Bread Financial - 10-Q quarterly report FY

     Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

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

      As of July 29, 2005, 83,604,593 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

      The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its wholly owned subsidiaries, the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2004.

      The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.

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

      For purposes of comparability, certain prior period amounts have been reclassified to conform with the current year presentation. Such reclassifications have no impact on previously reported net income.

      The following table sets forth the computation of basic and diluted net income per share for the periods indicated:

      In May 2005, the Company acquired the stock of Atrana Solutions Inc., a provider of point-of-sale technology services. Total consideration paid was approximately $13.1 million, including $1.5 million which was placed in escrow for a period of twelve to eighteen months to satisfy potential indemnification claims. The results of operations for Atrana have been included since the date of acquisition and are reflected in our Transaction Services segment.

      Intangible assets consist of the following:

      The changes in the carrying amount of goodwill for the six months ended June 30, 2005 are as follows:

      Debt consists of the following:

      As of June 30, 2005, the certificates of deposit had effective annual fixed rates ranging from 2.6% to 3.2%, and the credit facilities had a weighted average interest rate of 3.8%.

      On April 7, 2005, the Company entered into amendments to its three credit facilities. The amendment to the 3-year credit facility extended the maturity date from April 10, 2006 to April 3, 2008. The amendment to the 364-day credit facility extended the maturity date from April 7, 2005 to April 6, 2006. The amendment to the Canadian credit facility extended the maturity date from April 10, 2006 to April 3, 2008 and reduced the aggregate amount of the commitments permitted thereunder by $15.0 million from $50.0 million to $35.0 million. The range of margins on the interest rate on eurodollar loans for each of the three facilities and the commitment fee percentages, both of which are based upon the ratio of total debt under the credit facilities to consolidated operating EBITDA, as each term is defined in the credit facilities, was revised from 1.0%-1.5% to 0.5%-1.0% and from 0.1%-0.3% to 0.1%-0.15%, respectively. Except as set forth above, the remaining terms of each credit facility remain unchanged.

      A reconciliation of deferred revenue for the AIR MILES®Reward Program is as follows (in thousands):

      For the three and six months ended June 30, 2005, the Company has utilized an effective tax rate of 37.5% to calculate its provision for income taxes. In accordance with Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting, this effective tax rate is the Company’s expected annual effective tax rate for calendar year 2005 based on all known variables.

      The components of comprehensive income, net of tax effect, are as follows:

      Consistent with prior periods, the Company classifies its businesses into three segments: Transaction Services, Credit Services and Marketing Services.

      At June 30, 2005, the Company had two stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. No stock-based employee compensation cost is reflected in net income for stock options, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation.

      In the first quarter of 2005, the Company changed the valuation model used for estimating the fair value of options granted from a Black-Scholes option pricing model to a Binomial lattice pricing model. This change was made in order to provide a better estimate of fair value. The Binomial model can incorporate a range of possible outcomes over an option’s term and can be adjusted for changes in certain assumptions over time. The Black-Scholes model assumptions are more constant over time, which is not always consistent with an employee’s exercise behavior. In accordance with APB Opinion No. 20, “Accounting Changes,” this change was made for options granted to employees beginning in the first

quarter of 2005. Options to purchase a total of 0.1 million shares of common stock were granted in the second quarter of 2005 at a weighted average fair value of $15.01 per share. The Black-Scholes model would have produced a pro forma stock compensation expense that was approximately 14% lower than that derived from the Binomial model. As a result of this change, the after-tax increase in pro forma stock-based employee compensation expense for the six months ended June 30, 2005 was approximately $0.3 million.

      During the six months ended June 30, 2005, 125,872 shares of performance based restricted stock were granted under the 2003 Long Term Incentive Plan (“2003 LTIP”). The restrictions on the shares subject to these grants do not lapse unless specified performance measures tied to either cash earnings per share or total shareholder return are met. If these performance targets are met, the restrictions on some of these shares lapse at the end of a three-year period. However, the Company’s Board of Directors may accelerate the lapsing of such restrictions if certain annual cash earnings per share performance targets are met. As the performance targets have not been met, compensation has not been earned. The Company has recorded $5.1 million associated with the award as unearned compensation in the stockholders’ equity section of the accompanying balance sheet.

      Additionally, during the six months ended June 30, 2005, the Company awarded 269,438 shares of time-based restricted stock with vesting periods of two to three years. The Company recorded $11.1 million (the aggregate value of the common stock based on the market price at the date of the award) as unearned compensation in the stockholders’ equity section of the accompanying balance sheet. The Company recorded $1.9 million and $3.3 million of amortization expense for the three and six months ended June 30, 2005, respectively, related to shares of time-based restricted stock outstanding.

      On June 7, 2005, at the annual meeting of stockholders, the stockholders approved and adopted the Company’s 2005 Long Term Incentive Plan, effective July 1, 2005. The plan reserves 4,750,000 shares of common stock for grants of incentive stock options, nonqualified stock options, restricted stock awards, restricted stock units and performance shares to officers, employees, non-employee directors or consultants performing services for the Company or its affiliates.

      On June 8, 2005, the Company’s Board of Directors authorized a repurchase program to acquire up to an aggregate of $80.0 million of its outstanding common stock through June 2006. As of June 30, 2005, the Company has repurchased 456,700 shares of its common stock for approximately $17.1 million under this program.

      On June 7, 2005, at the annual meeting of stockholders, the stockholders approved and adopted the Amended and Restated Employee Stock Purchase Plan (the “ESPP”), effective on July 1, 2005. No employee may purchase more than $25,000 in stock under the ESPP in any calendar year, and no employee may purchase stock under the ESPP if such purchase would cause the employee to own more than 5% of the voting power or value of the Company’s common stock. The ESPP provides for three month offering periods, commencing on the first trading day of each calendar quarter and ending on the last trading day of each calendar quarter. The purchase price of the common stock upon exercise shall be 85% of the fair market value of shares on the applicable purchase date as determined by averaging the high and low trading prices of the last trading day of each quarter. An employee may elect to pay the purchase price of such common stock through payroll deductions. The maximum number of shares that were reserved for issuance under the ESPP is 1,500,000 shares, and subject to adjustment as provided in the ESPP. Employees are required to hold any stock purchased through the ESPP for 180 days prior to any sale or withdrawal of shares.

      On June 7, 2005, the stockholders, at the annual meeting of stockholders, approved the Executive Annual Incentive Plan (the “Executive Incentive Plan”). Under the plan, the Company may grant to each eligible employee, including executive officers and other key employees, incentive awards to receive cash upon the achievement of pre-established performance goals. No participant may be granted performance awards in excess of $5.0 million in a calendar year.

      The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented in this quarterly report and the notes thereto included in our Annual Report filed on Form 10-K for the year ended December 31, 2004.

      Our year to date 2005 results included significant new agreements:

      There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2004.

      Adjusted EBITDA is a non-GAAP financial measure equal to net income, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, fair value loss on interest rate derivative, depreciation and other amortization and amortization of purchased intangibles. Operating EBITDA is a non-GAAP financial measure equal to adjusted EBITDA plus the change in deferred revenue less the change in redemption settlement assets. We have presented operating EBITDA because we use the financial measure as part of our monitoring of compliance with the financial covenants in our credit facilities. For the six months ended June 30, 2005, senior debt-to-operating EBITDA was 0.7x compared to a maximum ratio of 2.0x and operating EBITDA to interest expense was 32.8x compared to a minimum ratio of 3.5x. As discussed in more detail in the liquidity section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, our credit facilities together with cash flow from operations are the two main sources of funding for our acquisition strategy and for our future working capital needs and capital expenditures. As of June 30, 2005, we had borrowings of $264.5 million outstanding under these credit facilities and had approximately $175.5 million in unused borrowing capacity. We were in compliance with our covenants at June 30, 2005 and we expect to be in compliance with these covenants during the year ending December 31, 2005.

      We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA and operating EBITDA are not intended to be performance measures that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA and operating EBITDA are not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA and operating EBITDA measures presented in this Quarterly Report on Form 10-Q may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.

     Revenue. Total revenue increased $70.9 million, or 23.6%, to $370.6 million for the three months ended June 30, 2005 from $299.7 million for the comparable period in 2004. The increase was due to a 73.2% increase in Marketing Services revenue and a 7.8% increase in Credit Services revenue, partially offset by a 1.2% decrease in Transaction Services revenue as follows:

     Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $57.7 million, or 24.9%, to $289.2 million during the three months ended June 30, 2005 from $231.5 million during the comparable period in 2004. Total adjusted EBITDA margin decreased to 22.5% for the three months ended June 30, 2005 from 22.8% for the comparable period in 2004, due to a decreased margin for Transaction Services and a change in the mix of margin being contributed by the Marketing Services and Credit Services segments.

     Operating Income. Operating income increased $11.1 million, or 24.0%, to $57.3 million for the three months ended June 30, 2005 from $46.2 million during the comparable period in 2004, due to the revenue and expense factors discussed above.

     Interest Expense. Interest expense increased $1.4 million, or 140.0%, to $2.4 million for the three months ended June 30, 2005 from $1.0 million for the comparable period in 2004, due to higher average balances under our credit facilities related to the acquisition of Epsilon.

     Taxes. Income tax expense increased $3.6 million to $20.6 million for the three months ended June 30, 2005 from $17.0 million in 2004 due to an increase in income before income taxes. Our effective tax rate of 37.5% in 2005 improved from the 37.7% effective tax rate in 2004.

     Revenue. Total revenue increased $134.7 million, or 22.0%, to $746.4 million for the six months ended June 30, 2005 from $611.7 million for the comparable period in 2004. The increase was due to a 72.1% increase in Marketing Services revenue and a 7.2% increase in Credit Services revenue, partially offset by a 1.7% decrease in Transaction Services revenue as follows:

     Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $112.7 million, or 24.2%, to $577.7 million during the six months ended June 30, 2005 from $465.0 million during the comparable period in 2004. Total adjusted EBITDA margin decreased to 23.1% for the six months ended June 30, 2005 from 24.0% for the comparable period in 2004, due to decreased margins in Transaction Services and Marketing Services, partially offset by an increased margin for Credit Services.

     Operating Income. Operating income increased $18.2 million, or 18.0%, to $119.6 million for the six months ended June 30, 2005 from $101.4 million during the comparable period in 2004, due to the revenue and expense factors discussed above.

     Interest Expense. Interest expense increased $1.4 million, or 37.8%, to $5.1 million for the six months ended June 30, 2005 from $3.7 million for the comparable period in 2004, due to higher average balances under our credit facilities related to the acquisition of Epsilon.

     Taxes. Income tax expense increased $6.4 million to $42.9 million for the six months ended June 30, 2005 from $36.5 million in 2004 due to an increase in income before income taxes. Our effective tax rate of 37.5% in 2005 improved from the 37.7% effective tax rate in 2004.

      Our delinquency and net charge-off rates reflect, among other factors, the credit risk of our private label credit card receivables, the average age of our various private label credit card account portfolios, the success of our collection and recovery efforts, and general economic conditions. The average age of our private label credit card portfolio affects the stability of delinquency and loss rates of the portfolio. We continue to focus our resources on refining our credit underwriting standards for new accounts and on collections and post charge-off recovery efforts to minimize net losses. An older private label credit card portfolio generally drives a more stable performance in the portfolio. The average age of our portfolio is consistent with our historical trends as shown at June 30, 2005 with 57.1% of securitized accounts with balances and 61.6% of securitized receivables being greater than 24 months old.

     Delinquencies. A credit card account is contractually delinquent if we do not receive the minimum payment by the specified due date on the cardholder’s statement. It is our policy to continue to accrue interest and fee income on all credit card accounts, except in limited circumstances, until the account balance and all related interest and other fees are charged off or paid beyond 90 days delinquent. When an account becomes delinquent, we print a message on the cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account rolling to a more delinquent status. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If we are unable to make a collection after exhausting all in-house efforts, we engage collection agencies and outside attorneys to continue those efforts.

      The following tables reflect statistics for our securitization trusts as reported to the trustee for compliance reporting.

      The following table presents the delinquency trends of our securitized credit card portfolio: