| IPAYMENT INC Item 1A Risk Factors Risks Relating to the Proposed Merger We believe that the current market price per share of our common stock reflects an expectation that the proposed acquisition of iPayment by Mr |
| That acquisition is, as described above, subject to the satisfaction of a number of conditions |
| There can be no assurance that those conditions will be satisfied and that the proposed acquisition will occur |
| If the proposed acquisition does not occur, the price per share of our common stock is likely to decline |
| Risks Relating to our Business The full impact of our recent acquisitions on our operating results is not fully reflected in our historical financial results, which as a result, are not necessarily indicative of our future results of operations |
| Since January 2003, we have expanded our card-based payment processing services through the acquisition of four businesses, two significant portfolios and a 51 percent interest in an independent sales group as well as several smaller portfolios of merchant accounts |
| These acquisitions have contributed to a substantial portion of our total revenues |
| The full impact of these acquisitions on our operating results are not fully reflected in our historical results of operations due to the recent nature of these acquisitions and their varying stages of integration |
| As a result of these acquisitions, our historical results may not be indicative of results to be expected in future periods |
| 13 _________________________________________________________________ [46]Table of Contents 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 &apos &apos charged back’’ to the merchant’s bank and credited to the account of the cardholder |
| If we or our processing 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 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 dlra4dtta7 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 |
| 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 |
| Please see &apos &apos Business — Risk Management’’ for a discussion of our procedures for detecting merchant fraud |
| Charges incurred by us relating to chargebacks were dlra4dtta4 million, or 0dtta6prca of revenues in 2005, dlra3dtta9 million, or 1dtta1prca of revenues in 2004, and dlra3dtta7 million (which excludes the dlra1dtta3 million reduction in an earlier estimate for merchant losses from a single merchant to reflect lower actual losses), or 1dtta6prca of revenues in 2003 |
| We have incurred substantial debt, which can impair our financial and operating flexibility |
| We have incurred debt in connection with the financing of our operations and acquisitions |
| As of December 31, 2005, we had total debt of dlra100dtta2 million, and a net working capital deficit of approximately dlra4dtta7 million |
| We may incur additional debt in the future in order to pursue our acquisition strategy or for other purposes |
| Substantial indebtedness could impair our ability to obtain additional financing for working capital, capital expenditures or further acquisitions |
| Covenants governing any indebtedness we incur would likely restrict our ability to take specific actions, including our ability to pay dividends or distributions on, or redeem or repurchase, our capital stock, issue, sell or allow distributions on capital stock of our subsidiaries, enter into transactions with affiliates, merge, consolidate or sell our assets or make capital expenditure investments |
| In addition, the use of a substantial portion of the cash generated by our operations to cover debt service obligations and any security interests we grant on our assets could limit our financial and business flexibility |
| 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 |
| 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 sponsor banks will not terminate their sponsorship of us in the future |
| 14 _________________________________________________________________ [47]Table of Contents 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 75prca of our annual transactions |
| 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 dlra11dtta7 million in fiscal 2006, and for each subsequent year through 2011 of at least 70prca 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 |
| Please see &apos &apos Business — Marketing and Sales’’ for a description of our independent sales group relationships |
| 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 S 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 &apos &apos key person’’ life insurance on any of our employees other than Mr |
| 15 _________________________________________________________________ [48]Table of Contents 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 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 |
| 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 |
| 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 &apos &apos closures’’ that we initiate due to heightened credit risks relating to, and contract breaches by, a merchant |
| During 2004, we experienced average volume attrition of 1prca to 1dtta5prca 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 |
| Increased attrition in merchant charge volume may have a material adverse effect on our financial condition and results of operations |
| We cannot predict the level of attrition in the future, particularly in connection with our acquisitions of portfolios of merchant accounts |
| If we are unable to increase our transaction volume and establish accounts with new merchants in order to counter the effect of this attrition, or, if we experience a higher level of attrition in merchant charge volume than we anticipate, our revenues will decrease |
| 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 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 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 liabilities |
| 16 _________________________________________________________________ [49]Table of Contents We face uncertainty about additional financing for our future capital needs, which may prevent us from growing our business |
| If we are unable to increase our revenues, we will need to raise additional funds to finance our future capital needs |
| We may need additional financing earlier than we anticipate if we: • decide to expand faster than planned; • need to respond to competitive pressures; or • need to acquire complementary products, businesses or technologies |
| 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, that have rights, preferences and privileges senior to our common stock |
| We cannot assure you that we will be able to raise additional funds on terms favorable to us or at all |
| If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs |
| This may prevent us from increasing our market share, capitalizing on new business opportunities or remaining competitive in our industry |
| We currently rely solely on common law to protect certain of our intellectual property; should we seek additional protection in the future, we may fail to successfully register certain trademarks, causing us to potentially lose our rights to use such trademarks |
| Currently, we rely on common law rights to protect certain of our marks and logos |
| We do not rely heavily on the recognition of our marks to obtain and maintain business |
| We have recently been granted trademarks for certain of our marks, but these trademarks may be successfully challenged by others or invalidated |
| 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 |
| General 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 a 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 |
| 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 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 |
| 17 _________________________________________________________________ [50]Table of Contents We do not intend to pay cash dividends on our common stock in the foreseeable future |
| We currently anticipate that we will retain all future earnings, if any, to finance the growth and development of our business and do not anticipate paying cash dividends on our common stock in the foreseeable future |
| Any payment of cash dividends will depend upon our financial condition, capital requirements, earnings and other factors deemed relevant by our board of directors |
| Further, under the terms of a loan agreement, we are restricted from paying cash dividends and making other distributions to our stockholders |
| 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, after we acquired the merchant processing portfolio of First Bank of Beverly Hills in June 2001, we discovered that one of the merchants for which it was providing processing services was in substantial violation of the Visa and MasterCard card association rules |
| This merchant was unable to fund the resulting credits and chargebacks |
| As a result, we were obligated to fund these credits and chargebacks, which resulted in a loss to us of approximately dlra4dtta7 million |
| 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 assure you 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 |
| 18 _________________________________________________________________ [51]Table of Contents We have significant intangible assets and goodwill, the carrying value of which we may have to reduce if our revenues relating to these assets decline |
| We have acquired numerous intangible assets related to purchased portfolios of merchant accounts and business operations |
| The intangible assets represent a substantial portion of our total assets |
| Statement of Financial Accounting Standards Nos |
| 141 and 142 require us to periodically re-examine the value of our purchased assets |
| A material decline in the revenues generated from any of our purchased portfolios of merchant accounts or business operations could reduce the fair value of the portfolio or operations |
| In that case, we may be required to reduce the carrying value of the related intangible asset |
| Please see &apos &apos Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies’’ for a discussion of how we test impairment of the assets |
| Additionally, changes in accounting policies or rules that affect the way in which we reflect these intangible assets in our financial statements, or the way in which we treat the assets for tax purposes, could have a material adverse effect on our financial condition |