North Carolina of the North Carolina Judgment, which is currently pending.

Since December 2007, there has been no further action on this matter, except for court-ordered status conferences. The last status conference was held on February 9, 2009, at which the court continued the “stay” and set June 4, 2009 as the date for the next status conference. We continue to believe that the claims asserted against us in the North Carolina lawsuit are without merit and that we have meritorious defenses to these claims, as well as numerous grounds, to have the Sister State Judgment vacated or to obtain substantial relief from enforcement in California of the Sister State Judgment entered against us on the North Carolina Judgment. We currently intend to continue to vigorously defend ourselves in these related matters. At this time we cannot predict with any certainty how the North Carolina appellate court will rule on Vericomm’s appeal and/or, in the event appellate relief is ordered, the likely outcome it may have on either the North Carolina lawsuit and/or the claims asserted against us in these related actions. There can be no assurance that we will be successful or prevail in our defense, or that a failure to prevail will not have a material adverse effect on our business, financial condition or results of operations.

Employment Development Department of the State of California, Notice of Assessment No. 00008

As previously reported, we fully investigated and reviewed the facts and circumstances relevant to this matter and have consulted with our attorneys regarding the applicable law relevant to the Assessment. Our investigation and review to date indicates that no audit was conducted, nor was information obtained from us by the EDD to support the Assessment. We believe that for the audited covered period we did not improperly classify or treat certain individuals as independent contractors rather than as employees, and the Assessment should be “abated” in full (including any penalties or interest accrued on the Assessment). Since we last reported on this matter, we received a copy of the notice of Lien filed by the Employment Development Department of the State of California regarding the audit assessment amount that is identified as an unpaid tax assessment and the collection of state tax revenue mandates the notice and statutory lien filing as part of the collection of tax revenue. Nevertheless, we have also continued to pursue resolution by use of a voluntary tax audit conference and we recently contacted the EDD employee assigned to our account by the EDD Sacramento Collections division to discuss arrangements.

Although we are still currently subject to the Assessment, we believe that, based on information currently available, the ultimate outcome of this matter and our liability associated therewith may have a material adverse effect on our business, financial condition, or results of operations. However, the results cannot be predicted with certainty and in the event of unexpected future developments or additional information, it is possible that this matter could be unfavorable to us.

Other- Merrick Bank

This matter was last updated in our Annual Report for the year ended December 31, 2007, filed on Form 10-K with the Securities and Exchange Commission on March 14, 2008 and there has been no change in the status of this matter since we last reported on it. In September 2005, we were notified by Merrick Bank, one of our sponsor banks, that due to certain Visa and MasterCard fines against Card Systems Solutions (one of our payment processors) in connection with their mishandling of credit card data, Merrick Bank increased our reserve requirement from $0.5 million to $1.4 million. During the twelve months ended December 31, 2006, Merrick Bank released $0.6 million of the reserve to us but subsequently increased the reserve requirement an additional $0.3 million during 2007. We worked with Merrick Bank to obtain information regarding the increase and the fines

against Card Systems Solutions, but have not been able to determine what contingent liability we may have for such fines., if any. We have reserved $0.3 million, or 50 percent of the net amount, in our Consolidated Statement of Operations for the year ended December 31, 2008. Additionally, as we also previously reported on our Form 10-Q filed with the Securities and Exchange Commission on November 13, 2007 for the third quarter ended September 30, 2007, Merrick Bank notified us of a potential liability totaling less than $0.5 million, and during the third quarter of 2007, reduced the reserve $0.5 million for the liability they alleged we owed them. We advised Merrick Bank that we did not agree with their claim that we are liable for the $0.5 million liability at issue and contested their prior offset made against our reserve funds because the claim was unrelated to the 2005 Visa/MasterCard fines. We also objected to the offset made against our reserve funds without our prior consent. We have reserved half of the $0.5 million liability they alleged in our Consolidated Statement of Operations for the year ended December 31, 2007. As such, our reserve balance was approximately $0.6 million as of December 31, 2007 and 2008, and as discussed above, the remaining $0.6 million reserve at Merrick, as discussed above, is recorded as restricted cash on our Consolidated Balance Sheet as of December 31, 2008.

We intend to further investigate these matters, vigorously defend our business against any such fines and/or seek proper indemnification from third parties as applicable. There can be no assurance that we will be successful in defending against fines or obtaining indemnification. Although the ultimate outcome of each of these disputed matters and our liability associated with each of them cannot be predicted with certainty, based on information currently available and potential insurance coverage, in our opinion, the outcome is not expected to have a material adverse effect on our business, financial condition or results of operations. However, the results cannot be predicted with certainty and in the event of unexpected future developments or additional information, it is possible that this matter could be unfavorable to us.

We are also subject to certain other legal proceedings that have arisen in the ordinary course of our business and have not been fully adjudicated. Although the ultimate outcome of these other legal proceedings cannot be predicted with certainty, based on information currently available, advice of counsel, and available insurance coverage, in our opinion, the outcome of such legal proceedings is not expected to have a material adverse effect on our business, financial condition or results of operations. However, the results of legal proceedings cannot be predicted with certainty, and in the event of unexpected future developments, it is possible that the ultimate resolution of one or more of these matters, could be unfavorable. 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 expense and may result in significant diversion of management’s attention.

6. Investments

Investments in Merchant Advances

In 2007, we began, on a selective basis, offering advances to prospective and current merchants based on expected future processing volume that will be repaid by reductions in amounts otherwise paid to the merchants on future transactions processed by the Company. However, we no longer offer new merchant advances to our customers. Our existing merchant advances are reflected in “Investment in merchant advances” in the Consolidated Balance Sheets. We account for the discount income and costs associated with our merchant advances in accordance with SFAS No. 91 “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” The merchant advances, plus our discount income, are generally collected over periods from six months to one year. Our discount income is recognized over the term of the agreement as Revenues in our Consolidated Income Statements using the effective interest method. In connection with certain of these advances, origination or other fees may be incurred by the Company in connection with the origination of the advance. The amounts paid are deferred and amortized as a reduction of deferred origination fees over the life of the advance. The objective of the method of income and expense recognition is to record a constant effective yield on the investment in the related advances. Deferred origination fees were $0.5 million and $0 as of December 31, 2008 and 2007, respectively, and are included within “Investment in merchant advances” on the Consolidated Balance Sheets. Investments in merchant advances were $4.5 million, net of allowance for doubtful accounts of $3.8 million, at December 31, 2008 and $0.1 million at December 31, 2007. The allowance for doubtful accounts is further described in “Reserve for Losses on Merchant Accounts” within Note 2.

Payments for Prepaid Residual Expenses

During the year ended December 31, 2008, we made payments totaling $4.2 million to several independent sales groups in exchange for contract modifications which lower our obligations for future payments of residuals to them. These payments have been assigned to intangible assets in the accompanying Consolidated Balance Sheets and are amortized over their expected useful lives.

7. Long-Term Debt

Long-term debt consists of the following (in thousands):


	December 31,
	2008			2007
Senior secured credit facility:
Term loans	$	494,638		$	501,488
Revolver		—			2,200
Senior subordinated notes, net of discount		192,633			193,534
Various equipment lease agreements		55			135

		687,326			697,357
Less: current portion of long-term debt		(17,324	)		(6,899	)

	$	670,002		$	690,458

On May 10, 2006, in conjunction with the Transaction further described in Note 1, we replaced our existing credit facility with a senior secured credit facility with Bank of America as lead bank. The senior secured credit facility consists of $515.0 million of term loans and a $60.0 million revolving credit facility, further expandable to $100.0 million. The senior secured credit facility contains a $25.0 million letter of credit sublimit and is secured by the Company’s assets. Interest on outstanding borrowings under the term loans is payable at a rate of LIBOR plus a margin of 2.00% to 2.25% (currently 2.00%) depending on our credit rating from Moody’s. Interest on outstanding borrowings under the revolving credit facility is payable at prime plus a margin of 0.50% to 1.25% (currently 1.25%) or at a rate of LIBOR plus a margin of 1.50% to 2.25% (currently 2.25%) depending on our ratio of consolidated debt to EBITDA, as defined in the agreement. Additionally, the senior secured credit facility requires us to pay unused commitment fees of up to 0.50% (currently 0.50%) on any undrawn amounts under the revolving credit facility. The senior secured credit facility contains customary affirmative and negative covenants, including financial covenants requiring maintenance of a debt-to-EBITDA ratio (as defined therein), which is currently 6.25 to 1.00, but which decreases periodically over the life of the agreement to a ratio of 4.00 to 1.00 at December 31, 2011. We were in compliance with all such covenants as of December 31, 2008. The senior secured credit facility also contains an excess cash flow covenant (as defined therein), which requires us to make additional principal payments after the end of every fiscal year. At December 31, 2008, this payment attributable to this covenant was $12.2 million and is included in the current portion of long-term debt. Principal repayments on the term loans are due quarterly in the amount of $1.3 million, which began on June 30, 2006, with any remaining unpaid balance due on March 31, 2013. Outstanding principal balances on the revolving credit facility are due when the revolving credit facility matures on May 10, 2012. At December 31, 2008, we had outstanding $494.6 million of term loans at a weighted average interest rate of 5.42% and no borrowings outstanding under the revolving credit facility.

On May 10, 2006, in conjunction with the Transaction further described in Note 1, we also issued senior subordinated notes in the aggregate principal amount of $205.0 million. These senior subordinated notes were issued at a discount of 1.36%, with interest payable semi-annually at 9 ³/4 % on May 15 and November 15 of each year. The senior subordinated notes mature on May 15, 2014, but may be redeemed, in whole or in part, by the Company at any time on or after May 15, 2010, at redemption prices specified in the indenture governing the senior subordinated notes, plus accrued and unpaid interest. The senior subordinated notes contain customary restrictive covenants, including restrictions on incurrence of additional indebtedness if our fixed charge coverage ratio (as defined therein) is not at least 2.00 to 1.00. We were in compliance with all such covenants as of December 31, 2008

During 2007, the Company spent $8.9 million on repurchases of senior subordinated notes. During the second quarter of 2008, the Company spent an additional $1.1 million on repurchases of senior subordinated notes. The Company intends to hold the senior subordinated notes until maturity. In accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, the repurchase was accounted for as an extinguishment of debt. We reflected these transactions as reductions in long-term debt within the Consolidated Balance Sheets as of December 31, 2007 and 2008. We amended our senior secured credit facility to allow for repurchases of our senior subordinated notes up to $10.0 million, and have now completed note repurchases under that amendment. At December 31, 2008, we had outstanding $194.5 million of senior subordinated notes and $1.9 million of remaining unamortized discount on the senior subordinated notes.

We had net capitalized debt issuance costs related to the senior secured credit facility totaling $4.9 million and net capitalized

debt issuance costs related to the senior subordinated notes totaling $5.8 million as of December 31, 2008. These costs are being amortized to interest expense on a straight-line basis over the life of the related debt instruments, which is materially consistent with amounts computed using an effective interest method. Amortization expense related to the debt issuance costs was $2.2 million for both the years ended December 31, 2007 and 2008. Amortization expense related to the debt issuance costs was $1.4 million for the period from May 11 to December 31, 2006 (Successor). Amortization expense for debt issuance costs related to our previous credit facility was $0.4 million for the period from January 1 through May 10, 2006 (Predecessor). The remaining unamortized balance of debt issuance costs related to our previous credit facility in the amount of $2.5 million were written off to interest expense as a result of the Transaction as of May 10, 2006.

The maturities of long-term debt (before unamortized discount) are as follows (in thousands)


Year ended December 31,	Amount
2009	$	17,347
2010		5,183
2011		5,150
2012		5,150
2013		461,864
Thereafter		194,500

Total	$	689,194

8. Income Taxes

The provision for income taxes and liabilities for the years ended December 31, 2008, 2007 and 2006, was comprised of the following (in thousands):


	2008			2007			2006
	Successor			Successor			Combined
Current:
Federal	$	13,743		$	9,417		$	2,078
State		2,778			1,347			(317	)

Total current		16,521			10,764			1,761
Deferred		(6,327	)		(5,272	)		2,542
Change in valuation allowance		523			223			—
FIN 48 adjustments		178			290			—
Minority interest		(395	)		—			(249	)

Total income tax provision	$	10,500		$	6,005		$	4,054

The differences between the federal statutory tax rate of 35% and effective tax rates are primarily due to state income tax provisions, deferred tax valuation allowance and permanent differences, as follows:


	2008			2007			2006
Statutory Rate		35	%		35	%		35	%
Increase (decreases) in taxes resulting from the following:
State income taxes net of federal tax benefit		4	%		4	%		0	%
Recognition of previously reserved deferred tax assets utilized in current year		0	%		-2	%		0	%
Permanent differences		0	%		11	%		80	%
Increase to valuation allowance		2	%		2	%		0	%
Other		0	%		3	%		-4	%

Total		41	%		53	%		111	%

Deferred income tax assets are included as a component of other assets in the accompanying consolidated balance sheets as of December 31, 2008 and 2007 and were comprised of the following (in thousands):


	2008			2007
Current deferred tax assets:
State taxes	$	—		$	692
Net operating loss		164			323
Other		3,625			628

Total current deferred tax assets		3,789			1,643

Current deferred tax liabilities:
Accrued liabilities		—			(468	)
Prepaid expenses		(348	)		(134	)
Other		—			(37	)

Total current deferred tax liabilities		(348	)		(639	)


Net current deferred tax asset	$	3,441		$	1,004


Long-term deferred tax assets:
Tax benefit of unrealized loss on fair value of derivatives	$	8,287		$	4,903
Net operating loss		1,552			930
Cancellation of debt income		1,342			—
Other		(746	)		414

Total long-term deferred tax assets		10,435			6,247

Long-term deferred tax liabilities:
Intangible assets, net of depreciation and amortization		(4,906	)		(12,595	)
Other		(538	)		(254	)

Total long-term deferred tax liabilities		(5,444	)		(12,849	)


Net long-term deferred tax asset (liability)	$	4,991		$	(6,602	)

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting and reporting for uncertainties in income tax law by prescribing a comprehensive model for the financial statement recognition, measurement, presentation and disclosure for uncertain tax positions taken or expected to be taken in income tax returns.

The cumulative effect of adopting FIN 48 was an increase in tax reserves of less than $0.1 million with a corresponding decrease to the January 1, 2007 accumulated deficit balance. Upon adoption, the liability for income taxes associated with uncertain tax positions at January 1, 2007 was $0.3 million, which, if recognized, would favorably affect our effective tax rate. During 2008, we accrued $0.1 million of interest related to our uncertain tax positions. As of December 31, 2008, our liabilities for unrecognized tax benefits totaled $1.2 million, with $1.1 million included in other long-term liabilities and $0.1 million included in accrued liabilities and other. Interest and penalties related to income tax liabilities are included in income tax expense. The balance of accrued interest and penalties recorded in the consolidated balance sheet at December 31, 2008 was $0.1 million.

The following presents a rollforward of our unrecognized tax benefits (in thousands):


	Unrecognized
	Tax Benefits			Interest
Balance January 1, 2007	$	349		$	25
Decrease in prior year tax positions		(67	)		16
Increase for tax positions taken during the current period		405			—

Balance December 31, 2007	$	688		$	40


Decrease in prior year tax positions		—			—
Increase for tax positions taken during the current period		452			116

Balance December 31, 2008	$	1,140		$	156

We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With limited exception, we are no longer subject to federal, state and local income tax audits by taxing authorities for the years through 2003.

At December 31, 2008, we had approximately $1.3 million of federal net operating loss carryforwards that will be available to offset regular taxable income through 2018, subject to annual limitations of up to $0.9 million. We had state net operating loss

carryforwards of approximately $26.2 million as of December 31, 2008.

SFAS No. 109, Accounting for Income Taxes, requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. At December 31, 2008, we had $0.7 million of valuation allowances on deferred tax assets. The net deferred taxes recorded at December 31, 2007, represent amounts that are more likely than not to be utilized in the near term.

9. Restructuring

In January 2007, the Company adopted a plan to close its Westchester, Illinois office and migrate all services performed in that office to its office in Calabasas, California. The plan was designed to take advantage of the centralization of all corporate administrative services throughout the Company and to realize certain efficiencies in order to improve profitability. As a result, the Calabasas office became responsible for managing the combined operations of both facilities and increased the number of active merchants Calabasas will be supporting. The Company accounted for the plan in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities, and the plan was substantially completed during the first quarter of 2007.

One-Time Termination Benefits. The Company recognized severance charges of $0.4 million during the first quarter of 2007. These charges relate to work force reductions of approximately 70 employees and are included in Selling, General and Administrative expense in its Consolidated Statements of Operations. In addition, the Company recognizes severance expense ratably over the future service period as necessary if the benefit arrangement requires employees to render future service beyond a minimum retention period. The Company determined the severance expense to be recognized under this method to be de minimis in fiscal 2007.

Contract Termination Costs. Under the terms of its operating leases in Westchester, the Company was obligated for rent associated with these leases that continued to be incurred for its remaining term without economic benefit to the entity through January 2008. In accordance with SFAS No. 146, the Company recorded a charge to earnings to recognize the cost of exiting this facility of approximately $0.2 million, which equaled the total amount of rent, net of estimated sub-lease income, for the remaining period of the leases. These charges were also included in Selling, General and Administrative expense in the Consolidated Statements of Operations.

Other Associated Costs. Other costs associated with the restructuring plan included employee relocation costs, other personnel-related expenditures and property and equipment disposals that were incurred as a result of the office closure. These costs were expensed when incurred and totaled approximately $0.3 million and are included in Selling, General & Administrative expense in the Consolidated Statements of Operations.

A reconciliation of the beginning and ending liability balances (included in “accrued liabilities and other” on the consolidated balance sheets) and related activity is shown below.


			Charged to
	January 1,		Costs or					December 31,
	2007		Expenses		Deductions			2007
One-time termination benefits	$	—	$	392	$	392	(1)	$	0
Contract termination costs		—		245		234	(2)		11
Other associated costs		—		273		262	(3)		11

	$	—	$	911	$	888		$	23


			Charged to
	January 1,		Costs or						December 31,
	2008		Expenses			Deductions			2008
One-time termination benefits	$	0	$	(0	)			(1)	$	—
Contract termination costs		11		(11	)			(2)	$	—
Other associated costs		11		(11	)			(3)	$	—

	$	22	$	(22	)	$	—		$	—


(1)		Payments of one-time termination benefits

(2)		Payments of contract termination costs

(3)		Payments of other associated costs

10. Stock Options and Warrants

Prior to the Transaction, we had two separate stock option plans. All outstanding options were exercised or cancelled in conjunction with the Transaction on May 10, 2006 and both of the plans were terminated at that time.

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment, (“SFAS No. 123R”) using the Modified Prospective Approach. The incremental pre-tax share-based compensation expense recognized due to the adoption of SFAS No. 123R for the period from January 1, 2006 through May 10, 2006 (Predecessor), was $4.5 million. The share-based compensation expense recognized for the period from January 1, 2006, through May 10, 2006 (Predecessor) includes $3.6 million due to the acceleration of option vesting as a result of the Transaction. There was no compensation expense recognized in accordance with SFAS No. 123R for the period May 11 to December 31, 2006 (Successor), as all stock options and restricted stock were exercised or redeemed at the closing of the Transaction.

Prior to January 1, 2006, we measured compensation expense for our stock option awards under the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employee, (“APB 25”), and related interpretations. APB 25 required compensation expense to be recognized based on the excess, if any, of the quoted market price of the stock at the date of the grant over the amount an employee must pay to acquire the stock

11. Related Party Transactions

During 2008, our shareholders repurchased $14.2 million of our senior subordinated notes. These repurchases caused us to recognize cancellation of debt income for tax purposes for the year ended December 31, 2008, which resulted in an increase to both our tax expense and our deferred tax assets of $1.3 million. The deferred tax asset will be realized as an income tax benefit over the remaining life of the senior subordinated notes.

The majority shareholders of CPC have loans outstanding to CPC of $0.3 million. These loans bear interest at 10% and are due in June 2010. The shareholders are also employees of CPC.

Our former office in Bridgeville, Pennsylvania was owned by a former employee and was leased to the Company under an operating lease while the former employee was considered a related party. Annual rent payments under this arrangement were $30,000. However, as of January 2007, the individual was no longer considered a related party.

Effective August 2002, we began utilizing internet processing services from BluePay Inc. Certain of our former employees are shareholders of BluePay. These former employees ceased to be related parties in January 2007. While BluePay was considered a related party, payments were $0.3 million for the period from May 11 to December 31, 2006, and $0.1 million for the period from January 1 to May 10, 2006.

12. Significant Concentration

Our customers consist of a diverse portfolio of small merchants whose businesses frequently are newly established. As of December 31, 2008, we provided services to small business merchants located across the United States in a variety of industries. A substantial portion of our merchants’ transaction volume comes from card-not-present transactions, which subject us to a higher risk of merchant losses. No single customer accounted for more than 3% of revenues during any periods presented. We believe that the loss of any single merchant would not have a material adverse effect on our financial condition or results of operations.

13. Segment Information and Geographical Information

We consider our business activities to be in a single reporting segment as we derive greater than 90% of our revenue and results of operations from processing revenues and other fees from card-based payments. During 2008, 2007 and 2006, we had no single customer that represented 3% or more of revenues. Substantially all revenues are generated in the United States.

14. Employee Agreements and Employee Benefit Plans

During 2002 and 2001, we entered into employment agreements with various officers to secure employment. Under the terms of the agreements, we provided the employees with salary, incentive compensation and stock grants and/or options in return for various periods of employment. On November 10, 2008, Messrs. Daily and Grimstad each provided us with notice of their intention to not renew their respective employment agreements with us. Accordingly, Messrs. Daily’s and Grimstad’s respective employment agreements terminated on February 25, 2009 pursuant to their terms. Following the termination of their employment agreements, Messrs. Daily and Grimstad intend to continue to serve as our chief executive officer and president, respectively, pursuant to at-will employment arrangements, the terms of which remain subject to negotiation.

We sponsor a defined contribution plan (the “Plan”) under Section 401(k) of the Internal Revenue Code, covering employees of iPayment, Inc. and certain of its subsidiaries. Under the Plan, we may match contributions of up to 3% of a participant’s salary. Employer contributions for the year ended December 31, 2008, the year ended December 31, 2007, the period from May 11 to December 31, 2006, and the period from January 1 to May 10, 2006 were $197,000, $199,000, $117,000, and $96,000, respectively.

15. Summarized Quarterly Financial Data

In accordance with generally accepted accounting principles in the United States, or GAAP, our Predecessor results have not been aggregated with our Successor results and, accordingly, our Consolidated Financial Statements do not show results of operations or cash flows for the year ended December 31, 2006. However, in order to facilitate an understanding of our results of operations for the year ended December 31, 2006, in comparison with the years ended December 31, 2007 and 2008, in this section our Predecessor results and our Successor results for calendar 2006 are presented on a combined basis. The combined results of operations are non-GAAP financial measures and should not be used in isolation or substitution of the Predecessor and Successor results.

The following unaudited schedule indicates our quarterly results of operations for 2008, 2007 and 2006 (in thousands, except charge volume):


	1st			2nd			3rd			4th
	Quarter			Quarter			Quarter			Quarter			Total
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Audited)
2008 (Successor)
Revenue	$	185,455		$	212,580		$	203,654		$	193,136		$	794,825
Interchange		108,381			121,855			116,188			104,146			450,570
Other Cost of Services		55,773			62,055			61,449			62,255			241,532
Selling, general, and administrative		4,818			4,915			5,003			5,553			20,289
Income from operations		16,483			23,755			21,014			21,183			82,434
Net income (loss)		1,331			5,772			3,729			3,471			14,303
Charge Volume (in millions)		6,535			7,280			6,924			6,044			26,783

2007 (Successor)
Revenue	$	177,740		$	192,674		$	193,599		$	195,096		$	759,109
Interchange		103,620			112,440			111,264			110,631			437,955
Other Cost of Services		54,284			57,743			57,105			59,405			228,537
Selling, general, and administrative		6,549			4,708			4,688			5,199			21,144
Income from operations		13,287			17,783			20,542			19,861			71,473
Net income (loss)		(1,715	)		1,338			3,387			2,421			5,431
Charge Volume (in millions)		6,368			6,915			6,829			6,685			26,797

2006 (Combined)
Revenue	$	170,901		$	189,162		$	186,959		$	186,966		$	733,988
Interchange		98,113			109,735			109,584			107,680			425,112
Other Cost of Services		52,649			56,339			57,969			57,093			224,050
Selling, general, and administrative		5,320			11,863			4,785			5,483			27,449
Income from operations		14,818			11,225			14,623			16,712			57,376
Net income		7,622			(6,645	)		(730	)		(285	)		(40	)
Charge Volume (in millions)		6,123			6,836			6,783			6,595			26,337

16. Guarantor Financial Information

In connection with the May 2006 issuance of 9.75% senior subordinated notes due 2014, we and all of our existing and future subsidiaries (the “Guarantors”) that guarantee our other debt or debt of the guarantors have fully and unconditionally guaranteed, on a joint and several basis, our obligations under the related indenture (the “Guarantees”). iPayment, Inc., the issuer of the senior subordinated notes and parent company of the Guarantors, has no independent assets or operations. Any subsidiary of iPayment, Inc. other than the Guarantors is minor, and there are no significant restrictions on our ability to obtain funds from our subsidiaries by dividend or loan.

17. Significant Developments

During the first two months of 2009, we made payments totaling $20.0 million to reduce our term loan obligations under our senior secured credit facility. These payments satisfy our excess cash flow sweep covenant and a portion of our future mandatory prepayments, as defined within our credit agreement.

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

None.

ITEM 9A. Controls and Procedures

Disclosure Controls and Procedures. Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this Annual Report (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to our Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) 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.

Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the reliability of financial reporting and the preparation and fair presentation of published financial statements for external purposes in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation, pursuant to Rule 13a-15(c) promulgated under the Exchange Act, of the effectiveness, as of the end of the period covered by this Annual Report, of its internal control over financial reporting. Based on the results of this evaluation, management concluded that our internal control over financial reporting was effective as of the Evaluation Date.

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this Annual Report.

During the twelve months ended December 31, 2008, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. Other Information

On May 10, 2006, in conjunction with the Transaction further described in Note 1, we replaced our existing credit facility with a senior secured credit facility with Bank of America as lead bank. The senior secured credit facility consists of $515.0 million of term loans and a $60.0 million revolving credit facility, further expandable to $100.0 million. The senior secured credit facility contains a $25.0 million letter of credit sublimit and is secured by the Company’s assets. Interest on outstanding borrowings under the term loans is payable at a rate of LIBOR plus a margin of 2.00% to 2.25% (currently 2.00%) depending on our credit rating from Moody’s. Interest on outstanding borrowings under the revolving credit facility is payable at prime plus a margin of 0.50% to 1.25% (currently 1.25%) or at a rate of LIBOR plus a margin of 1.50% to 2.25% (currently 2.25%) depending on our ratio of consolidated debt to EBITDA, as defined in the agreement. Additionally, the senior secured credit facility requires us to pay unused commitment fees of up to 0.50% (currently 0.50%) on any undrawn amounts under the revolving credit facility. The senior secured credit facility contains customary affirmative and negative covenants, including financial covenants requiring maintenance of a debt-to-EBITDA ratio (as defined therein), which is currently 6.25 to 1.00, but which decreases periodically over the life of the agreement to a ratio of 4.00 to 1.00 at December 31, 2011. We were in compliance with all such covenants as of December 31, 2008. Principal repayments on the term loans are due quarterly in the amount of $1.3 million which began on June 30, 2006, with any remaining unpaid balance due on March 31, 2013. Outstanding principal balances on the revolving credit facility are due when the revolving credit facility matures on May 10, 2012. At December 31, 2008, we had outstanding $494.6 million of term loans at a weighted average interest rate of 5.42% and no borrowings under the revolving credit facility.

On May 10, 2006, in conjunction with the Transaction further described in Note 1, we also issued senior subordinated notes in the aggregate principal amount of $205.0 million. These senior subordinated notes were issued at a discount of 1.36%, with interest payable semi-annually at 9 ³ /4 % on May 15 and November 15 of each year. The senior subordinated notes mature on May 15, 2014, but may be redeemed, in whole or in part, by the Company at any time on or after May 15, 2010, at redemption prices specified in the indenture governing the senior subordinated notes, plus accrued and unpaid interest. The senior subordinated notes contain customary restrictive covenants, including restrictions on incurrence of additional indebtedness if our fixed charge coverage ratio (as defined therein) is not at least 2.00 to 1.00.

The agents and the lenders under the senior secured credit facility and their affiliates have provided, and future lenders under the senior secured credit facility may provide, various investment banking, other commercial banking and/or financial advisory services to iPayment for which they have received, and will in the future receive, customary fees.

PART III

ITEM 10. Directors and Executive Officers of the Registrant

The following table provides information about our directors and executive officers as of December 31, 2008:


Name and Age		Principal Occupation, Business Experience and Directorships
Gregory S. Daily Chairman and CEO Age 49		Mr. Daily has served as Chairman of our board of directors and Chief Executive Officer since February 2001. From January 1999 to December 2000, Mr. Daily was a private investor. In 1984, Mr. Daily co-founded PMT Services, Inc., a credit card processing company, and served as President of PMT Services, Inc. at the time of its sale to NOVA Corporation, a credit card processing company, in September 1998. Mr. Daily served as the Vice-Chairman of the board of directors of NOVA Corporation from September 1998 until May 2001. Mr. Daily has served as the Chief Manager and President of Caymas, LLC, a private investment company, since January 2001 and he has served as the Chief Executive Officer of Hardsworth, LLC, a private investment company, since May 1997.

Carl A. Grimstad Director and President Age 41		Mr. Grimstad has served as our President since April 2001 and served as our Chief Executive Officer until February 2001. From January 2000 until March 2001, Mr. Grimstad held various executive positions with iPayment Technologies and from March 2000 until April 2001, also served as the Vice-Chairman of iPayment Technologies. Mr. Grimstad has served as the Vice President and Secretary of Caymas, LLC since January 2001. Since 1995, Mr. Grimstad served as managing partner of GS Capital, LLC, a private investment firm.

Robert S. Torino Executive Vice President and Assistant Secretary Age 55		Mr. Torino has served as our Executive Vice President since January 2001 and as our Assistant Secretary since August 2002. From January 2001 to September 2002, he served as our Chief Financial Officer. Mr. Torino served as Chief Financial Officer of iPayment Technologies, Inc. from April 2000 to December 2000, and as Executive Vice President and Chief Operating Officer of iPayment Technologies, Inc. from July 2000 to December 2000. From October 1999 to April 2000, Mr. Torino served as Chief Executive Officer of M80 Technologies, Inc., a start-up software development company. Mr. Torino served as President and Chief Executive Officer of TRUE Software Inc., a software development company, from April 1995 until its acquisition by McCabe & Associates in October 1999.

Clay M. Whitson CFO and Treasurer Age 51		Mr. Whitson has served as our Chief Financial Officer and Treasurer since October 2002. From November 1998 to September 2002, Mr. Whitson was Chief Financial Officer of The Corporate Executive Board Company, a provider of best practices research and quantitative analysis focusing on corporate strategy, operations and general management issues. From 1996 to October 1998, Mr. Whitson served as the Chief Financial Officer of PMT Services, Inc., a credit card processing company.

Afshin M. Yazdian Executive Vice President, General Counsel and Secretary Age 36		Mr. Yazdian has served as our Executive Vice President and General Counsel since February 2001. He has served as our Secretary since August 2002 and served as our Assistant Secretary from February 2001 to August 2002. Mr. Yazdian served from March 2000 to January 2001 as General Counsel and Vice President of Mergers and Acquisitions for eConception, a technology venture fund. From August 1997 to March 2000, Mr. Yazdian practiced in the corporate and mergers and acquisitions groups at the law firm of Waller Lansden Dortch & Davis, PLLC.

CODE OF BUSINESS CONDUCT AND ETHICS

We have adopted a Code of Business Conduct and Ethics (the “Code of Ethics”), which applies to all directors, consultants and employees, including the Chief Executive Officer and the Chief Financial Officer and any other employee with any responsibility for the preparation and filing of documents with the SEC. A copy of the Code of Ethics is included as Exhibit 14.1 to this Form 10-K. The Company will disclose amendments to provisions of the Code of Ethics by posting such amendments on its website. In addition, any such amendments, as well as any waivers of the Code of Ethics for directors or executive officers will be disclosed in a report on Form 8-K.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors, executive officers and persons who own more than ten percent of the our common stock (“Section 16 Persons”) to file reports of ownership and changes in ownership in our common stock with the SEC. Based on our records and other information we believe that all Section 16(a) filing requirements

for the Section 16 Persons have been complied with during or with respect to the fiscal year ended December 31, 2008. As a result of the Transaction, beginning May 11, 2006, the Company no longer has a class of equity securities registered with the SEC and therefore its directors, officers and 10% shareholders are no longer required to make Section 16 filings.

ITEM 11. Executive Compensation

Compensation Discussion and Analysis

The primary goals of our executive compensation program are to link the interests of management and stockholders, attract and retain a highly-skilled executive team, and base rewards on both personal and corporate performance.

As a private company, we do not have a compensation committee. Our board of directors is currently composed of Mr. Daily and Mr. Grimstad. The board, in consultation with the other executive officers, establishes policies and makes decisions regarding compensation of directors and executive officers. The executive compensation program currently contains two elements:

	•		competitive base salaries, and

	•		annual cash incentives determined by the performance of each executive officer and the Company against predetermined targets.

The program is designed so that the combination of these two elements, assuming performance targets are met, will generally be comparable to similar positions with peer companies.

Base Salaries. Base salaries for our executive officers are determined, in part, through (a) comparisons with peer companies with which we compete for personnel and (b) general geographic market conditions. Additionally, the board evaluates individual experience and performance and our overall performance during the period under consideration. The board reviews each executive officer’s salary on an annual basis and may increase salaries based on (i) the individual’s contribution to the Company compared to the preceding year, (ii) the individual’s responsibilities compared to the preceding year and (iii) any increase in median pay levels at peer companies.

Annual Bonuses. The board’s policy is to award annual bonuses in order to motivate and reward the Company’s executive officers, as individuals and as a team, and to attain our annual financial goals and operating objectives. Annual bonuses typically reflect competitive industry practice and certain performance metrics. Annual bonus awards for the executive officers in 2008 were made at the discretion of the board. There is currently no formal bonus plan in place for executive officers.

Stock-based Compensation. Upon closing the Transaction on May 10, 2006, all outstanding options were exercised or cancelled and all stock-based compensation plans were terminated. We currently have no share-based compensation plans.

Chief Executive Officer Compensation. Mr. Daily is the majority stockholder and since July 1, 2006, he has elected to draw no annual salary. In reaching this arrangement, the board determined that Mr. Daily’s equity position serves as sufficient incentive to align his interests with our long-term performance. The board intends to review this determination annually.

Summary. The board believes that the combination of competitive base salaries and annual incentives paid in cash comprise a highly-effective and motivational executive compensation program, which works to attract and retain talented executives and strongly aligns the interests of senior management with those of the stockholders of the Company in seeking to optimize long-term performance. The board has reviewed the total compensation received by the executive officers during the year ended December 31, 2008, and has determined that those amounts were not excessive or unreasonable.

The following table shows the cash and other compensation paid or earned and certain long-term awards made to our Chief Executive Officer, Chief Financial Officer, and each of our three most highly compensated executive officers (the “Named Executives”) for all services to us in all capacities for 2008, 2007 and 2006.

SUMMARY COMPENSATION TABLE


							Long-Term Compensation Awards
	Annual Compensation						Restricted		Securities
Name and							Stock		Underlying		All Other
Principal Position	Year		Salary		Bonus		Awards (1)		Options (1)		Compensation			Total
Gregory S. Daily		2008		—		—		—		—		—			—
Chairman and		2007		—		—		—		—		—			—
Chief Executive Officer		2006	$	150,000		—		—		—	$	5,000	(1)	$	155,000

Carl A. Grimstad		2008	$	300,000		—		—		—		—		$	300,000
Director and President		2007	$	300,000		—		—		—		—		$	300,000
		2006	$	300,000		—		—		—		—		$	300,000


							Long-Term Compensation Awards
	Annual Compensation						Restricted		Securities
Name and							Stock		Underlying		All Other
Principal Position	Year		Salary		Bonus		Awards (1)		Options (1)		Compensation			Total
Clay M. Whitson		2008	$	296,000	$	100,000		—		—	$	8,880	(1)	$	404,880
Chief Financial Officer		2007	$	296,000		—		—		—	$	2,220	(1)	$	298,220
and Treasurer		2006	$	296,000		—		—		—	$	11,510	(1)	$	307,510

Afshin M. Yazdian		2008	$	185,000	$	230,000		—		—	$	7,950	(1)	$	422,950
Executive Vice President,		2007	$	185,000		—		—		—	$	4,388	(1)	$	189,388
General Counsel and Secretary		2006	$	170,000	$	100,000		—		—	$	8,100	(1)	$	278,000

Robert S. Torino		2008	$	230,000	$	200,000		—		—		—		$	430,000
Executive Vice President		2007	$	230,000		—		—		—		—		$	230,000
and Assistant Secretary		2006	$	230,000	$	100,000		—		—		—		$	330,000


(1)		Represents Company’s matching of 401(k) plan contributions made by executive officers.

AGGREGATED OPTION EXERCISES IN 2006 AND
YEAR-END 2006 OPTION VALUES

The following table contains information concerning stock options to purchase common stock held as of December 31, 2006, by each Named Executive. These options were granted under the Company’s Stock Incentive Plan.


					Number of Securities				Value of Unexercised
	Shares				Underlying Unexercised				In-the-Money Options
	Acquired		Value		Options at Fiscal Year-End				at Fiscal Year-End
	on Exercise		Realized		Exercisable		Unexercisable		Exercisable		Unexercisable
	(#)		($)		(#)		(#)		($)		($)
Gregory S. Daily		—	$	—		—		—	$	—	$	—
Chairman and Chief Executive Officer

Carl A. Grimstad		50,000	$	1,375,000		—		—	$	—	$	—
Director and President

Clay M. Whitson		238,810	$	8,038,235		—		—	$	—	$	—
Chief Financial Officer and Treasurer

Afshin M. Yazdian		128,167	$	4,177,384		—		—	$	—	$	—
Executive Vice President, General Counsel and Secretary

Robert S. Torino		20,000	$	550,000		—		—	$	—	$	—
Executive Vice President

COMPENSATION OF DIRECTORS

Following the closing of the Transaction in 2006, we did not pay our directors, Gregory S. Daily or Carl. A. Grimstad, any compensation for their service as directors. We continued this policy in 2007 and 2008.

EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS

Gregory Daily

In February 2001, we entered into an employment agreement with Gregory S. Daily, our Chairman of the Board and Chief Executive Officer. The employment agreement was originally for one year, with successive one-year terms unless either party provides written notice to the other party ninety days prior to the expiration of the term. In connection with the execution of his employment agreement with us, Mr. Daily purchased 156,161 shares of our common stock in April 2001 at a price of $0.02 per share. Pursuant to the terms of his employment agreement, Mr. Daily was initially entitled to an annual salary of $12,000, plus a bonus, as determined by the board of directors in its sole discretion, based on Mr. Daily’s performance, our business and financial condition and the operating results achieved. Commencing in 2004, our compensation committee approved an increase in Mr. Daily’s base salary to $300,000, which was the amount of Mr. Daily’s base salary in 2005. Since July 1, 2006, he has elected to draw no annual salary. In addition, Mr. Daily is entitled to receive those employee benefits generally provided to our executive employees.

On November 10, 2008, Mr. Daily provided us with notice of his intention to not renew his employment agreement with us. Accordingly, Mr. Daily’s employment agreement terminated on February 25, 2009 pursuant to its terms. Following the termination of his employment agreement, Mr. Daily intends to continue to serve as our Chief Executive Officer, pursuant to at-will employment arrangements, the terms of which remain subject to negotiation.

Carl Grimstad

In February 2001, we entered into an employment agreement with Carl A. Grimstad, our President. The employment agreement was originally for one year, with successive one-year terms unless either party provides written notice to the other party ninety days prior to the expiration of the term. In connection with the execution of his employment agreement, Mr. Grimstad purchased 147,601 shares of our common stock in April 2001 at a price of $0.02 per share. Pursuant to the terms of his employment agreement, Mr. Grimstad was initially entitled to an annual salary of $180,000, plus a bonus, as determined by the board of directors in its sole discretion, based on Mr. Grimstad’s performance, our business and financial condition and the operating results achieved. Our compensation committee approved an increase in Mr. Grimstad’s base salary to $300,000 in 2005. In addition, Mr. Grimstad is entitled to receive those employee benefits generally provided to our executive employees.

On November 10, 2008, Mr. Grimstad provided us with notice of his intention to not renew his employment agreement with us. Accordingly, Mr. Grimstad’s employment agreement terminated on February 25, 2009 pursuant to its terms. Following the termination of his employment agreement, Mr. Grimstad intends to continue to serve as our President, pursuant to at-will employment arrangements, the terms of which remain subject to negotiation.

Clay Whitson

In June 2002, we entered into an employment agreement with Clay M. Whitson, our Chief Financial Officer and Treasurer. The employment agreement was originally for one year with successive one-month terms beginning each month after September 3, 2003. Under the agreement, Mr. Whitson is entitled to an annual base salary (currently $296,000), to be reviewed annually by the Compensation Committee, plus a bonus of (a) up to 50% of his base salary for achieving performance criteria established by the board of directors or (b) a pro rata portion of such bonus which is greater or less than the amount in clause (a) based on Mr. Whitson’s performance, our business and financial condition and the operating results achieved. If a change of control (as defined therein) occurs and Mr. Whitson’s employment agreement is not terminated, Mr. Whitson’s bonus must be at least the highest bonus determined by the board of directors (whether or not paid to him prior to the change of control) during any of the three fiscal years preceding such change of control. Mr. Whitson will also receive those employee benefits generally provided to our executive employees.

We may terminate Mr. Whitson’s employment agreement without cause. If Mr. Whitson is terminated without cause prior to a change of control, he will be entitled to his then existing base salary and bonus for the entire period remaining on the term of his employment agreement. Mr. Whitson may terminate the employment agreement without cause, whereby he will be entitled to a pro-rata amount of his base salary and bonus for the portion of the term of his employment agreement completed on the date of termination. Mr. Whitson may also terminate the employment agreement for cause following a change in control.

Retirement Plan

Mr. Daily, Mr. Whitson and Mr. Yazdian participate in iPayment’s defined contribution plans. iPayment’s contributions to its defined contribution plans on behalf of the named executive officers are shown in the “All Other Compensation” column of the Summary Compensation Table.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

On May 10, 2006, Holdings acquired all of our issued and outstanding common stock. Holdings is a wholly-owned subsidiary of iPayment Investors. The general partner of iPayment Investors is iPayment GP, LLC (“GP”). Under the limited partnership agreement of iPayment Investors, GP is granted full authority to act on behalf of iPayment Investors and the limited partners of iPayment Investors may not participate in management of iPayment Investors or vote for the election, removal or replacement of GP. The board of directors of GP is comprised of Gregory S. Daily and Carl A. Grimstad and any action by the board requires the vote of both directors. As a result, Messrs. Daily and Grimstad may be deemed to share beneficial ownership of all of our outstanding shares. Messrs. Daily and Grimstad disclaim beneficial ownership of such shares except to the extent of their respective pecuniary interests therein. Mr. Daily’s indirect percentage interest in us is 65.8% (including shares held in trust for the benefit of certain family members of Mr. Daily) and Mr. Grimstad’s percentage interest in us is 34.2% (including shares held by certain members of Mr. Grimstad’s immediate family). None of our other executive officers beneficially own any of our shares.

ITEM 13. Certain Relationships and Related Transactions

In the ordinary course of business, the Company and its subsidiaries from time to time engage in transactions with other corporations or financial institutions whose officers or directors are also directors or officers of the Company or a subsidiary. Transactions with such corporations and financial institutions are conducted on an arm’s-length basis and may not come to the attention of the directors or officers of the Company or of the other corporations or financial institutions involved. The Board of Directors does not consider that any such transactions would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and the Board of Directors is not currently aware of any related party transactions other than those set forth below.

The majority shareholders of Central Payment Company (“CPC”) have loans outstanding to CPC of $0.3 million. These loans bear interest at 10% and are due in June 2010. The shareholders are also employees of CPC.

Effective August 2002, we began utilizing internet processing services from BluePay Inc. Certain of our former employees are shareholders of BluePay. These former employees ceased to be related parties in January 2007. While BluePay was considered a related party, payments were $0.3 million for the period from May 11 to December 31, 2006 and $0.1 million for the period from January 1 to May 10, 2006.

ITEM 14. Principal Accountant Fees and Services

We do not have an audit committee. As a result, our board of directors performs the duties of an audit committee. Our board of directors evaluates and approves in advance the scope and cost of the engagement of an auditor before the auditor renders audit and non-audit services. We do not rely on pre-approval policies and procedures. The following table sets forth the aggregate fees billed to iPayment, Inc. for the years ended December 31, 2008 and 2007, by Ernst & Young LLP:


	2008			2007
Audit Fees	$	415,000	(a)	$	369,000	(b)
Audit Related Fees		—			—
Tax Fees		146,000			51,000
All Other Fees		—			—

	$	561,000		$	420,000


(a)		Comprised of fees for the fiscal 2008 financial statement audit and review of financial statements included in our Form 10-Q quarterly reports, and services that are normally provided by the independent registered public accounting firm in connection with statutory and regulatory filings or engagements.

(b)		Comprised of fees for the fiscal 2007 financial statement audit and review of financial statements included in our Form 10-Q quarterly reports, and services that are normally provided by the independent registered public accounting firm in connection with statutory and regulatory filings or engagements.

PART IV

ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) 1. Financial Statements

The Consolidated Financial Statements, together with the report thereon of Ernst & Young LLP dated March 27, 2009, are included as part of Item 8, Financial Statements and Supplementary Data, commencing on page 32, above.

Schedule II — Valuation and Qualifying Accounts
iPayment, Inc.


			Additions
	Balance at		Charged to		Charged to					Balance at
	Beginning of		Costs and		Other					End of
	Period		Expenses		Accounts		Deductions			Period
Period from January 1 to May 10, 2006
Deducted from asset accounts:
Allowance for doubtful accounts	$	508,000	$	131,000	$	—	$	399,000	(1)	$	240,000
Valuation allowance on deferred tax asset		—		—		—		—			—
Reserve for merchant losses		1,144,000		1,398,000		—		1,198,000	(2)		1,344,000


Total		1,652,000		1,529,000		—		1,597,000			1,584,000


Period from May 11 to December 31, 2006
Deducted from asset accounts:
Allowance for doubtful accounts	$	240,000	$	229,000	$	—	$	194,000	(1)	$	275,000
Reserve for merchant losses		1,344,000		2,168,000		—		2,304,000	(2)		1,208,000


Total		1,584,000		2,397,000		—		2,498,000			1,483,000


Year ended December 31, 2007
Deducted from asset accounts:
Allowance for doubtful accounts	$	275,000	$	638,000	$	—	$	145,000	(1)	$	768,000
Valuation allowance on deferred tax asset		—		—		223,000		—			223,000
Reserve for merchant losses		1,208,000		466,000		—		654,000	(2)		1,020,000


Total	$	1,483,000	$	1,104,000	$	223,000	$	799,000		$	2,011,000


Year ended December 31, 2008
Deducted from asset accounts:
Allowance for doubtful accounts	$	768,000	$	304,000	$	—	$	74,000	(1)	$	998,000
Valuation allowance on deferred tax asset		223,000		—		523,000		—			746,000
Reserve for merchant advance losses		—		4,283,000		—		461,000	(3)		3,822,000
Reserve for merchant losses		1,020,000		700,000		—		401,000	(2)		1,319,000


Total	$	2,011,000	$	5,287,000	$	523,000	$	936,000		$	6,885,000


(1)		Write-off of previously reserved accounts receivables.

(2)		Write-off of previously reserved merchant losses.

(3)		Write-off of previously reserved merchant advances.

2. Exhibits

Reference is made to the Exhibit Index beginning on page 63 hereof.

EXHIBIT INDEX



2.1		Agreement and Plan of Merger, dated as of December 27, 2005, among iPayment Holdings, Inc., iPayment MergerCo, Inc. and iPayment, Inc., (incorporated by reference to Exhibit 2.1 of the Registrant’s Form 8-K for the period December 28, 2005).

2.2		Guarantee, dated as of December 27, 2005, by Gregory S. Daily in favor of iPayment, Inc. (incorporated by reference to Exhibit 2.2 of the Registrant’s Form 8-K for the period December 28, 2005).

2.3		Guarantee, dated as of December 27, 2005, by Carl A. Grimstad in favor of iPayment, Inc. (incorporated by reference to Exhibit 2.3 of the Registrant’s Form 8-K for the period December 28, 2005).

3.1		Certificate of Incorporation of iPayment, Inc., attached as Exhibit A to the Certificate of Merger of iPayment Merger Co., Inc. into iPayment, Inc. (incorporated by reference to Exhibit 3.1 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

3.2		Bylaws of Merger Co., as adopted by iPayment, Inc. (incorporated by reference to Exhibit 3.2 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

4.1		Indenture, dated as of May 10, 2006, among iPayment, Inc., the Subsidiary Guarantors named therein and Wells Fargo Bank, N.A. as Trustee (incorporated by reference to Exhibit 4.1 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

4.2		Purchase Agreement, dated as of May 3, 2006, among iPayment, Inc., the Subsidiary Guarantors named therein, Banc of America Securities LLC and J.P. Morgan Securities Inc. (incorporated by reference to Exhibit 4.2 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

4.3		Registration Rights Agreement, dated as of May 10, 2006, among iPayment, Inc., the Subsidiary Guarantors named therein, Banc of America Securities LLC and J.P. Morgan Securities Inc. (incorporated by reference to Exhibit 4.3 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

4.4		Form of Note (included as Exhibit A to Exhibit 4.1 hereto) (incorporated by reference to Exhibit 4.4 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

10.1		Credit Agreement, dated May 10, 2006, among iPayment, Inc., as Borrower, iPayment Holdings, Inc., the Subsidiary Guarantors named therein, Bank of America, N.A., as Administrative Agent, JPMorgan Chase Bank, N.A., as Syndication Agent and Banc of America Securities LLC, as Sole Lead Arranger (incorporated by reference to Exhibit 10.1 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

10.2		Security Agreement, dated May 10, 2006, among iPayment, Inc., iPayment Holdings, Inc., the Subsidiary Guarantors named therein and Bank of America N.A. (incorporated by reference to Exhibit 10.2 of the Registrant’s Form S-4 filed with the Commission on July 21, 2006).

10.3		Pledge Agreement, dated May 10, 2006, among the Pledgors named therein and Bank of America N.A. (incorporated by reference to Exhibit 10.3 of the Registration’s Form S-4 filed with the Commission on July 21, 2006).

10.4		Service Agreement, dated July 1, 2002, between First Data Merchant Services Corporation and iPayment Holdings, Inc. (incorporated by reference to Exhibit 10.16 of the Registration Statement on Form S-1 (File No. 333-101705) filed with the Commission on March 4, 2003).

10.5		First Amendment to Service Agreement, dated October 25, 2002, between First Data Merchant Services Corporation and iPayment, Inc. (incorporated by reference to Exhibit 10.14 of the Registration Statement on Form S-1 (File No. 333-101705) filed with the Commission on December 6, 2002).



10.8		Employment Agreement, effective September 3, 2002, between Clay M. Whitson and iPayment Holdings, Inc. (incorporated by reference to Exhibit 10.36 of the Registration Statement on Form S-1 (File No. 333-101705) filed with the Commission on December 6, 2002).

10.9		Merchant Program Processing Agreement, dated January 31, 2003, among iPayment Inc., Chase Merchant Services, LLC and JPMorgan Chase Bank (incorporated by reference to Exhibit 10.37 of the Registration Statement on Form S-1 (File No. 333-101705) filed with the Commission on March 3, 2003).

10.10		Asset Purchase Agreement, dated December 27, 2004, between iPayment Inc., iPayment Acquisition Sub LLC, First Data Merchant Services Corporation and Unified Merchant Services (incorporated by reference to Exhibit 10.32 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004).

10.11		Services Agreement, dated December 27, 2004, between iPayment, Inc. and First Data Merchant Services Corporation (incorporated by reference to Exhibit 10.33 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004).

14.1		Code of Ethics (incorporated by reference to Exhibit 14.1 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003).

21.1		Subsidiaries of the Registrant, filed herewith.

31.1		Certification of Gregory S. Daily, Chief Executive Officer, pursuant to Securities Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

31.2		Certification of Clay M. Whitson, Chief Financial Officer, pursuant to Securities Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.1		Certification of Gregory S. Daily, Chief Executive Officer, pursuant to Securities Exchange Act Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.

32.2		Certification of Clay M. Whitson, Chief Financial Officer, pursuant to Securities Exchange Act Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.


		Page
Caution Regarding Forward-Looking Statements

PART I

Item 1	Business		3

Item 1A	Risk Factors		11

Item 1B	Unresolved Staff Comments		18

Item 2	Properties		18

Item 3	Legal Proceedings		19

Item 4	Submission of Matters to a Vote of Security Holders		19

PART II

Item 5	Market for Registrant’s Common Equity and Related Stockholder Matters		19

Item 6	Selected Financial Data		19

Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)		20

Item 7A	Quantitative and Qualitative Disclosures About Market Risk		31

Item 8	Financial Statements and Supplementary Data		32

Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures		55

Item 9A	Controls and Procedures		55

Item 9B	Other Information		55

PART III

Item 10	Directors and Executive Officers of the Registrant		56

Item 11	Executive Compensation		57

Item 12	Security Ownership of Certain Beneficial Owners and Management		59

Item 13	Certain Relationships and Related Transactions		60

Item 14	Principal Accountant Fees and Services		60

PART IV

Item 15	Exhibits and Financial Statement Schedules		61

Signatures			62
EX-21.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2


IPAYMENT INC.

By:	/s/ Gregory S. Daily

	Name:	Gregory S. Daily
	Title:	Chairman and Chief Executive Officer

	March 31, 2009


Signature		Title

/s/ Gregory S. Daily		Director
Gregory S. Daily

/s/ Carl M. Grimstad		Director
Carl M. Grimstad

	1.		I have reviewed this annual report on Form 10-K of iPayment, Inc.;

	2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

	4.		The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the Company’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting; and

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.


/s/ Gregory S. Daily Gregory S. Daily
Chief Executive Officer
(Principal Executive Officer)


/s/ Clay M. Whitson Clay M. Whitson
Chief Financial Officer
(Principal Financial Officer)

	•		the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

	•		the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


/s/ Gregory S. Daily Gregory S. Daily
President and Chief Executive Officer
(Principal Executive Officer)