iPayment Inc.

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, 2006


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 of incorporation or organization)		(IRS Employer 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 o No þ

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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 June 30, 2006, 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, 2007, 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; restrictive covenants governing the Company’s indebtedness; 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 annual report 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, 2006, we provided our services to over 140,000 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 over 1,000 independent sales groups, which gives us a non-employee, external sales force representing more than 3,500 sales professionals, as well as a direct sales force of approximately 150 sales professionals. Our relationships with the independent sales groups allows 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 2005 ranking of the top bank card acquirers, or owners of merchant card processing contracts, as one of largest providers of card-based payment processing services in the United States. In 2006, we continued to grow as our merchant processing volume, which represents the total value of transactions processed by us, increased by 2.4% to $26,337 million in 2006 from $25,725 million in 2005. During the same period, our revenues increased by 4.5% to $734.0 million in 2006 from $702.7 million in 2005. These increases were primarily attributable to our acquisition of one business, National Processing Management Group, in October 2005. Income from operations decreased to

$57.4 million in 2006, from $63.8 million in 2005. Income from operations in 2006, is net of $0.8 million of share-based compensation expense recorded under SFAS No. 123R, as well as $6.9 million of compensation expense related to accelerated vesting of options and restricted stock recognized as a result of the Transaction. Income from operations for 2006, also included $1.0 million of incremental amortization expense as the result of the revaluation of intangible assets resulting from the Transaction and adoption of an accelerated amortization method for purchased portfolios. Excluding these items, income from operations would have increased to $66.1 million for 2006. We believe our ability to recruit and retain independent sales groups and sales agents, combined with our experience in identifying, completing and integrating acquisitions, provides us with significant opportunities for future growth.

Acquisition by iPayment Holdings

On May 10, 2006, we consummated a merger with iPayment Holdings, Inc. (“Holdings”) and iPayment MergerCo, Inc. (“MergerCo”) (the “Transaction”). MergerCo was merged with and into us and we, as the surviving corporation, became a wholly-owned subsidiary of Holdings. Holdings is a wholly-owned subsidiary of iPayment Investors, LP (“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. The total amount of consideration necessary to consummate the merger and the related transactions was approximately $895.4 million. These funds were obtained primarily from $170 million of equity financing and substantially all of the balance from debt financing. We entered into a senior secured credit facility, consisting of a $515.0 million term loan facility and a $60.0 million revolving credit facility. We also issued $202.2 million principal amount of the senior subordinated notes.

Significant 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.

In December 2003, we entered into an Asset Purchase Agreement with FDMS, pursuant to which we acquired a portfolio of merchant accounts and agent bank agreements (the “FDMS Agent Bank Portfolio”) from First Data for a price of $55.0 million in cash. The portfolio had approximately 18,000 small merchant accounts representing approximately $4 billion in annual bankcard volume.

Pursuant to these asset purchase agreements, 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 2007, 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 Agreement, 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 Agreement and we are required to pay to 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 $2.0 trillion in 2004 to $2.2 trillion in 2005, and are expected to grow to approximately $3.6 trillion by 2010, representing a compound annual growth rate of approximately 7.4% from 2005 to 2009. 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 2005, there were approximately 6.1 million merchant locations in the United States which generated approximately $2,202 billion of annual Visa and MasterCard charge volume. Based on estimates from First Annapolis, we believe that this charge volume resulted in approximately $5 billion in annual revenue to payment processors (net of interchange and assessment fees). 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) generated only approximately 40% of Visa and MasterCard annual charge volume in 2005 (approximately $880 billion), they accounted for approximately 80% of annual net revenue generated from payment processing (approximately $4 billion).

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 merchants 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, 2006, chargeback losses as a percentage of our total charge volume were approximately 1.4 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 A 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, 2006, we marketed and sold our services through over 1,000 ISGs, a non-employee, external sales force representing more than 3,500 sales professionals with which we have contractual relationships. These relationships are typically mutually non-exclusive, permitting us to establish relationships with multiple ISGs 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 ISGs 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 ISGs 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 ISGs 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 ISGs 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 ISGs, 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, 2006, we had outstanding loans to ISGs in an aggregate amount of $2.7 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 ISGs 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 2009. We secure the loans by the ISGs’ 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 ISGs. 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 JPMorgan Chase, and our other sponsoring banks are HSBC Bank USA and Bank of America. 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.

Our agreement with JPMorgan Chase grants JPMorgan Chase the right to approve our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants (including the processing fees that we charge), our customer service levels and our use of any ISGs. In addition, we have agreed with JPMorgan Chase not to solicit any merchants that currently process through JPMorgan Chase or any merchants that belong to industries that are considered unacceptable due, in part, to reputation concerns, card association rules, legitimacy and level of risk. The initial term of our agreement with JPMorgan lasts through April 2007, unless terminated earlier as provided for in the agreement. Thereafter, the agreement is automatically renewable at the agreement of both parties for successive one-year periods.

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 Vital Processing Services, LLC 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, Vital Processing Services 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 this agreement 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, 2006, we provided processing services to over 140,000 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 4% of our aggregate transaction volume for 2006. 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 make them less likely to change providers because of the inconvenience associated with a transfer. During 2006, we experienced an average monthly attrition of approximately 1.0% to 1.5% of our total charge volume. 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 in assessing the risks associated with providing payment processing services to small merchants. These risks include the limited operating history that many of the small merchants we serve have 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 receives daily reports from Card Commerce International, a risk management services company, that highlight all exceptions to the established daily merchant parameters such as average ticket size, total processing volume or expected merchandise returns.

	•		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 2006, and which we believe represents 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, 2006, these reserves (which are not included in our accompanying consolidated balance sheet) totaled approximately $50.3 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 two 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 assure you 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, Inc. (a subsidiary of Bank of America), 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. 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 2006, 2005 and 2004, 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. All shares and per share calculations included in the accompanying audited consolidated financial statements of iPayment, Inc. have been adjusted to reflect this reverse split.

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 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.

Employees

As of December 31, 2006, we and our wholly-owned subsidiaries employed 426 full-time personnel, including 14 information systems and technology employees, 34 risk management employees, 237 in operations and 141 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 employees. We have employment agreements with our President, our Chief Executive Officer and our Chief Financial Officer. None of our employees are represented by a labor union, and we have experienced no work stoppages. We believe that our employee relations are good.

Available Information

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are available free of charge on our website at www.ipaymentinc.com as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Item 1A. Risk Factors

Risks Relating to our Indedbtedness

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

As of December 31, 2006, we had consolidated debt of $714.7 million, $512.2 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 assure you 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 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, we will be able 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, 2006, we would have been able to borrow an additional $59.2 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 fix 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, 2006, our non-guarantor subsidiaries had total assets of $4.9 million, and total liabilities of $4.6 million, and for the year then ended had total revenues of $4.5 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, 2006, we had approximately $512.2 million of debt that was senior to our senior subordinated notes and approximately $59.2 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 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 assure you 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 your interests as a holder 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 thereunder 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 assure you that we will have the financial resources to repurchase your 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 subordinated notes.

The future market price of our senior subordinated notes depends 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 could have an adverse effect on the market prices of our senior subordinated notes. In addition, credit rating agencies continually revise their ratings for companies that they follow, including us. We cannot assure you that any credit rating agencies that rate the senior subordinated notes will maintain their ratings on the senior subordinated notes. A negative change in our rating could have an adverse effect on the market price of 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 notes offered hereby. 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 notes. We do not intend to apply for a listing of any of the notes on any securities exchange. We do not know if an active market will develop for the 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 in the future face, 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 assure you 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 $3.6 million, or 0.5% of revenues in 2006, $4.4 million, or 0.6% of revenues in 2005, and $3.9 million, or 1.1% of revenues in 2004.

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 JPMorgan Chase, and our other sponsoring banks are HSBC Bank USA and Bank of America.

The initial term of our agreement with JPMorgan Chase lasts through April 2007 and is thereafter renewable at the agreement of the parties for successive one year periods. 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 give the sponsoring banks 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 $9.8 million in fiscal 2007, and for each subsequent year through 2011, of at least 70% of the amount of the processing fee paid during the immediately proceeding 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.

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 2006, we experienced average volume attrition of 1.0% to 1.5% per month. 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 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.


	Page
PART I
Item 1 Business		3
Item 1 A Risk Factors		12
Item 1 B Unresolved Staff Comments		21
Item 2 Properties		21
Item 3 Legal Proceedings		21
Item 4 Submission of Matters to a Vote of Security Holders		21
PART II
Item 5 Market for Registrant’s Common Equity and Related Stockholder Matters		22
Item 6 Selected Financial Data		22
Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)		23
Item 7A Quantitative and Qualitative Disclosures About Market Risk		36
Item 8 Financial Statements and Supplementary Data		37
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosures		61
Item 9A Controls and Procedures		61
Item 9B Other Information		61
PART III
Item 10 Directors and Executive Officers of the Registrant		62
Item 11 Executive Compensation		63
Item 12 Security Ownership of Certain Beneficial Owners and Management		66
Item 13 Certain Relationships and Related Transactions		67
Item 14 Principal Accountant Fees and Services		67
PART IV
Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K		68
Signatures		68
Ex-21.1 Subsidiaries of the Registrant
Ex-31.1 Section 302 Certification
Ex-31.2 Section 302 Certification
Ex-32.1 Section 906 Certification
Ex-32.2 Section 906 Certification

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Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents